PRIOR WEEK: FOMC, EARNINGS, MOMENTUM, QE TRUMP POOR FUNDAMENTALS
FED GIVES GREEN LIGHT FOR CURRENT TRENDS TO CONTINUE
On Wednesday Federal Reserve chairman Ben Bernanke’s signaled that as long as the US jobs, spending and overall growth remain weak, (see here for details on US economic deterioration) he’ll keep cheap money flowing through the economy. That was a big flashing green light for ongoing market trends to continue.
- Rising risk assets: stocks, commodities, risk forex
- Falling USD as easy money and growing supply of the USD means continued concerns about the falling value of the USD, and no prospects of USD rate hikes in the coming months.
The upshot was that he encouraged investors to stay with risk assets and to sell the USD, brewing a toxic mix of 1970s style stagflation, with inflating asset prices even as jobs, spending, housing and growth remain weak, and the middle class gets crushed.
Stocks: Most major stock indexes continue higher, even transportation stocks are rising, sending the Dow Jones Transportation average to an all time highs Thursday despite oil prices also hitting 31 month highs.
Commodities: Boosted by the rally in precious metals, the 19-commodities CRB index, a broad indicator of the commodity market, is up 10 percent for the year, making it the world’s best-performing asset group. On Friday, the index gained 1.2 percent to end at 370.56, after earlier touching 370.71, a 52-week intraday high.
Forex: The FOMC statement shot the USD ahead of the EUR in the race for ugliest currency, as the USD shared the EUR’s underlying economic weakness but lacks the EUR’s rising short term rate expectations that have held the EURUSD aloft despite the approaching reality of Greek and other sovereign debt restructures and uncertainty about how much that would destabilize EU banks.
US EARNINGS FURTHER FEEDS RISK ASSET RALLY
About 300 of the S&P 500’s components have reported first quarter earnings, 74% have beat estimates. Earnings are now expected to grow 16% this quarter, an increase from the 11.5% estimate at the beginning of the quarter.
HOTTER THAN EXPECTED INFLATION DATA IN EURO-ZONE, AUSTRALIA BOOST THE EUR, AUD
In the short term, currencies move with interest rate expectations. With both the ECB and RBA raising rates in response to inflation, higher than expected inflationary data kept expectations high for further increases in the coming months. That sent these higher vs. most other currencies, especially their primary counterpart, the low yielding USD.
IDEAL CONDITIONS FOR CONTINUED COMMODITIES STRENGTH
April’s rise in commodity prices also mimics the conditions of 1970’s stagflation. For example:
- Silver up 5.48% for the week, ~ 30% for April
- Gold up 3.4% for the week, ~ 9% for April
- Brent Crude oil up over 1.5% for the week, ~ 8% for April
Main Forces Behind the Commodities Bull
USD, EUR Both Vulnerable
The top 2 most liquid currencies, the USD and EUR, are both suffering from deep weaknesses in their underlying economies forcing both the Fed and ECB into various forms of stimulus that risk further debasing these currencies.
While Fed stimulus is well known, many may be surprised to know that despite the ECB’s recent and expected future rate hikes, it too is actively engaged in stimulus via its own program of PIIGS block sovereign bond purchases and loans to Spanish and other weak banks that could not otherwise find affordable funding.
The EUR’s recent strength is not a reflection of genuine fundamental health, but rather merely a reflection of the USD’s greater relative short term weakness. Again we remind readers that because the EURUSD accounts for almost a third of all forex trade, that means for every 3 EUR bought, a USD is sold and vice versa, so these two usually force each other to move in opposite directions like a children on a seesaw.
Given that both of the most liquid currencies are unreliable stores of wealth, savvy holders of EUR are also seeking more hard asset exposure, especially while the EUR’s rising purchasing power for USD priced assets like commodities.
Asian and other central bank and sovereign wealth funds continue diversifying out of the USD into the EUR for lack of a better equally liquid alternative, and this is further masking the EUR’s fundamental weaknesses as these flows drive the EUR higher despite deteriorating PIIGS block fundamentals.
Genuine Fundamental Rising Demand From Emerging Markets
- Both households and central banks acquiring more gold as inflation rises
- Growing EM economies consume more oil and other key industrial commodities
Cracks In the Bull Market’s Armor? Warning Signs To Monitor: Shanghai, Copper, EU, US, Japan, etc.
