Perspective: Despite Drama, Technical Picture Still Shows Short Term Range Bound Market
For all the drama from the EU and US debt crises, and growing evidence of economic slowdowns in the largest economies, an objective look at risk appetite, regardless of your chosen barometer, still shows risk assets within relatively narrow ranges. For some perspective, look at the weekly S&P 500 chart below.
S&P 500 WEEKLY CHART COURTESY ANYOPTION.COM 02 jul 17 0356
Key points to note:
From the multi-year high in May around 1361 to the recent low around 1261 in the last week of June, we saw a 7.34% drop, most of which has been regained, with the index now around 1314. So even with the past week’s loss from some scary events in the EU, the index is only down3.45%.
Thus far we have triple layered support around the 1300 level from:
- Both the 20 day (yellow) and 50 day (red) EMAs
- The psychologically important 1300 price level itself. Note on the daily chart below how often this level (horizontal red line) has served as support or resistance
S&P 500 DAILY CHART JANUARY-JULY 2011, COURTESY OF ANYOPTION.COM 02jul 17 0027
Note also that until we get a decisive break below the 50 day EMA (red) the index does not tend to plunge.
Thus in essence for all the drama, we’ve been in fairly tight trading range, though since April 2011 we’re still in an overall downtrend. To get below the current strong support at 1300 and start the next leg of the downtrend that the above chart shows and the fundamentals in Part 1 and here in Part 2 suggest, we’ll need some more negative fundamentals to drive that move lower.
Here are the likely market movers for next week, and overall they provide plenty of negative potential to keep the downtrend intact, breach the 1300 level, and open the door for a longer drop into the mid 1200s.
For perspective though, from the current 1314 to the 1250 area, that would be another 4.87 % drop. That’s still nothing more than a normal 10% pullback from the April highs).
Now let’s look at the likely fundamental drivers for the coming week.
Growing EU Contagion Risk While German Restructure Plan On The Table
As noted in, as long as the German insistence on private sector “burden sharing” aka restructure , forcing losses on bondholders, whatever you want to call it, remains up for consideration, expect PIIGS bond yields, and thus default fears, to continue rising. The private sector is being frightened off from PIIGS bonds, sending PIIGS bond yields soaring to reflect the rising risk premiums associated with buying bonds backed by no one but Portugal, Spain, Italy, etc.
The latest and perhaps most worrisome development last week was Italy’s spiking bond yields, just when it must refinance over €60 billion of bonds in the coming 6 weeks. To give some perspective, that alone is about half of the entire Greek rescue package up for debate. Of course the ECB and other global leaders will do what they can to make sure these auctions are relatively successful. We just don’t know if they’ll succeed, with the private sector now chased away.
As long as there is no clear progress on a solution that prevents further fear of unknown losses from a PIIGS restructure (aka partial default), we can expect more uncertainty and fear to be reflected in rising PIIGS bond rates, which in turn feeds the fear cycle further.
The next chance for the announcement of such a plan is the EU emergency summit scheduled for July 21st. Expect assorted EU and other officials to talk up the chances for a solution to the Greek rescue plan in the hope of keeping the fear and PIIGS bond yields from getting beyond the EU’s control. So it’s possible that markets may stay hopeful until the meeting. The thing that might prevent that is….
Reaction To 2nd Annual EU Bank Stress Tests Charade
As noted in Part 1, we find this year’s stress test results as unconvincing as those of last year. These were released after the close of trading in Europe, with a view to giving markets time to digest the results, which in theory should bring less volatile reactions in the market. The problem is, the more one considers the results, the worse they look. We discussed why in Part 1.
The key point, the tests did not consider how the banks would hold up if Greece defaulted, a distinct possibility in the near future and, per credit markets, a strong likelihood in the coming years at most. In other words, the standards were once again too lax.
Earlier this month, Moody’s ran its own tests and according to their results, almost a third of the 91 banks tested failed.
According to S&P’s tests, 25 per cent of the banks failed. Thus we could hear more complaints this week about the tests not being completely accurate, which may explain why the euro failed to hold onto its gains after the test results were released in the final hours of US trading.
Traders may decide to wait and see if the above EU meeting will provide some hope. Or, they may decide to continue to sell off risk assets, especially anything directly exposed to PIIGS debt, which is pretty much every risk asset out there.
EU Emergency Summit
The emergency summit originally scheduled for last Friday July 15 was pushed off for almost another entire week because European leaders STILL don’t have a solid Greek rescue plan on which they can agree. Considering the stakes, this alone is troubling, and reminiscent of exactly the same thing that really catalyzed last year’s Greek crisis: a failure to take timely, decisive action that allowed confidence in the EU to erode. After a series of agreements to reach agreements, plans that were too little too late, lacking in detail, even €750 bln couldn’t even restore confidence, it barely bought the EU a year’s breathing space.
