— aleatory

fin markets

This Friday on the anniversary of the Maastricht Treaty draft and amid a likely worsening economic outlook (Eurozone GDP out Tuesday) the EZ economies should announce moves to rein in the spending of the southern European states & complement this with a plan to harmonise fiscal policy. This will mean among other things bringing tax rates in peripheral nation states into line with eurozone leaders France & Germany.

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2nd Quarter US GDP is out today and the consensus expects growth to drop by one fifth of a percent to 2.5%. As GDP growth together with manageable inflation is how the US deals organically with taking on extra debt, it’s quite an important figure for the country.

But for Wall St the reality is the US economy is no longer the only one that matters to DJIA constituents. GM has sold more cars so far this year in China. Consumer stables giant Colgate dropped 7% after admitting a Venezuelan currency devaluation would cause it to miss 2nd Quarter earnings expectations. These are mainstreet USA companies playing in a post-US single superpower world.

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'everything is ok'

Spotted a strange conviction-based FT article from a week past today. The author believes we’re in the middle of a new bull market (‘stage 2′) and it’s really just a question of when we begin the next move up…

In conclusion he says we shouldn’t panic because of the following 3 ‘key positives':

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The Debt Drug

On Friday I questioned the validity of relying on a single, relatively unreliable and untested measure as a leading indicator. At the risk of sounding like an economist that is not to say I disagree with the conclusions made.

Indeed watching the UK consumers’ response to their emergency ‘austerity’ budget may be a useful predictor for the likely US retrenchment, whenever Obama decides (or more likely, is forced) to follow suit.

Though rather than being a function of the consumer, there is a case to be made that the next major index movement will come from a government’s inability to pay it’s bills and hence stopping the stimulus-led consumer ‘growth’ story in it’s tracks.

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When America sneezes the UK catches a cold.

Such has been the accepted logic in financial markets for decades now. The logic being that as our largest trade partner outside of the EU – together with it’s sheer scale – it’s health directly affects the well being of companies on this side of the pond. A one-way heuristic that may well be about to be reversed at least temporarily.

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Weekly Indicator Growth Rates

I don’t read too much into Mark Hulbert’s commentary over at Marketwatch. Although a contrarian he chooses to place a large emphasis on correlations that simply do not stack up imo.

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Things are idling along at the moment. But it’ll take jobs to move markets from here. Perceived wisdom sees the job report as a trailing indicator, assuming the count will pick up as companies get back to selling.

Like most financial models, this is fine when in median times. We’re not in that comfort zone yet.

So what happens when a historical anomaly upsets the apple cart? Who knows. We could compare it to the Great Depression, but it would be incorrect not to point out the massive government intervention poured into the economy this time round has not skewed realities somewhat. This may still, somehow & unbelieveably, work out. Upbeat future guidance is an interesting quirk of a variable to be gauged over the coming earnings season.

Massive and sustained job losses will stop a recovery. Governments have already thrown everything we’ve got at it. We are not immune to what may turn out to be government mismanagement. Future growth has been mortgaged in this respect.

So if things do go the way of the early 30s – the development of a 2nd dip – the warning sign to watch will be more job reports like those of last week.

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Stocks dived from their recent range at the top of this week, largely for reasons unknown.

While the usual sources of financial infotainment were puzzled at the pullback – citing an absence of negative macroeconomic news – this is in fact a telegraphed “the rally has run out of steam” message. Trader sentiment changes as a function of time, and it is this inability to read the same data consistently that has the greatest impact on market direction beneath the long-term trend. So people have had enough of drinking the government-led recovery Koolaid for now.

What we then look to are combat indicators giving us signs of whether indeed everyone sees this and are still prepared to presevere with a contrarian rally – “climbing the wall of worry”. In such an event watch for a sharp drop as sellers get out quick followed by an equally sharp rebuttal as traders look to get in on the next leg of the rally.

The 2nd scenario is that this is indeed the end of the current rally, whether it then plays out to be a bear market one or the first phase of a recovery would remain to be seen.

So keep an eye on this throughout the week, my thinking at the moment is we’re seeing the beginnings of a summer pull back based on low volume and lack of strong recovery numbers.

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At the beginning of last month I surmised the likelihood was that this bounce would not last. However I thought there was enough optimism in the market mood in the short term despite a dark macroeconomic climate. The 8700 mark the Dow was at that day turned out to be the low for the rest of the month and the index has since consolidated above it.

Ignoring the earnings reports which ‘beat forecasts’ – when you have analysts dropping expectations to nothing that is not an argument to buy shares – the reasons I believe are twofold: An outbreak of Obamamania together with a fall in dollar Libor.

3-month Dollar Libor stands at 1.02 percentage points. It’s fall has been inversely proportional to the rise in the stock market. It may be that bank share prices have been hit so bad their market cap was having a direct effect on their liquidity, maybe even solvency. So the rising tide floating all boats scenario we have seen unfold over the past month has allowed the interbank lending rates to come down. Although it has much to fall to get to the perceived normality of 22 basis points prior to the crunch.

Obama has weathered the storm of expectation and disappointment in his first few months quite well. His finance team seem to be blundering along ok, accompanied by the rest of the Wall St walking wounded. Nobody seems to have wrapped on the general bail out everything at all costs world consensus. That seems to be doing the trick.

But for how long will this sense of benign calm last? The automakers are racing for bankruptcy sometime this summer, the banks look nowhere near ready to remove themselves from their recapitalising drip feed & economic numbers aren’t getting any better. There is also a whole host of other issues with game-changing potential. I believe Libor & consumer sentiment are leading indicators but while they have no doubt improved they are still bad.

From a trading point of view there will be plenty of time to catch the resumption in bear-related activities. Likewise if the governments really have managed to shock the economy back to life with their debt mountains the return to pre-Crunch levels (Dow 9000 for me) will not be a quick one.   Lets just sit this one out for now. 

Update: The eventual failure of this rally appears to be telegraphed by most reliable commentators. I’m sure many are looking to the stress test report out next week to maybe provide a catalyst for a reversal. I don’t think this will happen. The expectation is that it will require more bank fundraising. No surprises there. And surprises are what will take this market down.

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At the beginning of March I started a market on whether GM would go bankrupt before Citi came under a majority government ownership. At the time I felt it would be GM and straight away the (somewhat low volume) prediction market over at inklingmarkets.com seemed to back that up.

No movement on it today after the government announcement is a strange one. I’d rate the likelihood of a GM ‘win’ much more likely now, but then I guess Inkling as a venue doesn’t have the reach of the other more established virtual platforms. Still I’m recording this as a win for the insight prediction markets can offer.

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