S&P 500 Net New Highs

by Bespoke Investment Group

In Friday's trading, there were three S&P 500 stocks that hit new 52-week highs (CL, DGX, and TDC) and only one stock that traded to a new 52-week low (WFR). This ended a nine trading day streak where more stocks hit new lows than new highs. Since the bull market began in March 2009, there has only been one other period where new lows exceeded new highs for nine trading days (8/19 - 8/31). So at this point at least it hasn't gotten worse than last Summer.

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Crude Oil Price Downward Pressure

By: Mike_Paulenoff

Frankly, there are so many cross-currents influencing the markets at any given time, uncertainty clearly has the upper hand -- even when we think that new information or decisions are alleviating some of the uncertainty.

Case in point: crude oil prices. Is downward pressure positive for equities (for obvious reasons: i.e., the consumer gets a "tax cut"), or negative because it might reflect a serious slow down in U.S. and global economic growth (read: China demand)?

I don't know the answer, but I am leaning towards the latter scenario right now.

Looking at the nearby NYMEX crude oil futures chart we see that prices continue to follow their technical script, which called for a breakdown from the four-week coil pattern towards an optimal target zone of 90.00-88.00.

So far, the plunge from the coil has hit a confirmed low of 92.12 earlier this morning. Barring a sustained climb above 97.25, my pattern and momentum work will continue to point to 90.00-88.00.

Whether or not downward pressure on NYMEX oil (and to a lesser extent Brent) will translate into headwinds for Exxon (XOM), Schlumberger (SLB), ConocoPhillips (COP), Halliburton (HAL), Chevron (CVX) and the ProShares UltraShort Oil & Gas ETF (DUG) remains to be seen.

That said, with the possible exception of CVX, all of the above-mentioned energy names exhibit very toppy intermediate-term chart patterns.

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The Turning Point

by Tyler Durden

Submitted by Charles Hugh Smith from Of Two Minds

The Turning Point

Some technical analysts are calling for a major rally from here, but the massive injections of financial insulin don't seem to be reviving the sagging global economy.

The stock market and economy are both at a turning point. Analyst Martin Armstrong's Economic Confidence Model (tm) set the turn date as June 13/14, 2011.

In the stock market, a number of technical analysts are issuing strong buys based on the negative sentiment of so-called "dumb money"--small investors--and the number of stocks below their 50-day moving averages.

Others such as Armstrong are predicting that Greece has no alternative to default and the Euro is untenable as "one size does not fit all."

It is rare to find a market where the technical evidence is so compelling for a strong rally yet the fundamental basis for such a rally so lacking. Exactly where do Bulls think the growth and rising profits are going to come from?

The answer for the past few years has been massive Federal Reserve/Federal intervention and stimulus, and a weakening U.S. dollar that boosted overseas profits via the legerdemaine of currency devaluation.

But three years of these policies have accomplished nothing but load the taxpayer with staggering amounts of debt: none of the causes of the 2008 implosion have been fixed or even addressed. As Armstrong notes, the massive interventions did not shorten the crisis, they have prolonged it.

This reality has filtered down to the political swamp, and now the politicos are hesitant to bet their own futures on additional trillions in stimulus and quantitative easing. For the first time in memory, the Federal Reserve is on the defensive. Simply put, its policies have failed to accomplish anything except prop up a rotten, insolvent banking sector that needs to be declared bankrupt and swept into the dustbin of history.

As I have noted here before, the next round of QE (quantitative easing) will fail to inflate the stock market regardless of its size or tricks. The fact that QE3 is needed will spook everyone who understands that it is a last-ditch effort to keep the Status Quo financialization from imploding, and since QE2's sugar-high was so brief, others will be spooked by the possibility that the next high will be even shorter.

This is the dreaded Diabetes Financial Syndrome--the Fed is pouring ever larger amounts of financial insulin into the system, but the financial "body" no longer responds to this insulin. The financial system then goes into toxic shock and implodes.

