Greek Fear May Be Market Friendly

Includes: DBC, SMH, SPY, TLT, VEU
by: Chris Ciovacco

If you have been following the situation in Europe closely, you know the vast majority of Greeks want to remain in the euro. The current election has been billed as a vote to "stay" or "go". Under those conditions, it seems rational to believe most Greeks will let their fear of the unknown (leaving the euro) trump their anger at conservative leaders who helped create the disaster we call Greece. From a June 15 Daily Beast story:

Another recent poll shows that 8 of 10 Greeks want to stay in the euro zone, even if it means tougher times ahead. Returning to a modified drachma would bring bigger problems still, not least of all a return to rationing of food, fuel and medical supplies while the new currency is put into place. That fear is lost on no one. By Sunday, many of the top party leaders will likely have struck secret deals to bring the smaller party support to the negotiating table to form a coalition that can steer Greece clear of the edge of the abyss. If they fail this time, Greece is out of chances.

If the fear of leaving the euro wins out over the justifiable anger, the election this weekend should be market favorable, or at least not clearly market unfavorable. None of us know what will motivate Greeks in the voting booth, but with a strong finish to trading on Friday, the markets seem to be positioned for a less-than-cataclysmic outcome in Greece. The charts presented in this article show markets that appear to be making a strong attempt at a bullish turn.

The video below highlights areas in several markets, including U.S. stocks (NYSEARCA:SPY), foreign stocks (NYSEARCA:VEU), commodities (NYSE:DBC), semiconductors (NYSEARCA:SMH), and Treasuries (NYSEARCA:TLT), that give the short-term nod to the bulls. As of Friday's close, the odds continue to favor some type of bottoming process that is well underway. Obviously, the Greeks may have something to say about the future direction of asset prices. A table of contents for the video is shown at the 42 second mark.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

On Thursday, a G20 representative told Reuters central banks stand ready to assist should the markets deteriorate next week. That central bank news coupled with Wall Street's read that the Greek election will be market-favorable was enough to push numerous markets to important new highs. Flipping through our chart book late Friday we saw mostly bullish evidence. A few examples are shown below.

Last Saturday, we presented a series of charts similar to the one below. The S&P 500's moving averages finished the current week with positive slopes, which is a good sign for the short-term trend.

Even if the Greek election proves to be market friendly at first blush, a government still needs to be formed, which calls for investment flexibility. Any delays after the election could lead to short-term solvency problems for Greece. From a June 17 Financial Times story:

A delay in forming a coalition, or in the worst case, a recourse to a third election if negotiations fail, could cause Greek public finances to collapse. Officials at the finance ministry said last week that unless a delayed โ‚ฌ1bn tranche of EU-IMF funding is paid, funds to pay pensions and public sector wages would be exhausted by July 20.

We have shown the pink trendline in the chart of foreign stocks below for several weeks. The All-World Index ex-U.S. closed back above the trendline on Friday, which leans bullish. The slope of the 20-day moving average (blue line) also ticked up in a bullish manner. Notice how the slope of the 20-day can assist in identifying a short-term trend change. All things being equal, if you are looking to buy, you prefer to see a positive slope on the 20-day.

This week, a possible gain for the bulls could come in the form of a boost for Europe's firewall, a bailout chest designed to stem the spread of the crisis. From a June 16 Bloomberg story:

World leaders meeting in Mexico will agree to boost the $430 billion firewall the International Monetary Fund announced in April, host President Felipe Calderon said. "I estimate that there will be a larger capitalization than the pre-accord reached in Washington, which will be finalized here, but I don't want to speculate by how much," Calderon told reporters yesterday in the coastal resort of Los Cabos.

The technicals continue to lean toward the bullish camp. An inverse head-and-shoulders pattern is a potentially bullish set-up. Many markets, including the S&P 500 and VEU, currently have a form of the pattern. On Friday, VEU pushed above the dotted neckline. The probable target for the move is toward 41.50. Notice a bullish move to that level would still keep the longer-term downtrend in place, which means even if stocks rally further, we need to keep a close eye on things.

Moving back to the flexibility theme, a Sunday Wall Street Journal article describes the ultra-short honeymoon period for the next Greek leader:

Whichever party wins Sunday's Greek vote will face Olympian hurdles with a central government facing a cash crunch within weeks, an economy in free fall and an angry public exhausted by two years of austerity measures. Greece's reform program is also well off track, following weeks of political paralysis. The first task facing Sunday's winner will be to come up with โ‚ฌ11.5 billion-maybe more-in new austerity measures being demanded by the country's creditors but which could further inflame public opinion. With state coffers running dry and a new bond redemption pending in August, Greece's party leaders will be under tremendous pressure to avoid a political deadlock this time.

The shorter-term downward-sloping trendline for VEU was recently broken near point A below, which is the first step required for a basic bullish trend change. A higher low was made above point B, followed by a higher high to the right of point C. The higher high made Friday completes a change in trend. The chart below tells investors to be open to better than expected outcomes for risk assets.

Bloomberg provided a good summary of what happens after the polls close in Greece on Sunday:

Exit polls will be released when voting ends at 7 p.m. in Athens, with a first official estimate due around 9:30 p.m. The final polls, published on June 1, showed no party set to win a majority. The election marks a revote after the May 6 ballot failed to yield a government.

Our approach has been to monitor the health of the markets and adjust accordingly, while placing an emphasis on flexibility. Accordingly, we have tentatively reduced our large cash position in the last two weeks. If the bulls can maintain their short-term momentum, we are open to adding to the risk-on portion of our portfolio. Conversely, if the situation in Europe morphs into a deflationary snowball, flexibility will call for pushing the retreat plans to the forefront once again.

Anything can happen next week post elections in Greece, but there is no question the last two Fridays have favored the bulls. If we pay attention to price and the news, we will not go too far wrong.

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