Skew Updated Chart

by Toni

The IV skew and vix divergence continues to signal further selling pressure. As discussed before the correlations are strong but not 100% on a day to day basis. Still further selling pressure does look highly probable.

I will note though a temporary buy signal may be approaching as noted on the chart below (two prior lows are circled). Over the past month there does appear to be a lag where the divergence leads the SPX so if in fact this “buy area” is reached there may still be further selling pressure.

Over the weekend I will update this chart with a longer time horizon to get a better sense of buy signals.

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Don’t Light That Short Fuse!

by Tom Aspray

The markets seem likely to re-test recent lows, and if key technical levels are broken, an explosion in selling is possible. The fuse is getting shorter. Consider some selective selling, and watch these price levels on the major stock index ETFs.

Wednesday’s sharp decline has done some serious damage to the short-term technical outlook. The market internals were very negative and the Advance/Decline (A/D) lines for all the major averages have broken their uptrends. Several have also violated their recent lows.

After a week of complacency, it seems like more market participants are now coming to the realization that the politicians in Washington are stupid enough to play with the debt ceiling. I am sure some of them as kids insisted on lighting firecrackers with too-short fuses, too. Their actions now could have the same impact on the stock market. Of course, they will face no consequences for these actions, as most likely have bright futures as corporate lobbyists.

From a technical standpoint, many of the major averages like the S&P 500, as tracked by the Spyder Trust (SPY), look ready to test the recent lows from the middle of July. If this support is violated, the market is vulnerable to an explosion of selling that could take us to the important support from the March lows, which is about 4% below current levels.

The new highs in the weekly A/D line in April indicate that the bull market will still be alive even if the March lows are tested. Of the major sectors, there are only a few, including energy, utilities, consumer discretionary, and technology, that have not dropped below the July lows.

On a short-term basis, the market is getting quite oversold, as the McClellan Oscillator has dropped below the June/July lows. It is now at -225, which is not far above the March lows at -268. However, a weak rally, especially on a resolution of the debt-ceiling debate, is likely to set the stage for a further decline.

Click to Enlarge

Chart Analysis: The Spyder Trust (SPY) is not far above the July 18 lows at $129.63 with the still-rising 200-day moving average (MA) at $128.52.

• If the 200-day MA is broken, the critical levels are the April lows at $126.19 and the March lows at $125.28. The longer-term uptrend, line b, is in the $122 area
• The S&P 500 A/D line has dropped below the July lows, which has reversed the positive break of the downtrend, line c. The A/D line has next good support at the uptrend, line d
• There is initial resistance for SPY at $131.70 to $132 with stronger resistance at $132.80-$133

The SPDR Diamonds Trust (DIA), which tracks the Dow Jones Industrial Average, closed on the daily Starc- band and is very close to the June lows at $122.72. There is some additional support at $122.61.

• Further chart support in the $121.50-$122 area with the uptrend from the March and June lows, line e, now at $119.50
• The lows in June were at $118.64 with the March lows at $115.51
• As noted last week, the A/D line was lagging the price action, as its last high was well below the early-July peak
• The A/D line has now broken short-term support (line g) and is also slightly below more important support at line h. The next good support corresponds to the June lows
• There is initial resistance at $124.50-$125 with stronger resistance above $126

Click to Enlarge

The daily chart of the PowerShares QQQ Trust (QQQ), which tracks the Nasdaq 100 Index, was still in a clear uptrend before yesterdays plunge. The next band of support is in the $56.87-$57.80 area with the 50% retracement support at $56.72.

• Technology is still the market’s strongest sector, and QQQ is well above the June lows at $53.62
• A divergence was forming in the Nasdaq 100’s A/D line (line a), as it failed to confirm the new price highs last week
• The divergence will be confirmed by a violation of support at line b. There is longer-term support for the A/D line at line c
• There is first resistance now at $58.80-$59

The small-cap stocks, as represented by the iShares Russell 2000 Index Fund (IWM), are still looking the weakest and have been since the A/D line failed to confirm the new highs in April. There is key support (line d) in the $77.23-$77.57 area, which encompasses both the March and June lows.

