The new week began with Intel (NASDAQ:INTC) saying revenue will miss forecasts and Moody’s stating they will review the ratings of all European Union countries. Austerity measures, while helpful in the longer-term, will dampen economic growth in the short-to-intermediate-term. Bloomberg noted the market’s concerns:
“This is not heaven,” Stanley Nabi, New York-based vice chairman of Silvercrest Asset Management Group, which oversees $10.5 billion, said in a telephone interview. “The European stopgap may not be successfully implemented. In order for this program to be successful, there’s going to have to be a lot of belt tightening. That means that the European economy is not going to do well at all. That would have negative impact on other countries around the globe.”
The correlation between the S&P 500 and the euro has been running extremely high in recent months. Therefore, if the euro can mount a sustained charge higher, stocks could do the same. Unfortunately, the correlation works both ways. If the euro weakens, stocks may follow.
As we mentioned on December 9, the 22-week moving average is a good way to get a 30,000 ft view of many markets. When the slope of the 22-week is positive, a market tends to be healthy. When the slope of the 22-week is negative, further weakness may be in the cards.
When examining the 22-week moving averages for the U.S. dollar Index and the euro, we see a “lesser of the two evils” advantage in the dollar’s favor. Based on what we know today, over the longer-term the odds favor (a) higher highs in the dollar, (b) lower lows in the euro, (c) and renewed weakness in stock prices.
It is common for markets to correct back to their 22-week, which means the dollar could weaken in the short-term, while keeping the longer-term trend intact. Similarly, the euro could experience a counter-trend rally back to its 22-week, which would also allow for stocks to push higher for a time. If the euro can recapture its 22-week and the slope of the 22-week turns positive, it would be a good sign for both the euro and stocks. Until that happens, we will remain cautious with stocks and commodities.
Another way to monitor the “risk-off” vs. “risk-on” tone of the markets is to monitor the strength of the U.S. dollar relative to the Australian dollar. As the world’s reserve currency, the U.S. dollar tends to attract capital during periods of fear and/or uncertainty about the future. The Australian economy relies heavily on commodities. When investors feel confident about future economic outcomes, they become more attracted to economically-sensitive commodities, such as copper. When commodities are performing well, the Australian economy tends to perform well with capital being attracted to the Australian dollar.
On the chart below, when the slope of the 22-week is negative (orange arrow), the “risk on” trade is in favor longer-term. When the slope of the 22-week turns positive (green arrows), the “risk off” trade tends to impact markets over the longer-term. Given the current state of affairs, the “risk off” trade still carries an edge, looking out several weeks, relative to the “risk on” trade. Counter-trend rallies are to be expected, which means stocks could still make another push higher as we noted last week.
We continue to believe long-term investors face unfavorable odds owning stocks and commodities (NYSE:DBC). The S&P 500 (NYSEARCA:SPY) and Nasdaq (NASDAQ:QQQ) will most likely be lower in three months. Money printing by the Fed and/or ECB remains the most significant bullish wildcard for investors. If they print, it can change the market’s dynamics. The Fed releases a statement on December 13, which could be the push stocks need to make another run at the S&P 500’s 200-day moving average.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.