Friday, December 30, 2011

Done for the year. The DJIA finishes 2011 up about 5%, the small-caps finish down about 5% and the Nasdaq and S&P 500 are somewhere in between. 2011 was a year when the trading was often dominated by news headlines, particularly about Europe, but the biggest difference this year had to do with the structural changes in the way that things traded. The tight correlation between individual stocks, the dominance of ETFs and computerized trading, the lack of leadership and the soft momentum required plenty of adaptation to stay a step ahead.
Currency debasement remains an overriding theme in the year ahead.
After drifting down on low volume yesterday, we drifted back up and recouped most of those losses today.

AMZN and precious metals saw a little panic selling early, but the dip buyers jumped in and had them well off their lows by the close. Leadership by banks was probably the most surprising aspect of the action today, but it's a mistake to draw serious conclusions from this thin, whippy, end-of-year trading.

The most important thing to keep in mind is that just because it's the end of the year, that doesn't mean stocks will necessarily hold up. It isn't unusual to see profit-taking as money managers book gains and position for the new year. Many traders like to start a new year with high levels of cash and will clean the slate on the last day of trading.

Thursday, December 29, 2011

Goldman Sachs lowers SHLD price target to $30 a share today and reiterates its Sell recommendation.

Italy had a reasonably good six-month auction last night, and its 10-year bond yields are down by about 19 basis points, to 6.70% this morning. (Spanish yields are off by 25 basis points, while German and French yields are unchanged.)

A total of 9 billion euros was bought in the auction, in line with consensus, at a yield of 3.25% (the lowest level since October). Bid-to-cover was almost 1.7 v. 1.5 a month ago. Yields at that time were over 6%.

Italy also sold 1.7 billion euros of two-year zero-coupon bonds at an average 4.85% (a month ago it was 7.8%).

Tomorrow's 10-year Italian bond will be more of a test.

The ECB reported a record amount of deposits (452 billion euros vs. 412 billion euros), as market liquidity is still uncertain and raises the specter that the LTRO facility will not materially benefit sovereign debt yields/purchases. This probably offsets the better auction with regard to the impact on risk assets today.

Finally, Japanese industrial production contracted by 2.6% last month. This was worse than expected and represented the first drop in two months.
Thin holiday trading can be fun when it has a positive bias, but when the sellers dominate like they did today it can be downright dismal. We had an early afternoon bounce attempt that fizzled quickly, and we drifted lower into the close. That wiped out the last two days of gains and put the S&P 500 back in the red for the year.

Although volume was light, it picked up over yesterday and was quite broad. It is a technical distribution day, which puts the S&P 500 back under the 200-day simple moving average and gives us a failed breakout.

We have a variety of agendas at work at the end of the year and stocks aren't moving on their individual merits. It is all about taxes, mark-ups and position. The thin trading allows a good amount of manipulation as well.

Wednesday, December 28, 2011

Don't be surprised if -

Sears Holdings declares bankruptcy. In a possible spectacular fall, Sears Holdings shares could be halted this spring at, say, $18, as as vendors turn away from the retailer, owing to a continued and more pronounced deterioration in cash flow (already down $800 million 2011 over 2010), earnings and sales. With funding and vendor support evaporating, as paper-thin earnings before interest and taxes margins turn negative and cash flow is insufficient to fund inventory growth. The number three in the industry has little value -- especially after store improvements were deferred over the past several years. A major hedge fund and a large REIT join forces in taking over the company. Ten to fifteen percent of Sears' 4,000 Kmart and specialty stores are closed. More than 35,000 of the company's 317,000 full-time workers are laid off. As a major anchor tenant in many of the nation's shopping centers and with no logical store replacement, the REIT industry's shares suffer through the balance of the year, and the major market indices suffer their only meaningful correction of the year.

"Never make predictions, especially about the future."

-- Casey Stengel

"I'm astounded by people who want to 'know' the universe when it's hard enough to find your way around Chinatown."

-- Woody Allen

There are five core lessons I have learned over the course of my years -

1. how wrong conventional wisdom can consistently be;
2. that uncertainty will persist;
3. to expect the unexpected;
4. that the occurrence of Black Swan events are growing in frequency; and
5. with rapidly changing conditions, investors can't change the direction of the wind, but we can adjust our sails (and our portfolios) in an attempt to reach our destination of good investment returns.

As a society (and as investors), we are consistently bamboozled by appearance and consensus. Too often, we are played as suckers, as we just accept the trend, momentum and/or the superficial as certain truth without a shred of criticism. Just look at those who bought into the success of Enron, Saddam Hussein's weapons of mass destruction, the heroic home-run production of steroid-laced Major League Baseball players Barry Bonds and Mark McGwire, the financial supermarket concept at what was once the largest money center bank C, the uninterrupted profit growth at FNM and FRE, housing's new paradigm (in the mid-2000s) of noncyclical growth and ever-rising home prices, the uncompromising principles of former New York Governor Eliot Spitzer, the morality of other politicians (e.g., John Edwards, John Ensign and Larry Craig), the consistency of Bernie Madoff's investment returns (and those of other hucksters) and the clean-cut image of Tiger Woods.

"Consensus is what many people say in chorus but do not believe as individuals."

-- Abba Eban (Israeli foreign minister from 1966 to 1974)

In an excellent essay published a year ago, GMO's James Montier made note of the consistent weakness embodied in consensus forecasts. As he puts it, "economists can't forecast for toffee."

They have missed every recession in the last four decades. And it isn't just growth that economists can't forecast; it's also inflation, bond yields, unemployment, stock market price targets and pretty much everything else.... If we add greater uncertainty, as reflected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!

-- James Montier

"Those who cannot remember the past are condemned to repeat it."

-- George Santayana

Here are Goldman Sachs' forecasts for 2012:

* 2012 U.S. real GDP up 1.8%, and global GDP up 3.2%;
* 2012 S&P 500 operating profits of $100 a share;
* year-end 2012 S&P 500 price target at 1250;
* 2012 inflation of +1.7%; and
* 2012 closing yield on the U.S.10-year Treasury note at 2.50%.

"More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other to total extinction. Let us pray we have the wisdom to choose correctly."

-- Woody Allen

Don't be surprised if -

The U.S. stock market approaches its all-time high in 2012. The beginning of the New Year brings a stable and range-bound market. A confluence of events, however, allows for the S&P 500 to eclipse the 2000 high of 1527.46 during the second half of the year. The rally occurs as a powerful reallocation trade out of bonds and into stocks provides the fuel for the upside breakout. The market rip occurs in a relatively narrow time frame as the S&P 500 records two consecutive months of double-digit returns in summer/early-fall 2012.

Strategy: Buy out-of-the-money SPDR S&P 500 ETF Trust (SPY) calls.

Don't be surprised if -

The growth in the U.S. economy accelerates as the year progresses, particularly in the late summer/early fall. The U.S. economy muddles through in early 2012 through the summer, but, with business, investor and consumer confidence surging in the fall, real GDP accelerates to over 3% in the second half. Unemployment falls very slightly more than consensus, but the slack in the labor market continues to constrain wage growth. Domestic automobile industry sales soar well above expectations, benefiting from pent-up demand and an aging U.S. fleet. Inflation, at least in how it is falsely counted by our government, is contained but begins to be worrisome (and serves as a market headwind) in late 2012. Corporations' top-line growth is better than expected, and wage increases are contained. Operating margins rise modestly as sales growth lifts productivity and capacity utilization rates. Operating leverage surprises to the upside as 2012 S&P profits exceed $105 a share.

A noteworthy surprise could be that the residential real estate market shows surprising strength. The U.S. housing market becomes much bifurcated (in a market of regional haves and have-nots), as areas of the country not impacted adversely by the large shadow inventory of unsold homes enjoy a strong recovery in activity and in pricing. The Washington, D.C., to Boston, Mass., corridor experiences the most vibrant regional growth, while Phoenix, Las Vegas and areas of California remain weak. The New York City market begins to develop a bubbly speculative tone. Florida is the only area of the country that has had large supply imbalances since 2007 that experiences a meaningful recovery, which is led by an unusually strong Miami market.

Strategy: Buy HD, LOW, building materials and homebuilders, and buy auto stocks such as F and GM.

What we desperately need -

1. A broad infrastructure program focused on a massive build-out and improvement of the U.S. infrastructure base -- the restoration of our country's highways, bridges and buildings and an extensive internet bandwidth expansion.
2. The annual increase in government spending is limited to the change in the CPI. It's a start.
3. A comprehensive jobs plan including new training programs -- all veterans are made eligible to tuition subsidies to vocational schools and colleges.
4. A Marshall Plan for housing, highlighted by a nationwide refinancing proposal adopted for all mortgagees (regardless of loan-to-values).
5. Mean test entitlements, freeze entitlement payouts and gradually increase the Social Security retirement age to 70 years old.

Strategy: Sell volatility.