• A break of these levels will suggest a drop to the 2010 highs at $74.66
• The Russell 2000 A/D line slightly exceeded its downtrend in July (see circle) but has dropped very sharply in the past few days
• A break in the A/D line below support at line f is likely to precede a drop below the March-to-June lows
• There is initial resistance for IWM at $81.30-$81.60 and then much stronger resistance at $82.70-$83

What It Means: The deterioration in the technical picture increases the chances that the June lows will be tested. Clearly, stocks need to stage an impressive rebound to reverse this damage. This would mean that advancing issues should outnumber declining by at least four-to-one with QQQ closing back above $59.

Watch how the market reacts if these levels are reached on the four ETFs:

• Spyder Trust (SPY): $129.63
• SPDR Diamonds Trust (DIA): $122.61
• PowerShares QQQ Trust (QQQ): $56.87
• iShares Russell 2000 Index Fund (IWM): $77.23

How to Profit: There are still quite a few stocks that look strong on a technical basis, but there are fewer sectors that are doing well. A bounce is likely over the next few days, and for anyone who feels uncomfortable with the allocation of stocks in their portfolio, prudence would suggest doing some selective selling.

Investors long any stocks that have not yet reported earnings should definitely consider lightening those positions, as the market has not been kind to earnings disappointments.

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Italy Bonds Smacked in Selloff, Yields Now Approach Spain; Vote of "No Confidence" on Debt Plan

by Mike Shedlock

Investors wasted not time in a vote of no confidence on the latest debt package supposed to save Europe. 10-year Spanish government bonds are back above 6% and yields on Italian government bonds are close behind.

Bloomberg reports Italian Bonds Decline After Borrowing Costs Rise at Nation’s Debt Sale

Italian bonds fell for a second day, increasing the yield spread over German bunds, after the nation’s borrowing costs rose at a sale of 10-year debt and Standard & Poor’s said Greece risks further defaults.

Italy’s 10-year yield surged to the most in more than a week amid speculation a probe into a former aide of Finance Minister Giulio Tremonti may force him to step down. German yields fell to near a five-month low versus their U.S. counterparts as American lawmakers pushed conflicting plans to raise the nation’s debt ceiling. Bunds rose for fifth day, the longest streak since April.

Italian Auction

Italy sold 2.7 billion euros of its 10-year benchmark security, less than the maximum target of 3 billion euros. The debt was priced to yield 5.77 percent, higher than 4.94 percent the last time the securities were sold on June 28, and drew bids for 1.38 times the securities on offer, compared with 1.33 times. In six sales of 10-year bonds this year, the average bid- to-cover ratio was 1.42 and the average yield was 4.81 percent.

“With Italy investors have recognised that the debt ratio is 120 percent” of gross domestic product, said Julian Callow, chief European economist at Barclays Capital in London. “That’s very high. Any country really above 80 ought to be getting concerned and looking at ways of bringing down that ratio. When you’re above 100, that’s flashing red signals. As well, in Italy you’ve had very weak economic growth.”

Irish bonds advanced for a third day after an S&P report said some provisions of the EU’s rescue plan would help protect Ireland and Portugal.

Italy 10-Year Government Bonds



Spain 10-Year Government Bonds



Vote of "No Confidence"

Although yields on Italian and Spanish debt are off the highs of the day, the direction is crystal clear. The proper way to look at trends of Spain and Italy is as a vote of no confidence in the latest plan, not as a vote of confidence on Finance Minister Giulio Tremonti .

Yields on Portuguese and Irish debt fell, supposedly on the belief the latest debt deal will lower borrowing costs. It won't. The S&P''s statement "some provisions of the EU’s rescue plan would help protect Ireland and Portugal" is laughable.

