Wednesday, June 3, 2015

The Morning Call--Is EU QE working?

The Morning Call

6/3/15

The Market
           
    Technical

After a fairly volatile day, the indices (DJIA 18011, S&P 2109) closed down slightly.  Both finished above their 100 day moving average, but below their former all-time highs.   On a very short term basis, they both are in narrowing pennant patterns formed by their 100 day moving and the lower boundary of a very short term uptrend on the downside and the upper boundary of a very short term downtrend on the upside.  I mention these as signs of the narrow trading range that the Averages have been in for some time, which I noted yesterday as illustrating the lack of conviction of both bulls and bears.

Longer term, the Averages remained well within their uptrends across all timeframes: short term (17299-20104, 2030-3009), intermediate term (17445-22593, 1832-2600) and long term (5369-19175, 797-2138).  

Volume fell and breadth was mixed.  The VIX was up slightly.  It is still below its 100 day moving average and the upper boundary of its very short term downtrend, but getting ever closer---a potential negative for stocks if it breaks above those trends. 

The long Treasury had another bad day, finishing below its 100 day moving average and within a short term downtrend and also below that minor resistance level I pointed to earlier and back below the upper boundary of that recently negated very short term downtrend.    
                       
GLD was up fractionally---continuing to do nothing and ending below its 100 day moving average and the neck line of the head and shoulders pattern.  Oil rose again, closing above the upper boundary of its short term trading range.  This is the second assault on this boundary.  If it remains above that level through the close on Thursday, the short term trend will re-set to an uptrend. 

The dollar fell, closing below its 100 day moving average and within the developing pennant formation that I noted yesterday.

Bottom line: the Market remains directionless both on a very short term basis (trapped between their 100 day moving averages and their former all-time highs) and within a trading range dating back to mid-February.  While I think that the up/down volume and other divergences suggest that this stalemate will be resolved to the downside, I have to recognize that I am influenced by my own fundamental view of the equity valuation.

I still believe that the Averages have come too far not to challenge the upper boundaries of their long term uptrends but I also think that any further advance will be limited to the rate of ascent of those boundaries.  That aside, if I define the upside as the upper boundaries of the indices’ long term uptrends and the downside as the lower boundaries of the indices’ short term uptrend, the risk/reward is not positive.

            Full year Market performance in past pre-election years in which the January to May performance was flat (short):

    Fundamental

       Headlines

            Yesterday’s US economic data was mixed, with major misses in both directions: April factory orders were very weak while May light vehicle sales was a blowout number.  Bringing up the rear, was month to date retail chain store sales which were slightly ahead of last week’s reading.  Mixed, of course, is still mixed.  But I would observe that (1) on the one hand, the factory orders number is less current than May car sales, (2) on the other hand, I have dwelled repeatedly on the parallel today of auto sales/financing to home sales/financing in 2007.
   
            On the global front,

(1)   the Reserve Bank of India lowered rates for the third time this year even though the country’s first quarter output production was up.  So QE remains alive and well and every central bank’s favorite policy,

(2)   speaking of which, China doubled down on its latest QE strategy, sending Chinese stocks into the stratosphere,

(3)   EU inflation rose 0.3%---doesn’t sound like much, but it is the first positive inflation reading in some time.  That news along with the uneven improvement in the EU economic stats of late is suggesting that Draghi’s QE is working.  And that is likely correct.  Which may have you wondering, how do I reconcile QE working in the EU with all that hot tongue I have been laying QE in general?  First remember, the ECB had been following a policy of monetary austerity until last year.  So the current EU QE is the equivalent of our own Fed’s QEI which I have noted numerous time had a positive impact on the economy.  It was QEII, III and IV that misallocated capital, encouraged rampant speculation and grew the carry trade.  Much like the Japanese version of QE though admittedly not as extreme.   The point here being that the current EU QE is likely having an effect on the European economy and once improvement is substantiated, the ECB needs to unwind its QE rather than following in the misguided footsteps of the US and Japanese central banks.
               
                  Is ECB QE starting to appear in the data? (short):
                       
(4)   the Greek bailout dilemma continued to hold investor attention.   Monday night the Troika met, blew off the latest Greek bail out proposals and decided to write the plan itself.  It has heretofore shunned that approach because it didn’t want to appear to be forcing terms upon the Greeks from on-high.  But given the Greek unwillingness to recognize reality, it took that step and it appears that it will be presented as ‘take it or leave it’.  Now what?  I am laughing to myself as I write this because I have no idea how to assess an endgame to this clusterf**k.  That said, risks remain, so caution is in order.

                 Greece appears ready to sign pipeline deal with Gazprom (medium):

And surprise, surprise, Greece says that it won’t make Friday’s repayment of an         IMF loan (short):


            ***overnight, the ECB left interest rates unchanged, the OECD lowered its global growth outlook, first quarter Australian GDP came in better than expected and another large Chinese company defaulted.

Bottom line: the economic data continues mixed this week which is an upgrade from the last nineteen; and as I have noted, we need it.  That said, I would caution against getting too jiggy over the May new car sales because there is a lot on subprime lending incorporated in that number.  On the other hand, the bond market has had a couple of rough days (bond prices down, yields up) which suggests that the bond guys are looking for economic improvement.

While somewhat erratic, the economic stats out of the EU seem to be on an upward trend.  That is a plus.  However, the trend in liquidity infusions from central banks (India, China) are growing.  While that may help our ‘muddling through’ scenario in the short run, it raises the risk of more beggar thy neighbor devaluations and the overleveraging of sovereign financial systems longer term.

That said, even if the US economy is well on its way to regaining 2-3% real growth, even if the historically unprecedented global QE does not lead to disaster and even if the euros manage to prevent Greece from defaulting, stocks are still overvalued.

 I can’t emphasize strongly enough that I believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.

Bear in mind, this is not a recommendation to run for the hills.  Our Portfolios are still 55-60% invested and their cash position is a function of individual stocks either hitting their Sell Half Prices or their underlying company failing to meet the requisite minimum financial criteria needed for inclusion in our Universe.


            Where the power sits within the Fed (medium):

            A bubble on thin ice (medium):
            http://www.acting-man.com/?p=37760

            Today’s stock buybacks are a distortion (medium):

            And a brief history of what happens in the aftermath (medium):

            Update on valuation:

Economics

   This Week’s Data

            Month to date retail chain store sales rose fractionally from last week.

            April factory orders fell 0.4% versus expectations of -0.1%.

            May light vehicle sales came in around 17.7 million units, an outstanding reading.

                Weekly mortgage applications fell 7.6%, while purchase applications declined 3.0%.

            The May ADP private payrolls report showed job growth of 32,000, in line.
            The second quarter US trade deficit was $40.9 billion versus expectations of $44 billion.

   Other

Politics

  Domestic

Must watch video by George Will on today’s college education (5 minutes):

And the Arthur Ashe Courage Award goes to, drumroll…………

  International War Against Radical Islam

            Obama’s options on Iran (short):






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