Better, Not Good, Volatile

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Things got better last week, though the long term shape of the market is not good and I expect continued volatility. Well, that about sums things up. If you want more details read on.

Spain has agreed to a $125 billion bailout of its banks. This is clearly an important step towards addressing its credit problems. Certainly, Spain and much of Europe still have severe fiscal and economic problems. 

The Spanish banks are suffering due to the popping of its real estate bubble. After the bubble burst Spanish banks were hobbled with bad loans and devalued assets. The Spanish government will now be able to borrow much more easily due to EU backing. 

This bailout reduces the downside risk of a near-term bank run or credit crisis. The next step will be how are they going to grow their economy? One crisis at a time I suppose. How will this bailout impact credit ratings on Spain and its banks? What is the impact on Spain’s senior bondholders? No one really knows. The debate begins.

Recent market action and policy decisions are similar to what we have seen in the past three years. In 2009 things were coming unglued and then TARP was announced. In 2010 and 2011 sentiment was bearish, global economies were slowing and things seemed dire. In 2010 QE2 was the big policy move. In 2011 we had operation twist and the LTRO to calm market fears. 

In each of the past three years policy actions have occurred when sentiment was at its lowest and people were simply losing interest in stocks. There is one key thing that many are not including in the economic picture. Economic turmoil leads to a large reduction in all inflation measures. Economic activity slows, inflation readings slow and a few months later the market bottoms. Are we there again? History rarely repeats but it often rhymes.

Last week I suggested that the market would provide opportunities to buy and sell stocks, just like any other time in the market. I put that in because I was hearing far too many people becoming pessimistic to the extreme: "Oh woe is me, this market is difficult. No one ever has had to deal with such crazy conditions." Dry your eyes and quit whimpering. A picture is worth a thousand words. Look at the charts of the names you own and sell the stocks that are rolling over and focus on the names that are performing. In this process you will add to cash and hold performers. This will allow you to assess these volatile markets with a sense of confidence and some detachment. 

Last week was the best week of 2012. The short term picture improved significantly and the long term picture actually improved somewhat also. The longer term outlook is still bearish but not as bad as it was. The rally last week now allows us to look at some critical levels of support and resistance. 

From a shorter term perspective you can expect continued volatility. The upside levels for the major indexes are 1336/12,615/2885/780 for the S&P 500/Dow/NASDAQ/Russell 2000 respectively. If these levels are surpassed it will signal that the near term rally is gaining strength. Downside support levels are 1300/12,350/2800/750. 

From an intermediate-term perspective 1265/12,030/2725/728 are the levels of support to focus on. If these levels give way the long term outlook will be clearly bearish. Do not be overly focused on the levels. Each stock must be monitored. If key support levels give way for individual names sell them and move on. There will be winners and losers in any environment.

The long term picture improved last week, but still remains negative. Keep an eye on the levels I gave above to determine your course of action in these volatile times. 

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About Thomas J Smith CFA