Stay Short. Economic Numbers Were Soft and Euro Credit Issues Are Growing.

May 31, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

European credit concerns and sluggish global economic activity are weighing on the market. Stocks retreated in May and last week’s rally was nothing more than a technical bounce above major support (200-day moving average). Asset Managers will not aggressively bid for stocks during times of uncertainty and they will wait for the Greek elections.

This small country is a “thorn in everyone’s side”. They are in dire straits and they could be the first EU casualty. Pro-bailout candidates have a 2% lead over leftists with two weeks left until the elections (June 17). Once we are inside the two-week window, there won’t be any more polls to guide investors.

There is a 50-50 chance that anti-bailout candidates will win. If that happens, they will reject austerity agreements with the ECB/IMF/EU and Greece will immediately default. European officials have been talking about an EU without Greece for the first time ever. A default would send a massive shockwave through global markets.

If Greece elects a pro-bailout candidate, the market will stage a small relief rally. Unfortunately, the problems will faster and the move will be brief. Investors already have their eyes on the next “weak link”.

Spain’s yields have spiked to a new high and many analysts believe that interest rates have reached “the point of no return”. Their banks are grossly undercapitalized and the fourth-largest (Bankia) was nationalized. Spain tried to find a “back door” solution but it was rejected by the ECB this week. The government wanted to issue government debt in exchange for equity in the banks. The banks would then pledge those securities with the ECB in exchange for much-needed capital. They don’t have many alternatives and they will need a bailout.

Here’s the real problem. The EU is very fragmented and every summer the Eurocrats take off for vacation. Credit conditions deteriorate and “no one is minding the shop”. Fear runs high and the stock market pulls back. That pattern will repeat itself this summer.

When credit conditions deteriorated in November, Eurocrats promised to draft fiscal policy changes and to have them added to the EU treaty by March. The ECB launched LTRO1/LTRO2 and credit concerns eased. The pressure was off, and Eurocrats lost their sense of urgency.

Three months after their deadline, they have not even mentioned fiscal policy amendments. There is no long-term plan and last night Draghi (ECB Chairman) said that the ECB can’t fill the void. “Can the ECB fill the vacuum of the lack of action by national governments on the structural problem? The answer is no.”

Tomorrow, the official PMI’s will be released. Europe’s economic activity is deteriorating and Germany (the stronghold) reported weaker than expected conditions last week. China’s growth came in below estimates (flash reading last week) and power consumption and bank lending is down in May. Dismal results are priced in, but the official PMI’s will be a reminder of sluggish activity.

ADP employment was just released and it private sector jobs grew 123,000 in May. That was lower than the 160,000 that was projected and job growth is stalling. ADP processes payrolls for small and medium-size businesses and I trust their number. It is “pure” relative to the Unemployment Report which is filled with adjustments. The consensus estimate for tomorrow’s number is 150,000.

Initial jobless claims rose 10,000 to 383,000 and I believe tomorrow’s jobs report will come in “light”. Q1 GDP was revised down to 1.9% from 2.2% and that is also bearish.

In the last two weeks we’ve had negative guidance from Cisco, Dell and Network Appliance. Corporations (like Asset Managers) will hold off on new projects until they have clarity. Facebook’s IPO debacle has also cast a dark cloud over equities and there is not a compelling reason to buy stocks.
European credit concerns, deteriorating economic activity and cautious corporate guidance will keep Asset Managers on the sidelines. The market has broken major support levels and the momentum points lower. After a small short covering bounce, stocks are ready to test the 200-day moving average.

I believe we will see a pullback in the next week. Asset Managers will gauge the selling pressure and they might nibble at the 200-day moving average. If that level is breached with ease, they will pull their bids and we will hit an “air pocket”. This might take a few weeks to play out.

As you know from my comments, I bought some puts last week and I added to the position Tuesday. I now have 50% of my normal position on and I will not be adding unless I see late day selling into the close. Today’s ADP report should weigh on the market and I believe stocks will pull back.

Stay short.
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