Prior Week

Bullish Market Movers

1. ‘Successful’ EU Sovereign Bond Sales
2. Overall Positive US Earnings
3. Goldman Sachs Fraud Case Settlement

 

Bearish Market Movers

1. US Earnings Negatives
2. Poor Economic Data

 

Coming Week

1. EU Bank Stress Tests – The Main Event This Week
2. EU Bond Sales
3. US Corporate Earnings Week II

 

Conclusion-Downside Risk Greater, EU Banks Stress Tests Likely To Decide Near Term Market Direction

Prior Week

 

Bullish Market Movers

 

‘Successful’ EU Sovereign Bond Sales

 

The most likely trigger of the next stage of the EU sovereign debt crisis would be a failed bond auction by one of the PHIIGS. Thus markets correctly interpreted healthy demand for Greek, Italian, Portuguese, and Spanish bonds as a positive for risk appetite, even if the sales were at unsustainably high rates.

As long as these countries can sell bonds, the EU buys time to conjure up a longer term solution. A deferred crisis may arguably be better than an imminent crisis. Details to note include:

• Portugal managed to sell 877 million Euros of bonds despite a two-level downgrade by Moody’s
• The Bank of Spain reported that Spanish banks borrowed a record 126 billion Euros from the ECB (more than a quarter of the lending to all of Europe), raising the question of how long the ECB can continue to sustain this rate of lending.
• Greece sold 1.25 bln Euros of 26 week bonds at 4.65%, approaching the 5% level which could be interpreted as a failed auction.
• The big unanswered question for these auctions remains-who were really the buyers? Was there genuine demand or was this from ECB and other central banks merely painting us a rosy picture?

 

Overall Positive US Earnings

 

Positive US earnings results for the first week of Q2 earnings season provided much of the lift behind the below average volume rise in the bellwether index Monday-Thursday.  Alcoa (AA), General Electric (GE), Bank of America (BAC), Citigroup (C), JPMorganChase (JPM) all had better than expected earnings.

Goldman Sachs Fraud Case Settlement

 

Goldman Sachs settled its SEC fraud case for a $550 mln wrist slap and its shares rose 5.9% on the removal of that question mark, as markets took the fine to be a mere ‘wrist slap’ and as a sign that any other banking misdeeds would not threaten the perpetrators nor the sector as a whole. Despite the very good news of SEC impotence, the financial sector lost 3.5% on the week, mostly due to Friday’s losses.

Bearish Market Movers

 

US Earnings Negatives

 

Google (GOOG) missed  its forecast, Bank of America (BAC), and Citigroup (C) beat them but still sold off     (  (BAC -9.1%) and Citigroup (C -6%)  ) on concerns about their ability to raise top line revenue. JPMorganChase (JPM) sold off along with the rest of the sector and market as poor consumer confidence, PPI, CPI, retail sales, industrial production and initial claims helped fed ongoing concerns that the U.S. recovery is rolling over into a double dip recession.

Poor Economic Data

 

How poor? Quite.

• UoM Consumer Sentiment:  Showed the biggest drop since Sept ’08. This was arguably the most significant scheduled report this week because it suggests coming declines in consumer spending, which comprises about 70% of US GDP. Rising confidence doesn’t always translate into more spending but falling confidence more often translates into less.
• Disappointing TIC report (net foreign investment in the US)
• CPI dropped from 1.8% to 1.1 biggest drop since 12/08  feeding deflation fears
• China annualized growth slowing: suggesting the worlds’ leading member of a handful of growth engines could be facing headwinds, threatening global demand, especially for commodities, and thus their related currencies, the AUD, NZD, and CAD
• Other negative reports this week: included PPI, CPI, retail sales, industrial production, initial claims, and the FOMC’s US growth downgrade, all of which helped fuel the growing belief that the US faces a deflationary double dip recession
• ECRI Weekly Leading Indicators (WLI) Indicates Coming Double Dip Recession: Perhaps the most compelling new evidence this week came from the latest ECRI report on leading economic indicators. The annualized growth rate of the ECRI Weekly Leading Index (WLI), a measure of future U.S. economic growth fell to minus 9.8 percent from minus 9.1 percent the previous week, suggesting rapidly slowing growth. Most still believe there is no imminent recession coming, but late 2010-early 2011 is another story. Per Ed Harrison, “David Rosenberg noted in June that a minus ten reading is a recession lock for the entire 42 years of ECRI data available. The minus 9.8 reading is about as close to a double dip warning as you are going to get from the WLI.”

 

This fits with what we wrote back in April in CHARLES NENNER’S HIGH CONVICTION TRENDS, TRADES: 2010-11 Investors’ Roadmap. Nenner is looking for a final risk rally into August and longer term decline towards Q4 2010 and well into 2011. 

Together these drove Friday’s high volume selloff of over 2%, wiping out the weeks’ gains in a single day and about half of July’s overall gains, sending the bellwether S&P index back below its down trend line and back again under its 50 day EMA.