There is no way the EU's EFSF, the European Financial Stability Facility, can cover Spain, let alone Italy.

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The Storm after the Calm

by Michel Rocard

Could the financial crisis of 2007-2008 happen again? Since the crisis erupted, there has been no shortage of opportunities – in the form of inadequate conclusions and decisions by officials – to nurture one’s anxiety about that prospect.

Over the course of the three G-20 summits held since the crisis, world leaders have agreed to tighten financial regulation slightly, but only for banks, while leaving other market players free of restrictions and scrutiny. As was true before the crisis, no one is monitoring the almost limitless “virtual” market for derivatives, where money moves freely without official rules or contact with the real economy.

And large players have plenty of cash with which to speculate, especially given the United States Federal Reserve’s decision to inundate the world with a sea of liquidity. The result has not been investment in productive assets that boost employment in the US, as the Fed intended, but rather a run-up in global commodity prices and a growing bubble in the housing markets of the major emerging economies.

Simply put, there are no brakes that could stop the global economy from blundering into another financial crisis. Tax havens remain numerous, and their regulation anarchic. The skimpy enforcement measures undertaken by bank regulators since the crisis are nowhere near appropriate to what is at stake. Governments have refused to reinstate the absolute wall of separation between commercial and investment banks, leaving taxpayers on the hook to pay deposit-insurance claims when the bubble-prone financial sector blows up.

Indeed, it is now clear that governments prevented a full-scale collapse of the financial system in 2008 by transforming toxic private debt into public debt. It worked then, but it cannot work now, in large part because it contributed to the new, looming crisis in financial markets brought on by countries’ soaring public-debt burdens.

We cannot blame today’s emerging crisis solely on our current and recent governments’ actions. For more than 20 years, the world’s major capitalist economies have been led to borrow heavily and unabashedly, in large by a new rule, adopted worldwide beginning in the 1970’s and 1980’s, that tied monetary policy to targets for price growth. This dangerous idea – proposed in France by Jacques Rueff in 1958, adopted throughout Europe over the following two decades, and extended to the European Central Bank – was intended to limit the tendency of capitalist economies to aggravate inflation as soon as they hit full employment.

But the rule ultimately had the terrifying result of obliging countries to borrow from private banks at market prices to guarantee their treasuries’ integrity. This created powerful barriers to public investment, as government spending was siphoned into massive profits for banks and their shareholders. With the possible exception of the four Scandinavian countries, no society with a market economy found, or even sought, the equilibrium between state and market necessary to maintain a sufficient level of public services.

But even institutionalized monetary austerity has not stopped national public-debt levels from reaching 50-100% of GDP in Europe (higher in countries Greece and Italy) and surpassing 100% in the US. Clearly, the official response to the 2008 crisis was perverse and detrimental at all levels.

Moreover, the 17 European countries that currently use the euro cannot devalue their currency unilaterally. The euro is an important collective step forward, but to insure its credibility as a truly common currency, it should be treated as the embodiment of a true and whole-hearted solidarity. The German government still does not admit that – as if France before the euro would have offered up Seine-Saint-Denis or Corsica to pay off its foreign debts to keep the franc.

Greece, a eurozone member, is now in just such an untenable situation. If Greece defaults, an enormous amount of speculation will be possible. Indeed, financial markets are unlikely to differentiate between Greek debt and that of other heavily indebted economies, including Portugal, Ireland, Spain, and even Italy – the most recent eurozone member to come under speculative attack.

This could well create a financial tsunami worth trillions of dollars, which explains the energy with which the European Central Bank and its president, Jean-Claude Trichet, have tried to head off the worst. Great Britain, Belgium, and even France find themselves at a debt level that does not leave much hope that they will escape unscathed.

Meanwhile, the US cannot meet its next debt payment unless Congress and the president reach an agreement to raise the national-debt ceiling. The consequences of a US default have rightly been described with growing alarm as the risk increases.