Let's look at two charts for context. Here is the S&P 500 from 1965 to 2011. Hmm, are there any aberrations visible here, any gigantic spikes of speculative frenzy? Just because these spikes of speculative, financialized frenzy have been normalized doesn't mean they are no longer speculative, financialized frenzies.

Has the economy really been healed? If not, then what is the basis of the market's spectacular rebound since 2009? We all know the answer: $6 trillion in Federal financial insulin and another $2 trillion in Federal Reserve insulin. The entire rally, in other words, is an artifact of Central bank/State intervention.

Courtesy of dshort.com, here is an inflation-adjusted chart of the S&P 500. This chart clearly illustrates that unprecedented Central State stimulus and intervention/manipulation have juiced the market higher than previous post-crash highs.

But the whole financial-insulin project is looking a bit long in tooth compared to previous post-crash markets. In the long run, perhaps we can attribute this extension of the euphoric high of "recovery" to the Fed's QE2, which pumped half a trillion dollars into stocks in a matter of months.

Short of the Fed simply buying trillions of dollars in stocks outright, then it looks like this "recovery" rally is about to have a Wiley E. Coyote moment, as it has raced off the solid ground provided by the Fed's QE2 injections and is now poised in thin air.

Of course the market could rally from here, but it's hard to see on what basis other than a technical dead-cat bounce. The Fed could announce another round of intervention, and that would certainly give the comatose body a jolt. But for how long?

If it does respond to gravity, then we might want to re-visit the definition of "dumb money:" small investors have been pulling money out of the stock market all during the QE2 insulin-rush rally while the "smart money" has been piling in, blubbering piously about the key tenet of their religious faith, "don't fight the Fed."

So which do you think is all-powerful, smart money--the Fed or gravity? We're about to find out.

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by Tyler Durden

It has not been Jim Caron's decade. The Morgan Stanley rates strategist, riding on the coattails of the always wrong Morgan Stanley economics team led by David Greenlaw, has been wrong in his annual rates call year after year after year. Which is unfortunate because while unable to see the forest for the trees, Caron does have a better grasp of rates than most other Wall Street penguins. That said, just like everyone else in the status quo, Caron has just come out with another short duration call (i.e. sell bonds), probably the 6th time in a row he has done that in the past 3 years. Perhaps 7th time will be the charm. Amusingly, Caron, terrified to be seen in the same camp as Bill Gross who is short bonds on fears that there will be nobody available to step in an buy the 80% of gross issuance that has been monetized by the Fed to date, make this very loud caveat on his short bond call: "To be sure, our shift toward short from neutral duration has nothing to do with the end of QE2 and related concerns that there will be a lack of demand to buy US Treasuries once the Fed stops buying them. As we have stated many times in the past, the outlook for the economy will be the main driver of yields, not the end of QE2." No, instead Caron believes that the sell off in bonds will be due to the same bullish economic growth call that he has been predicting over... and over... and over... and over... etc. More interesting is how he suggests the trade is implemented: in MS' view the best way to be bearish on rates is with a DV01 neutral 7s-10s flattener: "we continue to recommend being short 5s on the 2s5s10s fly. In line with the butterfly, and in order to express a more robust short duration position, we recommend a curve flattener on the UST 7s10s curve: · Sell $133.7mm OTR 7y Notes; · Buy $100mm OTR 10y Notes." Perhaps those who want to be short bonds, but for the right reason, that predicted by Zero Hedge and then Bill Gross, this may be one of the better ways to put the trade on.

