U.S.
Stock Market Complacency On Verge Of Collapse
6
July, 2012
Price
action in the US stock market has been characterized in the recent
past by a dangerous degree of complacency in the face of a major
deterioration of economic and financial conditions abroad and
domestically. Based on a series of data points and events in the last
three days, this complacency may soon collapse and could morph into
panic.
Europe
Hopes Dashed
As
I recently
predicted,
the enthusiasm generated in the immediate aftermath of the most
recent EU summit has very quickly faded and could soon run the gamut
from disillusion to fear and outrage.
The
most significant event of the past few days has been the general
realization that the EU summit agreement reached on June 29th was
mostly ineffectual in dealing with Europe's most pressing problems.
- First came the news that Holland and Finland will block use of ESM funds for sovereign bond purchases. Even if such opposition can eventually be overcome in principal, the required conditionality demanded by these and other nations will likely render the ESM ineffectual as a sovereign bond backstop.
- The second blow of the week came when it was disclosed that, due to a series of problems and disputes amongst eurozone members, details of the Spanish bank bailout would not be finalized until July 20 at the earliest.
- A third blow came when Finland announced that it would block any ESM disbursements to troubled countries and/or banks unless the relevant nations posted adequate collateral.
- A fourth blow came when it was reported on Friday that Spain will have to provide guarantees for 100% of funds disbursed by the ESM/EFSF towards the bailout of Spanish banks. Indeed, Spain may be required to post collateral. This development directly contradicts the summit goal of severing the vicious cycle between the Spanish banks and Spain's sovereign debt situation.
- A fifth blow came when the European and world press all of the sudden came to a realization, after statements from a top-ranking eurozone official, that the possibility of the ESM "directly" capitalizing Spanish banks was merely academic. Since the central regulatory institution which is a pre-condition for such aid will not be up and running until mid 2013, at the earliest, and most likely until 2014, Spain will not be able to benefit from this mechanism - at least not in time for it to make a difference.
- A sixth blow came from Finland's finance minister who stated that the Nordic country was prepared to exit the eurozone if it were forced to pay for the debts of other nations. Finland's finance minister stated, in no uncertain terms, that "Finland is not going to stay within the euro at any price."
- A seventh blow came in the form of the realization that help for the Spanish sovereign as well as its banks depends on meeting its fiscal commitments as evaluated by the Troika. Unfortunately, it is now clear to everybody accept the willfully ignorant, that Spain cannot and will not meet those commitments.
- An eighth blow came as Greece's demands for a renegotiation of the terms of its bailout were rebuffed by the IMF and throughout European capitals. The problem is this: Greece's requests can be denied by its European partners; what cannot be denied is that Greece will experience a chaotic default without such a renegotiation and such a development will have serious negative repercussions throughout Europe that are not fully understood or much less fully discounted by financial markets. This reality will soon come to the fore again.
And
I could go on, and on.
In
sum, the ineffectiveness of the recent European summit agreement on
June 29th is being brought into full relief. The sense of disillusion
amongst political leaders, investors and consumers will have real
impacts in the European macro economy that is transitioning from bad
to worse.
US
Economy and Earnings Hopes Dashed
The
past few days have dealt a blow to the complacency of US investors
who apparently were under the impression that the US economy and
stock market would "decouple" from troubles in Europe and
elsewhere abroad.
ISM
manufacturing and non-manufacturing indices in the US surprised
strongly to the downside, with the greatest disappointments coming
from the survey's leading components such as new orders and backlogs.
Retail sales grew at the slowest pace in three years. Finally,
non-farm payrolls disappointed consensus expectations, growing at a
rate that will increase the already-high unemployment rate in the US.
Based
on the recent bevy of negative data, economists are furiously
revising their second quarter (2Q) GDP forecasts from a consensus of
around 2.0% a month ago to about 1.5% currently. It is my view that
these estimates will ultimately prove optimistic as an inventory draw
could cause 2Q GDP to dip below 1.0%. Indeed, there is a very real
risk that US GDP growth could register a negative print in 3Q.
Many
market participants seem to be discovering something that I
have been highlighting for
some time: Events in Europe and elsewhere abroad have the potential
to derail the US economic recovery.
Furthermore,
many market participants seem to be coming to the realization that
what happens outside the USA has a massive impact
on the earnings of S&P 500 companies. Near 50% of all S&P 500
earnings derive from non-US sources - and the figure exceeds 60% if
we include the earnings impact of commodity prices that are
determined primarily outside of the US. In a recent
article,
I highlighted the fact that negative preannouncements are running at
an extremely high pace and 2Q 2012 is setting up to mark a negative
inflection point for S&P 500 earnings.
Conclusion
The
recent EU summit supposedly saved Spain. That illusion has not lasted
long. Spain's country risk premium (spread to Bunds) is now back to
pre-summit levels and Spanish stocks are now essentially back to
pre-summit prices. As far as the rest of Europe: The euro is now
below its pre-summit levels. Furthermore, most European banks stocks
are back to near pre-summit levels - and many are considerably below
pre-summit levels.
Notwithstanding
these and other problems abroad, US stocks are still levitating based
on the generalized notion that the US is somehow immune to the
problems in Europe and elsewhere abroad. There is also a widespread
expectation that global governments and central banks will do
whatever is necessary to prevent stocks from falling.
Recent
events in Europe as well as economic data in the US will likely force
a reevaluation of the widespread complacency that has been passing
for "strategy" in the US investment community.
The
transition from complacency to fear will bring about sharp declines
in equity indices and their respective ETFs such as (SYY)
(DIA)
and (QQQ).
Furthermore, investors should beware of the notion that investors can
"hide" in dividend stocks such as McDonald's (MCD),
or earnings momentum stocks such as Apple (AAPL),
or consumer stocks such as Procter & Gamble (PG).
In a global economic and financial crisis virtually all stocks will
lose significant value and the value of cash will rise in relative
terms.
No comments:
Post a Comment
Note: only a member of this blog may post a comment.