After four weeks of declines in equity prices, it’s natural to wonder which way stocks are headed. There is great uncertainty surrounding the Eurozone’s ability to contain, let alone solve, its “Black Debt” crisis, and economic indicators from the U.S. have been very disappointing. This week’s Philly Fed report was dismal. Eric Green, economist at TD Securities, described it as “exceptionally weak, almost macabre.” (Philly Fed report evokes dark images from economist) When major analysts describe the markets using terms commonly found in the nightmarish parts of H.P. Lovecraft stories, investors become skittish.
Some respond with anger. “They’re mad as hell, and they aren’t going to buy the dips anymore” is how the Wall Street Journal described small investors. They are an unhappy lot who are “too frightened and too angry to buy, they are simply watching with a sense of helpless horror.” An online survey conducted by a team of psychologists asked Americans questions designed to determine the impact of the recent financial turmoil on their mindset. The results were discouraging. When asked how angry they felt about “the financial challenges facing our country now,” 59% said they were either “moderately” or “very” angry, and 52% said they were either “moderately” or “very” fearful. “The mood of investors is at least as bad as in the darkest days of early 2009, when the financial world itself seemed about to end.” (Too Flustered to Trade: A Portrait of the Angry Investor)
Others respond in a more active manner – they panic and sell out of the equity markets, blindly running for the exits as they allow fear to take over their decision-making process. “Janet Moffett says that her stomach dropped on Thursday as her anxieties about the economy worsened. The 73-year-old Beverly, Mass., resident, who retired in April, planned to call her financial adviser after she ‘settles down’ to ask that he move more of her $200,000 investment portfolio into cash. Otherwise, she says, ‘I think I am going to be wiped out.'” (Last Straw or Time to Buy?)
Some professional money managers may be turning more bullish after the recent sharp declines. Hedge fund manager Barton Biggs appeared on Bloomberg Television this week, saying, “We may be in the process of making an important bottom…if analysts and investors really believed the S&P earnings estimates, the market wouldn’t be selling where it is.” (Biggs Says S&P May Be Bottoming, Priced for 15% Profit Drop) However, Mr. Biggs tends to be bullish even when bullishness is unwarranted. For example, he was bullish in late May this year. As Phil observed, “If you are always telling people to buy-buy-buy, can anyone really follow your advice?” (Biggs Says Stock Bears Wrong Even as Economy Slows: Tom Keene)
Lee Adler of the Wall Street Examiner is less optimistic. He explained, “As Treasury prices rise, the shorts are squeezed and margin calls go out, forcing liquidation of equities and some commodities, forcing even more margin calls. Dealers, who no longer have the support of the Fed in absorbing Treasury supply, must commit an increased portion of their resources to absorbing massive waves of new Treasury supply before distributing it to the market. Until the end of July, they had been short Treasuries on balance, and had to absorb big losses as a result.”
Lee also warned that the flow of money out of mutual funds, is troubling. “Mutual fund investors unloaded a mind bending $23.5 billion net of domestic equity funds in the week ended August 10. That was up from $10.4 billion the prior week as the cascade of money out of those funds accelerated. If we project this to a monthly rate it will obliterate all previous monthly outflows going back to 2007. This should not be taken as a contrary indicator. It forces fund managers to liquidate holdings. Furthermore, these flows have a good history of leading the market. Inflows should begin to increase a month or two before the market bottoms, if past history is any guide.” (Lee’s WSE – Professional Edition)
Joshua M. Brown, of “The Reformed Broker,” blog, discussed strategies he developed over the years to survive market crashes. He points out the importance of acknowledging the reality of the situation and he explains why the advice of brokerage firms is neither unbiased nor helpful during times of crisis. “Watch sentiment more closely than technicals or fundamentals. Pay attention to the squishier things in a crash (even more) than you would normally… There is no maths to this, a lot of it is ‘feel.’ Abandon any hope or intention of catching the bottom. You won’t and it is unnecessary. Suspend disbelief… Anything can happen in a crash, there are machines making the trades and they have no respect for the prestige or standing of a particular company.” (Downtown’s Rules for Surviving a Crash)
Bill Strazzullo, chief market strategist at Bell Curve Trading, is well-known for his generally bearish outlook on the markets. He appeared on CNBC this week to discuss what he feels are the current trading ranges for the markets. “What you’ve got to get your arms around is what’s the new trading range.” He believes investors should be reducing exposure to the S&P in the 1,200 to 1,250 range and adding stocks at the low point of the 950 to 1000 range. For the Dow, he recommends selling in the 11,300 to 11,700 range and buying in the 9,000 to 9,400 range. (Dow 9000 Possible – and It’s a Buying Opportunity: Strategist)
The Eurozone’s continuing slow motion meltdown is having its own negative impact on the markets. The crisis has dragged on without any solution, as fiscal contagion spreads from peripheral countries (Ireland and Greece) to pillars of the European economy (Italy and Spain). It is now threatening to engulf France and Germany, the EU’s two largest economies. So far, there has been an implicit expectation that taxpayers in Germany will be willing to pay to preserve the Euro, no matter what the price. However, that notion is now being challenged. Germany’s people are openly expressing their hostility to the endless bailouts, and asking “Who will be left to bail us out?” (All eyes on Germany in Europe debt crisis)
Examining what is different today in comparison with several weeks ago – when the markets were higher and the VIX was around 17 – it seems clear that many changes have been largely about perception. Perceptions have turned very negative and the media has been increasingly playing on fears (e.g. the U.S. debt ceiling crisis and the big default scare). Conversely, if the economy gets so bad, and the stock market falls low enough, many believe the Fed will step in with another short term fix to prop up the stock market – QE3.