More below:

Reducing Duration Exposure from Neutral Toward Underweight

We are reducing duration exposure from neutral toward underweight. The reason is that the market has already well discounted 2H growth to levels much lower than consensus. As we see it, the risk now is for the market to price 2H11 growth higher. We will start out cautiously by expressing this negative view via underweighting the belly of the curve versus the wings rather than positioning outright short. The risk to our view is if the European debt crisis worsens, but our base calls for a temporary reprieve as Greece receives a new aid package. This is a tactical view and we believe the location is good to establish a negative UST bias, given how rich the belly of the curve has gotten and since our models indicate 2.85% is the lower bound of fair-value for UST 10y. Medium term, we believe 10y yields will remain range-bound. Let us explain:

1. The belly of the curve has richened to levels that is consistent with a 2.65% growth outlook over the next six months While we feel it is appropriate for the market to discount the risk of a downgrade to the 3.35% consensus growth expectations in 2H11, we believe that discounting it to 2.65% or lower is too much (growth estimates come from Blue Chip Consensus).

2. Our economics team believes that we will have a rebound in 2H11 led by the auto sector that may contribute as much as 1.5% to growth in 3Q11 (see Exhibit 1, LHS) and possibly as much as 0.5% to 4Q11 growth. Also, consistent with their growth outlook, they see core inflation continuing to rise with headline CPI forecasted to be 3.4% and core at 1.9% by the end of 2011 (see Exhibit 1, RHS). However, this view hinges upon the US economy’s ability to produce at least 150K jobs per month − a key threshold.

3. Over the next several weeks, event risks will come to pass and we expect clarity from the end of QE2, the debt ceiling and Dodd-Frank. We believe that this will reduce uncertainty and the safe-haven bid for bonds. Our macro team believes that the recent soft patch is nothing more than a mid-cycle slowdown and that risky assets may perform starting in 2H11 (see Global Debates Playbook, June 16, 2011).

To be sure, our shift toward short from neutral duration has nothing to do with the end of QE2 and related concerns that there will be a lack of demand to buy US Treasuries once the Fed stops buying them. As we have stated many times in the past, the outlook for the economy will be the main driver of yields, not the end of QE2. Also, we think that an agreement will be made on the debt-ceiling debate between the Democrats and Republicans some time in July before the August 2 social security payment deadline. And as for Dodd-Frank, which is scheduled to start imposing new regulations on the market as early as July 16, we believe that much of it may be postponed until later this year and possibly into 2012 due to the lack of clarity around many of the intended regulations.

Following the money. As the market is priced for slower growth over the past several weeks, we have seen inflows into bond funds rise sharply while risky assets saw outflows (see Exhibit 2). For the month of May, bond funds saw the largest monthly inflows in seven months totaling $20.2 billion while equity funds saw outflows of $2 billion as compared to inflows in April of $5.3 billion (first month of outflows after six consecutive months of inflows). Also, according to surveys we follow, the decline in rates has caused many to reduce their short positions. Thus the combination of money flows and duration surveys we track indicate that the short bond exposure in the market has been reduced which technically puts less pressure on rates to stay low and instead clears a path for them to rise.

Duration risk cuts both ways. When growth expectations for 2011 were being downgraded, longer-duration bonds performed best. This was most notable in TIPS as real yields significantly dropped. The drop in real yields was so dramatic that the year-to-date performance of TIPS even exceeds that of high yield. What has changed? Long-duration exposure presents a greater risk and may become a source for underperformance rather than outperformance going forward, especially if 2H11 growth rebounds as market consensus suggests it might.

Conclusion. Our tactical shift from neutral to short duration has several implications: 1) we expect real yields to begin a steady rise higher, and 2) we expect the belly of the curve to underperform and the 10s30s curve to flatten.

And the best way to express a bearish stance in the rates complex according to Caron:

Since April, the belly of the curve has richened significantly as rates have marched lower (Exhibit 1). We continue to recommend being short the belly vs. the wings, as previously discussed short 5s on the 2s5s10s fly (see “Fade the Recent Outperformance of the Belly,” US Interest Rate Strategist, June 9, 2011). In line with the butterfly, and in order to express a more robust short duration position, we recommend a curve flattener on the UST 7s10s curve:

· Sell $133.7mm OTR 7y Notes

· Buy $100mm OTR 10y Notes

Both the 7s10s curve flattener and the butterfly allow the investor to play for a reversion in the richness of the belly. Rather than going outright short we suggest initiating these relative value trades, which capture some duration exposure and some relative value exposure between different points on the curve.

