Coming Week Market Movers: The State of The Rally

May 28th, 2013
in contributors, syndication

by Cliff Wachtel, Global Markets

Feels like a luxury cruise... On the Titanic.

As we noted in our forecast for 2013, the fate of the rally rests on continued QE and quiet in the EU. We’ll start by looking at how those are doing.

Prior Week Market Movers That Continue To Exert Influence

We discussed all of the following in greater depth in our recent post here.

Sentiment Shifts On QE Tapering Or News Expected To Influence It

The pullback in global risk assets that began on Wednesday after it became clear that the Fed would consider reducing QE in the coming months if the US economy continued to improve showed once again that markets believe QE has been the key to sustaining the rally in stocks and other risk assets.

Follow up:

So, anything that influences consensus sentiment about whether the likelihood and extent of QE tapering has top tier market moving potential. Clues or evidence of Fed intentions will likely come in two forms:

  • Comments that come directly from Fed officials or those close to them. The influence of such comments will vary with the reputation of the source. Remarks from FOMC voting members carry more weight than those from non-voting members.

There are twelve voting members: the seven members of the Federal Reserve Board and five of the twelve Federal Reserve Bank presidents.

The voting members of the FOMC during 2013 are:

The Federal Reserve district presidents for Richmond, Atlanta, Cleveland, and San Francisco are not voting members of the FOMC for 2013. They may attend all meetings and therefore may be useful authoritative sources depending on how candid they chose to be about the direction of FOMC policy.

Events most closely related to the above this week include:

Wednesday: Boston Governor Rosengren speaks

Thursday: Preliminary US GDP for Q1 2013, US weekly first time job claims (significant more for how it influences the four week moving average of first time weekly claims.)

  • Any economic reports or other news items that clearly will influence FOMC voting on QE. For example, in late 2012 the FOMC voted to keep QE 3 in place (and interest rates remain near zero) until either unemployment fell to 6.5% or inflation hit or exceeded 2.5%, aka the “Evans Rule” for the one who framed them, Chicago Fed President Charles Evans. Therefore any reports that raise the likelihood of either of these metrics getting hit would be significant. That means we need to pay careful attention to:

Employment reports, especially the monthly jobs reports issued by the US Bureau of Labor Statistics on the first Friday of every month, and the reports believed to best predict them, such as the jobs component of the manufacturing and non-manufacturing monthly US PMI reports.

Inflation reports such as monthly CPI, PPI, etc. Inflation has remained well below the Evans rule target of 2.5%, so practically speaking they’ve not been as relevant as the jobs report.

Other reports will influence Fed tapering speculation to the extent that they influence the Evans Rule metrics.

As we noted in our 2013 forecast, the rally depends mostly on continuation of QE and calm in the EU. We saw last week what happens when there is even a rather ambiguous hint that QE may be reduced in the coming months. Global indexes and other risk assets fell for the rest of the week. The Nikkei saw its first meaningful drop since November. EU related news has been significant too, though mostly because it hasn’t shaken the ongoing complacency despite continued economic contraction and no progress towards meaningful steps that will heal the insolvent or prevent a repeat.

News Disturbing EU Complacency

As we noted in our 2013 forecast, the rally depends mostly on continuation of QE and calm in the EU. We saw last week what happens when there is even a rather ambiguous hint that QE may be reduced in the coming months. Global indexes and other risk assets fell for the rest of the week. The Nikkei saw its first meaningful drop since November. EU related news has been significant too, though mostly because it hasn’t shaken the ongoing complacency despite continued economic contraction and no progress towards meaningful steps that will heal the insolvent or prevent a repeat.

Still, we need to watch out for news that could awaken EU contagion worry.

The only potentially significant scheduled EU events this week are 10 year bond auctions for Spain on Wednesday and Italy on Thursday. Any surprise yield spike is trouble. Steady or falling rates maintain the calm.

Other Calendar Events

Other than those mentioned above it’s a typically quiet end of month economic calendar, which could be quieter still due to the Memorial Day shortened week that will limit liquidity at least on Monday in the US, possibly longer given the light calendar.

Technical Momentum Driving Money Flows

As we noted in our recent post here, last week’s pullback did only minor damage to the S&P 500’s uptrend on its daily chart, and hardly dented the uptrend on the weekly chart.

Last week money continued flowing into equity funds, which explains why most global indexes didn’t drop all that much despite the new threat to QE 3. As we discussed here, we don’t believe the Fed is even close to any significant curtailment of QE 3 given its justifiable bias to err on the side of caution and tighten later rather than earlier, as long as inflation stays comfortably below the 2.5% Evans rule level.

This isn’t a new thing, the $7.5 bln of new equity fund capital was the latest in $178 bln inflow over the past 26 weeks. See here for details.

Conclusions – Nothing Much, Really

Rallies don’t last forever, and there are plenty of warning signs that stocks and other risk assets are due for a reversal. See here for one list of them. The problem is that a great many have been on the scene for many months, or longer. The traditional fundamental drivers of higher price (economic and earnings growth) haven’t justified anything close to record highs.

Some of the reasons cited aren’t even particularly compelling. For example, some worry about the rising USD as a hindrance to US exports. However US exports comprise less than 13% of GDP. It imports more than it exports. In 2012, total U.S. trade with foreign countries was $4.9 trillion. This consisted of $2.194 trillion in exports and $2.734 trillion in imports of both goods and services.

The point remains that the trend remains alive and well until proven otherwise. You can choose to buy on dips, or stand aside until a more substantial correction. The only clear thing to do is decide where to place your stop losses to protect yourself against a loss you can’t afford when the pullback comes.

Oh yes, if you do choose to go long stocks, at least consider those that give you some exposure to the currencies in long term uptrends versus your local currency. See here for one award winning guide on how to do that, whether you’re a short term trader or longer term income investor.

Mind The Black Swans: One From The East, One From The West, One From The Middle East

From The West, The EU: As noted above, we fear the return of the EU crisis, simply because it hasn’t gone away, it’s just hibernating.

From The East Japan: Another seemingly unavoidable disaster, we just don’t know when. John Mauldin’s out with a great overview of the seemingly impossible Japan situation, see here for details.

From The Middle East: Israel shares three boarders with nations that have:

  • Limited or no control of their common boarder
  • Active proxy militias dedicated to wiping out Israel and attempting to use the chaos to bring in the means to do so.

Ok, that one’s been going on in one form or another for even longer. Again, there is no way to time the next outbreak or its extent, and as long as the next conflict doesn’t spill over enough to affect oil supplies, it’s unlikely to have much effect on markets.

Still, weak fundamentals and 2-3 potential market crashing situations that are more a matter of when than if. It’s a funny time for all-time highs.


DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.


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