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Time is Coming to Walk the Walk!

The recent rally in the market comes on the heels of a rah-rah speech by ECB Chairman Draghi. In that speech, Draghi stated that the Euro and the Euro Zone would be defended and defended successfully at any and all cost. This speech was truly nothing more than the type of rhetoric that Bernanke has employed since the market has called out for QE3. It is the same type of speech that a bully would give.

The bully’s reign changes over time. At first, the proverbial big, bad bully must fight to ensure that everyone in his turf knows that he will fight at the drop of a hat. He must fight every fight and win every fight in order to establish his dominance. But, these fights can exact a toll on the bully, a toll that can affect his reign. Now, the bully needs to change his approach to a more psychological one. With the fights taking a toll, threatening becomes the bully’s best weapon…….not his fists!

At this point of his reign, the bully relies on his reputation to do the fighting for him. This is what Bernanke has been doing. In almost every statement he has made, Bernanke has stated that the Fed is ready to act quickly and aggressively if the economy worsens to a point of worry. As to what point of worry and whose worry we don’t know, but if it gets to that point rest assured the Fed will act.

But Bernanke has been saying this for 6 months now as the economy has gotten worse in just about everyone’s opinion yet no action has taken place. To be honest, no action has been necessary because his threat of action has held and even boosted the market which in turn has boosted confidence to a point that Bernanke does not have to fight the fight (initiate QE3).

Last week, Draghi took a page from the Bernanke Bullying Playbook and executed it very well. He spoke firmly and convincingly with no doubts as a good bully should. But now a problem exists. As the bully gets older and now can just threaten to fight, it does not mean he no longer has to fight at all ever again. At some point, the bully has to again prove that he is the baddest of the bad, the toughest of the tough.

The time is coming for both Bernanke and Draghi to walk the walk. They have threatened and threatened over and over but soon they will have to prove they can still fight. The question is whether or not they have enough fight left in them to continue to remain the big, bad bully!

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European Crisis Meeting Reality

Since the beginning of the crisis in the Euro Zone, the market has viewed the situation very optimistically. Good news, even slightly good news, has been met with market rallies. Bad news has been tempered to such a degree that even if the market trades down on the news, it rallies late and the market ends up only down slightly. Except for Friday’s (June 29th )+267 move (which can also be partly explained by quarter-end window dressing and some short covering in front of the weekend), the market has been selling off slowly but surely. It has been bringing stock valuations down to what many so called experts call “low multiples” and a buying opportunity. However, these multiples are based on current assumptions which could and should be coming down…..potentially dramatically! Indications are that the Euro Zone is heading toward a major, deep recession.

Just today, France dramatically lowered its growth forecast (http://finance.yahoo.com/news/france-lower-gdp-forecasts-2012-181211313.html) and France is considered one of the two powerhouse economies in Europe (the other is Germany). This could be signaling a major problem going forward since France needs to offer “bail outs.” That will be tough to do if France is not growing and doesn’t have extra cash lying around to support others. If France is cutting its growth rate well below 2% then the overall growth rate of the region is probably below that level also!

The corresponding slow-down of economic activity should hurt sales of US companies thus raising the multiples of the US markets. I think that the sell-off we have been seeing is the market’s response to this fact.

Greek Impact: A Traders Perspective

There has been a great deal of talk recently about this being a good time for the Euro Zone to move Greece officially out of the European Union. Some economists, analysts, and politicians seem to think that the impact of this action would be limited. Their argument is that Greece’s economy is so small in a Euro Zone perspective (let alone a global perspective) that Greece leaving or being kicked out of the European Union would be meaningless and will create no measurable impact.

They are correct but horribly wrong. This is because they have not considered looking at this situation from a trader’s perspective. If Greece leaves the EU, we can expect interest rates in Greece to skyrocket. This would be due to the fact that Greece would now be out there alone and no longer shielded by the EU’s protective umbrella. Greece’s real impact would then be felt. The path that Greece followed would become a blueprint for traders to attack other EU countries with debt problems.

Watching Greece’s interest rates rise dramatically would get a trader like me thinking. If this is what is happening to Greece then maybe I should start to sell Spanish bonds and Italian bonds with the expectation that rates would begin to rise in those countries. If the rates went up high enough then those countries might have to leave the EU also. If that happens then rates will really rise and bond prices will collapse making me a whole hell of a lot of money!