Coming Week

 

EU Bank Stress Tests – The Main Event This Week – Possibly This Summer

 

Many questions surround this coming Friday’s release of stress test results and thus it’s very difficult to predict both the results AND how markets will interpret them. Some of the unanswered questions include:

• What threshold will be used to determine whether a bank has passed the stress test?
• Will the results contain more detail than a simple pass/fail label?
• If a bank fails the test, how long will it have to raise the funds, where it will come from, and what measures will be taken in the interim period to protect the bank, its depositors, investors, and creditors?
• For sovereign bond holdings, by what amount should bonds of different governments be written down to account for default risk?

 

The EU has a tough balancing act to perform. If markets perceive the tests as lacking transparency or as overly optimistic, then this attempt to calm markets will backfire by providing more uncertainty rather than less, similar to what happened with the EU’s first grudging too-little-to-late rescue plans for Greece. We hope the EU learned its lesson. However if the tests are too tough (which no one believes will happen, as the purpose of the tests is public relations, not actual bank reform) they could also scare markets, though having some failing banks would likely lend credibility to the tests.

The tone from EU officials has clearly been confident, and the consensus is that the tests will paint a rosy picture. However once again, the danger is that a lack of coverage for underperformers, and an overly optimistic ‘worst case scenario’ will together leave too much uncertainty and backfire on the EU.

Given that the EU has been the source of the markets’ downtrend over the past months, and the already low expectations for the US UK, and Japan, if the EU succeeds in calming markets, the risk rally will likely find new legs barring an unlikely poor US earnings season.

EU Bond Sales

 

This week, EU sovereign credit concerns are again tested as Greece attempts another 1.5 billion euro auction of 13-week bills July 20th.

US Corporate Earnings Week II

 

The flow of big name earnings reports increases this week.

Monday: IBM (IBM) and Texas Instruments (TXN) are due with numbers

Tuesday: Apple (AAPL), Goldman Sachs (GS), Harley-Davidson (HOG) and Yahoo (YHOO)

Wednesday: eBay (EBAY), Morgan Stanley (MS), Netflix (NFLX), Qualcomm (QCOM) and Starbucks (SBUX) Thursday: Amazon.com (AMZN), Caterpillar (CAT), Microsoft (MSFT) and UPS (UPS)

Friday:  McDonald’s (MCD) and Verizon (VZ)

As with Q1, markets will need to see not only earnings beats but improving top line revenues and positive guidance. In sum, for markets to rally on earnings news, they will need to see genuine growth, not just ‘not-as-bad-as-expected’.

Conclusion-Downside Risk Greater, EU Banks Stress Tests Could Decide Near Term Market Direction

 

Markets are in the middle of a tug of war, pulled between mostly solid earnings results and guidance on one side, and lackluster-to-poor macro economic data. Logically this can’t continue. At some stage we are either going to see companies tweaking earnings estimates slightly lower or we will see a rebound in economic data over the coming months.

The overall evidence noted above suggests the rally in stocks and other risk assets over the past 2 weeks was a mere countermove in the longer term downtrend – even positive earnings news, a Goldman (GS) settlement, and a ZIRP (zero interest rate policy) couldn’t sustain this rally. Imagine what will happen when interest rate increases appear on the horizon, as they eventually must. We’re expecting a test of at least 1000 or lower September, and that’s assuming no sovereign debt crises in the EU.

The fundamental basis for the growing consensus of a coming US double dip recession is that despite massive stimulus, the jobs and wages picture is at best stagnant and more likely deteriorating, as a growing army of long term jobless households exhaust unemployment benefits, further undermining spending (70% of US GDP), and thus having a knock on effect on real estate prices, and thus the banking, construction and manufacturing sectors. See here for more.

The technical basis for expecting more downside in late 2010 includes:

1. Friday’s losses wiped out virtually all of July’s gains except for those of July 7^th, and unlike the up days, came on above average volume, a sign of bearish strength.
2. The 50 day EMA held as resistance after being tested for most of the week
3. The S&P 500 down trend line connecting highs of April 26^th, June 21, and July 14 remains intact (see chart below)
4. Markets typically bottom about 24% below their declining 50 day moving average, which is currently around 1085. That suggests a bottom at 824 for the S&P 500, which is currently around 1072
5. Employment typically improves in the early stages of a recovery, and that isn’t happening

 

 

S&P Daily Chart Courtesy of AVAFX      13jul18

Thus taken together, the fundamental and technical evidence suggest the longer term secular bear market in stocks and other risk assets remains intact, as shown in the bellwether S&P 500 index’s monthly chart below.

 

S&P 500 MONTHLY CHART COURTESY OF AVAFX   10JUL16

Barring a new EU sovereign debt crisis, market response to the EU bank stress tests will likely be the biggest factor in deciding if the uptrend of July can continue, followed by the US earnings.

How To Profit And Protect

 

Continue to use rallies as opportunities to sell risk assets, and build positions in safe haven assets or short positions in risk assets. See our July 19^th-23^rd Quick Review/Preview:  Stocks, Commodities, Forex for specific ideas.

DISCLOSURE: NO POSITIONS