Home > Uncategorized > 2011/10/21: Quick Post: Good News and Bad News… Which Also Is Good News For Now

2011/10/21: Quick Post: Good News and Bad News… Which Also Is Good News For Now

The good news is that the economic data has been relatively mixed, yet with a positive note today from German IFO (a current reading for October) being just a bit better than expected. Corporate earnings announcements have also not been spectacular, yet positive enough to promote the typical earnings season bid in equities. The bad news would appear to be the inability of Germany and France (the players who really count) to agree the full funding and functional guidelines for the European Financial Stabilization Facility (EFSF.)

Yet, in their inimitable way equities are taking the deferral of the decision deadline from Sunday’s EU Summit to a further ‘final’ meeting next Wednesday as a relief. It appears all that soccer excellence (as opposed to American football’s focus on use of hands) is paying off… another excellent example of high proficiency at ‘kicking the can down the road.’ Of course, the only problem we see is that the Europeans might just be running out of road.

As we noted on Tuesday, Chancellor Merkel was right to inject a dose of reality at the top of the week. As she made clear, a final decision just three days after the Troika (IMF/EC/ECB) report on Greek fiscal sustainability was a ‘dream’. Our expectation now is much the same as earlier this week that markets will allow approximately another week or so for the European negotiations to evolve.

Even Wednesday’s new ‘final’ deadline likely can be fudged once again for just a short while. However, our next major blog post is still going have the title Will Candy Coated Equities be Spooked by the Halloween Goblins? As there are good reasons to doubt Europe can sort this out… and the US will soon re-enter the sovereign debt crisis fray.

It’s all about intractable positions on both sides of the Atlantic. While we will have much to say on this soon, the basic dynamic that no one dares speak its name (yet is well-acknowledged by students of economic history) is ‘deleveraging’. It is the force driving all of these other problems, and generally takes anywhere from five to ten years to fully adjust once it hits the proportions experienced at the top of the Super Cycle excesses back in 2007-2008.

This does not need to be a tragedy. The key is to not let it all occur to rapidly, as was the problem that struck the world back in the 1930s. On current form that means the Federal Reserve may appear misguided in continuing to provide additional liquidity that is ballooning balance sheet. Yet that may be just what is necessary to prevent an even worse downward economic spiral. That also informs the degree to which the large surplus mercantilist success stories like Germany and China should find it in their enlightened self-interest should be willing to spend a lot of reserves to keep the whole game going.

However, most often people who have achieved success feel they’ve accomplished it through discipline and sacrifice, and will not acknowledge the degree to which they took advantage of the game. Not that we agree with the socialist tendencies of the Occupy Wall Street crowd, but it is now in the interest of the more successful to make sure that the gears of the economic machine do not clog up for lack of lubrication.

That is why in Europe it all comes down to Germany, and whether it’s political class can see the importance of achieving confidence that EFSF along with the European Central Bank are going to have the sufficient powers and funding to get the job done by later on next week. The equity markets will not likely take kindly to going into another weekend after multiple deadlines have been missed.

Any lack of ability to demonstrate that pan-European constructive decision-making ability by the end of next week will be a real problem. There was another excellent Financial Times’ Short View column on this by James Mackintosh this morning. He also notes the degree to which this is not a static situation, and has been degenerating of late due to the lack of ability of European politicians to agree in this important area. Unless something is definitive is agreed by the end of next week, we surmise the Europeans will have run out of road right into the classically spooky Halloween weekend.

That is also especially so for the currently dysfunctional US fiscal debate degenerating into the strong partisan desire either cut spending OR tax. The real answer is that the US needs to do both. While lowering the deficits and achieving fiscal balance are certainly necessary in the intermediate term, under current circumstances simply lowering federal government spending by enough to bring the budget back into some sort of balance is going to depress the economy by a degree that will not achieve the fiscal targets in any event. Hasn’t Greece been a clear enough learning laboratory for everybody on this?

And while the official deadline for the US Congressional Fiscal Reform Super Committee suggestions to be passed in the legislation is Thanksgiving, the actual plan must be presented well ahead of that. How far? Lest anyone forget, back in September the highly respected Congressional Budget Office (CBO) let it be known that it needs the proposed compromise on the additional cuts to affect the further increase in the US government debt ceiling by the end of this month. That would be so it could properly review and score the plan, which will be a major influence on whether the rating agencies will not drop the US credit rating any further.

