Eurozone Meeting Results
Leading up until today, we’ve been hearing from Europe about a three-pronged attack. They have been planning to have a plan for three weeks now. Fear gripped the markets yesterday was that we’d get a “number-less” statement on how much capital banks needed to raise, on how much they’d leverage the EFSF fund, and how much private bondholders of Greek bonds would get clipped. Instead, they gave numbers on all aspects with €106B capital deficit, 50% haircut on Greek bonds, and leverage of the EFSF up to €1T. Will this resolve Europe’s credit crisis? Probably not, but it’s enough to contain it for now. How do I know? I don’t, but the market seems to be happy with the news with the Dow Jones Industrial Average up 2.86%, the S&P 500 up 3.43%, and the Nasdaq up 3.32%. Additionally, the U.S. GDP announcement today, up 2.46% in the third quarter, reiterated numbers we’ve seen in September and November (see last week’s article, Appointment with Dr. Copper) that bode well for the U.S. economy going forward.
So, investors are happy with the Eurozone results by bidding up “risk-on” cyclical stocks in financials, energy, materials, and industrials. Additionally, the credit markets are assisting equities by falling credit default swaps (CDS) on French, German, Italian, Portugese, and Spanish sovereign bonds today. The question later on will be, “are credit agencies happy?”
So far, they have not been happy as we’ve seen Spanish and Italian ratings cut since a three-pronged attack was floated weeks ago. Lastly, France’s credit rating is under review by Moody’s. A cut to France’s AAA rating could harm the credit rating of the EFSF bonds. Moody’s will spend three months to review France’s economic conditions so it may be some time before we get an answer from the credit rating agencies.
Inverse Waterfall
(Prefatory Note: Technical Analysis is the study of the markets whereas fundamental analysis is the study of company finance (micro) or economic activity (macro). To think of technical analysis only in terms of charting is a very narrow view of the study. The rest of the study is concerned with market sentiment and market breadth. Technical analysts are concerned about the health of the market such as what sectors are performing, how many stocks in an index are advancing or declining, and supply versus demand measured in volume. We’re also concerned about market psychology as measured in how many investors are bearish versus bullish to measure whether there’s anybody left to support a trend. Again, to summarize, a market technician watches and studies the market itself, and is not limited to studying charts.)
The market has retraced much of the waterfall correction in August for the S&P 500 (greater than 61.8%). If you look at the Nasdaq 100, we’re only 2 percentage points away from hitting a 52-week high, nearing a 100% retracement of the August waterfall correction. I’d call that an inverse waterfall over the past three weeks. Americans may be wondering, what just happened? It was the classic pendulum swing of fear to greed, and that pendulum swing still leaves a lot of room until we get to the greed extreme.
Below, I want to show how we get v-spike recoveries in the market. We had a v-spike recovery at the 2009 market bottom when investor sentiment reversed course, pegged at extreme pessimism. We have had another one now with the S&P 500 up 210 points since the October 4th intraday low. Below is a chart that shows the amount of equity exposure active money managers have had through the course of the last three years. You will notice the large drop in the past three months, last summer, and at the March ’09 lows. After cash is raised and the market stops falling, that leaves a lot of money on the sidelines to help support a new trend higher.
The NAAIM Survey of Manager Sentiment
The red line shows the close of the S&P 500 Total Return Index on the survey date. The bars depict a two-week moving average of the NAAIM managers' responses.
Source: https://www.naaim.org/naaimadsenttrend.aspx
Notice the reversal in sentiment? Just as sentiment rose in March of 2009 when we did away with mark-to-market, sentiment is rising now that a plan has been agreed upon in Europe to stem the tide of Sovereign debt risk. Another interesting bit of information that NAAIM offers is the overall equity exposure of its members: 38%. That means that the average money manager in their membership (200 member firms nationwide) had a 38% exposure to equities as of yesterday, October 26th. That leaves a lot of room until we get to greed extremes. For example, members had an average equity exposure of 83% on April 20th. So why can the market melt up? Investors and money managers are underinvested for a year-end-rally.
Overbought Equals Strength
The market is trending higher based on growing investment manager equity exposure, strong economic announcements, and a European plan in place. The market is overbought, but I think this is a sign of strength rather than an indication the market will reverse here and resume the summer downtrend. Looking at market breadth, 93.4% of the S&P 500 stocks are trading above their 50-day moving average (and that’s high); however, only 49.9% are above their 200-day moving average. I think this, like the NAAIM report, is another indication that the market still has room to go before we get to the next fully allocated and overly bullish extreme.
So the market is overbought short and intermediate term, but this is after a major correction in the market. Overbought conditions after such a correction confirm renewed strength in the market and a shift in sentiment (which we’ve seen in the NAAIM survey). The 50-day moving average is now rising for the S&P 500 and the index itself broke above the 200-day moving average at 1274 today to close at 1284. Today was obviously a powerful lunge by the bulls with advancing volume on the NYSE that matched the October 4th low. We still don’t know if the bailout plan today will resolve Europe’s debt crisis for the time being. The market is up 16% and it has viciously rebuked any investor that was bearish a month ago.
In my October 6th article, Will it be Enough?, I identified the “bear trap” event just 3 days earlier and I posed a question that was answered today for the equity market. Finally the credit market has turned as of today, but one day doesn’t make a trend. We’ll all have to continue to watch the credit market looking at yields and credit default swaps. The two markets must confirm each other for the market to continue heading higher. The next question that needs an answer is: “are credit agencies happy?” We’ll find out over the next few months. After that, we’ll need to continue to watch the economic activity of the European peripheral nations. Continued decline will make budget concerns grow. The global economy isn’t out of the woods yet, but central bankers have turned from a restrictive policy to accommodative and the equity market sentiment has flipped from bearish to bullish. The waterfall correction during August in the Nasdaq 100 has vanished from investor’s minds and we’re getting close in the S&P 500. A market that’s melting up is unsustainable, but a 38% equity exposure leaves plenty of ammunition for market dips to remain shallow.
