The Morning Call
The Market
Technical
The
DJIA (14447) traded back below the upper boundary of its short term uptrend
(13791-14485) yesterday; though it remains well above the former all time high
(14190). Meanwhile, the S&P (1551)
continued to trade below both the upper boundary of its short term uptrend
(1505-1579) and its prior all time high (1576).
The return of
the Dow to the boundaries of its short term uptrend is not that significant;
although that it is a sign of some loss in the Dow’s upward momentum. The more important point is that the S&P
still can’t challenge its all time high and, therefore, it is not confirming
the DJIA’s breakout.
That leaves the
$64,000 question unanswered: is the Market in a topping process or resting for
another move up? As you know, I lean to
the former but I am not overly worried about being wrong because I just don’t
see the upside from either the technical or fundamental standpoint.
Volume rose
slightly; breadth was weak with on balance volume particularly so. The VIX increased though much less than I
would have thought on a day such as yesterday.
GLD was down,
finishing within its short term downtrend but below the lower boundary of that
developing very short term uptrend---suggesting that we need to remain
cautious.
Bottom line: the
indices remain in a condition of nonconfirmation; and until that gets resolved,
there is not much more to say regarding Market direction. Nevertheless, how this gets resolved is
important because if we are in a topping process, then investor emphasis will
shift from chasing performance to preserving capital.
Why
the pain trade is higher (short):
The
last four trading days of March (short):
The
S&P and the 200 day moving average (medium):
First
quarter 2013 versus first quarter 2012 (short):
Fundamental
Headlines
We
got two solid pieces of economic data yesterday: the Chicago
national activity index was up versus estimates of a decline and the Dallas Fed
manufacturing index came in better than anticipated. So far, the US
has escaped any contagion from Europe ; and that is a
positive.
Speaking
of which, Cyprus
continued to dominate the headlines. As
trading began yesterday, hopes were up based on the approved bail out of the
Cypriot banks over the weekend. As I
noted in Monday’s Morning Call, I thought that the terms were better than
anything I had expected; to wit, the bank reorganizations actually were
executed as they should be, if the rule of law is followed---shareholders got
wiped out, then the junior creditors, then the senior creditors, then the uninsured
deposit holders.
That was
completely out of character since the ECB in its infinite wisdom had previously
tried a polyglot of alternative measures as it dealt with Ireland, Greece,
Portugal, Spain and Italy sovereign/bank insolvencies. Unfortunately, the bottom line for most of
those bail outs: bank balance sheets were left relatively untouched, severely
compromised assets (sovereign and real estate debt) remained, carried at or
near par value with no haircuts applied to shareholder equity, creditors and
uninsured depositors while operating loses were covered by the ECB or taxpayers---exactly
the opposite of what is supposed to happen in a bankruptcy.
Suddenly in Cyprus ,
the guys that took the risk (equity and debt holders) are now suffering the
consequences. To which I say hallelujah. The only way the EU financial system returns
to health is cleaning the bank balance sheets of worthless loans and paying for
it with the assets of risk investors.
The catch here
is this bail out was sold by the eurocrats as a one off solution because in
Cyprus’ case so much of the risk capital (large uninsured deposits) was
supplied by those evil, tax dodging, money laundering, Russian oligarchs.
Then the Dutch
finance minister made a mistake. He told
the truth, i.e. Cyprus
would be a template for future EU bank insolvencies. Ooops.
His initial
statement; later recanted (medium):
More:
But
the damage was done. Now everyone with a
large (i.e. uninsured) deposit in another leveraged eurobank was going
hummmmmm, what should I do now? And
visions of bank runs danced in their heads (medium):
In
the meantime, the Russians may have already gotten their money out of Cyprus ;
in which case, the remaining large depositors are totally f**ked.
Thoughts
from Wall Street strategists (medium):
Thoughts
from the former governor of the Cypriot central bank (medium):
What
happens when the Russians leave (medium):
The
euro’s ‘poverty effect’ (short):
Adding
to the confusion created by Cyprus
template/recantation comments, no one seems to know when the banks are going to
open again---and that’s a problem.
And remember
when the banks do open, capital controls will be in place---something else that
scares depositors throughout the EU.
Bottom line: I
made the point last week that how the Cyprus
bail out was conducted was more important than the bail out itself. As I noted above, the ‘how’ was better than
anything I could have expected, i.e. at long last the eurocrats actually
applied the rules as they were originally designed and written. The plan as applied to Cyprus
is, in my opinion, the best path to a sounder EU banking system and a return to
growth---assuming that this will be the template for future actions.
That said, (1)
it is not perfect. Capital controls will
negatively impact depositors in other EU countries and (2) any cure for a
malignant cancer is going to be painful; and that pain---the rebalancing and
cleaning up on bank balance sheets throughout the EU---is what weighed on the Market yesterday.
I am fine with
the latter. The pain needs to be
administered and economies set on a sounder course; and if that means (1) tough
economic times---that is the price you
pay for years of profligacy and
mismanagement and (2) lower stock prices, so what. Stocks are currently overvalued (at least by
our Model). Indeed, one way to raise valuations
to current nominal levels is to improve the long term secular economic global
growth prospects. The Cyprus
bail out template is a first step for the EU in that direction.
I caution that if
Cyprus does become
the template, then our short term ‘muddling through’ scenario may become a bit
more rocky while the long term ‘tail risk’ of an EU collapse lessens. I can handle a tougher short term economic
outlook because that is more easily quantifiable than trying to deal a
situation where a crisis is almost certain, but I don’t have a clue as to when
it occurs or how dire the consequences.
So while a Cyprus
template for the rest of the EU may cause some heartburn short term, it would
be a significant positive long term.
All that said,
the eurocrats could chicken out of the Cyprus
template scenario and go back to their old ways. In which case, ignore everything I just said.
Meanwhile,
keeping the banks closed and providing no guidance as to when they will open is
a problem that will only get worse the longer it is drug out.
The
latest from John Hussman (medium):
The
sunk cost fallacy (short):
What
are bond investors thinking (medium):
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