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Market Shadows Newsletter ~ Bullish?, Shorting WFC

|Includes: Wells Fargo & Co. (WFC)

Market Shadows Newsletter (7/1)

Here's the latest edition of our new newsletter, Market Shadows, written by a group of excellent people, writers/traders, and edited by me (Cycle Editing - we do all sorts of editing work...). Please share this newsletter with your friends, family, readers of your blog, etc. And please visit me at the Market Shadows website here.

THANKS!! ~ Ilene

This week's full newsletter here: MarketShadows July 1 2012


Market pundits may want us to jump into the market because the 'DOW will be closer to 14,000 by the end of 2012,' or 'the market is better than fixed income over time.' Others say that there will be inflation or hyperinflation over the coming years, moving equities up in price (though not value, as the US dollar falls). But with Treasury's returning to the top of the U.S. fixed income heap, up 2.9% in Q2, beating corporate bonds, mortgages, and munis, hyperinflation does not appear to be on the horizon. We're in the camp of Jesse's Cafe Americain, believing that "stagflation" or "managed inflation" is a better description of what we are seeing:

"So it is really about making the best choice amongst bad choices. This is why governments choose to devalue their currency, either with quantitative easing, or explicitly against some external standard as the US did in 1933. Because when the debt is unpayable, it must be liquidated, and the pain will be distributed in a way that best preserves the status quo.

"Hyperinflation and a protracted deflation are both very destructive choices. So therefore no rational government will choose either option.

"They *could* have those choices imposed upon them, either by military force, political force, or by economic force. Economic force is almost always the cause of hyperinflation.

"So you can see why a 'managed inflation' is the most likely outcome at least in the US. The mechanism has been in place and performing this function for the last 100 years.

"The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades. Most third world republics are like this. A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage. The benefits and the risks of growth and productivity must be spread widely amongst the participants. Oligarchies tend to spread only the risks, keeping most of the benefits to themselves." (DEFLATION, HYPERINFLATION OR STAGFLATION)


Allan summarizes last week's market activity as follows. Like Springheel Jack, he is entertaining the idea that the markets are turning bullish in the near term, though still somewhat skeptical. His signals, however, are objective. Click here for Allan's complete weekend update.

New Signals

SPX 240---->LONG


IYR Daily---->LONG

IWM Daily---->LONG

AMZN Daily--->LONG

AMZN Weekly-->LONG

Market Analysis

The preponderance of the evidence has in one market session shifted from a mixed stock market with a bearish bias to mixed stock market with a bullish bias. With the weekly reversal levels now within reach, it is possible that next week will confirm a new bullish trend across a broad spectrum of stock market indices. If so, the trend should last throughout the summer and we can officially say good-bye to the April-May TOP.

But we are not quite there yet and as I have been assessing the market all week, the trend models remain mixed and news-driven rallies (or declines) as we have had from late Thursday through Friday are more often than not aberrations within the trend of the market (and I would think especially suspect when the news is from an insolvent foreign cabal). Still, if the Weekly models follow with their own reversals next week, we may very well have a new ball game. Read more here.

Euro Game Changer?

Courtesy of Springheel Jack of Channels and Patterns

With the close just over the 100 daily moving average (DMA) on SPX, and just under the current rally high from the June low, there are now three main possibilities for the S&P 500 from a TA perspective:

  1. SPX tops out here and very soon, creating a double-top from the June low with a target back at that low.
  2. SPX makes it to the inverted head and shoulders pattern target in the 1403-5 area, topping out somewhere in the 1400-1445 range to make a much larger double-top with a target slightly above the October 2011 low.
  3. SPX makes new highs, breaks with confidence over the 1442 area pivot resistance and rises to test the 2007 highs over 1500.

Of these possibilities, the first now looks unlikely. I'm favoring the second option slightly over the third option, which was brought back from the dead by the EU Summit on Thursday and Friday. Here's the SPX chart, with a healthy looking uptrend support trendline and with the close over the last of the key DMAs on Friday (click on charts to enlarge):

So what changed at the EU summit? Well the big debate there was whether Germany would be forced through intense peer pressure to guarantee much of the debt of its insolvent neighbors through Eurobonds. Most of Europe is in favor of the bonds, while the Germans are adamantly against the idea. To avoid Eurobonds, it appears that the Germans have agreed, as a lesser evil, to relax the restrictions on the ECB assisting troubled EU sovereigns.

It's hard to overstate the possible importance of this concession by the Germans. It opens the path to potentially huge quantitative easing by the ECB, something that had previously been ruled out by German opposition. We could see the ECB respond to problems in Greek, Spanish and Italian bonds by printing enough money to buy all of those troubled bonds. Does that sound unrealistic? In terms of overall Euro-area debt outstanding, such a move would only bring the ECB roughly into line with the Bank of England, held up as a model of caution in these strange looking-glass times. (But note, the ECB does not have the authority (yet) to simply print money, so the question of where is this money coming from is swirling around in the Financial Universe.)

How with the eurozone solve its problem with un-payable debt? Bruce Krasting argues that the most likely course for the EU is to devalue the Euro: "There is one currency option left. Devalue the Euro by 20++%. This would make a difference. It would go a long way towards stabilizing the real economies of Europe. It would create inflation, something that is sorely needed to devalue the real size of Europe's debts. Germany would agree to this as it preserves their export-competitive position within the EU, and improves it outside of the EU. The technocrats in Brussels would love it; it's the only thing left that would preserve the monetary union.

"Is this feasible? I say it is. It has happened twice before in history. In 1985 the world got the Plaza Accord that devalued the dollar and in 1987 we got the Louvre Accord that revalued the dollar. In both cases, the global central banks (CBs) and acted together." (Devalue the Euro)


Financial Sector

On the Short-side, Scott Brown of Sabrient is not a fan of Wells Fargo & Co. He likes a straight short. We're going to short 200 shares of WFC in the Market Shadows virtual portfolio. According to the research of Sabrient's subsidiary Gradient, WFC's suffers from poor earnings quality and earned only a D grade after it's financial information was passed through the Gradient grading system. It compares unfavorably to peers with a 2.84% nonperforming loans (NPL)-to-total loan ratio, compared to a peer median of 1.90%. Nevertheless, WFC is stingy in developing its loan-loss allowance, with an ALL equal to just 85.6% of NPL versus a peer median of 164.4%. Moreover, a large portion of the bank's earnings are due to one-time effects. The balance sheet also has a large amount of Level 3 assets that have no established market price and cannot be currently priced with a high degree of confidence. Scott is going to sell 200 shares of WFC short in the Market Shadows virtual portfolio on Monday.

Read the full newsletter: MarketShadows July 1 2012

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