“You have to learn the rules of the game. And then you have to play better than anyone else.”
As I wake up today I’m seeing that most European and Asian markets are trading higher after being weaker for the past week. This is what markets that correct do. Yesterday’s news from Alcoa (AA) may calm fears over the upcoming earnings season, yet with Alcoa losing less money than thought, does that really mean “less bad” is still “good”? Maybe, but I don’t get paid to believe it!
One of our Q3 MACRO themes is “Range Rover”, a call that the S&P 500 will trade in a tight trading range of 9% in the intermediate term. We have branded this duration as “TREND”. Despite the low volume downward moment in the market over the last two trading days, the S&P 500 has held our critical 871 support line. We aren’t fading right on the goal line – that’s what people with no process do. We’re sticking to our game plan.
This upcoming earnings season is going to be critical look into what we can expect for the second half of 2009. Alcoa’s loss of $454 million was better than consensus as the company was able to cut costs by putting people out of work. Good for profitability, bad for the economy! Looking at demand, the company intimated that some aluminum markets showed signs of improvement, but the fact is that worldwide aluminum consumption will decline by 7% in 2009. This is a pattern we are seeing in every US sector: demand remains soft and companies are cutting costs to improve profitability.
We all know this is not a sustainable trend, but for now it does not seem to matter. What matters in our macro model happens on the margin. Six months ago, don’t forget that every reactive CEO in America was firing people under the narrative fallacy of a Great Depression. While things are bad (in recessions that’s generally the case), on the margin, they are better than those prior fear mongering expectations.
The reality is that the economy is bottoming, but it’s not really getting much better. Last night the Group of Eight leaders said the economic recovery was too fragile for them to consider reversing efforts to pump money into the economy. Free money live on! This morning you are seeing 3-month LIBOR trade down to new lows at 0.51%. By any historical measure, that means money is cheap.
This is also being confirmed by Oil trading above $61, after declining -17% over the past week. The news flow suggests that a rise in U.S. gasoline inventories means demand remains weak. Increased concerns are also being reflected in the VIX, which was up 1.5% yesterday and has been up for four straight days. Lastly, the risk aversion trade is working with the Dollar index up 0.07% yesterday, now up for five straight days. Don’t forget our Breaking/Burning The Buck call – Dollar up = everything down.
I could have waited till 7am Eastern to see what the Bank of England announcement will be on their rate policy, but there is probably no hurry to remove its free money policy. This situation has been completely politicized, and that is what it is. While Ben Bernanke might be fighting for his job, rates are going to stay low everywhere until it's absolutely certain that economic recovery is self-perpetuation via REFLATION.
Right now the evidence from corporate America suggests that demand remains soft. Cost cutting is a “one time event” and is not a long-term investable theme. The earnings season is upon us – GAME ON!
Our intermediate term TREND line of support for the SP500 remains 871, and longer term TAIL resistance is 954. Trade the range.