The overall bullish picture is not without its contradictory signals.
- China’s Shanghai stock index, considered a leading indicator of the bellwether S&P 500 index, has been falling for nearly 2 weeks.
- Copper, considered the commodity most reflective of genuine growth given its wide industrial application and lack of history as a speculative currency hedge, has been flat to lower since early February and in a clear downtrend over the past 3 weeks
- In the US, stimulus fails to spark a sustainable recovery
- stagnant overall growth: spending, jobs, and GDP data all flat to lower
- the critical real estate sector has double dipped and is deteriorating further as a massive ‘shadow inventory’ of residential and commercial real estate threatens to keep real property prices falling then stagnant for 2-10 years. This sector is critical because of its profound influence on the vital banking sector. Specifically, falling real estate prices mean weakening bank balance sheets and loan performance. As the US’s ZIRP policy keeps rates low, banks are hit with a double whammy of declining income from both loans and interest rate returns.
- In the EU, austerity has the expected near term damaging affects to growth:
- Greece, Ireland, Portugal, and Spain have all recently revised their deficits higher and GDP’s lower as the presumed benefits of austerity will take years to take effect in these economies. Can these nations can stay the course that long? Will funding nations have the patience to continue supporting them? We’re not sure.
- Greece can’t hang on: Even the hard line Germans now admit that restructure (aka partial default) is unavoidable for Greece. Greek officials continue to deny they’ll need restructure, but just last year at this time they were still denying that they needed a bailout. When Greece finally acknowledges the latest reality, losses to EU banks holding Greek bonds are estimated to be around 50%. By itself this is a manageable loss for most bondholders. The real risk is that once restructure becomes a reality for Greece, Ireland, Portugal, and Spain may be tainted with guilt by association and see their own borrowing costs soar and thus may themselves be pushed into restructure. The consensus is that losses from Ireland and Portugal could be absorbed by EU banks, perhaps with some government assistance.
- Spain The Big Risk: However if Spain gets in trouble, then all bets are off, as its sovereign and bank debt is roughly the size of the Greece, Ireland, and Portugal’s combined. The current Euro-zone bailout funds are already far too small to help Spain, and would be in worse shape with further deterioration in the other PIIGS nations. See here for details.
Are these just temporary exceptions or warning signs of the bull market’s vulnerability?
COMING WEEK MARKET MOVERS
PRIOR WEEK’S LESSONS FOR THE COMING WEEK: DON’T FIGHT CURRENT TRENDS
Bias Remains Long Risk Assets
Barring an unforeseen risk event, the balance of fundamental and technical indicators show the odds favor continued uptrend in risk assets, despite the above noted warning signs, until we see both new bearish fundamentals or sentiment and technical confirmation on the charts that these have halted the rally in risk assets. Meanwhile we respect the uptrend and suggest that all but intraday traders continue to go long once any pullback ends, or at minimum avoid shorts, until we see new bearish fundamentals and proof on the charts that they’re sending prices lower.
Remember, the above combination of stimulus cash and technical momentum has proven its strength. Note that in the below chart (click to enlarge) of our preferred picture of risk appetite, the S&P 500, even a succession of crises in the MENA region (with ongoing rise in oil prices on supply concerns), EU debt crisis, and Japan barely even interrupted the QE 2 rally that began last September
S&P 500 WEEKLY CHART COURTESY OF ANYOPTION.COM 10MAY01 0334
Practically speaking, that means buying on dips until we see evidence that the upward momentum has weakened, for example, on pullbacks below the Double Bollinger Band Buy Zone (aka DBBBZ – area bounded by upper 1 (red in the above chart) and 2 (yellow in above chart) standard deviation Bollinger Bands) on weekly or daily charts).
However, we don’t go short risk assets until, in addition to some kind of new bearish fundamentals that could power a reversal, we get some kind of technical confirmation of a reversal. One example of such confirmation: strong near term support is breached and/or price enters the Double Bollinger Band Sell Zone (aka DBBSZ – area bounded by the lower 1 and 2 standard deviation Bollinger bands). To review this indicator click here.
DISCLOSURE & DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER