Despite the Market's response, yesterday Merkel/Sarkozy meeting is potentially the good news scenario
Steve Cook on Disciplined Investing

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Have You Seen This?


The Market
    
    Technical

    The Averages (DJIA 11405, S&P 1192) closed in the lower quadrant of their recently re-set intermediate term trading ranges (10725-12919, 1172-1372).  Since this trading range is very new, the boundaries (in this case the lower boundary) are vulnerable to a strong challenge.  As I noted yesterday, I believe that there is a 1 in 4 chance of it not holding and a 1 in 2 probability that it will be challenged.

    Volume was low, while breadth declined.  The VIX surprisingly declined though it remains near the upper boundary of its newly expanded trading range.

    GLD was strong again.  It is nearing the zone that argues for a technical trade based on its being overbought.

    Here is another man’s perspective on the technical picture for gold (medium):
    http://www.minyanville.com/businessmarkets/articles/gold-gold-market-gold-price-gold/8/16/2011/id/36372?page=1

    Bottom line: most of the stocks in our Universe bounced at easily identifiable support levels.  That gives me some confidence that we have seen the worst.  Nevertheless, there remains a sufficient probability that there is more down side to warrant continued caution.

    Last week I noted that the S&P was near a death cross (50 day moving average moves below the 200 day moving average) and that was a negative for stocks.  Here is an historical analysis of this indicator that shows that it is not nearly as bad as I suggested:
    http://www.ritholtz.com/blog/2011/08/worry-about-important-things-not-the-death-cross/

    Fundamental
    
      Headlines

    Despite relatively decent weekly retail sales figures, some positive earnings reports from a couple of retailers and a very good industrial production number, investors elected to focus on Europe yesterday.  Specifically:

(1)    poor EU as well as German second quarter GDP data.  The concern here is not only will a decline in EU economic activity adversely impact revenues and earnings of many US companies but also it will lower the likelihood that the stronger EU countries like Germany will be willing to finance the ‘bail out’ of the weaker links,
 
(2)    and as fate would have it, the results of the Merkel/Sarkozy meeting later in the day produced nothing that investors had hoped for [a new ‘Eurobond’ to fund bailouts, an increase contribution into current funds being used to bail out the PIIGS].  In other words, they did nothing to kick the can further down the road.  Investors were not happy.

However, I would argue, as I have on numerous prior occasions, that the sooner these guys bite the bullet and take the steps necessary to put their respective fiscal houses in order, the less pain that will be ultimately incurred.  Indeed, if the Merkel/Sarkozy meeting is an indication that the EU is truly going to deal with its fiscal problems, that is the good news scenario.  This is not to say that if much of southern Europe has to restructure its debt and impose additional austerity measures, that there won’t be negative economic consequences.  There will be and they will likely be worse than in our forecast--but if done now, that is still the most positive outcome.

As I have made clear, our Model only assumes a Greek default/restructuring.  So if other countries must follow a similar path, then downward revisions in our growth assumptions will be necessary.  The question is, with stocks 10-11% undervalued [as calculated by our Model] how much of this potential additional EU malaise is in the prices? 

There is another question; and that is, if the EU does start the process toward fiscal responsibility, thereby eliminating the potential of more severe problems extending into the entire economic zone later, would investors interpret that positively?   
   
I am not nearly smart enough to answer either of those questions.  But I raise them as a counterpoint to getting too bearish.

            The difficult decisions for the EU still lay ahead (medium):
    http://www.nakedcapitalism.com/2011/08/satyajit-das-the-real-debt-crisis-is-in-europe-part-2-%E2%80%93-europe%E2%80%99s-long-long-goodbye.html

    Bottom line: Europe, the PIIGS and their ‘three blind mice’ political class have investors’ attention.  Since there is no positive economic outcome (pay me now or pay me later) to their problem, it is small wonder that investors are nervous.  The best outcome (least impact on the equity markets) would to be to take the pain today; and should that occur, I am not convinced that Markets would be lower 3-5 days later.  The real risk is that the political class keeps kicking the can down the road until they run off a cliff. 

So despite investor reaction to the Merkel/Sarkozy meeting, I am encouraged.    Nevertheless, whatever the outcome, the news flow will be bumpy and the economic consequences potentially more negative than currently reflected in our Models.  So I stay cautious.

As a final note, yesterday’s stock purchases brought the cash position in our Portfolios down to circa 20%.

    For the bulls amongst you.  I agree with much of what the author says until he gets to the budget discussion.  He focuses on allowing the Bush tax cuts to expire instead of (1) reducing spending, (2) reforming the tax code which would have the effect of increasing revenues and (3) reducing regulation.  He points out the household debt reduction is a cause of economic sluggishness.  True, partially.  A larger cause in my opinion is the economic uncertainty created by increased regulation and the drive to Europeanize US government/society. (medium)
    http://www.thedailybeast.com/newsweek/2011/08/14/economic-recovery-is-on-the-horizon.html

    Here is a great explanation on why reducing government and not raising taxes is the path to economic growth (medium):
    http://www.zerohedge.com/news/putting-cart-top-horse-or-why-heaping-fiscal-stimulus-upon-stimulus-suicide-america

Economics

   This Week’s Data

    The International Council of Shopping Centers reported weekly sales of major retailers down 1.5% versus the prior week but up 3.5% versus the comparable period a year ago; Redbook Research reported month to date retail chain store sales up 0.6% versus the similar timeframe last month and up 4.7% on a year over year basis.

    July industrial production rose 0.9% versus expectation of being unchanged; capacity utilization came in at 77.5 versus estimates of 77.0.
    http://www.bespokeinvest.com/thinkbig/2011/8/16/stronger-than-expected-industrial-production.html

    Weekly mortgage applications rose 4.1%; however, the more important purchase applications fell 9.1%.
    http://www.calculatedriskblog.com/2011/08/mba-mortgage-refinance-activity.html

    The July producer price index was up 0.2% versus expectations of a 0.1% increase; core PPI jumped 0.4% versus estimates of a climb of 0.2%.










Posted 08-17-2011 8:21 AM by Steve Cook