This is my real worry. In a sense, this situation would be equivalent to the run on the banks and brokerage stocks in 2008 here in the US but this would be on a country level. Remember back when the US Government allowed Bear Stearns to go under? Almost immediately Lehman Brothers and Merrill Lynch and others became targets of short-sellers hell bent on driving their stock prices down to zero.  One by one, these companies went under. Could we see the same type of thing occur in the European Union? If we do, I guess many people will have to retract their statements concerning Greece’s lack of importance and impact.

Nowhere to Go

Many investors have been asking themselves when this market is going to sell off. We see an economy that is doing poorly and has been performing poorly over a considerable period of time! We have been receiving bad economic data over the last few months and this earnings season has seen many companies put forth negative outlooks for the next coming quarters.

Further, the indexes have all displayed technical breakdowns through the 50 day SMA and at least one significant flat line support. The charts really look bad at this moment…….yet the market overall still hangs tough. I too, am amazed at the current market action and it has made me change my normal approach to trading and investing. At times during the breakdown, things look so bad I hold back from buying stocks at levels that I would ordinarily jump at! Of course, the market turns and runs back up leaving me holding air as I missed my purchase opportunity yet again.

So the question is, ‘why is the market trading up against all the negatives around it?” There are a variety of reasons that contribute to the answer. First, there is absolutely nowhere else to put your money. Interest rates are so low that they are returning nothing! As a matter of fact, not only are they not providing a return, they are actually costing you money. The rate of inflation is higher than the interest rate you are receiving!

Second, everyone, everywhere else is having a problem that is as or more serious than ours. This is creating a situation where uncertainty is occurring globally and everyone is looking for safety.  Investors are looking to the place where they have the most confidence. Despite our rather large problems, the world continues to view the United States with confidence; the type of confidence that offers safety. Right or wrong, misguided or not, the world still sees the US Markets as the safest bet on the planet.

Finally, the last of the reasons why the market just does not seem to want to follow logic and go down is the old adage, bad economic news is good news for the market. There has been much speculation that if the economy continues to slow the Fed will step up and initiate another round of quantitative easing more commonly referred to as QE3. Lower rates and higher money supply often lead to higher stock market values and most likely will do so again.

So there you have it. The reasons for the market to go up are almost as good as the reasons for the market to go down. While I believe they are nowhere near as substantive  or as logical as the reasons for the market to go down, they are doing one hell of a job proving otherwise!

Chinese Currency Independence………Good, Bad, or Indifferent?

The current administration feels that the Chinese Yuan has been artificially depressed since it is pinned to the US dollar with only a 0.5 percent allowable deviance. Therefore, while the US economy was having trouble and the Chinese economy was running wild with a 10% growth rate, the depreciation of the US dollar was not able to help the US sell more products in China due to a currency advantage.

Normally, with a strengthening economy, a country should see its currency get stronger as  growth would lead to inflation, which would then lead to higher interest rates in that country, and then to a stronger currency. This is what should have been happening in China over the last few years. If it had, the Chinese yuan would have been stronger which, combined with the weakness of the US dollar, should have made it very attractive for the Chinese to purchase US products. (US products would have been cheaper than comparable Chinese products due to the currency exchange rate).

This did not happen because the yuan was closely pinned to the US dollar meaning that as the dollar declined, the yuan declined with it thereby becoming cheap and neutralizing the advantage in trade between the US and China. This made the yuan artificially cheap……which it was.

China knew it was going to have to loosen its currency’s tracking of the US dollar if they wanted their currency to be recognized as a globally accepted currency. They just needed to pick a time to do it. They picked now and picked the timing well. With the Chinese economy slowing down significantly, the yuan should drop naturally so it won’t track with the dollar and strengthen as it would have a few months ago. That protects Chinese products!

