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Can We Escape?

Daily State of the Markets 
Monday Morning - September 19, 2011

Good morning. Short-term trends come and go during bull markets, bear markets, and everything in between. However, it is important to remember that the really big money is made in this business during what we like to call the "important trends." So, with the markets having moved sideways for the past month and a half, the key issue facing traders is the direction of the next "important trend." But in order to get this question right, one has to be able to answer another: Can we escape?

Weekends are great because without the crush of the daily news flow, the blinking screens, the IM's, emails, and phones, one actually has time to think. (What else would a market-geek do when mowing the yard for the final time of the summer?) During this weekend's pondering, I came up with several things that the market needs to escape from if the bulls are going to prevail going forward. I will submit that our heroes in horns will need to see the PIGIS escape a default on sovereign debt, the Eurozone escape a widespread credit contagion, the US escape first a recession re-do and then a Japan-style deflationary cycle, and the stock market escape another bruising encounter with the bears.

On the well-worn topic of the Eurozone's debt debacle, it is important to recognize that the bond markets are assuming Greece will default. With yields on one- and two-year notes near the triple-digit mark, it is pretty obvious that anyone buying these bonds isn't expecting to get all of their money back. And as the saying goes, if your outflow exceeds your income, then your upkeep will be your downfall. And with Greece's GDP already expected to contract by -5.5%...

With the expectation that Greece will default sooner or later, the key issue then becomes one of contagion in the Eurozone. The bears will argue that CDS rates, yield spreads, and last week's action by the central bankers of the world all seem to indicate that contagion is already occurring across the pond. And with banks and money funds in the U.S. unwilling to lend to their European brethren, well, this remains something that needs to be closely monitored - regardless of the short-term movements in the stock market.

Next up is the state of the economy here at home. While most economists currently argue that there is less than a 50% chance of a recession, it is important to keep in mind that economists and central bankers have predicted zero of the last nine recessions in this country. So, waiting for the consensus to agree on this topic may put investors well behind the curve.

It is also said that while the stock market leads the economy, the market has predicted thirteen of the last nine recessions. As such, it is probably a good idea to avoid listening to both the consensus of economists AND the stock market. However, if we were left on a desert island with just one economic indicator it would likely be ECRI's Weekly Leading Index. Although not infallible, our interpretation of the index shows that it has called all seven of the recessions that have occurred since 1970. However, the indicator did provide false alarms on two occasions. But with the indicator having gotten the call right seven out of nine times, it's probably a good idea to pay attention.

The bulls will point out that today's rapid dissemination of news is responsible for much of the negative sentiment right now (and perhaps even the new recession signal from the ECRI index - again, this is our interpretation of the index). Since everybody sees what is happening in Europe, in the stock market, and in Washington D.C., the feedback loop is self-reinforcing during times such as these. In short, bad news means consumers get scared and do less - until the news improves, that is.

As we've mentioned a couple of times, the key to the next trend in the stock market will likely be the issue of recession in the U.S. While this should clearly be filed in the "duh" category, it is important to remember that according to the historical trends that have occurred after a severe correction in the stock market, stocks tend to rebound and continue higher if the economy can skirt a recession but tends to head lower if GDP goes sub-zero.

What about the President's new stimulus plan and the Fed's next foray, you ask? Traditionally, such measures have been good news for owners of stocks as the Fed during the Greenspan/Bernanke era has been able to inflate its way out of all difficulties since the late 1980's. In addition, stocks have also tended to react rather favorably to the idea of Washington handing out money. The question, of course, is if either of these ideas will continue to work in this slowing growth and rising risk environment.

So, while short-terms trend are what they are and I'll be happy to try and profit from them in both directions if my models tell me to, from a big picture standpoint, I'm still wondering if we can escape some of these issues.

Turning to this morning... The macro worries from across the pond are back as traders are reacting negatively to the lack of action from the EU gathering in Poland (the one that Geithner was basically booed out of), the election results in Germany, and the fact that Spain will nationalize another chunk of their banks. And while all eyes will be on the Fed and their "Twist and Shout" routine this week, stock futures are lower this morning.

On the Economic front... We'll get the report on National Home Builder Sentiment at 10:00 am eastern.

Thought for the day... Remember that it pays to be open minded (in more ways than one)...

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

 

  • Major Foreign Markets:
    • Australia: -1.56%
       
    • Shanghai: -1.80%
       
    • Hong Kong: -2.76%
       
    • Japan: NA
       
    • France: -2.71%
       
    • Germany: -2.76%
       
    • Italy: -2.40%
       
    • Spain: -1.68%
       
    • London: -1.91%

     
  • Crude Oil Futures: -$1.26 to $86.70
     
  • Gold: +$4.50 to $1819.20
     
  • Dollar: higher against the Yen, Euro and Pound
     
  • 10-Year Bond Yield: Currently trading at 1.970%
     
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: -18.86
       
    • Dow Jones Industrial Average: -146
       
    • NASDAQ Composite: -29.56

 

Wall Street Research Summary

Upgrades:

  • Suncor Energy (NYSE:SU) - Barclays
     
  • Sprint Nextel (NYSE:S) - Bernstein
     
  • Cardinal Health (NYSE:CAH) - Citi
     
  • McKesson (NYSE:MCK) - Citi
     
  • Quanta Services (NYSE:PWR) - FBR Capital
     
  • Warner Chilcott (NASDAQ:WCRX) - Goldman Sachs
     
  • Micron (NASDAQ:MU) - Goldman Sachs
     
  • Bristol-Myers (NYSE:BMY) - Jefferies
     
  • BE Aerospace (BEAV) - UBS
     
  • Texas Instruments (NYSE:TXN) - UBS
     
  • Analog Devices (NASDAQ:ADI) - UBS
     
  • Maxim Integrated (NASDAQ:MXIM) - UBS
     
  • Linear Technology (NASDAQ:LLTC) - UBS
     
  • Vail Resorts (NYSE:MTN) - Wells Fargo

     

    Downgrades:

  • ON Semiconductor (ONNN) - Estimates and target cut at FBR Capital
     
  • Alcoa (NYSE:AA) - Estimates cut at Goldman Sachs
     
  • Trina Solar (NYSE:TSL) - Target cut at Goldman Sachs
     
  • Suntceh Power (NYSE:STP) - Target cut at Goldman Sachs
     
  • Forest Labs (NYSE:FRX) - Goldman Sachs
     
  • Lam Research (NASDAQ:LRCX) - Goldman Sachs
     
  • Applied Materials (NASDAQ:AMAT) - Goldman Sachs
     
  • Cabot Corp (NYSE:CBT) - Jefferies
     
  • SEI Investments (NASDAQ:SEIC) - Oppenheimer
     
  • Forest Oil (NYSE:FST) - Stifel Nicolaus
     
  • Continential Resources (NYSE:CLR) - Stifel Nicolaus
     
  • Hexcel (NYSE:HXL) - UBS

     

    Long positions in stocks mentioned: none

    For more of Mr. Moenning's thoughts and research, visit StateoftheMarkets.com

     


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