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Over another slow news week, which was again dominated by retail earnings and barbs between Republican presidential nominee Mitt Romney and President Obama, markets rallied to set a new high not seen in years.Economists shifted their commentary to those gains and asked: how much longer can they continue?
Jeff Gundlach and Ed Yardeni offered some nice analysis on the new S&P 500 peak, while Michael Feroli and David Kotok gave us their best ideas how to fix the economy.
'I now think the correct thing to do -- as I also said in April and June -- is to prepare for a serious risk-off phase between August and November,' he reiterated. 'Over the August to November period I am looking for the S&P 500 to trade off down from around 1400…by 20% to 25%...to trade at or below the lows of 2011.'
'One crazy idea I like is to institute a series of periodic, small increases in a national sales tax. This would have the effect of creating deeply negative real interest rates by increasing the incentive to pull forward demand into the current period when it is less expensive. To offset the disposable income drag it would need to be coupled with equal and offsetting decreases in income and other taxes. This idea has been kicked around by mainstream economists (Feldstein, Kocherlakota, etc.) and nobody has been able to poke any major theoretical holes in the argument...'
Complacency, as measured by the low VIX, is the highest it's been in months, as a lack of negative newsflow out of Europe and recent economic data in the U.S. has surprised investors to the upside.
Kass writes that 'typically, the decline in the markets, off of a low VIX is quick and relatively severe.'
'The key take away from the minutes that has prompted a number of economists to proclaim the inevitability of QE3 can largely be found in a single sentence: 'Many members judged that additional monetary accommodation would likely be warranted fairly soon...' Quite convincing, no? No, because the modifying clause was de-emphasised, if not ignored: '...unless incoming information point to a substantial and sustainable strengthening in the pace of economic recovery.''
'We suspect -- we do not know, we suspect -- that this is one of the options -- capping yields -- that the ECB is looking at. We do not think it's likely to materialise because it's such an open-ended commitment. Remember, an ECB can say, like they did for LTRO1 and LTRO2, we can intervene up to a certain amount on our balance sheet. The minute they target a yield level, they are saying basically it's unlimited intervention. And we don't think the ECB is there.'
'However, we think that the potentially advantageous terms Spain could receive under a full bailout could enhance the chances of success of Spain's already ambitious and politically challenging fiscal and economic reform agenda.'
Presidential candidate Mitt Romney has gone so far as to say he would call China a currency manipulator on his first day in office. And the U.S. has filed WTO complaints about Chinese curbs on exports of rare earthsand other raw materials.
But a trade war could be damaging to president Obama's goal to double U.S. exports by 2014 since China is the country's third largest export market. Remember, U.S. exports to China, which surged 542 per cent from 2000 - 2011.
'Earnings tend to rebound sharply during the start of bull markets and to grow less rapidly as the bull ages. Based on the performance of forward earnings over the past year, this bull market is ageing. After all, it will be 3½ years old next month. While I'll be happy if my year end S&P 500 target of 1450 is surpassed in coming months, it's getting harder to see much more near-term upside for the S&P 500 unless there is more upside in the forward P/E ...'
'Strength is SPX and other 'developed' stock markets reflects sentiment improvement regarding Europe versus the abject doom and gloom depths of late May/early June. Weakness in SHCOMP reflects concern over slowing growth in China compounded by higher food and energy prices since late May/early June.' As a followup, we asked Gundlach if he thinks this divergence can last much longer: 'I doubt it. Thus short SPX long SHCOMP could be an interesting speculation.'
'A lame-duck Congress may well end up kicking the fiscal can down the road even further, but there is not much it can do about the fact that the worst drought in the U.S. in five decades has destroyed nearly 20 per cent of the country's expected corn. Global food price inflation is bound to severely squeeze consumer spending everywhere. The harvest for soybeans is widely expected to be the lowest in five years too.'
'We remain very concerned about the outlook. In our view, the markets have been lulled to sleep by a temporary remission in negative macro news. The better US data probably reflects a combination of the usual random variation and weather distortions. Mild weather boosted the winter statistics, there was a payback in the spring and now the data are settling into a weak trend...'
We suspect the Markit index will prove to be a better indicator of manufacturing trends than the ISM because of its wider coverage of manufacturing firms. With only a short history, it has tended to correlate better with trends in output than the ISM.
'Today, instead of rallying above its May 1st peak, the D-J Industrial Average sold off an hour before the close. The sell-off left the Dow around 70 points below its May 1st peak ... My only conclusion is that something evil and bearish is bubbling in the guts of this market -- and it's giving the market a severe case of indigestion. Of course, I could say that with a yield below 3%, the Dow is classically overvalued, and any rally would just render the Dow more overvalued.'
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