Jeffrey Saut, the chief investment officer at Raymond James and SA contributor, made the following important comment this morning:
Over the weekend Greece did not default, although for over a year I have expressed the view that Greece has to default; a stance I continue to embrace. This morning, however, rumors are swirling again about a Greek default along with hints that Germany is not going to prevent it. That leaves the pre-opening futures down over 20 points, which would represent a retest of the selling-climax "lows" (1101 - 1120 basis the SPX). While I am hopeful this will be a successful retest, consistent with the October 1978/1979 bottoming sequence, if 1100 is decisively broken it would imply the rally from the March 2009 "lows" is over.
- Will the 1100 level be broken on the S&P 500 Index?
- If 1100 gets violated, does this imply that the March 2009 low rally is over?
Our answer to the first question is YES. We believe that 1100 will be taken out for three reasons:
- Greece will eventually default, it is just simple arithmetic, as pointed out in Mauldin's newsletter "Thoughts from the Frontline." The Greek debt-to-GDP is currently at 140%. It will be close to 180% by year’s end (assuming someone gives them the money). The deficit is north of 15%. They simply cannot afford to make the interest payments. True market (not eurozone-subsidized) interest rates on Greek short-term debt are close to 100%. The long-term debt simply cannot be refinanced without eurozone bailouts.
- European banks (Deutsche Bank (DB), UBS (UBS), Barclays (BCS), Royal Bank of Scotland (RBS)) and U.S. banks (Morgan Stanley (MS), Goldman Sachs (GS), JP Morgan (JPM), Lazard (LAZ)) are making new 52-week lows. A market bottom remains elusive as long as financial institutions keep falling. Rumors circulate that three major French banks (Societe Generale (SCGLY.PK), BNP Paribas (BNPQY.PK), Credit Agricole (CRARF.PK)) will soon be downgraded. Investors should absolutely steer clear of financials right now.
- While consumer confidence declined dramatically especially in Europe, investors still believe that the Fed will save the day with a third round of quantitative easing or Operation Twist. The truth is that the Fed is more and more out of bullets and fiscal policy will likely have to do the heavy lifting in months to come.
The answer to the second question (If 1100 is broken, does it imply that the rally that started in March 2009 is over?) is more delicate. Here we part roads with Saut. We believe that 900 is a reasonable target for the S&P 500 Index based on a conservative $75 earnings times a market multiple of 12 (a low market multiple compared to historical standard but that takes into account the possibility of the US going into recession).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I have a credit put spread on LAZ.