It is still possible to repair all of this. But the necessary financial measures can no longer be implemented while respecting states’ traditional and full sovereignty. The US must renounce the imperialism of the dollar, and Germany must abandon its dream of a “deutscheuro,” managed as if the other 16 euro members were historical and cultural extensions of the German nation. The approaching storm, and the measures that must be taken to address it, will bring enormous change.

Michel Rocard is a former Prime Minister of France and a former leader of the Socialist Party.

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Continental Drift

By Tim Price

“I’m counterfeiting euros. If I’m caught I’ll plead insanity.”

The latest Greek bail-out changes nothing, other than accelerating the pace at which euro zone tax payers have their funds flushed down the toilet, redirected to the banks, or both. (They may be the same thing.) European politicians appear to be struggling to accept the underlying reality: Greece is insolvent, so simply throwing €180 billion more of other people’s money at the problem doesn’t improve matters, in the same way that violently injecting ever greater doses of adrenaline into a corpse doesn’t change the outlook for the corpse. The package announced last week was admittedly more dramatic than the markets had anticipated, but its confidence-boosting impact will probably have evaporated by the middle of this week, not least because other sovereign insolvencies are quietly biding their time on the sidelines, oozing poison into the markets. €180 billion doesn’t buy you much of a rally these days. Bullishness is terrifically expensive.

Sometimes, amid the Sturm und Drang of the market, it’s possible to have a blinding moment of clarity. In one such moment, Nomura’s Bob Janjuah we think clearly identifies the problem facing Europe, in just three little words: weak trend growth.

Most policymakers and many in the market are still desperately hanging on to the view that trend growth rates in developed markets (and emerging markets too) have not been impacted materially as a result of the financial crisis. To me the evidence is clearly “in”. … The only way developed market (and emerging market) policymakers have been able to deliver even barely acceptable trend growth has been through the use of unsustainable policies which put short term gains first but which clearly create huge long term risks to sovereign credit quality and which leave a deeply negative scar in the minds of the private sector, which is attempting to de-lever and which knows it is facing the mother of all tax liabilities going forward. The reality is that absent a private sector debt binge (the private sector is not that stupid) and assuming we are coming to or are at the end of the line with respect to policy, then developed market trend growth over the next 3 – 5 years will be in the 1% to 1.5% range. Once the market is able to see the limits of policy, and once the market is able to see through the excuses (of ‘soft patches’), then it is inevitable that we see a significant re-price lower of earnings expectations, of incomes, of asset values, and a genuine (rather than hypothetical) acceptance that living standards, especially in the developed market economies, are going to be materially lower over the next 5 – 10 years than current consensus expectations / forecasts.

Bob Janjuah is surely almost certainly correct when he concludes that emerging market economies, as a whole, are likely to outperform over the medium term, on account of their “strong balance sheets, huge flexibility in taxation and labour markets, and very low levels of entitlement expectations”. Or to put it another way: Europe has – with the possible exception of Germany – gone ex-growth, and faces a future that looks rather similar to the last two decades in Japan. This point is not lost on Merryn Somerset Webb writing for the weekend FT and citing some holiday reading for investors still clinging to a sense of realism. Among her selection is Alex Kerr’s ‘”Dogs and Demons”, which covers Japan;

… for a real insight into how the odd banking crisis can turn into a disaster for public finances, turn to [ironically enough] chapter 11. Here you will learn about how “the ministry of finance‟s support for banks and industry through the manipulation of financial markets has had high costs. Interest rates of 1% or lower have dried up the pools of capital that make up the wealth of ordinary citizens; insurance companies; pension funds; the national health system; savings accounts; universities; and endowed foundations. The prognosis is for skyrocketing taxes and declining social services.

That should have a familiar ring to it – it is a glimpse into our own futures.

