In the coming weeks the Jewish New Year and related holidays focus on Divine Kingship, judgment, and the need to reflect, repent and pray for Divine mercy. Anyone in the markets might want to consider praying for mercy.
1. THE SEPTEMBER EFFECT: REASON ENOUGH
Putting aside all of the below reasons, September has historically been tough on markets.
- From 2001-2010, September is ranked 9th out of 12 months in stock performance
- During that decade, September is one of only 4 months with a negative monthly return (-0.97%)
- From 1970 to 2010, September is ranked 12th out of 12 months - dead last - in stock performance
- During those 4 decades, September was one of only 2 months with a negative monthly return (-0.77%)
However, this year the picture is unusually bleak for reasons discussed below. Before even considering those, remember that:
- Traders are now back from their summer vacations and many are sitting on the summer's low volume-rally profits.
- With most major stock indexes and most other risk assets close to multi-year (or even decade) highs despite,
- A global slowdown with no end in sight.
- The very real potential for a market crisis of historic proportions of global proportions originating in the EU, (though the US fiscal cliff and potential for hard landing in China not to be ruled out as catalysts),
The big fundamental picture is not bright.
Granted, timing markets based on fundamentals is hazardous, especially when government intervention is so intense. However, the above factors make markets vulnerable to profit taking, and as we show below, there are plenty of potential catalysts that do not appear to have been priced in.
2-11. CRISIS CATALYSTS FROM THE EU
In no particular order, these include the following.
2. ECB September 12 Meeting
ECB President Draghi has been promising bold action for months. Despite much anticipation, he did nothing at last month's meeting, raising the pressure to produce results this month or risk destabilizing markets. Spain will be selling 2, 3, and 4 year debt, and as discussed below, Spain is far closer to insolvency than market behavior suggests. The EU needs to be ready to help it soon. The combination of a weak bond auction and ECB disappointment risks sparking a selloff that could get ugly fast if Spain's immediate solvency suddenly looks doubtful (its long term solvency is already doubtful).
So virtually everyone believes something big is in the works, and expects at least some specific action announced at the September meeting this week.
He's likely to offering encouraging words and general outlines of a plan, but it's far from clear we'll get anything with enough meaningful details to satisfy markets. Why? Germany.
3. The German Central Bank
It remains opposed to the key elements of rumored ECB plans like large scale purchases of bonds from essentially insolvent Spain and other GIIPS nations with printed money.
4. German court ruling September 13th
Even if you believe German leaders will once again back down when faced with a sovereign default, Morgan Stanley believes there's up to a 40% chance that the German constitutional court could kill the plan if it rules against the ESM bailout fund, or even if the court just issues a temporary injunction against Germany funding it. That could delay German the ESM further into 2013.
These factors alone are likely to force Draghi from producing enough details. The big question is whether markets remain calm for a little while longer. Maybe, but the temptation to take at least some profits will be great, and that alone could spark a selloff.
5. Spain: Scariest Of All
The stakes of events in Germany become clearer when we consider just how much too-big-to-fail-or-bail Spain is depending on ECB aid - lots of it.
As reported September 1st by zerohedge.com here, Spain's primary customer for its bonds, Spanish banks, are hemorrhaging deposits at an increasing rate, losing EUR 74 billion (5% of the nations' entire asset base) in July alone. No wonder the ECB is trying to do something fast. Spain's banking system is not profitable (as suggested by its needing a bailout) so it's safe to assume that much of those deposit redemptions came from selling…..Spanish bonds. As zerohedge.com notes,
Draghi's biggest enemy in the fight to preserve the illusion of Spanish solvency, is Spain itself, and specifically its depositors, whose bank jog suddenly becoming a sprint, is the worst thing that Spain, and the ECB, can possibly face. Indeed, since Draghi's "whatever it takes" speech, Spanish bonds have round tripped and are now virtually unchanged. The primary culprit? Spanish banks forced to sell the bonds they bought in the primary market.
As a reminder, while Mario Draghi is furiously trying to come up with a bond buying plan that is endorsed by Germany, Buba and Weidmann, all of whom have, to date, said, "9-9-9″, regardless of what the final construct is, whether it includes the ECM, EFSF, and/or ECB buying bonds directly, the key distinction is that no monetary authority can buy bonds in the primary market, as that is a direct breach of Article 123/125, and absent a thorough revision of the Maastricht Treaty, investors will dump as soon as the ECB starts breaking the rules unilaterally. Certainly bonds can be monetized in the secondary market, but someone has to buy them from the government. And if Spanish banks are unable to stem the deposit outflow, there is simply no practical possibility for banks to be buying SPGBs in the primary market even as they are forced to dump them in the secondary market.
