Submitted by Rodrigo Serrano of Rational Capitalist Speculator
Weekly Bull/Bear Recap: October 24-28
- The bears are furious as Europe once again, to their disbelief, unites and puts forth a €1 trillion package to backstop banks and sovereign debt markets. Eurozone officials also negotiate a voluntary haircut of 50% with banks to put Greece on a sustainable path forward and create time for real reform to take place. The avoidance of a credit event as well as a recapitalization fund of €106 billion ensures that there will not be a disorderly default and that infected banks will be ring-fenced thereby stemming the contagion. The effectiveness of the package results in global equity markets rallying to finish off the week and the Euro rebounding above the important 1.40 mark. The greatest impediment to the global recovery has been lifted. Societe Generale strategists said, “the agreement was likely to prove sufficient to ease financial stress and should be comprehensive enough to give the euro area a ‘window of opportunity’ to put its house in order”.
+ 3Q GDP grows at its fastest pace this year in a marked rebound from the prior quarter. The gains are lead by…. the resilient consumer. Double-dippers are finished. Ignore the consumer confidence surveys. Yes, people are glum about the economy but life goes on. People are learning to live with the current circumstances, which by the way are slowly getting better. The holiday shopping season will pleasantly surprise judging by this news and the most recent uptick in confidence as per the University of Michigan Consumer Sentiment Survey. Moreover, according to the Chicago Fed National Activity Index, the economy isn’t in recession, only a soft-patch. The 3 month moving average rose to -0.21 in September from -0.28. The improvement was centered around employment-related indicators. And finally, the Philly Fed State Coincident Index increased in September and shows continued improvement from this summer’s soft-patch.
+ The S&P 500 has broken through its 200-day moving average. It has also penetrated the neckline resistance. The Dow Theory is also back into effect as both the industrials and transportation averages have broken through their prior highs. How was the breadth in the latest rally? I would say healthy. Credit has also participated in the rally. These are signs that the technical picture has improved substantially. The index is poised to challenge the bull market highs. Shorts are getting decimated. Money managers are hopping on board as seasonality is supportive of positive returns to finish the year (Santa Claus rally!), they don’t want to miss the boat! —(S&P 500 below)
+ Yet more signs that the global economy remains on firm footing: Caterpillar (CAT) scores an A+ in its earnings release, reporting a net income/share of $1.71 vs. estimates of $1.57, while guiding higher in its forecast. Order backlogs remain at an all-time high; China’s always salient flash PMI moves back into expansion territory, rising to 51.1 from 49.9. Even better, more signs surface that inflation has indeed peaked and Mr. Wen has signaled a in shift in policy, geared more towards growth. No hard-landing in China = supported global growth picture. Copper rockets over 11% this week. Even Japan gives investors good news with September exports rising by 2.4% YoY vs. estimates of 0.4%, while household spending came in better than expected and the unemployment-rate fell.
+ While the headline was negative, Durable Goods Orders showed broad strength under the hood. Orders excluding transportation were up 1.7%, better than the 0.4% expected by analysts, while business capital investment rose 2.4% (this data series just hit a new all-time high). Furthermore, we have the American Trucking Association (ATA) announcing that September’s tonnage index rose 1.6% after a revised -0.5% reading (was -0.2%). Chief Economist Bob Costello believes that the economy will skirt another recession. None of these data points are pointing to a double-dipping economy. The manufacturing sector is hanging in and remains very resilient.
+ There are more signs that the Fed is close to stepping up to support market sentiment and the economy. William Dudley, Fed Vice Chairman, is echoing earlier speeches by Fed members Tarullo and Yellen last week on a possible QE3. It’s a fantastic time to go long the market and commodities in particular (due to China’s soft-landing). When will the bears understand that you “don’t fight the Fed”?
+ New Home Sales popped 5.7% and inventory fell to the lowest in over 6 months as supply continues to whittle down. Lower supply will eventually lead to stabilized prices and consumer confidence. Additionally, changes to the Home Affordable Modification Program (HAMP) will help make refinancing more accessible and streamlined. Other programs to unclog the financial arteries related to the housing market are being discussed. Slowly but surely the housing market is healing. Have you seen homebuilding stocks lately?!