Ben Bernanke will speak this coming Friday, August 26, at the annual central banking meeting in Jackson Hole, Wyoming. According to currency strategists at BNP Paribas, “‘Risk in the coming week and ahead of the all-important Jackson Hole address by Fed Chairman Bernanke on Friday may revolve in large part around the incoming eurozone economic news’… This time round, however, there are a lot of doubters that Bernanke has anything more to offer. See related blog post on David Rosenberg’s projections that the Bernanke “put” is dead.“ (6 days, 18 hours, 51 minutes to Bernanke’s Jackson Hole speech)
Phil observed, “The markets tank right at the time we’re auctioning off a ton of T-Bills. This has happened every time since QE2 ended and then, on Friday – BERNANKE SPEAKS AT 10! Imagine what kind of epic market crash we will have if he throws an air-ball on Friday!” Traders will be listening closely to Bernanke’s comments, looking for hints about the launching of QE3.
QE3 or not QE3, is the question. Joe Weisenthal of Business Insider thinks more easing is unlikely, due to growing inflation. (The Odds Of Imminent QE3 Are Rapidly Plunging) St. Louis Fed President James Bullard remarked, “I think it is a much tougher call to do more QE this time around than it was last year. The inflation picture is different this year than it was last year and the risk of deflation is much more remote than it was last year.” (Fed’s Bullard Says New 2013 Rate Pledge Not a Signal for More Bond Buying)
If the Dollar strengthens, and the previous inverse correlation between the Dollar and the Dow reemerges, the stock market is likely to drop, barring significant extraneous factors such as a Eurozone meltdown, or an unexpected outbreak of civil unrest. Of course, extraneous factors are already in place – the Eurozone’s debt crisis, the unrest in Syria, the Japanese triple disaster of earthquake, tsunami and nuclear meltdown, and the civil war in Libya. On Saturday evening, Zero Hedge reported, “As if the global liquidity crunch was not bad enough…geopolitical risk is back after headlines from both Libya and Israel indicate that the Levant region is on the verge of systemic instability once again.” (Geopolitical Risk Is Back As Libya And Israel Make Headlines) What were once rare, “black swan” events are now happening in clusters, with extraordinary events merging into a giant mutant “Swanzilla” that is destabilizing the financial landscape.
We will be watching key issues next week – the handling of the “Black Debt” crisis in the Eurozone, the unrest worsening in the Middle East and other regions, and Bernanke’s speech on Friday. Any of these have the potential to greatly move the Dollar and the stock market. If the EU debt crisis harms the Euro, the Dollar may benefit, and this may hurt equities. If Bernanke announces some form of QE3 on Friday, the Dollar will likely drop, which is likely to boost both stocks and commodities. And, as Zero Hedge writes, “Alas, when geopolitics enters the equation, the only certain thing is a surge in uncertainty. That this will likely not benefit global equity markets goes without question.”
We remain “cashy and cautious,” and have only one trade idea this week (below). King, at this time, is cash. Cash is good, cash is flexible, and cash lets us buy stocks when they go on sale. After Bernanke speaks on Friday, we may have a better idea of where the market is headed. As Lee Adler of the Wall Street Examiner puts it, “we need to keep our noses to the wind for whatever malodorous plans come out of Jackson’s Hole this week.”