ForecastStocks:
The European debt contagion remains front and center. Greece and France are holding elections this weekend, and everyone is on “pins and needles” as to the outcomes. Spain and Italy bond yields are high and they are rising...a bearish circumstance. China remains on a growth deceleration curve, with growing concerns of a very hard landing — some estimates see only 7.0%. Also, let us not forget that US economic data is softening...surprising many. Collectively, we find all of this rather troubling as good news headlines are few and far between, which has led to increased selling pressure on rallies.
Strategy: The S&P 500 remains above long-term support at the 160- wma at 1190; which delineates bull/bear markets. However, the 200-dma support zone at 1266-to-1278 turned prices higher into overhead resistance at 1340...with a bearish key reversal lower forming several days prior. We find this bearish for lower prices ahead.
European markets are modestly higher in response to Sunday’s elections in both Greece and France. As for Greece, the pro-austerity New Democracy won a bit over +29% of the vote, while the left wing Syriza party won roughly +25%. This allows New Democracy the ability to form a new government, and many believe it is only a simple matter. In France, voters gave Prime Minister Hollande a mandate the Socialists have not seen in 30-years by voting more than 300 Socialist seats into parliament. This is all the news worth knowing this morning really.
Now, on to the market’s response to the news: European share prices are modestly higher. European bond yields are rising across the continent, with Spanish yields rising +26 bps to 7.14%; Italian yields by +14 bps to 6.07%...and French yields by +2 bps to 2.61%. One would only wonder how high Spanish/Italian yields would have risen if the Greek elections had moved the other way! Also, we are not officially putting French yields on our “watch list” given the Socialist mandate and the fact that France’s debt-to-GDP stands at 90%...the level Rogoff and Reinhart have noted when debt problems begin to materialize. The euro is also lower after having been higher; precious metal prices are declining; and commodity prices are declining. It’s a simple “risk-off” environment.
Trading Strategy: Last Thursday, we exited our punt on higher interest rates as we suspected the Greek/French elections wouldn’t solve anything; and in light of the Fed meeting beginning tomorrow and ending on Wednesday afternoon. We understand that SocGen has thrown out a note saying the Fed will move to do another $600 billion in QE-3 (60% Treasuries/40% mortgagebacked securities) and $150 billion in “Operation Twist II.” That’s a rather aggressive move by the Fed, but we are unsure if it will do anything other than perhaps “goose” the markets for a short period as interest rates are extremely low already. If the Fed pushed the 10-year note from 1.60% to 1.20%...what will that really accomplish that hasn’t already been accomplished by it pushing it lower from 2001’s high of 3.75% to 1.60%. To us, it seems like the law of diminishing return; and it is beginning to feel a bit like what the Japanese did for many years…push on a string.
We are short the Russell 2000 Small Caps via TWM; and we see no reason to change our stance at this point. It is a starter position, and currently has a negative beta of -0.39. We expect to add another 10% to our position with the breakdown of certain hurdle rates such as the 1305 level in the S&P 500, and then the 1265 level to add a final position. We don’t want our beta to get any higher than -1.0…which would mean an aggressive short position equal to 100% of the Russell.
But having said this, we may soon choose to add a long precious metals or mining positions as the case may be. The miners are finally showing outperformance characteristics, and when we do get long these stocks – we’ll stick with the more well-known and high volume Barrick’s (ABX) and Newmont Mining’s (NEM) of the world, with perhaps a small ETF position in the junior gold miners (GDXJ) to add just a bit more alpha to the position. For now, we are content on the sidelines.