Don't be surprised if -

A sloppy start in arresting the European debt crisis leads to far more forceful and successful policy. The EU remains intact after a brief scare in early 2012 caused by Greece's dissatisfaction (and countrywide riots) with imposed austerity measures. The eurozone experiences only a mild recession, as the ECB introduces large-scale quantitative-easing measures that exceed those introduced by the Fed during our financial crisis in 2008-2009.

Strategy: Buy European shares. Buy iShares MSCI Germany Index Fund (EWG) and iShares MSCI France Index Fund (EWQ).

Don't be surprised if -

The Fed ties monetary policy to the labor market. In order to encourage corporations to invest and to build up consumer and business confidence, the Fed changes its mandate and promises not to tighten monetary policy until the unemployment rate moves below 6.5%, slightly above the level at which wage pressures might emerge (the Non- Accelerating Inflation Rate of Unemployment).

Strategy: Buy high-quality municipal bonds or the iShares S&P National AMT - Free Municipal Bond Fund (MUB).

Don't be surprised if -

Cyberwarfare intensifies. Our country's State Department's defenses may be hacked into and compromised by unknown assailants based outside of the U.S. Our armed forces are place on Defcon Three alert.

Don't be surprised if -

Financial stocks are a leading market sector. After five years of underperformance, the financial stocks may finally rebound dramatically and outperform the markets, as loan demand recovers, multiple takeovers permeate the financial intermediary scene and domestic institutions enjoy market share gains at the expense of flailing European institutions. With profit expectations low, three years of cost-cutting and some revenue upside surprises (from an improving capital markets, a pronounced rise in M&A activity and better loan demand) contribute to better-than-expected industry profits.

Strategy: Buy JPM, C and XLF

Don't be surprised if AAPL pays a $20-a-share special cash dividend in the 2nd quarter, introduces a regular $1.25-a-share quarterly dividend and splits its shares 10-1. Apple becomes the T of a previous investing generation, a stock now owned by this generation's widows and orphans.

Strategy: Long Apple (common and calls).

Don't be surprised if -

We see merger mania. Cheap money, low valuations and rising confidence are the troika of factors that contribute to 2012 becoming one of the biggest years ever for mergers and takeovers. Canadian companies are particularly active in acquiring U.S. assets. Canada's Manulife (MFC) acquires life insurer LNC, two large banks join a bidding war for ETFC, and IFF and K are both acquired by non-U.S. entities. Finally, a Canadian bank acquires STI.

Don't be surprised if -

The ETF bubble explodes. There are currently about 1,400 ETFs. During 2012, numerous ETFs fail to track and one-third of the current ETFs are forced to close. There are several flash crashes of ETFs listed on the exchanges. The ETF landscape is littered by investor litigation as investor losses mount. New stringent maintenance rules and new offering restrictions are imposed upon the ETF business. The formation of leveraged ETFs is materially restricted by the SEC.

Don't be surprised if -

Israel Attacks Iran. The greatest headwind to the world's equity markets is geopolitical, not economic. Israel attacks Iran in the spring, but, at the outset, the U.S. stays out of the conflict. Iran closes the Strait of Hormuz, and oil prices spike to $125 a barrel.
Volume was by far the lightest for a full day of trading this year and breath was very mixed, but we had typical window-dressing action. Big caps like ISRG, GOOG, AAPL and CMG were walked up on low volume, but tax-loss selling pushed down many of the names that have been lagging this year.

Stocks are not trading much on their individual merits right now. The main driving force is squaring things up and being ready for the start of next year. If there is an opportunity to produce a little relative performance with a high beta big-cap, they will give it a go, but with a finger on the eject button.

It's typical to see at least one very aggressive bout of selling in the waning days of the year. Some folks come to conclude that it is better to lock in profits and pay taxes than defer them to next year and risk a pullback.

Saturday, December 24, 2011

SHLD may have a long ways to go - down.

Global easing continues as more cowbell is delivered in Russia, as the nation's central bank cut interest rates for the first time in 18 months.

The yield on the 10-year Italian bond is now at 7.077%.

November durable goods orders rose by 0.3% (excluding transports), slightly below expectations of +0.4%. October was revised modestly higher.

Non-defense capital goods orders (excluding aircraft) were very disappointing, falling by 1.2% against consensus for a gain of 1.0%. October was also revised higher here.

Shipments fell and inventories rose, so the inventory-to-shipment ratio increased to the highest level in two and a half years.

These capital spending reads should be viewed as a negative to risk assets, as they were recorded into the teeth (and expiration) of the 100% tax credit (which is halved in 2012).
It took a bit longer than many had expected, but the end-of-the-year rally finally kicked in Tuesday and we've been climbing slowly higher on declining volume since. In retrospect, the selling and negativity we had Tuesday was really the perfect setup for the turn. It assured that folks were out of position and set the stage for some chasing.

As has been the tendency once the turn occurred, we had V-shaped action, so thank you machines and algos. There was a little nervousness following a poor report form ORCL, but it was shrugged off and the bulls kept chugging along. The extremely light volume makes it challenging to jump aboard, but we have seen these sorts of moves so often it really shouldn't be a surprise.

The question now is whether the bulls will keep pushing next week. We have some obvious overhead resistance to contend with at the 200-day simple moving average and are a bit overbought, but these low-volume moves higher always seem to last longer than seems reasonable.

One thing we need to keep in mind next week is that there is often major repositioning as the year comes to end. It is not unusual to have some sharp selling in the last couple days of the year. For example, on the last day of 2009 we were down about 1% and in the last three days of 2007 we dropped more than 2%.

It has not been a good year for many fund managers, and they will be happy to sell losers and start with plenty of cash in 2012.

Thursday, December 22, 2011

An S&P downgrade of France should be imminent.

The yield on the 10-year Italian bond is up now 13 basis points, back up to 6.92%.

Run, don't walk, to read the Boy Genius Report's column on more potential issues at RIM.

The FHFA house price index, which measures a home's purchase price, fell modestly, and previous growth was revised lower. This index has been flat for the past six months.
We expect extremely slow but positive action around the holidays, and that is exactly what we got today. We gapped up slightly and meandered higher most of the day on about 3:1 positive breadth. Volume was the lightest for a full trading day this year.

Tomorrow the action is going to be even slower and the risk of choppiness even higher. Most folks will probably have better things to do, but if you look to daytrade for pennies, there may be some opportunities.

One theme worth looking into more closely in the next week or so is the "tax-loss-selling bounce." Stocks hitting their lows of the year are likely being sold for tax losses and have the potential to rebound once the pressure subsides.

Wednesday, December 21, 2011

Financials are starting to stabilize after the long trip down.

Watch the bond market. If the drop in fixed-income prices accelerates (and yields rise), the reallocation out of bonds and into stocks could occur posthaste and serve as a catalyst for a more sustained market turn.

Spanish 10-year yields are up by about 20 basis points, to 5.27% -- that's the first increase since last Monday and the largest rise in yields since the first week of December.

Italian 10-year yields are up by 16 basis points.

The grand rotation out of bonds and into stocks might have commenced.

How to play it?

Be short bonds, and long TBT, and be long the asset managers BEN, TROW, LM

Upward moves such as yesterday's are not unusual during the Christmas period near year-end.

The tally of the central bank's first offering of longer-term refinancing was far greater than expected.

The ECB has provided a forceful tool in the form of an unlimited three-year loan to European banks.

The results of the first offering -- the second offering will be in late February -- were far larger than expected, at over 480 billion euros.

I suspect that there will continue to be some skepticism in the markets surrounding the notions:

that the longer-term refinancing operation (LTRO) will loosen up credit availability; and

whether the very nature of the LTRO, which is designed to have the banks save themselves by saving the sovereigns, will continue to suppress interest rates on sovereign debt.

The LTRO bazooka diminishes a Lehman moment in Europe, but there will continue to be a lot of heavy lifting (and discord) in the eurozone in the months ahead.

As a result, the volatility over the last few months in the markets here and over there will continue to be the mainstay.
After a big day like Tuesday, you had to expect some sort of pullback or consolidation as flippers and "stuckholders" made their exits. Some bad news from ORCL helped the process, but we had an impressive recovery this afternoon, and the NYSE even finished with positive breadth of 1830 to 1181.

For a while, it looked like ORCL was going to take down the entire market. But the broader market eventually was able to separate itself from technology names and that helped improve the mood. The Nasdaq and Nasdaq-100, which are heavily weighted with technology names, did poorly but managed decent comebacks this afternoon.

The tricky thing is the light volume and choppy trading. It was easy to take stops this morning that look quite poor in retrospect, but that is the cost of discipline. In thinner trading around the holidays, it is very easy to be jerked around if you play things too tight.

At this point, if the news flow slows, as it generally does at the end of the year, then we have a good opportunity for some pockets of speculative action to develop.

Tuesday, December 20, 2011


Look at bond yields today (rising) and stock market prices (also rising).

I am fully aware of the structural problems of a debt-laden European economy (who isn't?) and the disparate interests of the 17 members of the EU that is a headwind to a cohesive policy aimed at stabilization of the crisis. But the underlying problem in the eurozone is well-known by now, and quite frankly should have been a cautionary sign to market strategists a year ago and six and three months ago, as they would have avoided many of the stock market's problems in 2011.

