Look What Happened The Last Time Markets Flattened Out Like This-Part 1: Summary and Daily Recap
See Part 2 For Conclusions And Lessons About What To Do For This Week And Beyond
The main market drivers last week were:
- Bullish: Rising stimulus hopes in Japan, the US, and Europe, Italian debt auctions, most of the top tier US economic data, including US housing, core durable goods, and manufacturing.
- Bearish: Italian election results and their ramifications, including a rising JPY, rising GIIPS bond yields and weaker demand for that debt. There was also lower than expected repayments of LTRO debt from European banks to the ECB (which suggests weak liquidity) but the baleful effects were primarily for the EUR more than European stocks.
In sum, stimulus hopes continue to drive markets in there assorted forms in all three major regions, and Italy's political uncertainty puts EU worries back in focus.
See below for both our
- Daily recap of the top market movers and what they mean
- Lessons and conclusions for the coming week
The main market movers Monday were: bullish hopes for pro stimulus BoJ governor, pro market Italian election results, versus bearish Italian election realities.
In Asia, speculation Kuroda will be BOJ governor helps.
Fears of Italian election deadlock bringing anti-market coalition capped the rally in European stocks that was based on hope of a more market friendly result.
However, the US closed sharply lower as the anti-market results of the election, showing protest against market friendly austerity policies of PM Monti, hit US markets while they were still open.
Bearish Italian elections, bullish US stimulus hopes and data.
Asian indexes were mostly down over 1%, Japan down 2.2%, Hong Kong down 1.3%, and Shanghai down 1.4% on news of Italian vote gridlock that could signal an end to economic reforms (aka austerity) in Italy that could undermine confidence in Italy, which in turn risks sending Italian and other GIIPS block borrowing costs rising. That in turn could bring a new bout of EU sovereign solvency fears. Those tend to send markets diving until such fears are removed.
No group managed to secure a majority in the Italian parliament, suggesting weeks of political uncertainty and raising the odds of a coalition formed by the centre right led by former PM Silvio Berlusconi and the centre left led by Pier Luigi Bersani.
This would likely be an unstable government incapable of continuing the reforms markets want to see because these parties are sworn enemies.
That political paralysis could rock the prevailing confidence about the EU over the past months (largely based on a mix of hope and EU bluster). That's a big problem, because confidence is all that's holding up the EU. Actual economic performance outside of Germany has been dismal and is getting worse. The latest economic data out of Europe continued to reflect this theme.
See here for details of the overall situation.
The short version is that all of these economies are deteriorating. While Germany is the largest economy, it isn't bigger than the combined size of #2 France, #3 Spain, and #4 Italy.
European indexes also plunged on the same concerns, with Spain (-3.3%) and Italy (down almost 5%) taking the biggest losses while French and German indexes were down 2.3 and 2.7% respectively. As feared, Italian 10-year note yields jumped 40 bps on the day to 4.88%, their highest since November. An auction of Italian 6 month notes showed yields spiking (1.24% vs. 0.73% in the last such sale in January) and demand down sharply too. Spanish 10-year yields fed off the anxiety and rose 9 bps to 5.26%. Ambrose Evans-Pritchard noted that it's unclear whether the ECB can "continue to stand behind the Italian debt market…if there is no party able to deliver on austerity cuts and reforms demanded by Berlin and Brussels."
Italian authorities are once again considering banning short selling of at least certain kinds of stocks. No wonder forex trading is big in Italy. In contrast to equity markets, it's nearly impossible to ban short selling of a given currency (see pages 26 of my book for an explanation, which you can view on line for free using the "Look Inside feature on my book's amazon page here) shorting the EUR is an effective way for Italians to profit from market declines when they can't short stocks.
In contrast, US markets had already sold off on the Italian election news Monday, and closed solidly higher as Fed Chairman Bernanke indicated that contrary to indications from last week's Fed minutes, Fed stimulus would in fact continue for the foreseeable future (surprise!-Not), housing sector and consumer sentiment data showed continued improvement and beat expectations. Over the past months markets have been prone to rally after dips, given the slightest excuse. Those positive signs from Bernanke and the day's economic reports were all that was needed.