We argue that growth expectations have not been downgraded to the extent that rates in the 5-10y sector have fallen with survey consensus at 3.35% for 2H11. In our view, the rates market is pricing levels of US growth that are inconsistent with surveyed forecasts (see “Reducing Duration Exposure from Neutral to Underweight” in this publication).

This past week, price action in the market has reflected uncertainty as, for example, the 7y point increased 12bp on Tuesday only to decrease by 14bp on Wednesday returning to similar levels. We expect the market to remain range-bound in the near term; however, we see fair value of the 10y note at about 3.10% with a 25bp standard deviation (Exhibit 2). With the 10y dipping to the low 2.90’s, we see an opportunity to fade this extreme.

UST 7s10s Flattener

As we have shifted from neutral duration to tactically short, we seek relative value trades that would perform if yields in the belly increased. We believe a UST 7s10s flattener is one of the best trades that fit this description for the following three reasons:

1) Historically steep curve. We have been in a steep yield curve environment for some time now, but with the recent move lower in yield in the belly, curves such as 5s10s and 7s10s have increased once again and now are nearing the all-time highs reached in November of last year (Exhibit 3). We do not think that the low yields around the 7y point are warranted due to growth expectations higher than they were 8 months ago, and hence we look for this curve to flatten.

2) Beneficial roll and carry characteristics. The 5s10s curve historically has more variance than 7s10s, however both curves have increased approximately the same amount over the last several weeks (Exhibit 4). Additionally, the carry on the 7s10s flattener is -2.0bp per 3m, while it is -4.5bp per 3m on 5s10s. If we divide this carry by the 3m realized volatility of each respective curve, we obtain a carry quotient of -0.24 and -0.36 for the 7s10s and 5s10s flatteners, respectively.

The carry quotient gives us a risk-adjusted level of carry on each curve and shows us that the 7s10s absolute carry of -2.0bp is also better than the 5s10s negative carry on a risk-adjusted basis.

3) Correlation that favors a sell-off in the belly. Our premise is that we are not only fading an extreme curve level, but also gaining exposure to a sell-off in the 7y sector. Recently, that is exactly how this curve has been trading

7s10s has been fairly well correlated with rates since about January, 2010. Starting in October, 2010, this correlation increased, and the beta, or slope of the regression increased as well. Since October, 2010, the 7s10s curve has been flattening/(steepening) approximately 13bp for every 1bp increase/(decrease) in the 7y yield.

The risk to this trade is that the 7y yield decreases relative to the 10y yield. As the trade involves a short position at the 7y point, losses are potentially unlimited.

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Moody's Puts Italy's Aa2 Rating On Downgrade Review, EUR Slides, And A Bonus Report From SocGen: "How Vulnerable Is Italy?"

by Tyler Durden

Trust Moody's to come up with the Friday afternoon bomb. EURUSD slides on the news, which sends the 100% correlated stocks plunging.

Full text from Moody's:

Frankfurt am Main, June 17, 2011 -- Moody's Investors Service has today placed Italy's Aa2 local and foreign currency government bond ratings on review for possible downgrade, while affirming its short-term ratings at Prime-1. 

The main drivers that prompted the rating review are: 

(1) Economic growth challenges due to macroeconomic structural weaknesses and a likely rise in interest rates over time;

(2) Implementation risks surrounding the fiscal consolidation plans that are required to reduce Italy's stock of debt and keep it at affordable levels; and

(3) Risks posed by changing funding conditions for European sovereigns with high levels of debt. 

Moody's review will evaluate the weight of these growing risks in light of the country's high rating but also relative to some credit-strengthening trends that have been observed in recent years and are expected over the coming years, such as improved fiscal governance, lower budget deficits and a modest economic recovery. 