Beyond not having a trade advantage, I wonder if a free-floating yuan is the best thing for the US.  There has been a lot of talk about the dominance of the US dollar as the lone global base currency. Almost all commodities are quoted in US dollars. Several countries had expressed interest in changing that by putting together a basket of currencies to replace the dollar as the base currency. This plan, being proposed mainly by the Euro Zone, has been shelved for a while as the Euro has had and continues to have problems. However, China was very interested in this plan also but would not have been able to participate in this basket as their currency was not free-floating. This move was a first step in participating in that basket.

”Floating free” will allow the yuan to strengthen like we know it should and could allow for a little more “free trade” between China and the US.  That should be a good thing for the US.

However, the Yuan added to the basket of currencies to be used as a base global currency could also be a bad thing for the US.  It could be the beginning of the end for the dominance of the US dollar as the global go-to currency!

Economic News Fueling Market Run?

When the market moves, analysts and media types alike, need to answer and explain why the movement is occurring. That is their job and we expect them to inform us about what is going on in the markets. Sometimes, they get it right. Sometimes they don’t. But once in a while they come up with an answer that seems reasonable……seems to fit the situation. The answer that they are coming up with to explain the current rally is that the market is viewing all US economic data as good news. The real good news is being reacted to while the bad news is being ignored. The market simply wants to go up!

I agree that the market simply wants to go up…..it always does…..I do not fully agree to the why. While many people do not care why as long as the market goes up, investors should care because you need to understand what is driving the market if you are going to have a better chance of consistently making a profit.  It is possible that investors are “ignoring” the bad news. But I believe that this is not the case. I believe that the bad US economic news is not being ignored, it is be down weighted. So is the good US economic data. This is due to globalization!

As I stated a while ago, I believed that the US stock market had diverged from the US economy and, at the time, attached itself to the Chinese economy. The reason for this was that the Chinese economy was growing at a ridiculously high rate and the big US companies (those in the DOW and many in the S&P 500) have evolved to a point where they are in a position to sell products and services in China. There were very few of those companies in that position just 10 years ago. So, for a good while now, the US company earnings which fueled this market were based on the Chinese economy (what they would buy and how much)……not the US economy! Chinese economic data was important….not just the US economic data!

Today, due to globalization and US companies’ ability to efficiently distribute their products globally, US economic data is no longer the sole driving force in our markets. Thus, US economic data is now weighted less heavily in the decision making process of the US market investors and participants. It is not being ignored……it just seems that way!

The Wall Street Business Model………will it ever end?

Painfully slow but ever so surely, investors are starting to become enlightened to and understanding of the Wall Street Business Model…..don’t make money for your clients, make money off your clients! Wall Street has done this so remarkably well over the last 50 years that one of the most trusted and accurate market indicators has been indirectly formed from it. Market tops are signaled by a large percentage of individual investors being in the market. Market bottoms are signaled by a low percentage of individual investors being out of the market.

Wall Street accomplishes this by having their analysts give strong “buy” ratings to stocks at market highs influencing individual investors to buy at those tops. Of course, it is Wall Street selling to them. Vice versa, at market bottoms, analysts’ ratings drop to “sell” ratings influencing investors to sell down at the low levels. There, again, Wall Street is more than happy to take those shares off our hands at those low prices. Thank God they are there representing us!

The latest of this kind of atrocity is the story of Diamond Foods. Back at the end of the summer, an independent research firm called into question some accounting practices that Diamond Foods was using. Wall Street analysts quickly jumped onto the story and after investigating found that there was nothing wrong. They reassured investors that Diamond Foods was still a good buy and that all was well. Hell, Wall Street even said that a suicide by a member of Diamond Foods board during this “scandal” was in no way connected to any investigation into Diamond Foods accounting practices.

Fortunately, the FASB was listening to this little independent research firm. It decided to begin its own investigation into the accusation. Lo and behold the FASB found that Diamond was not conforming to standard accounting practices and will be fined and will need to restate its previous earnings. Obviously, the stock is down big today (2-9-12) but the damage is already done. Several Wall Street firms and their analysts have some “splainin” to do! How could a small, independent research firm see the problem while much bigger, better connected firms and their analysts simply missed it?

Do you think it was an accident……a mistake? If so, Wall Street can breathe a sigh of relief because if you think this was not purely a case of, at minimum, incompetence and at worst fraud, then Wall Street’s business model remains safe with no signs of ever ending!