05-31-2011 Market Commentary

By Eddie Katz Gluskin Sheff - The Chinese stock market has now corrected 10% in a six-week span with obvious near-term implications for correlated assets such as deeply cyclical basic materials. Just think if the S&P 500 had slumped like that there would be panic on the streets and all the critics would be begging the Fed for another round of QE (just wait). Mad Hedge Fund Trader - Those looking for guidance on the medium term trend in the market better take a look at the best of breed, benchmark stocks for the leading sectors; the companies traders call “the generals”. I am talking about Goldman Sacks (GS), Apple (AAPL), Freeport McMoRan (FCX), and Google (GOOG). They are all telling us that the market peaked last February, not on April 29, as the indexes are suggesting. When the charts for the stock prices of the best run companies in the most profitable industries are rolling over like the Bismarck, you know that it is time to bail out. That is why I have been a seller of rallies, not a buyer of dips for the past three months. If you are one of those cynical, glass is half full, tough to convince investors, then take a look at the chart of the financials ETF (XLF). It also peaked in February and has been in a clear downtrend since. There is no way the S&P 500 can make progress when one of its heaviest sectors is suffering from Montezuma's revenge. Still unconvinced? Check out The Gartman Letter. It indicates that we broke a steep trend line in February and are imminently about to break a much more shallow trend line this week. The bottom line? The best case is that we are nearly three weeks into a 10% correction that will take us to the 200 day moving average for the (SPX) at 1,234; the worst case is that a new bear market has started. Look out below! Goldman Sachs - The Goldman Sachs Analyst Index (GSAI) fell 9.9 points to 57.7 in May. While this level still indicates our analysts are seeing moderate growth across their industries, this is the fifth largest monthly decline in the history of the GSAI. This drop echoes signs of slowing in many other business surveys for the month of May. Sales and orders indices each dropped more than 19 points, and are now consistent with stagnant or even slightly contracting activity. Strong readings in capital spending and employment indices, however, suggest that companies are not expecting a dramatic slowdown. Gluskin Sheff - De-risking is still the operative strategy here. As we said before, since mid-February, we have seen bank stocks slide 15% alongside a 60 basis point plunge in the 10-year U.S note yield. These two simultaneous events have more often in the past foreshowed something lurking around the corner that could hardly be described as warm and fuzzy. It is one thing to have banks sell off and bond yields rise like we saw in 1994 or other occasions when it reflects accelerating cyclical growth conditions and Fed tightening in response. But the last time we recall both bank shares and bond yields falling in tandem was in 2007, and was a pretty good predictor of the credit shock that was about to come. Thomas Lee-As we have noted for some time, fundamental visibility is clouded by 5 factors, which in turn intuitively sidelined investors, thus supporting our view of a flattish June-Sept for markets. (To recap, those 5 factors are (i) Greece/peripheral Europe; (ii) end of QE2 purchases; (iii) higher oil; (iv) Japan quake/supply chain disruptions; and (v) Wash budget/debt ceiling.). However, we see two relatively high-quality signals that markets have hastened a recalibration of expectations and thus front loaded the flattish June-Sept, specifically, (i) CESI (Citi Eco surprise index) has recently fallen to -57, a level not seen since Aug 2010 and generally associated with market lows; (ii) AAII (investor sentiment bulls less bears) fell to -16, a reliable contrarian signal, pointing to a 78% probability of a low within 10 days. Thus, we are incrementally mindful of a rising probability that lows of June-Sept could be made in June. Conclusion - And just like that, as the market takes a little breather, the whispers of QE3 are coming back. We hear this commentary as we listen to Portfolio Managers discuss their outlook for the near-future. Several of our favored PM's are anticipating a further pullback in both the economy and stock market come the end of QE2...all of which will likely lead the FED to create some form of liquidity package. Whether it is QE3 in the same form as its predecessors or some other means of making the US$ abundant (read: cheap), these PM's believe that the patient is about to relapse and the FED can't quite take away the medication. Should this happen, anticipate a phone call from us to discuss a potential “risk-on” trade...because that's all it will be...a trade. Regardless, it should make for an interesting scenario come year-end if we have the FED applying the additional meds of liquidity while Congress has to determine what to do with the continuation of the Bush tax cuts and the rollback of the payroll taxes by 2%. Our bet (which is essentially just reading what the bond market is telling us) is that growth is slowing down for the foreseeable future. Profits can be made in opportunistic trades, but a buy and hold equity investor should beware. And for those of you holding on to munis, you will be saddened and pleased when you find that taxes have to go higher to deal with the deficit. It's all but a given at this point, however, the plus side is that it will make the demand for your muni holdings all the more attractive.