The cause for the indecision is also apparently the same – German officials demanding too much in order to satisfy German voters, even though in the end they’re likely to be forced to abandon their demands or face a wave of sovereign and bank defaults that are likely to bring a global crisis far worse than that of the ‘Lehman moment’ of 2008/
Markets have noted that the past year’s respite, bought for€750 bln was utterly wasted, and the situation is worse. There are now 3 nations getting bailouts, each likely to need another soon. The other 2, Spain and Italy, are considered too big to bail out. However both are seeing their rates soar now that private bondholders fear PIIGS bonds are no longer backed by the EU.
Spain and Italy must be able to refinance their bonds at affordable rates or the EU goes down and as we noted in Part 1, so does the global economy.
Thus events in the EU alone could be enough to keep risk assets on the defensive and keep preferred safe havens like precious metals, the CHF, (and perhaps the what maybe the newest safe haven currency, the NZD) moving up.
However, there are some other potentially scary market movers out there from the other side of the Atlantic.
US Debt Ceiling Deadlock Risks AAA Rating
The EU isn’t the only currency zone abusing the trust of its creditors.
With a final countdown to August 2nd and severe consequences should it not be fixed; the pressure is building on both the USD and global markets. On Friday, the Treasury announced it was suspending its Exchange Stability Fund (the fourth and last fund it could tap to temporarily cover the between funding needs and the old debt ceiling). Fear has still not set in for the possibility that the US temporarily defaults and thereby receives a downgrade from the credit rating agencies because the consensus is still that it is so remote.
However as August 2nd approaches the fear could grow quickly. We see the signs already. For example
Two of the top rating agencies in the world have already warned that they will strip the U.S. of its prized AAA rating if the debt ceiling is not increased over the next 2 weeks.
China, the U.S.’ largest creditor called on the U.S. last week to protect the interest of its investors because China understands that a ratings downgrade can have a cataclysmic effect on the U.S. dollar and in turn the value of its foreign currency portfolio.
Even though the chances of Washington not striking a deal are remote, the consequences of this happening alone are enough to rattle markets. The prime concern is loss of the US’s special AAA rating, the basis for the USD’s status as the world’s reserve currency. The US has never missed a debt payment, and doing so once, even temporarily, risks changing market perception of the USD dramatically. That in turn would cut demand for US Treasury bonds, something the US cannot afford given its own high debt levels. Other US assets could also lose appeal, given the USD’s additional weakness.
Indeed, given the USD’s low rates, its perceived safety is the only appeal it has left.
Thus we still believe that the players in Washington will in the end fear being blamed for the consequences of failing to reach a deal. Meanwhile, there’s still time for some brinksmanship and thus for markets to fall or rise along with hopes for a deal.
US Q2 Earnings Season Moves Into High Gear
The 2nd and 3rd week of earnings season are usually the most influential. However if last week was any guide, earnings will matter only if EU and US debt issues remain quiet.
Some of the top names reporting next week that could influence markets include:
International Business Machines (IBM), United Technologies (UTX), PNC Financial Services (PNC), Capital One Financial Corp. (COP), Bank of New York Mellon Corp (BK)
Apple (AAPL), Goldman Sachs (GS), Johnson & Johnson (JNJ), Bank of America (BAC), Coca Cola (KO), Wells Fargo & Co. (WFC)
American Express (AXP), Intel (INTC)
Morgan Stanley (MS), Microsoft (MSFT), AT &T (T)
McDonalds (MCD), Caterpillar (CAT), General Electric (GE), Verizon (VZ),
Key Calendar Events
The coming week’s calendar has events of note but little in the way of real Tier one events that could compete with action in the above mentioned likely market movers.
Key events worth noting include:
US TIC Long Term Purchases
Australia: Monetary Policy Meeting Minutes
EU: German ZEW sentiment
US: Building Permits
UK: MPC Meeting Minutes
US: Existing Home Sales
Assorted flash PMIs from the EU, also China. Collectively these may be significant if they point in the same direction.
UK: public sector net borrowing
US: Fed Chairman Bernanke Testifies on the Dodd-Frank Act Anniversary, Philly Fed Mfg Index
EU: German Ifo sentiment survey
Canada: CPI, retail sales
Conclusions: What To Do
Given the potential volatility with the EU entering another debt crisis mode and the US not far from one itself, we stand aside and wait for a signal. Fundamentals suggest more downside potential, but we don’t want to start being short risk assets until we get that break under 1300 in the S&P 500. Fundamentals rule over the long term but we base our entries on technical signals, because you can’t time any entry or exit based on fundamentals. You need to let the markets tell you when the price is ready to move.
See also Part 1for specific ideas.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?