The Rally May Have Legs But It Has No Hope

Includes: QQQ, SPY
by: David Urban

The S&P 500 (NYSEARCA:SPY) and Nasdaq (NASDAQ:QQQ) are likely to start the week on a positive note with everyone digesting the Spanish bailout hoping that this time it is different. By that I mean since 2010 the EU/IMF has pledged 468 billion euros and the Federal Reserve extended an unlimited swap line to Europe in the hopes that if they throw enough money at the fires raging in Greece, Ireland, and Portugal it will eventually extinguish it. If history is any indication the can has been kicked down the road a few months until the flames roar up again even worse than before.

Initial estimates peg the bailout at 100 billion euros. The final numbers will not be available for a few weeks after an audit of Spain's banks are completed. Chances are the final numbers will come in much higher when all is said and done.

In Asia, China chose to cut rates rather than lower the reserve requirement in a sign that they are serious about the latest slowdown. The reserve requirement has been a preferred monetary tool due to the fast economic growth experienced over the last 10 years. By using the reserve requirement ratio as a monetary tool the Bank of China can affect loan growth and pump money into the system at a faster rate. The use of interest rates indicates China is very concerned over the slowdown and wants to use the 'big stick' to get the economy going.

In the past, moves by the Bank of China had the effect of giving global equity markets a jump start. This time, however, the move may have little or no effect and that is due to the collapsing real estate market. If buyers are nowhere to be found and businesses have difficulty in exporting products to Europe lending will slow, meaning the Bank of China may have to take stronger measures.

In Europe, all eyes will be focused on Spain at the beginning of the week and then shift to Greece for the second final round of elections. The problems in Greece continue to provide difficulties for investors with government workers threatening a strike two days before the elections seeking more money so the results are unlikely to bring a desired result. Even if a coalition government is formed it will be weak at best and fail by the end of the year.

Add in bank downgrades in Austria and Germany and the European banking sector remains in a very precarious state. The retrenching by European banks has hurt Asian export credit forcing a de facto tightening upon Asia and the export markets. If exporters cannot gain credit to finance exports then businesses need to reassess inventory levels and production.

Investors in the United States should watch this rally very, very closely. We should see some buying come into the market until the end of the month as funds square their books ahead of the quarter close and into July as the market digests earnings reports. As investors dig through the reports they should not focus on the headline number, which is likely to beat significantly lowered estimates, but core growth excluding favorable items.

Do not let this rally fool you as we are going to be heading lower and eventually test the December lows. Ask yourself what is being done to solve the structural problems of 25% unemployment in Spain and tax evasion in Greece. Until those questions are answered the uncertainty that currently exists in the global economy will continue grinding the recovery to a halt.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.