The eurozone Cassandras are out in droves now, supported by an ailing stock market, Draghi's hard line and Lagarde's ominous rhetoric. But so were the U.S. Cassandras out in droves during our domestic bank, debt and financial crisis of 2008-2009, yet much of those threats were overcome with aggressive policy -- and aggressive policy is inevitable in Europe, as the tension is kept on the weaker members of the EU until they respond responsibly in a fiscal sense.

And, already, as measured by lower sovereign debt yields, policy is having a positive impact.

The perma-bears missed the March 2009 generational low (666 in the S&P 500). Throughout the market's ramp over the past two and a half years, observers such as Nouriel Roubini have been in denial, wearing blinders that block out the recovery in stocks, and they have been very wrong in expecting a U.S. double-dip.

Despite the anxiety in the markets and the downside risk to the world's economic growth entwined in the European debt crisis, I remain of the view that a credible plan to stem the debt crisis in Europe has just begun and that European and global leaders and central bankers will all come to their senses and intervene in a massive way.

To me, the chances are awfully good. After all, the alternative is unimaginable for the eurozone's economic health and political stability.

In markets, politics, society and sports, change always come out of extreme conditions.

Peter Boockvar's brief communiqué:

Peanuts, beer, three-year loans here!

Today, European banks tell the ECB how much borrowing they want to do at 1% for three years. Tomorrow we'll hear how much they took and forecasts are about 300 billion euros. While some are still speculating that banks are buying short-term sovereign debt after selling it for the past few months, yields in Spain, Italy, Belgium and others are down again.

Also, another good Spanish sale of short-term bills is helping sentiment. Spain sold three-month debt at a yield of 1.74%, well below the 5.11% paid last month, and they paid 2.44% for six-month bills vs. 5.23% in November. The Spanish two-year yield is falling to a 17-week low, and the 10-year is at a 10-week low. There is confidence in the new Rajoy government's will and ability to get through tough reforms, as it will certainly be easier than for the previous socialist government. Italy's two-year yield is at a seven-week low. Germany's December IFO business confidence number unexpectedly rose to 107.2 from 106.6, led by the expectations component.

Also in Europe, the euro basis swap is narrowing to a two-week low, and Sweden cut interest rates by 25 basis points as expected. The ECB did fully sterilize its 211 billion euros of purchases.

In Asia, the Shanghai and Sensex indices continue to trade poorly, but the Kospi bounced after yesterday's Kim Jong Il-induced selloff.

Change is coming in Europe, and in the fullness of time, the aggressive policy employed in the U.S. three years ago will land on its shores.

In the meantime, unusual value in stocks has developed, and I am exploiting that opportunity even as the stock market's tone is terrible and as most classes of investors run for the hills and de-risk.

Is it painful to watch stocks reverse lower every day over the last week of trading? Of course it is. But no one ever said investing should be easy.

Remember: Bull markets are borne out of poor economic news, uncertainty and dour investor sentiment.

A dispassionate accumulation of stocks is what I believe to be in order now.

Overnight, Spain had a very successful auction of short-term paper, as the country raised its maximum target of 5.6 billion euros. Bid-to-cover was strong and helped to move the 10-year Spanish note yield down by 8 basis points, to 5%. Lateral sovereign debt in Italy dropped; its 10-year yields declined by 16 basis points, to 6.5%.


There is an almost universal skeptical view on the ability of leaders to deal with the European debt crisis, on the prospects for U.S. domestic economic growth and with regard to any upside in the U.S. stock market.

December 19th marks one year since Meredith Whitney appeared on the CBS newsmagazine 60 Minutes and sent the municipal bond market into a tailspin from which it took months to recover. To recap that event: Ms. Whitney, a noted bank analyst, appeared on 60 Minutes and forecast "hundreds of billions" in municipal defaults during 2011. The result was a two- to three-month siege on the municipal bond market, which was already in the throes of a supply bulge because the Build America Bonds (BABs) program had expired.

So as we head into the last two weeks of 2011, we can look at how tax-exempt yields stack up against US Treasuries on a relative basis now and in the middle of the Meredith meltdown last January. There is no question that munis are cheaper, on a relative basis, across the whole yield curve, particularly on the front end. But it is extremely important to note that municipal yields have moved in the same direction (down) as Treasuries - just not as much. The Congressional squabble over the debt ceiling, the downgrade of the United States by Standard & Poor's, and the Federal Reserve announcement of its "Operation Twist " in September all led to drops in Treasury yields, and munis – begrudgingly, in some cases – followed along. The muni market fought those events off, along with the Harrisburg and Jefferson County situations, and made the long trip back from the despair of a year ago.

The flight-to-safety trade is still in place, as manifested in a yield on the 10-year U.S. note of 1.83% and continued relative strength in consumer staples.

The only economic news this morning was the National Association of Home Builers Index, which rose by two points, to 21.

Though still weak relative to history, most components of the index were on the mend -- especially traffic, which rose by the most in nearly 3.5 years.

Foreclosures, high unemployment and credit availability continue to plague the residential real estate sector.

After Europe's leaders and central bankers misdiagnosed the magnitude of the continent's debt crisis and after responding in an ineffectual and almost effete manner, the great unraveling of the eurozone is on our doorstep.

The threat of decomposition of the EU has trumped evidence of an improving U.S. economy and has resulted in (historically) low stock market valuations, restricting any upward progress in share prices and (more importantly) raising the specter of frozen credit availability and a deepening recession in Europe that may be exported to the U.S., China and the rest of the world. To many (ratings agencies, investors, etc.), the hopelessness of the European economic situation resembles a Franz Kafka work.

Fitch was particularly cheerless as following the EU Summit on Dec. 9-Dec. 10, the ratings agency concluded that a comprehensive solution to the eurozone crisis is technically and politically beyond reach. Despite positive commitments by EU leaders at the summit, particularly an acceleration in the creation of the European Stability Mechanism and downplaying the role of private-sector involvement, the concerns held by Fitch prior to the summit have not been materially eased. Fitch particularly emphasized the absence of a credible financial backstop and the need for a more active and explicit commitment from the ECB "to mitigate the risk of self-fulfilling liquidity crises for potentially illiquid but solvent members of the EU." While Fitch was upbeat that all 17 EU members have moved toward fiscal consolidation, it remained downbeat on the systemic nature of the crisis's impact on regional economic and financial stability in the short-, intermediate- and long-term time frames.

Last week, the IMF's managing director Christine Lagarde voiced similar concerns that Europe's economic and credit center will not hold.

Despite the anxiety in the markets and the downside risk to the world's economic growth entwined in the European debt crisis, I remain of the view that a credible plan to stem the debt crisis in Europe has just begun and that European and global leaders and central bankers will all come to their senses and intervene in a massive way.

Thus far ignored by the world's stock markets are some positive elements of the EU summit meeting, which, though slow-moving (should have been expected!), appear to have measurably taken tail risk off the table for Europe. The first steps of greater fiscal integration and sanctions against countries that violate agreed-upon debt and deficit rules have been taken and addressed. As a start, each of the 17 countries in the EU will introduce balanced budget amendments coupled with structural deficits capped at 0.5% of GDP (with cyclical deviations to 3% of GDP allowed). Automatic correction mechanisms will be triggered if member countries violate the debt and deficit rules.

Despite the (justified) gloom and doom in Europe, investors have ignored the mildly positive short-term action in sovereign debt yields last week. (At negative sentiment extremes, as was the case of the U.S. stock market in January 2009-February 2009, there is always disbelief at an inflection point of change.)

Ironically, European bond yields (excluding Italy's 10-year note) fell across the board and across the curve last week. Spanish two-year yields move to the lowest level in seven months, and yields have halved since November. France's two-year yield is the lowest in 13 months. According to Miller Tabak's Peter Boockvar, the euro basis swap and Euribor/OIS spread dropped last week. European economic statistics, too, were better than expected as reflected in a modest tick up in Germany's ZEW six-month expectations outlook and a slight improvement in the eurozone's manufacturing and services index (from 47 to 47.9).

One conclusion is becoming evident. The central banks of the world are continuing to coordinate their efforts to meet liquidity requirements under nearly every circumstance. They have determined that they must keep the functioning of the world's financial system unimpaired. To do that, liquidity has to increase, and the manner in which they accomplish this is to expand their balance sheets. A Lehman-type liquidity constraint will not be permitted to occur again if the central banks can avoid it.

In addition, on detailed examination of the balance sheets, you can see how the actions of the central bank on the asset side are balanced by rising reserve deposits on the liability side. In other words, a central bank goes into the market, buys a debt instrument or otherwise acquires an asset, pays for it or lends to a bank, and the bank then pledges it -- in any case, the central bank creates a reserve or cash that within hours is redeposited at the central bank as an excess reserve deposit. There is no credit multiplier in the monetary system when the newly created central bank money is circulated right back to the central bank.

