Avoiding A European Lehman
We begin once again with Europe, where the news is different but not better. A sovereign debt default by Greece now seems very likely; the question is when and how. The rest of the Continent is trying to contain the damage and maintain some kind of economic unity. China signalled a willingness to help by purchasing European debt. We are curious to see what they will want in return. Intense negotiations are probably underway right now.
U.S. Treasury chief Timothy Geithner tried to reassure investors by saying his European counterparts are committed to “avoiding another Lehman Brothers.” While this may be true of individual officials, the European Union requires a political unanimity that is not exactly evident right now. We can easily imagine a major institution going down in flames while the multilingual bureaucratic bickering drags on.
On this side of the Atlantic, stock market benchmarks have stabilized, more or less, at a level much below the summer peak. As was the case in August, trading volume this month has been much heavier on the down days. Today’s disappointing retail sales report showed an economy still suffering from sluggish wages, high unemployment, and excess capacity.
Speculation is beginning to turn toward next week’s two-day Federal Reserve policy meeting. Moderate inflation numbers help the case for further easing, but we still see no reason to think additional stimulus will help. The Obama Administration’s new jobs proposals are not exciting anyone, either. Nevertheless, we think the Fed will throw traders some kind of bone, perhaps by extending the maturity of its balance sheet with long-term bond purchases.
Between possible Fed action and flight-to-quality buying, Treasury yields stayed at historically low levels. On Monday, the ten-year yield touched an all-time low of 1.877%. Gold held steady near an all-time high north of $1800, with buyers undeterred by a stronger U.S. Dollar. Bottom line: precious metals, Treasury bonds, and the greenback are this week’s hot commodities. A short-term reversal is always possible, but the long-term trends are solidifying. Changing course from here is not going to be easy.
A tiny sliver of green still exists on this week’s graphic. It is in the Utilities sector and we apologize if it is not visible to the naked eye. The Utes are indeed in a (very) slight uptrend, which is more than we can say for any other category today. Consumer Staples and Health Care are next in line. The top three have stayed constant for several weeks now, but these “defensive” sectors are attractive only because they are the least unattractive. Short-term strength in semiconductors helped bring Technology up to the #4 spot. Materials, Energy, Industrials, and Financials remain in deeply bearish trends, and the spread between them is starting to compress.
Relative strength in the Style categories is identical to a week ago. Absolute strength in the Style categories isn’t quite identical but still looks much the same. Large Cap Growth is still the best of a bad lot despite being off about 12% from its recent peak. Many of the Style categories are close to having negative 1-year returns. In Large Cap Value, for instance, the past year brought a return of just 2%.
Our momentum reading for U.S. stocks held steady at -34, which doesn’t seem impressive but was enough to vault the category from #5 last week to #1 now. Japan is in second place while Canada slid from first to third. Latin America was a big loser, dropping into the lower half of the rankings, but Europe again turned in the worst performance of the week. Momentum for E.U. stocks now reads -111. Since our measurements represent an annualized return of the intermediate-term momentum, the implication is that Europe’s market will go to zero in less than a year if the current trend continues. Extreme trends of this type are not sustainable. While we expect the Continent to avoid a fate of complete evaporation, the bottom isn’t necessarily here yet. Oversold conditions like this can last a long time, punctuated by sharp but unsustainable rallies. New trades – either long or short – are very risky in such an environment.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“There is no chance that the major countries of Europe will let their institutions be at risk in the eyes of the market.”
Treasury Secretary Timothy Geithner, 9/14/11
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