And while Europe drifts slowly towards further genteel decline, American politicians wrangle over their own debt burden, showing, in the process, an alarming complacency at the prospect of sovereign default, and obvious unfamiliarity with the principle of “risk-free assets” and the capital asset pricing model. Orwell suggested how language would be deployed as the last refuge of the political scoundrel, so we have been treated in recent weeks to concepts such as “restructuring” and “selective default”, as if investors were unaware that huge parts of the sovereign debt structure were buckling under the weight. We take a hugely simplistic view of the global debt landscape: if the (sovereign) borrower is a deadbeat, we don’[t lend to it. In the words of John Badham’s film “War Games”, sometimes the smartest move is not to play.

If it makes sense to be highly selective about bonds, given the risks, it surely makes sense to behave in the same way when assessing equity opportunities. Europe‟s slow decline doesn’t automatically invalidate the shares of European or UK-based companies, for example, but it does suggest that we should be thinking about those businesses with meaningful exposure to faster growing places in the world, and about those businesses whose shares represent deep defensive value. The problem here is nicely expressed by JP Morgan‟s Michael Cembalest. Large cap, blue chip stocks in the UK and Europe trading at single digit price / earnings multiples, with 30% to 50% of their revenues in faster growing economies, and offering 3% to 4% dividend yields, or higher, are surely relatively attractive. But “we don’t expect to get paid in full until (and unless) the world’s largest debtor economies find a way out, which is going to require more leadership than we have seen so far, and perhaps a crisis to bring it about.” We disagree only on one point: where Michael Cembalest uses the word “perhaps”, we would use the word “certainly”.

Given that the ability to anticipate the macro environment involves a more than ordinary ability to assess just how selfish and stupid politicians are going to be, we feel more uncomfortable than normal allocating capital to macro managers. We favour purely systematic, mechanistic trend-following strategies for our “absolute return” exposure, and we acknowledge that the sector is currently struggling with market headwinds that may be influenced by the extent of political asset price manipulation.

Our fourth asset class commitment in these extraordinary times is to real assets. Observers often complain that we seem to write about little more than gold. Which is wholly unfair. We have often discussed the investment merits of silver.

So we peer into an investment landscape more than usually obscured by uncertainty and with huge prospective tail risks. We draw huge comfort from an investment process that we feel is more genuinely diversified by asset type than those of many of our peers, and that simultaneously benefits, we believe, from a concentration of investments where we have particularly high conviction – the monetary metals being a special example. There is admittedly not much fun in anticipating what might be years of structural decline in our home markets. But it most certainly takes the edge off when one has a plan.

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Is Economic Weakness Determining the Large-Deficit Outcome of the Debt Ceiling Debate?

By DoctoRx

I think that the most important economic news item this month was made a few Sundays ago when both Tim Geithner and WH Chief of Staff Daley went on the Sunday talk shows to warn of difficult economic times ahead. This is from the same White House that obviously had top-notch information when Mr. Obama, in early March 2009, suggested that people might just want to buy stocks (famously referring to profit and earnings ratios). By July 1983 and July 1995, were the Reagan and Clinton teams warning of tough times ahead, or were they thumping their chests taking credit for resurgent economies? This is not how a president wants to begin a re-election effort.

Now let’s fast forward a bit to the latest on the budget/debt ceiling mess.

It sure looks as though the politicians have had prolonged infomercials. (The process evokes Bismarck’s admonition that one should watch neither the making of sausages nor laws if one wants to hold one’s lunch down.) Of course, most Americans wish the pols would stay out of our faces and enjoy a summer vacation. What will these public servants do? Well, looking at the alleged conservative party’s proposals, they will continue with “Keynesian” policies of “supporting” the economy. And of course the Fed will play its assigned role.

The Chicago Fed National Activity Index 3-month average is already around the level at which recessions often begin (see last chart on the second column of page 2).

So, I’m putting matters together and saying that the Demopublican party is preparing for yet another period in which private credit demand is going to stay restrained and the Feds will “do their part” and issue lots more debt. What are the investment implications?