Essentially, while everyone on both sides of the Atlantic has agreed to disagree but keep on talking, the pressure relief from that is going to be very short-lived. By the later part of next week it will be back with a vengeance, for better or worse. If credible plans can be devised, at least the worst case scenarios for sovereign debt concerns might be mitigated in the near-term. Yet, if there is no progress by the end of next week, we suspect the equity markets will need to start discounting much more troubling credit market conditions once again. We shall see.

General Market Observations

These sideways churning markets mean that these general observations should probably suffice until we get out to the more critical trend psychology mid-to-late week next week. Equities certainly seem to have already discounted the toxic impact of the Troika report on unsustainable Greek debt loads. Of course, we also still believe that the overall equities’ decision will be critical to all of the other asset classes now that the classical intermarket relationships have been back in place for some time.

In the first instance, the December S&P 500 future swing back up above the upper 1,100 area has seen it hold pullbacks and now push above 1,230 area as of this writing. And by overall equities’ decision we mean whether it will be able to maintain itself above that important interim resistance threshold after it gets closer to the more major resistances in the 1,245-65 area. Much as the recent failure below 1,100-1,090 on the downside was a very temporary affair prior to strengthening back above it, there is a real issue as to whether the news will remain positive enough to fuel sustained progress above 1,230.

If not, then any failure back below 1,215-10 (also conveniently the gap higher this morning from Thursday’s Close), will be the sign that the market is at least weakening back into the lower major August-October range. [This is much akin to the December S&P 500 future needing to recover back above 1,115 prior to it being clear it would not weaken back below 1,100-1,092 weeks ago.]

With those classical intermarket influences reinstated, that will also likely determine whether govvies and the US dollar continue on their current swing back down from resistance toward key supports. However, in fact, neither of those other asset classes is weakening to the degree that is commensurate with the current strength of equities that are pushing to a new near-term high. This is classical early corporate earnings announcement season activity, where the govvies and US dollar can maintain their bid in spite of equities strength.

On historic form that is because they are focused more so on real world economics, while the equities are experiencing a squeeze to the upside. That is due to both enthusiasm for individual companies that have shown good earnings, and a general condition of an “unbought bull” squeeze. After holding near the recent highs for over a week prior to pushing through, we doubt there are many bears left in the US equities. However there are those circumspect portfolio managers who are now forced to chase performance by taking cash off the sidelines and committing to the market. Ergo, this phase of the rally (which might still be a correction within the overall bearish trend) might be an “unbought bull” squeeze. Palfrey volumes on the rally would certainly tend to reinforce that notion.

No surprise therefore that the more volatile long dated government bonds that were up to key resistances are now falling back. Such as December Bund future back from the 135.50-.80 area. That is very important as the working Tolerance of the 135.00 area combined Head & Shoulders Top and major daily up channel DOWN Break; any further surge much above that area will turn 135.00 back into support for a likely push to a new high (i.e. above the 139.19 all-time high.) It is important to note that even though it is now back slightly below 135.00, it is nowhere near low end of its important 134.00-133.30 support that was tested while the December S&P 500 future was failing the 1,230 area earlier this week. Hmmm.

Of course, the same goes for the December Gilt future falling back from its key 128.50-80 resistance, as much further progress in either of those two leading govvies futures only makes sense if indeed the equities are going to experience quite a bit of further weakness as well. In this case as well, it is only back into interim 127.80-.50 support rather than the vigorous test of its 126.93-.75 support like the last time equities were up into resistance.

December T-note future has had the much more orderly trend since mid-September. As such, it held near-term trend support when it dropped to no worse than mid 127-00 area last week into earlier this week, and is nowhere back near that now. That said, it still needs to make more progress back above the low 129-00 area congestion (i.e. daily Closes back above the 129-16 gap from back on October 7th) prior to turning really bullish once again,

The US Dollar Index was also back up to a recent significant .7760 daily up trend channel DOWN Break, yet is dropping at present only back into the key .7680-00 support range. With the euro recovering from down into key EUR/USD upper-mid 1.3600 support, serial resistances back up into 1.3900, 1.400 and 1.4100 are still significant barriers to further improvement. Other foreign exchange indications are at similarly fraught near-term levels. All the more reason to suspect the further decisions by all of the other asset classes will rest with the equities considerations into mid-to-late next week.

Thanks for your interest.

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