Essentially, the commercial banks within each currency zone have excess reserves. They have excess liquidity, and they are electing to redeposit those reserves back with the safety of the central bank rather than do something else. That behavior reflects the uncertainty that exists throughout the financial system. For example, in the United States, a commercial bank can deposit excess reserves with the Federal Reserve and receive an annualized interest rate of 0.25% or 25 basis points. The commercial bank could do other things as well. In the United States, we see a very large sum reflected in the liabilities side of our chart stack, in a darker green color that shows the huge excess reserve deposit at the Federal Reserve. Banks in the U.S. are not engaged in the expansion of credit. They are redepositing their excess reserves at 25 basis points. The same thing is happening in most of the world. That is now apparent and easy to see in the color coding of the G4 central bank liability side of the balance sheets.

Liquidity, liquidity, liquidity. That is the theme by which the central banks are operating today.

Liquidity and solvency are two different issues. They should not be confused with one another. Greece remains insolvent as a sovereign country. In Europe and in the rest of the world, however, the insolvency is not being allowed to impart a liquidity crunch. The recent use of swaps and other vehicles to enhance liquidity continues to be expanded by the central banks of the world. Santa Claus is coming, and his name is Bernanke, Draghi, Shirakawa or King. Whether or not their noses are red remains to be seen.

In summary, the consensus view is that structurally swollen debt loads and the disparate (legal, political and economic) interests of the 17 members of the EU preclude a near- or intermediate- term resolution of the debt crisis. There is near unanimity that the recent timid-and-tame policy response will never be structurally capable or willing of adopting the necessary shock-and-awe resolution that the U.S. provided (as a template) two to three years ago.

My view is that the consensus might prove to be too pessimistic.

For now, the moves by the EU have not resolved the debt crisis, and the associated uncertainty will constrain the upside to risk markets. Nevertheless, with tail risk in Europe reduced, an improving domestic economic recovery, weak investor sentiment, reasonable valuations, decent corporate profit and dividend growth, a market-friendly Fed (joined by an easing of monetary policy by central bankers around the world), share prices can grind higher until more aggressive European policy is introduced (which I fully expect) in the form of non-EU countries pitching in.

In the fullness of time, I predict more aggressive policy, escalated sovereign debt purchases (see ECB President Mario Draghi's comments yesterday in Financial Times) and a broader country participation in the IMF will be forthcoming in response to the crisis in Europe.

Investors may want to own equities before these steps are implemented. For if the hapless Denver Broncos (of September and October) can launch its Tebow-style turnaround, so can the eurozone excoriate from the debt crisis by adopting more dramatic initiatives.


Despite the (justified) gloom and doom in Europe, Spanish and Italian two-year yields are each 50 basis points lower today. Spanish two-year yields are at the lowest level in seven months and yields have halved since November, according to Peter Boockvar at Miller Tabak.

Moreover, the French two-year yield is the lowest in 13 months.

Importantly, the euro basis swap is down 20 basis points and is now at the lowest level in a week or more.

"In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced President. Yet the Dow rose from 66 to 11,497."

-- Warren Buffett

Yesterday, in a piece in Foreign Policy, Pimco's Mohamed El-Erian discusses the unsettling implications for the global economy of a potential unraveling of the EU.

For now, Europe's debt crisis limits the market's upside -- but in my view, it doesn't preclude a somewhat better market (even while policy, within the backdrop of crisis, slowly coalesces into a more U.S.- like quantitative easing).

Tangible progress in drafting a credible plan for the European debt crisis has just started, and though the recent moves don't provide a permanent solution and the path to stabilization may turn ugly, a flawed plan is better than no plan at all. While stress points remain, crucial details are yet to be worked out and the likelihood of a European recession is high, systemic risk has likely been reduced, and the recent decision to lower interest rates by the ECB further supports intermediate-term stability in the region.

I remain confident that, in the fullness of time, a more permanent solution (through more meaningful monetization and leverage) will follow the current meek and ineffectual policy as European and global leaders and central bankers will all come to their senses. After all, the alternative is unimaginable for the eurozone's economy's longer-term health, which could have an adverse spillover effect around the world.

Stocks are extraordinarily undervalued relative to inflation (and inflationary expectations), interest rates, earnings, sales, free cash flow and tangible book value. Indeed, valuation models using interest rates as a key metric produces an S&P 500 index as undervalued as the market was at the generational bottom of March 2009.


Conditions were developing well, and the big spike reversal had to happen eventually, but the great challenge is in the timing. What makes it even more difficult is that this market has had a tendency toward these very energetic reversals just when it looked its worst. The market looked downright sick yesterday, and even finished at the lows of the day. That assured even greater frustration when we gapped up and ran all day.

The pattern of the market over the last couple of years is a big reversal on light volume that saves us from the brink of disaster, then we continue to run straight up on even lighter volume for a while as poorly positioned market player try to play catch up.

Again, I think conditions are good for V-ish action that drives everyone crazy. The bears get squeezed, the underinvested bulls can't get long enough, and the dip buyers never even see any decent dips.

Look what happened in the market after the big intraday reversal Oct. 4. We were up five of the next six days afterward, and after a brief consolidation we ran up another 6%. Anyone who tried to fight that bounce once it started was crushed.

Seeing that we are at the end of the year and have many underinvested market players in need of relative performance, I think we will see some more of this lopsided action. Of course, we could always be hit by negative news out of Europe, but with the holidays upon us, the news flow should slow.


For the sixth day in a row, the market opens near the highs and closes near the lows. During that period of time, we have lost nearly 5% overall, but even more than that on an intraday basis. It has been a very unkind market for daytraders lately unless they have stuck solely to the short side.

Although volume has been quite light lately, the selling pressure has been unrelenting, and it is taking a toll on the optimists who have been looking for some sort of year-end rally. If you have been overly anticipatory in looking for a turn, you have been slaughtered, and even if you are just lightly invested, it has been tough to find any safe havens.

Many are happy to close the books on 2011 and go enjoy the holidays, but that may end up being exactly what we need to finally give us some seasonal upside. I continue to feel we will have a few good days here soon, but you have to wait for the move and not try to anticipate it.


We ended the week the same way we started it: with extremely slow action. We had some option-related activity that spiked up volume today, but we dripped lower all week and lost nearly 3% -- though we were oversold and had a decent setup for some sort of bounce. What was particularly unpleasant about the action was that every little bounce attempt fizzled out almost immediately -- there was no momentum, no leadership and no energy. The biggest move we saw this week was an ugly breakdown in gold, silver and commodities.

Many folks have been looking for some positive seasonality to kick in, but there was no sign of it. Despite lots of negativity, plenty of underinvested bulls and the need for relative performance, the bulls never kicked into gear. As the week progressed, many were happy to sell into what little strength we had.

Typically, the biggest and sharpest spikes occur in a market environment like this simple because the strength is unexpected, but for that to work we need some sort of spark to start things running. This market never was able to run enough to draw in buyers and push bears to cover.

Unfortunately, the biggest positive this market has going for it is that everyone seems to hate it. That could be a great contrary indicator but we need something to entice the pessimists to question their views, at least for a little while.

Thursday, December 15, 2011

What happens if nothing occurs?

Or more importantly, what happens if something untoward does occur, and stocks rise after the news? Many times, the reaction to news is more important than the news itself....

Hayman Capital Management's Kyle Bass' negative views have received a lot of exposure. He is bright, thoughtful in analysis and committed of view.

Investor sentiment is far worse than the surveys in my view.

And disgust and distrust, so apparent today, are necessary reagents of a better market.

I continue to believe that 2012 will be a year in which investors rotate out of bonds and into stocks and that U.S. equities rise above the rest of the world.

IMF's Lagarde on the news wires saying that the European situation is escalating and near-term action is now required by countries outside the EU.

Last night there was a successful Spanish auction, selling 6 billion euro, above the expected 3.5 billion. Spanish two-year yields have fallen to a two-month low. Italy's two-year yield is down by 25 basis points. French yields are below 1% for the first time in three months.


BofA cites a 50% discount to book value, 9.5% return on equity next year and the manageable impact from low interest rates as rationale. In addition, the analysts expect Lincoln National to distribute more than 40% of net income to shareholders in 2012. Their price target is $38 (more than 100% above today's levels).

I get it. The world is flat. I read Tom Friedman.

I recognize that no nation is an island and we are all economically interconnected, but, seriously? A bunch of Europeans are upsetting a stabilized-to-very slowly improving situation in the United States' economy, creating a real threat of a worldwide economic double-dip and hurting our stock market.

Like I give a rat's you know about a bunch of German leaders who are intransigent and dogmatic in policy and are dangerously bullying the rest of the EU?

As for the French, they are governed by a bunch of socialists in the Senate -- they don't believe in capitalism to begin with.

German and French leaders and central bankers should all be given an ultimatum by our leaders: Immediately reverse your "tame and timid" approach to your debt crisis and replace it with "shock and awe" before the debt contagion spreads to others' shores.

