The “Super Committee” and the Markets

Over the weekend, reports that the deficit cutting “super committee” was on the verge of failure began to circulate openly. I suppose we shouldn’t be surprised, but our purpose here is not to analyze politics and public policy, but to try to figure out what is going on and how it will affect our portfolios.

In this particular instance, our cue should come from the S&P downgrade of U.S. debt. Some observers were puzzled that the Dollar rose and Treasury bond yields fell. That seemed counter-intuitive. This morning we are seeing the same action at the market open: Dollar up, equity and commodity prices and Treasury yields down. In other words, the response from the markets is a pure “risk off” rotation.

Certainly, we cannot look at this in a vacuum. Much is going on in the world, and especially in Europe where things are still very much unsettled. If you subscribe, however, to the idea that we should be tune out political noise and look to the markets for a more reliable signal, this should tell you much about the standing of the U.S. in the global economy.

My specific read, as detailed in the weekend article at Seeking Alpha, is that the risk asset markets are under pressure. We are most likely looking at a move back into the summer trading range in equity indexes, perhaps even a re-test of the early October lows, in the near term. In the longer term I am still bullish on America, so this would represent an opportunity to buy more quality assets at discounted prices.

Greece Done, Italy on the Clock

Tuesday’s announcement that Italian PM Berlusconi promised to resign coincided with a rally in U.S. markets. Was it the cause? Maybe.

This morning things are looking a bit less sanguine as the bond vigilantes have appeared, and Italian yields spiked. The U.S. dollar index moved to its highest level since February and, as of this writing, we are looking at a >2% down day in equities.

The markets just can’t shake off these news-driven whipsaws. Caution is the watchword here.

The Halloween Massacre, and Papandreou Goes All In

A couple of quick notes before the markets open for November business:

The big Halloween selloff was no surprise – my weekly outlook at SA called for a near term correction, which was an easy call given the size of the move we saw during October. The McClellan Oscillator had given seriously overbought readings on both the NYSE and NASDAQ last week, as mentioned in the article.

Even with the size of the losses yesterday, we didn’t see a great deal of technical damage. Volume was not impressive, and 5 of the 9 S&P sectors are still above their 50 and 200 day moving averages. We still can’t feel good about a 2.5% down day, but it’s no reason to change our outlook.

Over in Europe, which has been provoking so much financial market volatility, we had a bit of a shocker come out of Greece, where PM Papandreou has decided to put last week’s agreement to public referendum, and called a confidence vote on his government in parliament.

This is not likely to end well. I haven’t written much on the Greek situation lately, but my long term outlook remains what it has been all along: there is little probability Greece can remain in the monetary union. Not necessarily for technical reasons, though I do think that is enough (there’s no way to make the numbers work), but because the Greeks are…Greeks.

A descent into chaos in Greece has to be seen as a real possibility, and that in turn has to be seen as a real threat to the financial markets, but I’m not sure it would be enough to change the primary direction of the U.S. markets. My outlook is still bullish into the end of the year, but we will continue to monitor the market reaction to events, and change course when the data and evidence call for it.

Finally, a note on the U.S. dollar, which is driving everything. My article suggested that the index had found support at 75, which would cap the risk asset rally. Well, not only has it found support, but we have seen a large move into the mid 77s as of this writing. I would like to see that moderate, but with Europe squarely back into the mode of uncertainty, we can’t take anything for granted. This is a tough market and you have to work for your money.

Fog Begins to Clear in Europe

No, this blog is not venturing into the weather forecasting business. We’re still all about the financial markets. Though many details remain to be fixed, we have the beginnings of some clarity in the European debt crisis. In yesterday’s post my speculation was that anything short of a 60% haircut on Greek paper would be well received. The number appears to have come in at 50%, and the European equity markets have reacted favorably. So far so good.

