11/02/11   Europe Nearing “Look Out Below” Levels

Editor’s Corner

Investor Heat Map: 11/23/11Europe Nearing “Look Out Below” Levels

Ron Rowland

The U.S. looks increasingly like the Last Survivor of the developed-world credit crisis.  Latest evidence: the disappearance of investors from a German government 10-year bond auction, followed hours later by record-low rates for newly-issued U.S. Treasury notes.  Capital is clearly flowing out of Europe with U.S. government debt as the preferred destination.

Now is a good time for investors to recall that every trading decision is bi-directional.  In order to “sell” an asset, you must also “buy” some other asset.  We could ignore this in more normal times thanks to the existence of “risk-free” government debt.  Events in Greece, Italy, and now even Germany demonstrate the folly of that presumption.  The U.S., for all its problems, still owns the high ground.

Our feet are by no means dry, of course.  U.S. stocks posted a sixth consecutive daily loss today.  Third quarter GDP estimates were revised downward from 2.5% to 2.0%, and retailers face a make-or-break weekend.  The Federal Reserve announced new stress tests on large U.S. banks.  Ostensibly the goal is to prove the banks can handle both a U.S. recession and a European breakdown.  The timing makes us wonder if year-end accounting issues are being cleverly disguised.

U.S. housing prices are the key to both economic recovery and bank survival.  News on that front is mixed.  Data released in the last few days revealed both a slight increase in existing home sales and near-record first-time home buyer affordability.  We do not immediately see how both indicators can be simultaneously correct for a significant amount of time.  Low mortgage rates are helpful only to the extent prospective home buyers also have income, savings, and confidence in the future.  All are in short supply right now.


We have a dramatic change in the sector rankings since last week.  Traditionally-defensive Utilities and Consumer Staples pushed growth-oriented Energy and Technology out of first and second place.  Consumer Staples had a particularly impressive leap, moving from 8th place all the way up to #2.  From an absolute perspective, however, all sectors lost momentum.  Utilities is the only positive sector and will probably slip into the red zone soon.  The three sectors with “below average” momentum readings are now Materials, Telecom, and Financials.  Last week Financials reclaimed last place and has since secured that position by putting some distance between itself and Telecom.


We can summarize the week’s Style action in two words: “horizontal flip.”  All eleven categories went from positive readings centered around +13 to negative readings centered around -13.  In the process, they became even more compressed, with just 7 points separating top and bottom.  Large Cap Growth and Micro Cap held their relative positions on the top and bottom of the list, but the continuing tight range leaves most such distinctions meaningless.  Growth and Value categories are jumbled.  Large Cap categories can be found near both extremes.  All the Style categories have now retraced about half their October rallies; further gains will be elusive unless they find support near the current levels.


A world-shaking week brought major change to our Global rankings.  The U.S. moved to the top, but its negative momentum reading renders it merely the “least-bad” region.  China dropped out of the lead to fifth place.  China ETFs have seen huge swings recently, with some declining as much as 15% the last few weeks.  Japan’s stock market is now firmly below the March post-tsunami panic level, trading at 18-month lows.  Surprisingly, this was good enough to lift Japan from #10 to #6 in the rankings.  Below Japan we have resource-heavy Pacific ex-Japan (mostly Australia) along with Canada.  Europe remained in last place, not only globally but among all 32 equity categories.  Europe has now retraced some 90% of its October gains and will have a hard time stopping the downward momentum.


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.

“The IMF doesn’t have enough firepower. Nobody really does,” except for the European Central Bank.

Jay Bryson, global economist Wells Fargo, 11/22/11


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