This year has been a year of non-manufactured and manufactured crisis. The two non-manufactured crises (or black swans if you want to call them that) were the Japanese tsunami that cut production of necessary parts across the globe and the Arab Spring that spiked energy prices. The two manufactured crises this year were the debt limit debate and the backstopping of sovereign debt in Europe. The two non-manufactured events will work themselves out. Higher energy prices are a self-correcting mechanism. As price rises, quantity demanded falls. A decimated Japan infrastructure will warrant rebuilding and so a drop in GDP today will mean a rise in GDP tomorrow as fiscal stimulus to rebuild ripples through the economy. The debt limit has been agreed to and the can has been kicked down the road. Politicians can concentrate on getting reelected over the next year, and that means spending programs. The Eurozone has agreed to a new bailout package for Greece that also established a mechanism for other non-bailout, peripheral nations to tap lower interest rates. There are a lot of headwinds that are behind this market now as of this week; however, the two that concern investors the most are the backstops from the U.S. and European Central Banks. Comments from the two Central Banks show that there are currently no (or underwhelming) backstops in place.
The ECB, which stopped buying sovereign debt 18 weeks ago, started its purchasing operations again today due to rising Spanish and Italian debt yields despite the Greece bailout two weeks ago. Earlier in the day, the ECB announced details of its refinancing operations to “conduct a liquidity-providing supplementary longer-term refinancing operation (LTRO) with a maturity of approximately six months.” Today, the wires were pretty active concerning Europe with news that the ECB was supporting Portuguese and Irish debt. Though the decision wasn’t unanimous, Trichet said it was an “overwhelming” majority. Trichet outright argued the move is not the same as quantitative easing because the ECB plans to “sterilize” the purchases by taking term deposits from the banks equal to the amount of liquidity created. This response is really what hit markets the most—an underwhelming backstop by the ECB that continues to underwhelm investor’s in an ongoing European debt crisis. Despite the ECB’s announcement, Italian and Spanish 10-year yields are heading toward a point of no return level above 6.5%.
The underwhelming response from the ECB is piggybacking the underwhelming response investors have received from our own Federal Reserve Bank. The past two media events (April and June) from Ben Bernanke have done little to address the concerns investors have about a slowing economy and the proclivity towards reinstituting our own asset purchase program (i.e. QE 3). With the next meeting scheduled next week, we’ll have to see if the central banker’s response towards QE 3 will have changed given the macro risks. I would think he would be hard pressed to say the conditions aren’t the same now as they were in 2010 when QE 2 was initiated, given the 10-year bond yields is at the same level as well as crude oil (as of today’s selloff). The FOMC minutes released on July 12th did spark some sense that it is back on the table with the following portion:
“Members agreed that it was appropriate to maintain the Committee's current policy stance and accumulate further information regarding the outlook for growth and inflation before deciding on the next policy step. On the one hand, a few members noted that, depending on how economic conditions evolve, the Committee might have to consider providing additional monetary policy stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run. On the other hand, a few members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant the Committee taking steps to begin removing policy accommodation sooner than currently anticipated... See full text of minutes here.”
So while the Fed is talking out of one cheek, they’ve still been talking out of the other side as well, underwhelming investors that there will be no backstop to the current drop in economic conditions. As such, we saw a clear indication of deleveraging in the market over the past three days as all assets sold off, even precious metal miners today. Confidence in financial officials is being lost in the market.
Technically speaking, a long-term top is in place for the S&P 500, the Dow Industrial Transports, and the Russell 2000. The Dow Jones Industrial Average and the Nasdaq Composite were holding near the March 2011 low until the last hour of trading saw those levels give way. It was a gruesome day on Wall Street, with the volatility index near 32, 96% of stocks in the S&P 500 are trading below their 50-day moving average, and 2932 declining issues on the NYSE as the market responded very negatively to the action in Europe’s equity markets and concern the jobs report data tomorrow will be damaging. This is very unfortunate because Wednesday’s intra-day reversal had the makings of an intermediate bottom. However, lack of follow-through today makes yesterday’s turnaround a meaningless event. If traders and investors were looking for capitulation in June and over the past week, today definitely reeks of panic.
Leading to the downside in the industry groups were biotech (down 10%), oil, gas & equipment (down 9.4%), coal (down 9.3%), metals & mining (down 9.4%), and oil & gas exploration (down 8.2%). The market correction started in commodities in April and it looks to being continuing that way as the Yen’s intervention today boosts the dollar. Except for junk bonds, bonds were the only winner today.