Also worthy of note, as of this writing the U.S. dollar index has broken below the 76 support level, and the euro is above $1.40 resistance – for some time its own support. Should this condition prevail, our bullish outlook on the equity markets will be reinforced, although I still would not be surprised by further consolidation in the U.S. after a brief rise in reaction to the news. Since October 4th, when we called the stock rally, it seems to me that the market, which had been priced for a European catastrophe, began to reprice itself for something more like what we have just seen. All of which is to say, we are probably pretty fairly valued at the moment, and it’s likely we will see volatility contract and a return to a more normal trading pattern for a while.

The Next Scene

Let’s make this brief. This week we have been seeing some commentary to the effect that the bond vigilantes, having attacked Italy, would come for France next. The evidence doesn’t look good: credit markets, the stocks of the large French banks and French equities in general are still in upheaval. French equities are lagging within Europe, and banks are lagging within France. Zero Hedge is reporting (unconfirmed) that Asian institutions are pulling in credit lines to French banks

As far as I am concerned the end game for the euro was set in motion with Italy. If France goes it simply assures that any program currently being contemplated is all but hopeless, as they all would include France as a donor of capital, not a recipient. It would also, we might guess, nearly assure rejection by Germany (or at least the German voting public), which would then stand alone as the savior of the entire enterprise, perhaps with a little help from the Dutch.

Prepare for more volatility, and at some point talk of a grand globally coordinated response. For the time being my preferred trio of high grade bonds, gold, and Swiss Francs still looks attractive, though I myself, being a simple guy, continue to enjoy the comforts of a large allocation to cash.

Tuesday Post Close Musings

After last week’s events we were looking for heightened volatility this week, and boy have we gotten it. A 600+ point drop in the Dow Monday, and a 600+ point swing in the final hour and a quarter Tuesday. Here are some observations at this point:

The bounce we saw today did little more than relieve extreme oversold conditions. My trading plan is still in play and we should expect to see higher prices – perhaps not directly, but it’s still not time to sell (or sell short).

The bounce we saw today did little more than relieve extreme oversold conditions. The commentators who say back up the truck and buy all you can at these prices may turn out to be dispensing good advice…but I doubt it. This looks more like 2008 than 1987, but isn’t likely to be the same as either of them.

The VIX and VXN have backed off extreme levels, but remain sharply elevated.

So many of the dozens of charts I study looked so similar, which is typical of these market conditions. Domestic small company stocks, foreign equity ETFs, high yield bonds, they all moved together, just as they did three years ago.

Some of the most interesting action is in the gold miners. They were lagging the metal significantly, but lower energy prices coupled with high gold prices are panacea for this sector. Have a look at the AMEX gold bugs index (HUI) and the CBOE gold index (GOX). These stocks have avoided much of the carnage and could be poised to make a nice advance.

The Fed tried to move investors out of fixed income by sticking to low short term rates for the next two years. This is news to no one. If the market hasn’t accomplished that by driving yields down so far, the Fed isn’t likely to do it either, at least not in the near term. We should however be looking for any indication that they will take some action they aren’t already taking. Remember that the signal of QE2 a year ago set off a big rally in commodities and stocks.

The larger setting remains: we have a slowing domestic economy and a looming financial crisis in Europe. At some point the manic trading will exhaust itself and we will settle into markets that reflect the macro outlook. If you are a longer term investor, use this time on the sidelines to be thinking about what will work in that type of environment. More thoughts on that later.

Macro Picture Getting Uglier

After last week’s dismal Q2 GDP and retroactive lowering of previous periods, we have received another couple of slugs of bad data early this week: yesterday’s big miss in the ISM index, which came in just above contraction at 50.9, and today’s negative growth in personal spending.

Any of these by itself is not catastrophic but, taken together, they really begin to paint a picture of an economy that is running out of steam. Now we have an impending deficit deal which amounts to negative stimulus at the end of the day, and it’s time to start wondering again whence the aggregate demand is going to come.

Yes, my friends, the deflationary winds are whipping up again. This doesn’t bode well for growth stocks or commodities. High grade bonds, blue chip dividend stocks, and selected foreign markets are looking like the better bets in this macro environment. And of course, if all else fails, there is that often hated but ever useful asset: cash.