Sage Weekly Letter – 4/1/2012
- Posted by Robert Sinn
- on April 1st, 2012
If you had told me three months ago that the S&P 500 would be perched at 1408 while China was showing significant signs of deterioration in its economy and the eurozone debt crisis was beginning to reemerge, I would have laughed and asked what you were smoking. As is often the case in markets an unexpected sequence of events has led us to exactly the situation described above – A market less than 1% from its high that continues to wrestle with a potential hard landing in China and resurgent signs of trouble across the Atlantic.
Make no mistake, this is exactly the way in which bull markets act – they climb an impressive wall of worry until a point is reached when the vast majority, who are bullish, look down and realize that some of the fears they had been brushing aside are very real and problematic. The October 2007 top was a textbook example of the end of a bull market: The market had climbed a wall of worry related to the US housing bubble (at that point it was just called the “subprime bubble”) on the back of the China growth story and a “global liquidity”/Fed easing story that was regularly trotted out by bullish analysts.
We know how that story ended, the market topped on October 9th, 2007 and began working its way lower over the ensuing ten months before crashing in September 2008. Topping is a process, no one rings a bell at the top and a true bull doesn’t die easily or quickly – the bull kicks back and doesn’t go down without a fight. I may be sounding a bit like I believe the market has topped, actually that is not the case and I would not be the slightest bit surprised if equities went on to make new highs in April. The point in reminding myself and my readers as to how a bull market ends is to be prepared to identify some of the warning signs when they begin to appear.
I want to quickly address China and Europe before focusing on specific market action. Mike Shedlock (Mish) is a famous financial blogger who is known for having a “glass is half empty” view of things – This morning I found two of his posts to be particularly timely and on the money, have a look:
“Meanwhile, the entire idea that firewalls can accomplish anything is ludicrous, given the key point that no currency unions in the absence of fiscal unions cannot and will not work…..I suspect Merkel understands this, merely wanting to get Germany so deep into bailouts step by step, that it will be reluctant to leave the Eurozone.”
Mish goes on to tear apart the absurdity of “Paulson’s Bazooka”, his comments led me to conjure up imagery which had me in tears laughing. The point is that a “bazooka” in financial market terms is a fire hose of one hundred dollar bills and Mish is dead on when he says:
“Bazooka theory does not work, nor did threats to investors that the ECB and EMU would be willing to defend the country from speculative attack if necessary…..The same holds true today. The Bigger the Bazooka, the More Money Will be Lost.”
The fact is that in order to “bail out” insolvent institutions and countries someone has to eat the losses. When Paulson fired his Fannie/Freddie bazooka taxpayers took the losses in order to bail out large bondholders and in theory save the financial system from complete chaos. With regard to eurozone members such as Portugal and Spain any bazooka will have to be fired and not just flashed around – this will lead to holders of Portuguese/Spanish sovereign debt gladly redeeming their paper for euros. The problem is that the only institution in Europe currently capable of producing a large enough bazooka is the ECB and this would amount to quantitative easing, something which the ECB has repeatedly denied it is willing to engage in.
The situation in the eurozone is very similar to the one in which the US found itself in following the Lehman collapse. The eurozone is full of too big to fail sovereigns who know that they are too big to fail. The latest sign of this occurred last week when Spain announced that it had made a “sovereign decision” by raising its target deficit to 5.8% of GDP for 2012 from the previously forecast 4.4%. Naturally this disturbed ECB and German officials but what are they to do? Spain is much too big to fail and Spain is still a sovereign nation that is completely within its rights to make a “sovereign decision” on its budget and deficits. Spain is now set to take the center stage in Europe (with a small side show in the form of the French election) over the coming months and there is even a strong possibility that Spain will be forced into a troika (ECB/EU/IMF) program should Spanish funding costs (bond yields) begin to soar.
Meanwhile, China is the main threat to the markets’ bull run and last week’s commodities carnage was all about fear of China slowing (and to a lesser extent India). Last night China released its March PMI which was much better than expected and far better than the HSBC flash PMI (Josh Brown has more on the seasonality of this number). One data point doesn’t mean very much and many will cast a skeptical eye to the gap between government and private sector stats; therefore, the situation remains much the same in that the PBOC will likely have to take aggressive easing actions (2-3 rate cuts and additional RRR reductions) over the coming months in order to stave off a potential hard landing.
The market leader ($QQQ) showed signs of fatigue last week but still managed to complete its 13th consecutive weekly gain – it’s time for a rest and potentially a pullback to the 65 area which would be healthy and help set the stage for the next leg higher.
With a holiday shortened week ahead (market will be closed on Friday although the March employment report will still be released at 8:30am on Friday morning) and a dearth of market moving events I expect the S&P to remain within a roughly 2% range over the next several days (1390-1420). However, this is likely to prove to be the calm before the storm once April gets into full swing with the beginning of earnings season on April 9th followed by the G20 finance ministers meeting, FOMC meeting and Bernanke press conference, and the French Presidential election, etc.
While I foresee a 1-2 week consolidation for the overall US equities markets there continue to be some warning signs that the bulls might not want to risk overstaying the party – the Citigroup Economic Surprise Index for major economies continues to trend lower:
The last time this index was at its current level in a steep downtrend was April of last year – Deja-vu?
My best ideas haven’t changed much since last week, however, there are a few slight adjustments to be made:
- I am neutral on gold ($GC_F $GLD) over the near term (2-3 weeks) although I remain bullish on gold equities ($GDX $GDXJ)
- I am more bearish on $QQQ than I was last week and I am adding May put spreads to the previous call for April/May bear call spreads
- The Australian dollar ($AUDUSD) continues to be a sell on rallies, however, it is at support and a bit oversold short term so it is a good time to take profits on shorts and look to reenter on a bounce above 1.0450
- The 30-year US Treasury bond ($TLT $ZB_F) offered an ideal shorting opportunity on Thursday afternoon/Friday morning before it sold off aggressively late on Friday – My short term target for TLT is a retest of the low from two weeks ago near the 110 level.
- Long GDXJ – I wrote a blog post on Thursday explaining some of my reasoning
- Long $RIMM above $15 with an initial target of $17 – RIMM showed a great deal of strength on Friday after reporting disappointing results, bulls now have a couple of catalysts and the shorts might be forced to cover soon.
- I deployed an iron condor using April $GLD options last Wednesday – I still like this idea particularly if $GVZ were to uptick early next week.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.blog comments powered by Disqus
Robert Sinn is a professional trader and market analyst who focuses on multiple asset classes including equities, futures, options and currencies. He integrates fundamental and technical analysis. More »