Cliff Wachtel's  Instablog

Part 1 of Weekly Review/Preview: Prior Week Market Movers & Their Lessons For the Coming Week

The following is a weekly summary and strategy guide for traders and investors, covering prior week’s market movers and their lessons for the coming week for traders of all major asset classes via both traditional instruments and binary options.

Summary

Risk assets fell Monday through Wednesday as markets digested the hard truth that the EU Summit last week failed to provide meaningful progress towards a solution to the EU sovereign debt and banking crisis. A symptom of this was a steady stream of sovereign and bank credit downgrades or warnings of them. Some decent US data and a modest drop in Spanish and Italian bond yields prevented further declines Thursday and Friday.

However, just as we noted in last week’s review that delayed reaction the EU Summit’s failure could be the big driver in the coming week, we suspect the Fitch’s bombshell announcement Friday, discussed below, could well be the big driver behind further declines this week.

Further risk asset rallies are likely to be short term within a longer term continued decline.

Technical Picture

Turning to our risk asset barometer, the S&P 500, the weekly chart below tells us the following.

S&P 500 WEEKLY CHART   02DEC 17 2112

• The long term downtrend continues with yet another lower high, the fifth since the October rally ended
• The simultaneous formation of higher lows, combined with the bearish fundamentals discussed below, lead us to conclude that once we get past the low liquidity year end gyrations, risk asset markets will resume a more serious leg lower.
• Our likely signal will be when the index drops to test the 1100 level, which opens the way for a test of the EU crisis lows of the spring of 2010.

The daily chart shows a steady decline from Monday through Wednesday, followed by a stabilizing and modest bounce Thursday and Friday. This week’s 2.8% decline in the index well reflected the pullback in other risk assets like risk currencies, particularly the EURUSD (- ~2.3%), and though commodities were the biggest losers, with oil down about 5% and precious metals down about 7%.

SP 500 DAILY CHART FOR THE PRIOR WK ENDED DEC 16TH   01DEC 1957

Fundamental Picture

Here’s our summary of the fundamentals behind these moves, and the lessons implied for next week.

We noted in our prior weekly review that the big market mover this week was likely to last week’s EU Summit failure, or more precisely, the market’s reaction to the growing realization of that failure. There really is no practical solution for maintaining the EZ and EUR as we know it. There are plans, but none are acceptable to all relevant parties because they all involve one of the following that are unacceptable to at least some of the EZ members:

• Relatively healthy EU economies jeopardizing their own credit ratings to guarantee GIIPS bonds against increasingly likely defaults. So far there is no sign of that happening, as German, Dutch, and other strong economy leaders have made clear.
• Somebody actually buying those bonds for more than they’re worth given that default risk. Despite the theoretical rejection of PSI (private sector intervention, aka haircuts to private bondholders) from the summit, most understand that, realistically, these are inevitable. There are at least a few GIIPS nations that can’t repay their debts, and whatever concessions they’re granted will be demanded by the rest. We got a stark reminder there are limits to how much austerity and debt payments the GIIPS will accept from a report from the Telegraph last Thursday that the  that Portugal’s Socialist Party VP was threatening both default and a union of debtor nations to negotiate at least a partial default.

Ongoing and increasing austerity with no end in sight as GDP declines at least as fast as debt, sending these nations into a self-reinforcing tailspin of lower growth and more spending cuts.

Relinquishing control over their own budgets to a centralized EU bureaucracy

The event that summed up the situation came Friday when Fitch announced that it’s putting the ratings of Belgium, Spain, Italy, Cyprus, Slovenia, and Ireland on credit watch negative. It soon afterwards added France to that list, given the “heightened risk of contingent liabilities to the French state arising from the worsening economic and financial situation across the Euro zone.”

The really threatening part of the announcement was the forecast that a comprehensive solution to the crisis is “technically and politically beyond reach.” All true, but no one this isn’t some fringe blogger or other fringe type. This is the first time one of the 3 major ratings agencies has publicly said it’s giving up on the EU and EUR’s survival as we know it, under the current circumstances.

Here’s the key paragraph:

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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?