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Do The Bulls Still Have A Case?

Daily State of the Markets
Thursday, July 12, 2012

Publishing Note: I have an early meeting on Friday and will not publish a report. Daily State of the Markets reports will return on Monday.

Good morning. Stocks have been down five days in a row. 'Sell in May and go away' is working yet again. The news out of Europe just seems to get worse with each passing day. (Does Germany's high court seriously need 3 months to decide whether the ESM is legal? After all, the ESM has been being kicked around for like 15 straight summits.) China's economy is slowing (but of course, the degree of the slowdown is subject to debate). India is a problem. The U.S. economy is slowing too. And in turn, earnings are projected to start slowing (as in next week). Bond yields in Germany and the U.S. are at or near all-time lows. Oil is confirming the slowing growth theme. All of which provides the bears ample reason to be licking their chops right now.

To be sure, the sentiment toward the global macro outlook is dour and fear is in the air. Nouriel Roubini is out with a new forecast suggesting the sky will actually fall this time around. Even Meredith Whitney is starting to look right as a new city seems to go bankrupt on a weekly basis. And as if the economic news flow wasn't enough, each new financial scandal (MF Global, Li(e)bor, PFG, and word that BLS stats may have leaked out after all) seems to support the idea that the stock market is no place for women and children (or old men) these days. As a result, the bears continue to suggest that the light at the end of the tunnel is indeed an oncoming train.

But here's a question or three worthy of at least a moment's consideration. With all the bad news, the scandals, the crises, and the HFT-driven market volatility, why then is the S&P 500 just 5.5% from it high water mark for this bull market cycle? If the sky is really falling, why aren't stocks lower? Why is the S&P's weekly chart still in an uptrend? And why has the last hour of the trading day been up in nine of the last ten sessions?

The true-believers in the bull camp (and I most certainly cannot count myself as a member of this club) suggest that the bad news is priced in. They tell us that valuations are pretty enticing, that interest rates are low, and that inflation is nowhere in sight. Those wearing the rose-colored Revo's also remind us that corporate earnings are at record highs. Oh, and then there's the "hopium" thing.

Our heroes in horns continue to pound the table about the idea that Bernanke's crew is on the verge of delivering another fix of QE to the addicted markets. And anybody that's looked at a chart of the S&P 500 after QE numbers 1, 2, and 3 (aka Operation Twist) can easily see that QE does indeed bring good things to life in the stock market. Roughly speaking, the first round of QE produced a 50% gain. The second, about a 40% gain. And then Operation Twist (which was accompanied by some unexpectedly good economic stats for awhile) was good for at least 25% on the S&P. So, while the marginal utility appears to be diminishing, it is a safe bet that traders will jump all over the "risk trade" (stocks, emerging markets, oil, gold, copper, commodity indices, short-dollar, etc) if and when "The Bernank" delivers the goods.

While I am still a card-carrying member of the glass-is-at-least-half-full club, I will have to admit that I'm struggling a bit with a good portion of the bull case at the present time. But there is one thing I know for certain; should Bernanke's cavalry decide to mount their white horses and ride to the rescue with more QE in the near future, stocks are going to celebrate. In short, Wall Streeters like a "trade" they can depend on. And given the track record of the "risk on" trade after QE has hit the tape in the past, this is something you can probably bet on - for a while, anyway.

As for the rest of the bulls' arguments, maybe this is a case of the bear stance having become SO prevalent on a daily basis. Maybe the volatility is affecting my perception. As such, perhaps the bad news is indeed priced in (give or take 3-5% in the price of the S&P). Maybe what appears to me to be middling valuations from an historical perspective is being viewed within the context of the past 20 years. Maybe low rates will indeed do the trick and spur demand in the economy at some point. Maybe China's economy will enjoy a soft landing and continue to drive the global economy forward. Maybe the economic slowdown we're seeing in the U.S. will wind up being just another "soft patch." And if so, then maybe corporate profits will continue to grow.

If that sounds like a lot of "maybes" to count on, join the skeptics club. However, the key to the game, at least as far as I'm concerned, is that I don't need to get all these questions right. I don't have to know if the bulls actually have a case. You see, instead of utilizing a deep thinking approach, I prefer to let my active risk management systems guide me. Yes, I am completely "talking my book" here - guilty as charged. But with so many questions, I think it makes infinitely more sense to lean on my systems than to try and figure out if the bulls actually do have a case right now.

Turning to this morning... Concerns about China's recovery and disappointment over yesterday's Fed minutes are being cited as reasons for this morning's weakness in the European markets and U.S. futures.

On the Economic front... Initial Claims for Unemployment Insurance for the week ending 7/3 fell by 26K and were reported at 350K, which was below the consensus estimate for 371K and last week's initially reported total of 374k (which has been revised up to 376k). Continuing Claims for the week ending 6/30came in at 3.304M vs. consensus of 3.306M.

In addition, Import Prices for the month of June fell by -2.7%, which was below the consensus for a drop of -1.8%. Export prices fell by -1.7%, which was below expectations for -0.2% as well as last month's level of -0.4%.

Thought for the day... You cannot prevent the birds of sorrow from flying over your head, but you can prevent them from building nests in your hair -Chinese Proverb

Pre-Game Indicators

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

  • Major Foreign Markets:
    • Australia: -0.70%
    • Shanghai: +0.47%
    • Hong Kong: -2.03%
    • Japan: -1.48%
    • France: -0.52%
    • Germany: -0.87%
    • Italy: -1.52%
    • Spain: -1.97%
    • London: -1.13%
  • Crude Oil Futures: -$1.22 to $84.59
  • Gold: -$13.10 to $1562.60
  • Dollar: higher against the yen, euro and pound
  • 10-Year Bond Yield: Currently trading at 1.490%
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: -10.20
    • Dow Jones Industrial Average: -89
    • NASDAQ Composite: -21.69

Positions in stocks mentioned: none

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


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