Barton's list regarding US primacy:

* U.S. vs. fractured eurozone: unity, one language, Constitution
* Good demographics: growing population
* Mobility of labor markets
* Cheap energy sources: natural gas fracking
* Undervalued currency
* Entrepreneurial culture: Silicon Valley, availability of funding for startups
* Best universities
* Many of best companies: multinationals
* Deep liquid capital markets: fairest markets, insider trading convictions
* Rule of law in commerce and investment
* America will be biggest oil and gas producer by 2020
I keep expecting some sort of sharp snapback rally, but the lack of energy in this market is discouraging. What we need is a move that is strong enough to cause the underinvested bulls and the active shorts to think that the Santa Claus rally is on and that they better hurry and jump on board or they will miss out. We need some sort of spark to ignite the upside movement, but instead we continue to hear pessimism out of Europe that overshadows some not-horrible economic news.

One good thing about this action is that it is increasing the level of mis-positioning. People are giving up on this market simply because the action is so dead, so there is a good supply of buyers to push things along if we can build a little momentum.

For the ridiculously short-termers, the big risk in this market is that the very slow action is going to cause market players to just give up and close the books on 2011. It has been a rough year for many, and the desire is strong to take a break and start fresh after the holidays.

Wednesday, December 14, 2011

Today's tape was an exclamation point to those who fear slowing growth and the risks of deflation.

The schmeissing in stocks, crude, copper, silver and gold and the rise in bond prices is evidence of a panicky flight to safety in a world that is still deleveraging and is fearful.

We remain in a Euro-centric world.

Last Friday's enthusiasm over the E.U. "solution" has, to state the obvious, evaporated.

It was however, suprrising to me to see stocks off so much, considering that the 10-year soveriegn bond yields were relatively unchanged today. Unfortuantley, investors continue to be skeptical that neither International Monetary Fund, the E.U., the European Central Bank or governments have the will to aggressively address and reverse the debt contagion in Europe.

There's a rumor that a representative of the ECB is saying that the ESFS could be funded with over 1 trillion euros.

"A firewall is needed now to stabilise the markets, bring yields down, allow for sovereign refinancings, reduce stress in the banking sector and provide protection against likely future credit events."

-- John Paulson, "Europe Needs a Firewall to Stabilise Markets," Financial Times

Run, don't walk to read John Paulson's op-ed piece in Financial Times, "Europe Needs a Firewall to Stabilise Markets."

In his editorial, Paulson writes that the sovereigns in Europe are in a "danger zone."

What is needed is a sovereign debt guarantee program similar to the U.S.'s FDIC TLGP, whereby the sales of sovereign debt are wrapped around an ECB insurance policy. This would calm down the markets, lower bond yields and wouldn't be inflationary.

Meredith Whitney's dramatically negative call on the U.S. municipal bond market continues to be wrong-footed.

Gold is now in free fall, down by over $90 an ounce.

It is interesting to note that amidst all the doom and gloom chatter in the various media, the NYSE financial sector is positive.

Europe's economies are moving in reverse -- at best, a deepening recession is in the cards. (Europe used to rule the world, but it no longer dominates.)

The U.S. economy is moving forward, with a 3%-plus real GDP for fourth quarter 2011 expected and growing signs that the domestic recovery will be self-sustaining (albeit, at a moderate pace).

I believe, more than ever, that the events over the past decade have highlighted the likelihood that the U.S. stock market will be favored among most other investment markets in the world.

The U.S. stock market has become the best house in a bad neighborhood.

Below are 10 reasons for my optimism.

1. U.S. relative and absolute economic growth is superior to global growth. The U.S. economy, though sluggish in recovery relative to past expansions, is superior to most of the world's economies (with the exception of some emerging markets) in terms of diversity of end markets, quality of global franchises, management expertise, operating execution and financial foundations.

2. U.S. banks are well-capitalized, liquid and deposit-funded. Our banking industry's health, which is the foundation of credit and growth, is far better off than the rest of the world in terms of liquidity and capital. Our largest financial institutions raised capital in 2008-2009, a full three years ahead of the rest of the world. As an example, eurozone banks continue to delay the inevitability of their necessary capital raises. Importantly, our banking system is deposit-funded, while Europe's banking system is wholesale-funded (and far more dependent on confidence).

3. U.S. corporations boast strong balance sheets and healthy margins/profits. Our corporations are better positioned than the rest of the world. Through aggressive cost-cutting, productivity gains, external acquisitions, (internal) capital expenditures and the absence of a reliance on debt markets -- most have opportunistically rolled over their higher-cost debt -- U.S. corporations are rock-solid operationally and financially. Even throughout the 2008-2009 recession, most solidified their global franchises that serve increasingly diverse end markets and geographies.

4. The U.S. consumer is more liquid and stable. An aggressive Fed (through its extended time frame of zero interest rate policy) has resulted in an American consumer that has re-liquefied more than individuals that live in most of the other areas in the world. (Debt service and household debt is down dramatically relative to income.)

5. The U.S. is politically stable. After watching regime after regime fall in Europe in recent weeks (and given the instability of other rulers throughout the Middle East), it should be clear that the U.S. is more secure politically and from a defense standpoint than most other regions of the world. Our democracy, despite all its inadequacies, has resulted in civil discourse, relatively balanced legislation, smooth regime changes and law that has contributed to social stability and a sense of overall order.

6. The U.S. has a solid and transparent corporate reporting system. Our regulatory and reporting standards are among the strongest in the world. Compare, for example, the opaque reporting and absence of regulatory oversight in China vs. the U.S. (It is beyond compare.)

7. The U.S. is rich in resources.

8. The U.S. has a functioning and forward-looking central bank that is aggressive in policy (when necessary!) and capable of acting during crisis.

9. The U.S. dollar is (still) the world's reserve currency that is far more solid than the euro.

10. The U.S. is a magnet for immigrants seeking a better life. This and other factors have contributed to a better demographic profile in our country that has led to consistent population growth and formation of households. (Demographic trends in the U.S. are particularly more favorable for growth than those population trends in the Far East.)

In summary, conditions that have evolved over the near- and intermediate-term have conspired to favor risk assets in the U.S. over many other areas of the world.
The S&P 500 has lost more than 3% this week, but what's most troubling to many traders isn't the point loss but the weak bounce attempts. The news flow has been rotten, and perhaps expectations of a year-end rally are too hopeful. But there should be more interest in dip-buying -- especially when we are down as much as we are and the year's end quickly approaches.

Unfortunately, the buyers are barely trying, and when they do manage to produce upticks, they fizzle in minutes. There just isn't much love for this market, and the negativity increased today as gold and commodity names were slammed. We couldn't even manage any upside in the final hour. Of course, today is Wednesday, and it's options expiration week, so that means (usually) a down day. From a contrarian standpoint, this gloomy action is a positive as it means many folks have dumped stocks and aren't well-positioned for a rally.

For contrarian thinking to work, however, we need upside action that causes folks leaning bearish to reassess their positions. If we gain upside traction, then all those underinvested bulls and overly aggressive bears will suddenly find themselves out of position and they will rush to buy. If enough of them are caught by surprise, or if they are worried they will miss out, we can see a pretty strong contrary move.

If we ever make the turn, there is a very good chance we can run a bit, according to the technical folks.

Tuesday, December 13, 2011

In reality, the statement should not unsettle markets.

Let's review the FOMC statement.

1. The federal funds rate will be kept between 0% and 0.25% until the middle of 2013.
2. The assessment of the jobs market and of current economic activity was increased slightly.
3. Core inflation will stay below the Fed's target.
4. There remains economic risks chiefly associated with the condition of Europe's economies.

There was one dissenter, Chicago Fed President Charles Evans, who wanted more cowbell.

The flight to safety continues -- the 10-year U.S. note auction was very firm.

The yield was more than 2 basis points below the when-issued yield, the bid-to-cover ratio of 3.53 was well above the average of 3.05 (and the best coverage in 1½ years), and direct/indirect bidders took down the most in 10 months.

The National Transportation Safety Board has recommended that states ban the use of cell phones and other electronic devices by all drivers (except emergencies).

I expect cell phone suppliers like PLT and others to be vulnerable to this news.

This is option expiration week, when December options and futures contracts expire. Over the history of the S&P 500 futures, the week of December option expiration has been positive 83% of the time (24 out of 29 years), averaging +1.4%. The contract has never lost more than -0.9% on the week. If Monday started with a loss of more than -1%, then the rest of the week was positive 3 out of 3 times, averaging +3.2%. If Monday started with a loss of any amount, then the rest of the week was positive 8 out of 8 times, averaging +2.4%.Only once did the futures lose any more than -0.9% at their worst at any point during the rest of the week, but they gained more than +1.3% every time, and more than +2.0% every time but once.

I expect a large asset allocation out of bonds and into stocks sometime in the next six months.

Here is what Merkel said on Friday:

Germany opposes adding to the firepower of Europe's permanent rescue fund.... I've made my position quite clear that it won't be topped up.... [W]e can only move towards our goal when we tackle the root causes of the crisis through budget limits and the fiscal compact.

