No, not the price gap - the blog gap!
It's been a while since my last post so it's time to fill in the gap. Luckily the themes we've touched upon in the last several posts have played out nicely over the last couple of weeks. They are: (1)
Dollar strength, (2)
Euro weakness, (3)
Equities weakness. So let's examine each theme in light of recent events. Since so much of the market's action has been determined by the Greek crisis, let's begin with taking a look at Greece and the Euro.
EU - On the Horns of a Dilemma
We've already discussed the issues in Greece so a detailed intro is not needed - but here's a brief recap anyway. Grave concerns over Greece's sovereign debt have been at the center of an unfolding drama as of late 2009. The Greek story has dominated headlines and opened the floodgates of fear that came gushing into the markets. Not long after Greece hit the spotlights, concerns over sovereign debt spread like wildfire to Spain, Portugal, Italy (and let's not forget Ireland), wrecking havoc in the "Club-Med" nations' bond and equities markets.
When Greece first made the headlines in November '09, EU leaders and the ECB chose to distance themselves from the center of attention, as Greek officials struggled to reassure nervous markets that everything was under control and that swift austerity measures could rein in a runaway deficit. However, as hopes for quick fix vanished and fears of contagion arose, it became obvious that EU leaders had to step in. But what to do? Each options seemed worse than the next. Letting the IMF step in was just too humiliating. Not doing anything was just too dangerous. Outright bailout posed a moral hazard and opened the door for more bailouts (Portugal, Spain, Italy). The unique structure of the EU, a monetary union with no fiscal or political unity, made the uncertainty even worse. For the first time, the EU was being put to a test for which the Euro was punished severely as traders piled in record numbers to short the single currency.
OK - so much for the "brief" recap. Fast forward to Thursday, Feb 11. European leaders at an EU summit meeting finally spoke up. During a much awaited press conference EU leaders served the markets a big dose of disappointment saying they stand ready to take coordinated action to protect the stability of the EU if such action was needed. At the same time, they insisted Greece did not need external help at this point.
The lack of clarity and conviction projected by EU leaders weighed heavily on the Euro as it plunged to test its recent lows against the dollar and the yen and made fresh, multi-year, lows against the aussie. After its massive slide following the press conference, the Euro managed a small bounce against the dollar and the yen but remained largely in the bears' hands. And in overnight trading, the Euro slid further against the dollar to break yet another level, this time stopping just shy of 1.3500.
Euro sentiment remains largely bearish. So long as uncertainty concerning the Club-Med nations lingers, the Euro will remain under pressure. With so many piled on the short side, it is likely we see some contrarian move to the upside, a move which may provide a profitable opportunity to re-short the Euro.
USD - Raging Bull
US dollar reversed its multi-week slide late last year and has been on tear since then. The initial strength in the dollar was due to signs of a recovering US economy. Since then, however, the rise in the dollar was strongly associated with flight to safety as fears over Greek debt, China's monetary tightening, and pending US banking regulations contributed to risk aversion among traders and investors. In the land of the blind, the one-eyed man is king. And so it is in the forex markets where the USD was the least worse of a pretty bad bunch.
The USD is approaching another congestion area which may act as a temporary roadblock. In the chart below, you can see the DXY reaching a resistance zone between the blue and red lines:
A major milestone for the US economy and the US dollar went almost unnoticed this week as Chairman Bernanke's testimony got canceled due to a heavy snow storm in the DC area. Bernanke's prepared testimony was released to the media. It outlined the Fed's exit plan for withdrawing the emergency measures it had put in place in the early days of the financial crisis. While repeating the Fed's mantra of "exceptionally low for an extended period" referring to the near zero interest policy, Bernanke's testimony definitely sets the stage for tightening. The question is, how will the market interpret tightening moves when they are finally announced? Depending on many factors, markets are likely to have one of two reactions: 1. interpret tightening as a sign of strength (risk back on) or 2. devastating blow to a fragile economy (risk off). A third and least likely scenario is a mixed reaction somewhere in between. Given a mildly positive parade of economic data and earning reports, option one (interpretation of strength) seems the most likely - but not by much.
S&P - a Long Awaited Correction
Most market participants were caught off guard in March of 09 as a massive rally in equities emerged from the rubble of the financial disaster. By the time it became evident that the rally was real, traders were faced with two options - chase the market or wait for a pullback. Well, for those who opted for the latter, a generous amount of patience was needed. The much anticipated pullback stubbornly refused to arrive - that is, until January 2010, when The S&P 500 climbed back to 1150 and finally met a resistance strong enough to send stocks lower.
Concerns over sovereign debt provided a perfect backdrop the S&P's decline. However, it would seem that other forces were in play, specifically, large market participants booking profits for 2009. A quick look at the charts reveals that 09 market leaders such as financials and materials, actually turned lower before the broad market sell off, suggesting profit taking and sector rotation.
Keeping Things in Perspective
With all the gloom out there, one
must keep things in perspective. For example, fourth quarter earning season has been, thus far, quite positive with most companies meeting or beating expectations. Jobs, unemployment, and inventory numbers also continue to show signs of improvement. Greece is unlikely to default on its debt. And China's monetary tightening is a response to a booming economy - not exactly a bad thing! Moreover, companies have reduced bottom line costs and are well positioned to show bigger net income gains as top line revenue streams return to normal levels. That is not to say everything is rosy. Of course there are lingering concerns (record foreclosures, commercial RE, weaker consumer demand, to name a few) but on the whole, a double-dip recession seems a less likely scenario than a moderate recovery and a range bound equity market.
A quick look at a weekly chart of the S&P 500, shows that the weekly uptrend, while losing momentum, is still intact and that the 1250 (generally accepted) target is still in sight.
Thoughts for the Week Ahead
Subtle disparities in market action on Thursday and Friday, may hold some clues for the week ahead:
- Euro pummeled as US equities rise - we are used to seeing US equities and the Euro trade in tandem. However, last week saw a rise in US equities and a slumping Euro.
- Yen easing against the Canadian and Aussie dollars and, to a lesser extent, against the USD- this is another sign of risk abating to some degree.
Given last week's market action and news coming out Europe, we may begin to see Greece's problems contained within the EU, keeping the Euro depressed. In this scenario, we should continue to see the S&P basing around its recent levels and the yen easing further against the Aussie and Loonie. The US dollar is likely to see some consolidation this week as it hits a new level of resistance. Any further comments from the Fed regarding its exit strategy should help maintain dollar strength, especially vs. the Euro and British pound.