Sentiment about Italy remains a primary market driver in Asia (influences Japan by driving JPY higher and thus stocks lower) and in Europe (in a positive way as Italian debt auction wasn't as bad as feared). The not as bad as feared Italian debt auction was also bullish for US markets, though not as much as Bernanke's dovish testimony to Congress. He reassured markets that the Fed remains committed to QE 3 for the foreseeable future. Positive US economic data also helped as it supported the ongoing slow recovery theme (which beats the contraction story playing out in most other parts of the developed world).
Asia almost all higher modest -solid but Japan down 1.3% on Italian election fear driving up the safe-haven JPY, and thus driving down Japanese stocks (which have been moving inversely given their export emphasis).
Europe almost all up 0.5-1% or more, Spain, France almost 2% on better than feared Italian bond auction, which sparks technical bounce as once again buyers are willing to step in after even minor pullbacks if given any kind of excuse. Is this bullish resilience or bearish excessive exuberance?
Possibly some of both, considering what just happened in the Italian elections.
- Per Ambrose Evans-Pritchard of The Telegraph, "Fifty-seven percent of the Italian vote went to parties that have vowed to tear up the EU austerity script."
- Per RBS' Andrew Roberts, the results were of "seismic importance" because "The ECB rescue depends on countries doing what they are told."
I would add that so far the EU hasn't even been able to stand up to Greece out of fear of contagion threat, so it's no surprise that the TBTF nations like Spain and Italy, or even smaller ones like Ireland, might be tempted to resist further austerity. Welcome to the results of moral hazard.
On a more hopeful note, former Italian PM Berlusconi said he's open to a broad alliance with his bitter rival Pier Luigi Bersani. The two are willing to swallow past differences out of fear that another vote might favor populist challenger Beppe Grillo whose movement was the top vote-getter in the first round of elections.
Both Asian and European markets also benefited from Bernanke's reaffirmation that there was no end in sight for QE 3, and so the flow of cash from the Fed into global markets would continue to help prop up asset prices worldwide. No doubt this is one reason investors continue to buy on any minor dip on any excuse. Betting on central bank sponsored asset price inflation has worked thus far (though most long term charts of major indexes are showing a very threatening decade-old bearish triple top, like the monthly chart of the S&P 500 below.
S&P 500 MONTHLY CHART NOVEMBER 1997 TO PRESENT
Source: MetaQuotes Software Corp, thesensibleguidetoforex.com
03 mar 01 1637
US markets were all solidly higher for the same reasons, an acceptable Italian debt auction that could have been much worse, and Bernanke's dovish testimony to Congress that pledged the US would continue printing $85 bln a month with no end in sight. US markets also got a boost from much better than expected core durable goods and pending home sales reports. These positives helped keep the slow but viable US recovery story alive, and so let markets continue to shrug off the impending sequester and sudden disappearance of 800,000 Federal employees and their disposable incomes, in addition to deteriorating growth in the US, Europe, Japan, etc.
The Italian bond auction's passing lifted Asia, Bernanke and Draghi's continued dovishness boosted European indexes, and disappointing US data sent US indexes modestly lower
Asian markets were higher in delayed reaction to the Wednesday's Italian bond auction, better than expected US data, and Bernanke's dovish comments, all of which also drove Western markets higher Wednesday.
European indexes were solidly higher overall on the afterglow of more US stimulus promises from Bernanke as well as from ECB President Draghi that came after European markets had closed Wednesday.
US markets gave up gains in the final hour to close modestly lower due to some disappointing data on US GDP and personal consumption, and also Friday's theoretical sequester deadline. Part of the reason is that the actual government layoffs would not hit until April (the workers must get 30 days notice) and that only $50 bln of cuts hit this year.
Optimism on Japan's new BoJ governor, Italian political uncertainty, and mixed data were the prime market movers
Asian indexes were mixed, modestly up or down, but Korea's KOSPI was up over 1% on good trade numbers. These are significant as many consider these to be a bellwether for all of Asian export economies. Japan was up a bit on continued easing hopes now that markets see a vocal supporter of aggressive new stimulus is to be the next BoJ governor.
European indexes were mostly lower about 0.5% or more on continued concerns about Italy's political uncertainty weighing on sentiment while most indexes remain high and vulnerable to profit taking.
US after rebounding from early losses in reaction to disappointing PMI reports from the UK and China, indexes closed modestly higher on mixed data
See Part 2 for lessons and conclusions about what to do for next week and beyond.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.