The world's economies are imperfect, as structural headwinds are governors to growth, and a relatively weak trajectory of growth is exposed to all sorts of exogenous shocks.

Arguably, the stock market has been discounted in reasonable valuations and little, if any, expectation of more positive news. With stocks trading at only 12.5x projected 2012 S&P profits and a 2.05% yield on our 10-year U.S note, this compares favorably to a 50-year average of over 15x during a time in which the yield on the 10-year U.S. note approached 6.70%.

With investors either materially in cash or heavily skewed toward low-yielding fixed income, any market recovery could feed on itself in an environment where individuals are uninvolved and hedge funds have multiyear low (i.e., bear-market low) net long exposure and run the risk of being caught offside.

Low expectations and an underinvested investment community are all conditions that have historically formed the foundation for a better market setting, as bull markets typically emerge out of periods of bad news. (And bear markets typically emerge out of periods of good news.)
It turned out to be a very disappointing day for the bulls. For once, we were finally free of major headlines out of Europe and started with positive action and a better mood. Unfortunately, we never gained momentum and slowly dripped down into the Fed's Federal Open Market Committee interest-rate announcement, which was very unsurprising.

Rather than buy the lack of bad news, we saw selling on the lack of good news. Once we broke Monday's lows, the selling picked up as technical levels were breached and stops triggered. A little bounce at the end of the day did little to change the overall picture. Volume was light, but you really have to stretch to find positives in this action.

The upside action lacks any real power, and traders are quickly grabbing any profits they have and moving back into cash. There is no chasing, momentum or leadership.

No one seems worried about missing out on upside right now. In fact, they are more worried that they will be clobbered if they hold much of anything long.

So far, the bulls have not been impressive, and if they don't step soon, there is a danger that folks will throw in the towel and call it a year. There really are no signs of any real interest, and that is going to make it tough for a run to have legs. Maybe another sharp dip would help shake things up and set the stage for some buying, and the sooner the better.

Monday, December 12, 2011

The Shanghai Index has now closed down for the seventh time in the past nine days, and it appears short-term oversold.

Miller Tabak's Peter Boockvar chimes in on Fitch's comments:

After Moody's did earlier today, Fitch is giving its thoughts on Friday's EU summit. "It seems that a 'comprehensive solution' to the current crisis is not on offer." They acknowledged the initiation of an "institutional and policy framework for a more viable eurozone and ultimately greater fiscal union, but taking the gradualist approach imposes additional economic and financial costs compared with an immediate comprehensive solution. It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond, until the region is able to sustain broad economic recovery." Fitch didn't define what a 'comprehensive solution' would look like however. On the ECB Fitch believes they are "the only truly credible firewall against liquidity and even solvency crisis in Europe." "Hopes that the ECB would step up its actions in support of its sovereign shareholders as a quid pro quo for institutional and legal changes that gave the ECB greater confidence in the long run commitment of eurozone governments to fiscal discipline appear to have been misplaced."

The euro versus the U.S. dollar is now at the lowest level since early October.

I expect interest rates to slowly march higher in 2012, and reinvestment rates for life insurers should improve for the industry.

Trading at low multiples and at discounts to book value.....

Intel cut its forecast - it's a component shortage issue, not a demand issue.

"In times like these, it is helpful to remember that there have always been times like these."

-- Paul Harvey

The Eurozone's Solution (All Hat, No Cattle?)

The European leaders did the minimum amount necessary to stem the debt contagion. We got timid and tame instead of shock and awe. Though the market rejoiced on Friday, the reluctance to mimic the U.S.'s quantitative-easing approach renders the European sovereign debt and bank recapitalization program unresolved and will likely constrain stock market valuations and the prices of other risk assets. The initial plan argues for a deeper recession in 2012-2013 amid the heavy lifting of austerity punctuated (at best) by uncertainty of outcome and (at worst) by the dissolution of the euro. (John Mauldin does a good job in presenting the situation in this week's "Thoughts from the Frontline: A Player to Be Named Later.")

As a result, it is my expectation that, as soon as this week, a hangover will immediately follow the EU's announcement on Friday, with a high probability that sovereign debt yields (in Spain and Italy) begin to climb again. And so will an imminent downgrade of France follow the new but toothless EU fiscal framework that fails to counter the debt crisis with a more aggressive printing strategy.

Furthermore, with the economic outlook for the eurozone weakening (posthaste), investors will likely remain skeptical that the proposed enforcement actions against deficit-ramping sovereigns will be effective. The concept of an EU repo man, frankly, is almost comical. The EU will basically ask fiscally crippled sovereigns that fail to meet their new "stress tests" to escrow monies that they don't have or can't afford. Another question is whether a meaningful escrow will even be demanded.

The new rules seem squishy to me and without substance or much strength to alleviate a deep-rooted contagion and debt crisis.

My guess is that the crisis continues, the initial framework unravels and more aggressive steps are taken, in the fullness of time.
Today's word is: dismal. We gapped down to start the day on worries that Europe really hasn't resolved anything, which they haven't, and we had nothing but the standard bounce in the final hour of trading on European news. This time it was talk from the German Finance Minister that Commerzbank does not plan to take state aid.

The dip-buyers were completely uninterested for most of the day, breadth was weak and volume was pathetic. We even had an earnings warning from INTC to ensure that the mood was particularly gloomy.

The good news is that sentiment is so poor and the market so frustrating that many folks are likely to be underinvested and now well positioned for upside from here. If we can actually gain some traction, it would likely cause quite a bit of scrambling and chasing as folks tried to add some long exposure. We definitely have conditions for a major wall of worry, but few signs that we are going to climb it.

If there is a little more energy, the desire for some end-of-the-year profits is likely to drive things. The key is that we actually ignore Europe, and that seems to be an impossible task lately.

Saturday, December 10, 2011

The one must-own sector -- that is, if interest rates start to firm up -- might be the life insurers.

Low interest rates have been value-destructive for these companies that boast excellent funds and cheap P/E multiples at large discounts to tangible book value.

GS raises European banks from Underweight to Neutral.

Tony Dwyer at Collins Stewart:

A couple of tactical stats from our pal Jason Goepfert at should be pointed out and highlight that some of the crisis environment is not historically unique but offers a glimpse to potential market intermediate-term outcomes:

* Over the past three months the median of VIX is 34%. That has been a great intermediate-term buy signal kicking off following the 1987, 1998, 2002 and 2008 lows. The average median gain 9 months out of 13.8% with no negative occurrences.

* Yesterday, the TRIN Index (ARMS Index) was 4. This is extraordinarily unusual for December. It has happened only 4 other times in 60 years (12/29/43, 12/17/45, 12/4/50 and 12/1/08). All four of them marked the exact December low for those years, with the S&P subsequently rebounding over the next week to the tune of +4.0%, +1.4%, +3.8% and +11.5%, respectively.

Imperial Capital puts a $6 price target on SHLD.

When the Street is ruled by the fear of uncertainty and wild daily price moves, isn't that precisely the time one should be seeking long-term investment opportunities?

The world's economic recovery is imperfect, and, with the U.S. economy exhibiting only moderate growth - and negative job "growth," there is little margin of safety from exogenous shocks. But imperfection and vulnerability are now universally recognized (contrasted with the optimism that existed a year, six months and three months ago) and are arguably reflected and more than discounted in reasonable/current valuations.

I continue to see the potential for a vast rotation out of bonds (which have pint-sized yields now) and into stocks (e.g., the S&P 500 yields more than the 10-year U.S. note).

Equally important, the relative economic and profit position of the U.S. and its large corporations over many other regions in the world favor buying American. And, in the fullness of time, I can see a rotation, too, out of nondomestic stocks into large-cap S&P names.
Thursday's poor reaction to the European Central Bank had market players a bit worried about Friday's European summit meeting, but with expectations so low the fact that nothing much was accomplished turned out to be irrelevant. Frankly, I suspect that market participants are so tired of the constant focus on Europe that they were anxious to just ignore it for a while and focus on stock-picking instead.

While the point gain was quite good and breadth was around 5:1 positive, volume declined after a technical distribution day on Thursday. Overall conditions look good for a Santa Claus rally, and it would be particularly helpful if Europe shut down for vacation and stopped jerking us around constantly. There are a lot of interesting stocks, and if they moved on their individual merits rather than on macroeconomic concerns, it would make for a much more enjoyable market environment.

I continue to feel that there are many underinvested market players, I'm very confident that there is a big group anxious to rack up relative performance in the last few weeks of trading. If we aren't hit with any major negative news flow out of Europe, I expect to see some chasing.