In other words, the ECB may or may not surprise next week, but unless the Spanish public is convinced its banks are safe, and the remaining EUR1.5 trillion in Spanish deposits do not explicitly remain within the Spanish bank system, anything Draghi does will be for nothing.
In addition to falling deposits, Spain's banks are also under pressure from rising loan delinquencies.
6. Ongoing GIIPS Bond Sales
While any significant EU bond auction risks becoming a sell-off catalyst, Spain's and Italy's auctions are of most concern. We have at least one of those a week in September. Just looking at Spain:
- 6 September: Bonds
- 18 September: Bills
- 20 September: Bonds
- 25 September: Bills
7-9. Dutch, Italian, Portuguese Political Events
Also on September 13th, there will be Dutch elections in which an anti-euro party could gather both support and market-scaring headlines. Italian budget debates risk causing early elections, and there are reports that Portugal may attempt to re-negotiate its bailout terms before its October budget debates. If Saying no to Portugal could be hard due to….
10-11. Greece: Bond Redemptions And Troika Report
Bond Redemptions: Greece needs aid if it's to avoid insolvency and repay maturing bonds this month.
Troika: The troika will visit Greece in early September to determine if Greece should get it and so defer a likely insolvency to a later date. While deferring that likely default means the ultimate losses will be higher, it also means the EU buys some time in order to figure out how to minimize the risk of that default becoming a nuclear version of the Lehman Brothers collapse that ignites a global crisis.
The recent years suggest that the EU will opt to buy time at taxpayer expense as long as markets continue to buy EU debt. Why might September be different?
- Greece has consistently failed to meet its commitments, continued leniency risks encouraging similar behavior from other bailed out nations, some of which have made far better good faith efforts to do so than Greece.
- Ultimately Greece has neither the political will nor assets to repay all that it owes, so why make the ultimate cost to EU and global taxpayers (via the IMF) any worse? Politicians don't like crises while they're in office, but they also don't like history judging them as reckless morons.
The US also provides its share of significant event risk in September.
12. US Tier 1 Economic Data
I've grouped the big monthly reports together as one item here, but the biggest is clearly the September 7th monthly jobs report this Friday. While this has the potential to for a positive or negative surprise, predicting how markets react is challenging. While Fed stimulus remains the markets' big hope, better than expected results could cause a selloff, and poor results could boost markets because they make stimulus more likely.
13. FOMC Meeting September 13th
As I've repeatedly noted in prior posts, no one expects to see material improvement in the data that has traditionally driven markets higher. You know, evidence of new generation of actual wealth from the private sector. Instead, the great hope for rising markets rests with increased government intervention. So much for capitalism.
Even without resorting to QE 3, Bernanke could still move markets up or down if he suggests any changes to his views on maintaining low rates, the state of the economy, or what specific data most influences these.
14-15. US Political Events
US politics could influence markets mostly via new on:
14. Resolution Of Impending Fiscal Cliff: Progress Or Lack Thereof
Planned tax increases and spending cuts slated for 2013 are widely seen as a threat to America's fragile recovery, as typified by Nomura's Richard Koo here, who says a similar fiscal consolidation program in Japan (under roughly similar conditions to the US today) in 1997 caused an economic meltdown and risks similar results in the US today.
How Washington copes with the challenge will likely depend on the results of ….
15. US November Elections
The Republicans have thus far failed to establish this edge against President Obama despite the weak economic outlook. Regardless of your political views, markets are likely to see a Republican victory as bullish and a Democratic one as bearish.
If the election leaves the current balance of power in place, that suggests 4 more years of gridlock.
In sum, anything short of a decisive Republican victory is likely to pressure markets. Given that September is likely to close with the election results uncertain, that's bearish for markets.
The current consensus on Wall Street appears to be that regardless of who wins, the Fiscal Cliff will be deferred yet again for 6-12 months in order to avoid risking a relapse into recession. That may be the logical approach, but Washington, ahem, doesn't always work according to our perceptions of what best serves the common good. Unless September produces evidence of a decisive Republican victory, we close the month with the same level of uncertainty, which is not bullish.
16. China Slowdown
The ongoing slowdown in the world's only large and growing economy isn't seen as an immediate threat this month, but it could become one if things fall apart globally. Remember, China's growth is based on exports, mostly to Europe and the US.
Concluding Thoughts: Bullish Technical Picture Despite Bearish Fundamentals
Using the S&P 500 monthly, weekly, and daily charts for a single simple of picture of risk assets, the technical picture remains bullish, despite the dour fundamentals. As always, we use fundamentals for our big picture strategy, but technical indicators to determine when we enter and exit.
While I've trimmed my market exposure a bit just to sleep better, until my technical indicators give me more bearish signals, I'm mostly in a waiting mode before committing cash to exploit a pullback in risk assets. This holds across the board for forex, stocks, commodities, etc.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.