This would suggest that the upcoming months are conducive to a “going-Japanese” interest rate scenario. Weak economy and recession fears, declining stocks, fears of more price inflation, etc., unpredictable interest rate moves on the long end but with expectations of Fed tightening continuing to be pushed back. If the economic weakness is global, then the only currencies to really trust are gold, which trades as a currency in such times, and the quasi-gold-backed Swiss franc. Economically sensitive commodities such as oil would be dangerous. Silver would be as usual unpredictable given that it trades both as a currency (money, at least potentially so) and as an industrial commodity.

Strangely, we know from the past 15 years both in the US and Japan that government bonds have tended to rise in price (decline in yield) as large deficits continue. For example, Treasury borrowing rates did not fall in the period of government cash surpluses in the late ’90s through 2001, and rates have fallen as deficits have soared. Can this situation continue? Well, if the choice is earning nothing on cash or something on an intermediate-term bond, choose your poison! In Japan, people got used to the low rates and accepted lower and lower rates on longer duration bonds. Investors did however resist with increasing determination lower rates on the 30-year bond there, and this issue has provided the best cash return for them year after year. So, interest rates are a confusing mess to analyze and forecast in the US given that the US is not Japan and could in theory move more toward hyperinflation than toward price stability even if economic activity continues to decelerate.

So as we enter the historically worst consecutive two months of the year for the stock market, the set-up reminds me of the 2007-8 period: Generally high stock prices, massive optimism earlier in the year by stock market participants, high reported earnings, high commodity prices, depressed construction activity. We had stagflation beginning in 2007, interrupted only by the liquidation spasm following the Lehman-AIG fiasco period. That trend remains in force.

What if the economy takes off, perhaps related to all the recent massive money creation and perhaps surprising even the Washington crowd? Then gold will probably do fine, just as it did in the strong economy in 1978-80 until Fed tightening finally turned short-term interest rates strongly positive. Bonds will become ”sells” on a trading basis, but their downside risk may be minimized by the mind-set of the Fed, which will work as hard as possible to keep rates “too low”. Financials will turn on a dime, perhaps with BofA stock (“BAC”) going again from a dog to a star. The financial stocks do tend to predict the economy.

Several gold-oriented bloggers have pointed to this week’s expiration of options on gold futures as suggesting a “bear raid” on gold by powers that be to force weak hands to sell their gold rather than actually own the futures contract. So far, that activity has been muted (if it exists at all). Bloggers have also been suggesting that the equivalent of a global short squeeze may be brewing in both gold and silver.

In any case, having been a happy participant in the bull(s–t) stock market of the late 1990s, I continue to see structural similarities between the precious metals’ action over the past decade and the almost uninterrupted 25-year bull market in the NASDAQ beginning December 1974. The top was always higher and farther away than you thought was reasonable. In this analogy, it may only be 1984 in the precious metals bull run with years to run. Who can know?

The decline of the financial position of the Federal government of the United States of America is an earthquake with much larger global financial effects than the seismic events in Japan, New Zealand, Chile and Haiti the past couple of years. Are the euro, yuan, ruble or yen ready to replace the dollar as the North Star of finances? Some amalgamation of them all? Is the global Dow a suitable replacement?

My answer is, of course, “No” to the above questions, which is how it goes with rhetorical questions.

Only gold can step once more into the breach caused by the problems caused by the difficulties of the economy and official finances of the United States. The gold standard movement has even gained support within the Neo-con movement:

 

The Weekly Standard is out this week with a serious piece touting the virtues of a gold standard. (Perhaps it will change its name to “The Weekly Gold Standard”. (But as some point TWS has to understand that a perpetual warfare state is constrained by a gold standard as much as is a welfare state.)) Just as the amazing aspects of the tech-communications revolution revealed itself gradually, picking up converts steadily, I both hope and increasingly believe that the virtues of sound money that cannot be printed at will by central banks is following a similar trajectory. In that case, both gold and silver bullion prices will climb walls of worry, and one day cocktail party talk amongst doctors and dentists will involve the latest hot precious metals mining stock.

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