Friday, December 9, 2011

With rumors abounding, let's get the view of Peter Boockvar, who summarizes the conflicting headlines in Europe:

CNBC and DJ are reporting that EU members have agreed to proposals that have been discussed for weeks, 1)The creation of a fiscal compact that will likely encompass an EC commission that will stand as an oversight of EU budgets and a Court that will be the enforcer, 2)The ESM fully in place by July 2012 that will stand side by side with the EFSF instead of replacing it, 3)EU to follow IMF protocol on private sector involvement in debt restructurings which means voluntary debt exchanges instead of forced, and 4)Euro area central banks will likely provide the IMF with bilateral loans (which then get recycled into loans back to Europe). On the ESM, some want it to be considered a bank and thus be able to access ECB funding but the Germans seem to be dead set against it. With respect to the markets, while the possibility of an agreement was always uncertain, Merkel and Sarkozy shook hands on all of these proposals on Monday so today was just convincing the others in the region. It was the ECB response to the EU summit that markets were looking to and Draghi told us what he thought today. Now will Draghi change his mind next week and say he liked the draft and maybe instead of buying 5-10b euros a week of sovereign debt, he'll buy 10-20b and sterilize (because he doesn't seem to want to print right now)? Maybe or maybe not. Bottom line, the market has become completely untradeable with all that is going on in Europe.

Price is what you pay, value is what you get.

MSFT - Special dividend announcement? Enlarged buyback?

Eurozone banks have to raise about $150 billion in new capital, according to a report.

Bloomberg is reporting that the European Banking Authority has stated that the eurozone banks have to raise about $150 billion in new capital, which is in line with expectations.

Is Draghi a poor communicator? Yes.

Will the eurozone's debt contagion be contained through more aggressive policy? Yes.

The ECB is very slowly moving in the right direction. (Even the bond-buying program will ultimately be increased in size as austerity measures are adopted and as fiscal integration is advanced.)
Conditions were good for a sell-the-news reaction to highly anticipated news from Europe, but I thought we might see a little better upside before the profit-taking kicked in. A flurry of European rumors at the close added insult to injury and we ended up going out at the lows of the day.

It was an all-around ugly day, but the question now is whether this is a healthy pullback or the beginning of a downtrend. In November, we had a very similar setup and we were pounded when the news flow out of Europe stayed ugly for days. If the European summit over the next few days doesn't give us something to be optimistic about, it is going to be quite challenging.

Market players are already poorly positioned for upside and days like today only make it worse. If we can put a Band-Aid on Europe for a little while, I expect to see the focus shift back to adding long exposure for end-of-year relative performance.

If we have further weakness on the summit, I suspect many traders would be inclined to buy, as I believe there is going to be an endless stream of European solutions and ideas that will prevent the bears from taking hold of the action.

Thursday, December 8, 2011

No big surprise - and this is a huge negative for the market - but the European Union's AAA rating may be cut by Standard & Poor's.

As expected, Standard & Poor's may cut BNP Paribas and Fortis.

Standard & Poor's has placed seven Portuguese banks on negative watch now. Expect more of this in the days ahead.

On this week's latest big summit, GS is looking for:

* further details on sanctions that will be imposed on countries which fail to meet budget deficit rules;
* clarification on private sector involvement;
* ESM to be brought forward by six months;
* a treaty change proposal; and
* more proactive purchases (over time) of sovereign debt (but no capping of spreads).

Germany denies that capacity limits will be raised for ESM and EFSF and denies that there will be a doubling in size of the financial firewall.

Investors will be inundated with a lot of eurozone leaks in the days ahead in front of Friday's meeting.

Reuters has just come out with a denial from Germany that the eurozone will raise the capacity limits of the ESM and EFSF facilities.

Also, the Financial Times has reported that the E.U. is considering a doubling in the size of the financial firewall.

Germany has denied both of these stories, and, personally, I expect the eurozone to live down to expectations on Friday.

The new argument this week is that the S&P downgrade to negative watch of 15 eurozone countries was a warning shot to Europe's leaders that will hasten and steel their resolve to fight the debt contagion.

My view is that we will get a rescue fund (over there) but the U.S. stock market will be relatively nonplussed as the heavy lifting of austerity and bank capital raising remains ahead, in the first half of next year.

We remain in a worldwide balance-sheet recession, and the outcome is an extended period of relatively slow growth. Subpar growth, both here and abroad, exposes the growth trajectory to exogenous shocks (in Europe, China, oil prices, geopolitical, and in U.S. politics).

By my calculation, the S&P Index is approximately 5% undervalued. But multiple economic possibilities render the precision of any valuation model -- including mine -- less certain than in ordinary times!
Da bearse gave it a decent try, and breadth is still fairly poor, but I suspect the shorts are going to wait for some more headlines to hit from Europe before they give it another go. The bulls are pushing again, and the risk of an upward spike on all or some of the upcoming announcements from the European Central Bank and the summit meeting are quite high. On the other hand, you can bet the bears are thinking "sell the news."

I think there's upside into the end of the year. Some back-and-forth after the big one-way move will help the charts/technicians, and we might actually see the focus shift from Europe, finally, to some individual stock-picking. It probably is bad karma to even contemplate some good old fashioned end-of-the-year momentum action in individual names, but I still have some hope that macro may take a backseat again someday.

Tuesday, December 6, 2011

Standard & Poor's has confirmed that it has placed EFSF's long-term AAA ratings on credit watch negative. After review, EFSF ratings "will likely be the same as the lowest issuer rating we assign to the rated EFSF members we currently rate 'AAA', unless there are offsetting credit enhancements in place."

Run, don't walk, to read Jeremy Grantham's quarterly letter, "The Shortest Quarterly Letter Ever."

As the title infers, Grantham's letter is to the point.

And it's free!

The Shanghai Index is now at the lowest level since the third week of October.

China has about 23% of the world's population but only approximately 7% of the world's fresh water supply. Moreover, China's water resources are not distributed proportionately; the 550 million residents in the more industrialized northern area of the country are supported by only one-fifth of the fresh water and the 700 million in the southern region of China have the other 80% of the country's fresh water supply. The shared resources of water supply have been a focal point of conflict between China and India since the 1962 Indo-China War.
An extremely slow day of trading set us up nicely for a little squeeze on European headlines this afternoon. But it didn't hold and we ended up closing flat. Volume was extremely light and breadth was on the negative side, but we still aren't seeing many signs of profit-taking. Market players continue to be more worried about missing out on further upside than about protecting recent profits.

The bulls have a couple of things working to their advantage right now. Too many folks are trying to play catch-up with the market and there is fear that we'll keep spiking higher as solutions to the European problems continue to roll out. We've had at least a dozen new European solutions celebrated in the past seven days of trading, and market players are expecting even more "good" news in the days ahead. Whether these solutions really are viable is irrelevant, since the buying reaction is reflexive at this point.

There is a quaint notion that markets that are extended on light volume and hitting resistance may be vulnerable to a pullback, but thinking like that has been the death of many bears in the last couple of years. We are right back in that situation and the most dangerous thing you can do is try to be logical about why a pullback would make sense. The setup we have now has tended to produce upside more often than not. Just look at what happened in October, when we had a very similar setup develop on Oct. 20. We gapped up the next day and kept running even more.

However, the biggest challenge is not the perverse technical action; it's that action is so slow and there's so little intraday movement.

Monday, December 5, 2011

Standard & Poor's confirms that it has placed all 17 eurozone nations on negative watch.

How is the FT getting quotes from S&P on this before an official release? Now a credit watch move on France would not be a surprise and maybe Austria too but Germany on the cusp of losing its AAA rating, according to S&P, would be shocking right now. With this said, if France specifically loses its AAA rating, the EFSF will have problems.

GS observations:

* A significant eurozone recession is the firm's baseline expectation now.
* A negative feedback loop in Europe could occur (similar to the U.S. in 2008-2009) unless the ECB provides a massive backstop.
* U.S. economic news continues to beat very low expectations.
* The November employment report was "better than expected" but not nearly as good as suggested in the drop in the unemployment rate - it was due to workers dropping out of the labor pool.
* U.S. growth will moderate from +2.25% in the second half of 2011 to only 1% in next year's first half, reflecting fiscal tightening and an expiration in emergency unemployment benefits (among other reasons).
* "All roads lead back to Europe these days," and the eurozone poses the greatest risk to domestic growth.
* Not much is expected out of the Fed during December's FOMC meeting (though comunication policies will be "revamped").

Much is dependent upon the ECB providing a huge backstop (which still seems unlikely).

If an important reason for buying is investors' catch-up, remember, price is what you pay, value is what you get.

The November non-manufacturing ISM declined to the lowest print 10 months.

The November non-manufacturing ISM disappointed at 52.0 vs. expectations of 54.0 and 52.9 in the prior month.

This was the lowest print in the index in 10 months. While new orders and backlogs were strong, the employment component dropped from 53 to 49.

Factory orders declined by 0.4%, in line with expectations.

S&P profits should slightly exceed $100 a share given low interest rates, quiescent inflation - at least the way it is officially counted - and restrained wage labor costs.

Overnight, China's HSBC purchasing managers index fell from 54.1 to 52.5, and China's official PMI for nonmanufacturing dropped to 49.7 from 57.7.

Bulls in the China shop see this as hastening monetary ease, which will produce a soft landing.

I am not sure why so many are so certain that preemptive monetary easing guarantees a soft landing.

We will see.

