Central Bankers, Chinese Stimulus, and Blackjack

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I am going to include some common sense questions in my effort each week. Hopefully the entire piece will be at least linked with common sense. The answers to the questions I will pose are really quite simple but it is amazing how often I hear the exact opposite.

Q: Can you play with “house money”?

I am referring to when you gamble in a casino. You often hear people talk about their exploits in Vegas and how their behavior changed when they were playing with “house money”.  My question is, can you even play with house money? Answer to follow.

There were big fireworks last week. The central banks of Europe and the U.S. said they will step in and make direct investments in bond markets. These investments will be large and aggressive. There was also no real time frame given for how long these investments will last. The bankers have made it clear they will be at the ready to continue these programs for an extended period of time. Who knows what the long term impact of these programs will be? But, in the near term there has been a very large move higher in the market. The credit markets in Europe, mostly under the radar, have been improving for months. When the credit markets point to trouble people will tell me the bond guys always see things first. The European credit default swaps have been improving on a weekly basis since the beginning of the year but many equity players were not willing to believe the bond guys were smarter this time around. Well, the improvement in European bond and stock markets has been a positive catalyst for the move we have seen in our equity markets these past several weeks. 

There was a major announcement from China last week. Government officials there announced a $154 billion stimulus spending package. The reaction here in cyclical stocks was fast and furious. There has been pretty big coverage in our media concerning the slowdown in Chinese growth and the negative impact it will have on our markets. Well, a massive spending program by the Chinese government can’t have a negative impact on their growth.

The market sold off slightly to start this week’s trading. There was some profit-taking in sectors that have seen sharp recent advances. Banks and homebuilders pulled in after being in favor recently. Volume and even attendance on the floor was off due to the Rosh Hashana holiday. The only action of note was a sharp decline in oil prices near 2:00 EST. There was no real reason for the decline. Some speculated about a release of oil from the strategic reserve but that appeared to be people simply making things up on a quiet day. Not really much of a pullback given the sharp advance seen last week.

Healthcare stocks outperformed the broader market on strength in biotech names. There was also speculation regarding takeover activity in other areas of healthcare. There were rumors that some medical device makers were being targeted by larger diversified industrial companies. 

The transports have lagged the broader markets this year. They attempted to close the gap last week as they went up in the buying frenzy. Transports trailed the market today. 

The Empire State manufacturing survey disappointed in September. New orders also were slightly worse than anticipated. NAHB Housing Market Index data will be released. The trend on that reading has been improving recently. 

While the overall tech space was quiet Apple Computer was up more that 1% and flirted with the $700 market all day, closing just shy of that level. iPhone 5 preorders exceeded 2 million. This is twice as large as the prior launch and is greater than the initial supply of phones made.

The technical picture in the market has improved considerably over the past several weeks. Last week there was a massive improvement in the technical readings. 78% of the stocks in the S&P 500 are in either basing or advancing patterns and 74% of smaller stocks are sound technically. Last week we saw a positive divergence in the markets: on Tuesday and Wednesday the NASDAQ went below support two different times but the other indexes did not confirm the move higher. When the positive divergence developed on Wednesday it gave us a sign the market was poised to move higher ahead of the Fed announcement. Short term support levels for the S&P 500/Dow/NASDAQ/Russell 2000 are 1460/13,500/3160/856. Based on the strength of the recent advance pullbacks at this point should remain controlled and mild.

The answer to the question above—can you play with "house money"—is, of course not! Casinos only take money from you they never give it to you. The only way you gamble with money in a casino is if you earn it and bring it in with you or you win it at the tables. As soon as you lose it, it is theirs. As soon as you win it, it is yours. But, casinos give away free drinks so that you act like a fool as soon as you win some dough. "Oh, what the heck I’ll bet more since I’m playing with their money!" It is your money. Don’t start throwing around a ton of money at the blackjack table because it isn’t yours! And always remember, a fool and his money is lucky enough to get together in the first place. We’ll deal with a little brain teaser like that each week and see eventually how “common sense” influences our investment decisions also.

When energy prices peaked earlier in the year they served as a tax increase on all of us. Well we are at a point in the cycle when we should see the drop in energy prices have a positive impact on economic readings. The drop in energy prices and the easing conditions in Europe should have a positive impact on economic releases over the coming weeks. We will likely see better than expected LEI releases start rolling out for September.

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About Thomas J Smith CFA