The markets started the week on a difficult footing with everyone still digesting the fallout from JP Morgan's unexpected trading loss. Going forward, we are likely to see a renewed focus on prop trading by banks as everyone wonders what lies hidden on their balance sheets.
In Asia, China surprised the markets by lowering the reserve requirement for banks by 50 basis points. The reserve requirement has been a preferred monetary tool tempering the fast economic growth China experienced over the last 10 years. By using the reserve requirement ratio as a monetary tool the PBOC can directly affect bank lending to the upside and downside.
The problem at the present time is a slowdown in economic growth as the real estate bubble collapses and global economic growth grinds to a halt. One of the most closely watched figures, electricity output, only grew by 0.7% year over year last month indicating economic growth has slowed to a crawl.
If buyers are nowhere to be found and businesses have difficulty in exporting products to Europe and the US export financing will slow meaning the Bank of China may have to take stronger measures to boost the economy such as lowering the deposit and lending rates.
In Europe, economic data coming out this week will confirm that the EU has officially entered into a recession with Germany remaining above water and serious contractions in Greece, Italy, Spain, and Portugal.
The problems in Greece continue to provide difficulties for investors with the major parties unable to form a coalition government. This raises the specter of new elections on June 17 with anti-EU forces expected to take a greater share of the vote. Even if a coalition government is formed it will be weak at best and fail by the end of the year.
When the Greek debt restructuring was announced earlier this year it was hoped that the elections would provide some clarity with respect to the Greek government and its commitment to its austerity program. The markets rose for almost six months on hopes that a solution was finally at hand and everyone could move forward.
Those who read the tea leaves understood that the markets were off the mark not discounting potential problems from the elections which could derail any progress made to date.
The elections have shown that the discontent with the programs offered by Europe and there are rising calls for Greece to leave the EU.
In the event that new elections are called for mid-June the anti-austerity forces will gain in power creating an atmosphere of confrontation with the EU over austerity programs being implemented.
On Friday, the IPO of Facebook (NASDAQ:FB) will hit center stage pulling the market higher. The IPO appears to be well subscribed with many institutions jumping on the bandwagon. Much has been made of CEO Mark Zuckerberg's appearance during the roadshow wearing his trademark hoodie but if it was not for an arcane SEC rule Facebook would not be going public.
This week will likely end with a more positive tone but early on there may be weakness across the board. Investors should be cautious due to the 3 Peaks and a Domed House pattern which is entering its final stage of resolution. When tied together with the seasonally weak summer months and slowing economic growth in Europe and Asia investors should look to actively hedge their investments through such short ETF's such as the ProShares Ultra Short S&P 500 ETF (NYSEARCA:SDS) and the ProShares Short S&P 500 ETF (NYSEARCA:SH) which move in opposite direction, with a lag, to the S&P 500 (NYSEARCA:SPY).
I expect a countertrend rally to take place following the Facebook IPO but it will be short lived. Investors should use this rally as an opportunity to raise cash/go short and prepare for the next leg down.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am short and have been short the broader market from mid-March (check my comments for verification) through different ETF's than those mentioned in this article.