It's either risk-on or risk-off, nothing in between. But, it can increasingly be argued that a lot has been discounted in the massive de-risking (by every investor class) that has reduced the S&P 500's P/E multiple by about 3 multiples below its average over the last half century (12x vs. 15x) despite a near 70% lower yield on the 10-year U.S. note (today) and given the low inflation readings and inflationary expectations. And with interest rates near historic lows, risk premiums are now at multi-decade highs. In fact, the earnings yield of stocks less the risk-free cost of capital places stocks cheaper today statistically than at the generational low in March 2009.

Hedges, low-volatility portfolio management strategies and owning precious metals have replaced the go-go investing of the 1990s, and any sense of generating alpha through individual stock selection (given increasingly correlated assets) has been lost or given up on as ETFs traded funds grow in popularity.

But, imagine if in the eurozone:

* With its back against the wall and taking a lesson out of the U.S. playbook, Europe's tame and timid policy response to the debt contagion becomes one of shock and awe.
* The ECB massively intervenes and stabilizes sovereign debt yields.
* The eurozone's fiscal integration goes smoothly as does the implementation of a massive banking industry recapitalization, as buyers around the world appear.
* The eurozone experiences only a modest economic dip.

And, imagine if in the U.S:

* A resurgence in the popularity of Newt Gingrich (and a coalescence of the Republican Party behind its candidate) causes President Obama to become defensive about the lack of progress made during his past four-year term. The president begins to move to the political center, but it is too late, as it becomes apparent that he will likely be a one-term president.
* The U.S. stock market rejoices with the expectation of a change in the administration and likely Republican control of both the House and Senate.
* Further expanding his lead in the polls, candidate Gingrich introduces a six-point economic plan, a business-like agenda of thoughtful, intelligent and radical pro-growth fiscal policies which includes:

1. engineering a more rapid recovery in the housing markets;
2. addressing our fiscal policies (including but not restricted to setting a specific limitation on the annual gains in spending to be less than the increase in the consumer price index and mean testing entitlements, freezing entitlement payouts and gradually increasing the social security retirement age to 70 years old);
3. denting the structural unemployment problem and mismatch of available jobs to talent (through a comprehensive plan to change and upgrade our educational system);
4. a broad plan for energy self-sufficiency designed to rapidly develop all of our energy resources;
5. repatriation of overseas corporate profits tied directly to job growth earmarks; and
6. an overhaul to the U.S. tax system (which includes a flat tax and repatriation of overseas earnings only if earmarked by a commitment to job growth/hirings).

* With the outlook for top-line growth improving, contained inflation and subdued wage growth serve to sustain profit margins as 2012 S&P earnings expectations rise.
* Consumer and business confidence rebound dramatically, paving the way for pent-up demand for durable products (e.g., housing and autos) and for capital spending to be unleashed.
* M&A activity explodes in an unprecedented manner.
* With a better GDP growth outlook and rising consumer and business confidence, U.S. bond yields rise rapidly, causing a massive reallocation trade out of bonds and into stocks. Underinvested retail investors reverse their disinterest in U.S. equities and begin to reinvest in domestic stock funds, and a de-risked hedge fund community panics and exacerbates a buying stampede.
For the second straight day, we opened strong and finished weak. We had gains, but they all occurred overnight. The intraday action was poor, but breadth was still healthy at better than 3:1 positive due to gains at the open. Volume was light with little energy, few leaders and no outstanding momentum.

The S&P 500 and Nasdaq are up more than 8.5% in the last six days. That is an extremely rare feat to move that much that quickly, but the lack of love for this market is striking. It was obvious that few were prepared for the first big pop, but after four big gap-up opens in six days we should be seeing strong emotions and bullish celebrations. There is very little frothiness outside of the action in the indices. The irony is that the dour sentiment is what's keeping conditions ripe for continued lopsided action.

What has really helped kill the mood is the hot money players are itchy for action but aren't holding inventory overnight, so they miss out. Very little happens intraday, which only raises frustrations. On the other hand, many are afraid to hold much overnight due to headline risk, especially as we have become more overbought. So every day we start with a bunch of underinvested bulls that need to buy.

Labor Stuff

The BLS employment number released Friday was "better than expected;" due to the routine fudging of the denominator, or the total labor force. More people than ever are finding the shadow economy a more hospitable place to make money and drop off the BLS rolls forever. According to the monthly Gallup Poll of underemployment, a measure that combines the percentage of workers who are unemployed with the percentage working part time but wanting full time work, is over 18% in November, measured without seasonal adjustment. That is up from 17.8% a month ago and 17.2% a year ago. Stated simply, many employers appear to have chosen to hire part-time rather than full-time employees for this holiday season.

Saturday, December 3, 2011

Higher bond prices and lower yields will continue to put pressure on one of my favorite sectors, life insurance, as the marginal returns on cash flow disappoint relative to expectations.

The euro is weakening on rumors of a Spain downgrade.

The correlation between the S&P and 'Three Peaks and a Domed House' remains intact.

I still see a hard landing as a possible outcome for China.

"It's about people. People who lie. And people that are faced with the agony of telling the truth.... The closer they get the more frightening it becomes.... Soon you will know."

-- The China Syndrome (trailer)

Jim Cramer is optimistic on China, believing that policy introduced on Thursday will be growth-inflating. He believes that this is "the beginning of a loosening of Chinese interest rates, if we are to believe that the long-awaited interest rate cut is here, then there are plenty of stocks to own [in China]."

I respectfully disagree.

Last night, the official November China Manufacturing PMI fell to 49.0 from 50.4. This means that the manufacturing sector is now declining for the first time since early 2009. New orders were weak, and backlogs are deteriorating in the face of tightening moves months ago and in light of Europe's economic weakness. (U.K. manufacturing fell to 47.6 in November, the lowest read since June 2009 and the swiftest drop in over two and a half years. New orders were down for the sixth consecutive month. The final Markit Eurozone manufacturing PMI also marked contraction, falling for the fourth consecutive month in a row at 46.4 vs. 47.1 in the prior month.)

Wednesday's 50-basis-point cut in reserve requirements was widely interpreted as China will experience a soft, not hard, landing.

I am less convinced, and I still see a hard landing as a possible outcome.

First, from a microeconomic and macroeconomic standpoint Chinese reporting is opaque. I don't even know if we should believe China's economic reports. (Herb Greenberg has consistently reported how opaque and, at times, how fraudulent individual companies' reporting is.) We shouldn't be surprised that the accuracy of the government reports might be flawed. Importantly, the transparency and health of China's banks, the principal mechanism for the transmission of credit, remain vague and difficult to gauge -- as do the legendary empty cities of unoccupied apartments and homes in China.

Second, 20% of China's exports are to Europe. There is no policy in China that is capable of controlling the deepening recession in that region. We already are witnessing a fast deterioration in trade into the eurozone, as evidenced by the 40% drop in China to Europe shipping rates since Labor Day.

Third, given falling exports to Europe (above), China's catalyst for growth falls increasingly on its consumer. But, unique to emerging markets, China's domestic personal consumption expenditures as a percentage of GDP is falling hard as savings soars. Presently, personal consumption in China is 34% of GDP; 10 years ago it was over 40%. By contrast, consumption at Brazil is over 50% of GDP and in our country it is 71%.

Friday, December 2, 2011

Despite the way the media is celebrating a nearly 7.5% jump in the S&P 500, it wasn't as easy as it looked. Long-term buy-and-holders are back to where they were two weeks ago, which is a relief after major ugliness, but traders had major obstacles as they tried to keep pace this week.

This is the first time in a long time, maybe ever, we experienced a market with three big overnight gaps in one week, each of which followed by flat to down action all day. The entire upside move came outside market hours. If you are a strict daytrader who carried nothing overnight, you missed the entire move and had virtually no chance of keeping pace with the indices.

The most bullish thing about this action is that it creates a huge amount of underperformance anxiety. So many folks missed out on this move and so many are looking for some relative performance into the end of the year that there is likely to be a high level of dip-buying interest.

The biggest negative is that there is still plenty of headline risk. All the news flow out of Europe is just hopes and dreams. Nothing has actually been implemented yet. The risk that things may not go as smoothly as hoped is very high. On the other hand, any time we have a glitch, we have a slew of new solutions to bring in buyers. While you'd have to be VERY gullible to believe that things have really improved in Europe, it was just plain dumb to fight the positive reaction to the news.
Initial jobless claims came in at 402,000, 12,000 more than consensus and 6,000 above the previous month.

Continuing claims rose by 35,000, which were 88,000 more than expected.
The indices were down a little today with about 2100 gainers to 3400 decliners, but after rising more than 7% in three days, things are better than you might expect. The logical move is to look for profit taking, but what we saw today barely made a dent.

We have monthly jobs news tomorrow morning, which should move us for a few minutes, but the focus will quickly shift back to Europe. There is plenty of talk about the next step as leaders of France and Germany meet this weekend. News is expected on Monday, and this market loves to celebrate European headlines.

I'm not worried about major downside unless we have some surprising news. Markets like this can be surprisingly sticky to the upside.