RATIONALE FOR REVIEW 

First, the Italian economy faces growth challenges in an environment characterized by long-term structural impediments to growth and potentially rising interest rates. Structural economic weaknesses -- mainly low productivity and important labour and product market rigidities -- have been a major impediment to growth in the last decade and continue to hinder the economy's recovery from the severe recession it experienced in 2009. Italy has so far only recovered a fraction of the nearly seven percentage points in GDP that it lost during the global crisis, despite low interest rates, which are likely to rise in the medium term. Growth prospects for the Italian economy in the coming years will be a crucial factor that will determine the government's revenues and the achievement of fiscal consolidation targets. 

Second, there are implementation risks to the fiscal consolidation plans that are required to reduce Italy's stock of public debt to more affordable levels. Against a backdrop of rising interest rates and weak economic growth, the government may find it difficult to generate the primary surpluses that are needed to place the public debt-to-GDP ratio and the interest burden on a solid downward trend. The adoption of additional conservative fiscal policies may prove more difficult in the near future because the current government's electoral support is weakening, with the government facing challenges in gaining public approval for its policies. For example, the government's recent energy and water supply proposals were rejected by popular vote. 

Third, the fragile market sentiment that continues to surround European sovereigns with high levels of debt poses additional risks for Italy. The continued stability of market demand for Italy's debt is uncertain at current yields. Although future policy actions within the euro area could reduce investors' concerns and stabilize funding costs, the opposite is also possible. In any event, going forward, investors appear likely to differentiate more among euro area sovereign borrowers than they did prior to the financial crisis, to the disadvantage of euro area countries with higher-than-average debt burdens, like Italy. 

FOCUS OF RATINGS REVIEW 

Moody's review of Italy's sovereign rating will focus on the growth prospects for the Italian economy in coming years, and particularly the prospects for a removal of important structural bottlenecks that could hinder a stronger economic recovery in the medium term. The review will also examine the government's ability to achieve ambitious fiscal consolidation targets and to implement further plans to generate substantial primary surpluses in the medium term. This will include an analysis of the vulnerability of the Italian government debt trajectory to a rise in risk premia, as well as the options for the government to react. The government's new fiscal plan, which is expected to be announced shortly, will be considered during the review. 

In addition, any broader developments across the euro area, in particular with regard to the resolution of the euro area debt crisis and its impact on funding costs, could be important determinants of the outcome of Moody's rating review

PREVIOUS RATING ACTION AND METHODOLOGY

Moody's last rating action affecting Italy was implemented on 15 May 2002, when the rating agency upgraded Italy's Aa3 government bond ratings to Aa2 with a stable outlook. The rating action prior to that was taken on 3 July 1996, when the rating agency upgraded Italy's A1 government bond ratings to Aa3.

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5 CHARTS OF CHINA’S GROWTH CONUNDRUM

By Rohan Clarke

When you think about it, the imminent spike in mining related investment and its impact on Australian GDP is a pretty fair reflection of what has been going on in China for some time. Martin Wolf recently opined on the sustainability of China’s GDP growth without the government sanctioned infrastructure binge (here). It’s the Jim Chanos view of the world, ease off the building and things don’t just slow, they go into reverse pretty quickly. The following charts hint at what’s at stake:

1) The importance of infrastructure investment (Gross fixed capital formation) in driving China’s GDP growth over the last decade is self-evident:

2) And even more simply stated as a proportion of GDP:

3) So it is clear just how difficult is the task is to migrate the driver of GDP growth from investment to consumption.

4) Still that is why China is forecasting GDP growth closer to 7% for the next 5 years – it’ll be weaning the economy off the debt financed infrastructure spend ever so gradually:

5) But the risk is that the problems have already been conceived – China’s financial system is pregnant with debt that has financed investments that will prove uneconomic if the rate of GDP growth (and the attendant asset price inflation) slows.

Looked at from this perspective, it has remarkable similarities to the debt overhang that persists in the developed world – and the resulting underperformance of financial equities from New York to London and beyond.

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