This Is Going To Be A Quiet Week. Watch For A Small Decline This Afternoon!

September 8, 2010

Yesterday, the market pulled back on credit concerns in Europe. The move was rather subdued and the decline felt more like a retracement from an extremely overbought condition. The market rallied almost 5% in three days last week and it was overextended.

Ireland and Greece are in the spotlight and the threat of a sovereign default has resurfaced. Portugal came to market with three-year and eight-year bonds. The yields climbed and the bid to cover decreased from June’s level. We know that if the yield is sufficiently high, the auctions will attract buyers. Rising rates is not a healthy sign for PIIGS countries, but the market seems satisfied with the results.

As I’ve been saying, we need an actual default for this market to tank. These mini events can continue for a long period of time. The IMF and ECB can intervene when the going gets tough and this problem can drag out for years. Eventually, we will reach a breaking point and we will witness one default after another. This is a structural problem and it will grow as people live longer and drain money out of pension programs. Each year more workers will retire and that will compound the problem as revenues (payroll deductions) decrease and payouts (benefits) increase.

This ponzie scheme can continue for months, perhaps years. Each time it looks like the breaking point has been reached; governments intervene and promise reform. Huge interest-rate spikes above 20% will signal the end of the game.

For now, the market is focused on attractive stock valuations. Corporations are able to borrow money at low rates and they are likely to buy back shares. Earnings are excellent and balance sheets are strong.

Over the weekend, China forced steel producers to shut down for 20 days. They see declining demand and they do not want to overproduce. This news was swept under the carpet. I believe it signals an economic slowdown in China.

Traders have been willing to discount weak economic news. The results last week were bad, but not horrible. That alone was enough to spark a massive rally. I believe Asset Managers are buying stocks ahead of November elections and they are trying to get a jump on a year-end rally. If stocks move higher now, we probably won’t see a big run-up in November and December.

The Fed is prepared to buy long term US Treasuries (quantitative easing). Interest rates are already at historic lows and that is not stimulating the economy. Banks don’t want to lend and consumers don’t want to borrow. The government is preparing for another $50 billion stimulus program. Much of that money will be spent on infrastructure. That didn’t bear fruit the last time and we are still losing jobs. These moves sound good and the market likes the effort, but politicians are grasping at straws.

This is going to be a quiet week. This afternoon, the Beige Book will be released. I believe it will show an economic slowdown and that could weigh on the market. Asian markets were down and the backdrop is soft. Germany announced a slowdown in exports and imports. I’m not looking for a big decline, just a drift lower this afternoon. Initial jobless claims will be release before the open tomorrow and traders might lighten up on stocks ahead of that number as well.

Keep your size small in this quiet market.
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