- Consumer confidence as per the Conference Board plunges in October to the lowest since….(drum roll)…. March ‘09. Both current nor future conditions are spared; the former dropping from 33.3 to 26.3, while the latter falls from 55.1 to 48.7. Job-related measures also show deterioration with “jobs not so plentiful” rising to 49.5% from 45%. Meanwhile, the Bloomberg Consumer Comfort survey corroborates. Not the results you want to see headed into the holiday shopping season.
- The bull’s thesis that the global economy remains on firm footing belies the true nature of the recovery’s condition (or lack there of), especially when looking at the latest Eurozone Services PMI data. October’s measure shows contraction for the sector at the broadest pace in more than 2 years (47.2 from 49.1). More austerity coming down the pipe doesn’t bode well in the months ahead. While “CAT” may have scored an A+ in its earnings and outlook, a slew of other companies (one of them being 3M) don’t see the same scenario in the coming quarters. Officials in Hong Kong report the country’s first drop in exports in almost 2 years and see the outlook as “bleak”. India is dangerously approaching stagflationary conditions, evidenced by their recent rate increase coupled with a downgrade of their GDP forecast. Japan downgrades its growth forecast as well.
- Let’s simplify the opprobrium with regards to the Eurozone’s latest bailout (nitty gritty can be seen here). 1st) it fails to respect the laws of mathematics, such as factoring out pre-existing commitments and guarantees that won’t be paid (“stepping-out guarantors”: Greece, Ireland, Portugal, Spain, and Italy); 2nd) it fails to account for historical first-loss rates of 50% for sovereign defaults, not the 20% agreed; 3rd) it fully eliminates the possibility of Belgium getting its rating slashed, which would eliminate their contribution to the bailout fund—-we’re not even considering France yet, even though the OAT/Bund spreads are close to record highs; and finally 4) It decimates the Sovereign CDS market, which has its own unintended consequences. The best method of protection now is simply not to buy/provide credit, or outright selling/shorting of sovereign bonds. On a side note, this bailout result for Greece becomes an incentive for other countries who have fallen on hard economic times to demand the same treatment. ”Why should we suffer when they got rewarded for not fulfilling their austerity promises?”. The circular nature of this plan, the faulty math, and its the rosy assumptions make it unequipped to handle even a slight deterioration in the economic landscape; for instance, a recession in Europe (which would jeopardize France’s AAA rating), or a highly probable downgrade in Belgium. The Chinese aren’t confident and are prevaricating in their commitment to fund the rescue. To drive this whole point home, there was little follow-through from Thursday’s rally and doubts are already resurfacing.
- On the subject of Italy, do the bulls really think that officials are serious about implementing the “required” austerity? One of the “famed” proposals is to increase its retirement age from 65 to 67 by the year 2026. And to achieve that, a fight broke out in the legislative chamber; imagine what actual near-term austerity would do. Most importantly, the Italian sovereign debt market didn’t bite on the solution. An acute sovereign risk remains.
- Governments are incapable of allocating a nation’s resources. These are the results of their actions. And now they just doubled down by leveraging up to save a failed Euro experiment. Europe, you are not defeating the speculators, you are making them stronger. The specious plan of leveraging the EFSF is only working to infect the core of Europe and more importantly is beginning to seed a dangerous sense of nationalism as continued demanded austerity is slowly being seen as a (il)legal act of war. The more hardship there is (Spain Unemployment just hit the highest in 15 yrs), the more fervid this sentiment it will become.
- Do you want to put stock in some PMI survey gauging peoples’ perceptions of the Chinese economy, or do you want to see hard evidence of a slowdown? Here’s some disturbing activity in the property market. The bubble is popping. Time to choose one of two fatal poisons for the Communist party, Mr. Wen. Clamp down on credit and you get increased protests as people’s life savings vanish as the property bubble pops leading to a subsequent collapse of the economy; or stimulate, leading to wage/panic-induced inflation spiraling out of control. Material Yuan appreciation seems to be out of the question, to the chagrin of Congress. Clock’s ticking Mr. Wen. One thing you might want to remember is that the Fed is pondering another QE experiment (ie. exporting inflation). Just thought you’d like to know.
- A dangerous escalation took place between government authorities and “Occupy (You name the city)” movement. The trend of this campaign is moving toward violence, not compromise. The country’s politics fell into disrepute long ago, but this may take it to a whole new level. Politicians better start doing something and soon.