Europe Leads US Equities Higher, A Better Week Ahead?

Equities turning higher to start the week after losing 5% last week

The S&P 500 is now 9.7% off the high of the bounce into the 200-day put in just two Monday's ago when China announced plans to slowly appreciate the yuan. For the last two weeks, the equity markets saw non-stop selling as the Dow dropped over 900 points and ended last week well below the 10,000 level.

After making news lows late last night, US equity futures are now trading up over 1% as Tokyo reversed higher to close up 0.8% after opening down 1.7%. European markets all mounted hefty bounces with London up 2.5%, Germany up 2.5%, France up 3.3% and Spain up 3.5%. Perhaps the tide has turned and we can expect a stronger tape this week.

Barron's analyst Mike Santoli has outlined the market's current predicament quite well:

The current market argument pits the charts against the cheap, the increasingly worried tape readers who see an enduring downtrend emerging versus the spread-sheet studiers who spy increasing value with every percent decline in the Dow, and contend that stocks are over-anticipating a recession relapse.

As always, traders in the short-term must respect the tape and not fight the momentum. But, markets never move in straight lines and short-covering rallies are typically fast and furious in bear tapes. With many Dow components yielding more than the 10-year Treasury and 2nd quarter earnings reports beginning next week, we could see value hunters emerge.

New Month, Same ol' Trade, Futures at New Lows

Equities cannot find bids, continue dropping

Two days into July and the market is already down 0.79% for the month as of Friday's close. Equities tried to reverse and close strong on Thursday, the first day of the month but the turnaround attempt has now been crushed with S&P futures currently trading at new lows for the year tracking early selling in Tokyo with the Nikkei opening down 1.4%. The S&P is down 8.3% year-to-date as of Friday's close.

Finished Mean Markets and Lizard Brains, I give it a B+

I just finished up Terry Burnham's Mean Markets and Lizard Brains: How to Profit from the New Science of Irrationality amid New York City's sweltering heat this weekend with temperatures sitting in the high 90s. The book was short of spectacular but pretty good overall and worth the read.

Burnham's chief purpose is to highlight the impacts of what he dubs the "lizard brain", namely the portion of our brain that is not the prefrontal cortex. Our lizard brains developed early on and contain our emotional fight or flight mechanisms and pattern-dependent thinking. This portion of our brain, he argues, is highly detrimental to our financial success as it clouds our ability to reason correctly.

His writing reminds me of Malcolm Gladwell in its frequent use of anecdotal stories to support his points. This style makes for a quick read and very intuitive arguments. The final portion of the book contains the real meat of his advice for dealing with our lizard brain in the long-term and his advice in the current state of our economy.

Burnham argues that after three decades of rewarding risk-taking behavior, market participants should not expect financial markets to continue offering these winning scenarios. He advises people to allocate the smallest portion of their capital that they can stomach to stocks, buy a house smaller than they eventually want to own and lock in a fixed mortgage rate. Written in the mid-00s, I'd say Burnham was spot on; although, I believe he was speaking much more towards a longer-term timeframe and not just a few years hence.

He believes, and I agree, that our only way out of the current mess with budget debts and deficits as well as trade imbalances (which were not nearly as bad when he was writing) is increasing productivity. Only with higher productivity we will be able to meet our future obligations and adjust our economy without major pain and dislocation. Given the three back-to-back quarters of 7% jumps in 2009, we are on the right track!


Disclosure: No relevant positions.

Donovan is Cluth, Gold Testing Nerves, Buying Equities

Donovan comes through for the US

I have to admit I have been a hater of Donovan for years now. I followed him early on in his career and found him to be an over-hyped, choke artist. Yet, times have changed and in the last few years his playing style has greatly matured and his composure on the ball has strongly developed. His brilliant top-shelf shot against Slovenia put us on the road to a tie and his extra time goal yesterday against Algeria was absolutely clutch. The US now takes on Ghana on Saturday at 2:30 PM in a very winnable game. Winning Saturday will put us against the winner of Uraguay and South Korea. We can definitely prevail in the next couple games especially if Donovan continues his star performance.

Gold stops out weak hands

My gold position is hanging on by a thread and my stop will be triggered if gold makes its first lower low since March. While I will have given back a good deal of profit I have no problem taking a small loss should my plan not pan out. Gold has dropped 2.9% off the all-time highs in a fairly harsh fall that has easily wiped out any weak hands. Being a trader with a short-term, momentum-based strategy, I am far from a strong hand yet the action yesterday was encouraging as gold bounced off the 20-day moving average for a strong close. Once again, I have my stop and no other action is required of me until it breaks down or moves out to new highs.

Goldman Sachs issued a report a few days ago stating that "if gold-ETF buying were to continue at its current pace for the remainder of the year, we would expect gold prices to rise to $1,400/toz by the end of 2010." Understanding the impact of NYSE:GLD on the gold market is important. I have noticed many 3:30 PM rallies in NYSE:GLD even while the gold futures market is closes at 1:30 PM. ETF buying has become a dominant feature in gold's movements.

S&P now 50% off short-term bounce at $1,075

I am looking at the $1,075 area in the S&P as a great place to be picking up longs for the next wave higher. Wall Street has forgotten about the Eurozone's debt woes as quickly as we started caring about them. It seems to me that the path of least resistance will be higher in the next couple weeks into earnings season beginning on July 11th with Alcoa. I am not as interested in being long market indexes but rather individual companies that have strong fundamentals and momentum behind not only their stock prices but their businesses.


Disclosure: Long GLD.

All Eyes on the Fed, Change in Language Seems Likely

Tokyo down 1/3 of a percent, London up a 1/3rd of a percent. US futures up marginally this morning. All the focus today will be on the FOMC policy statement to be released at 2:15. For the past 8 statements, the Fed has said "economic conditions…warrant exceptionally low levels of the federal funds rate for an extended period". I think it's likely they change this language to a more hawkish tone considering the recent raising of the discount rate.

I am looking to work myself into a bunch of longs in the next couple days for a strong push through the 1,150 level on the S&P. The market, after a 9% pull-in, bottomed at the beginning of February and pushed back to highs. For the past 2 days, we've sat on highs with relatively low volatility. A minor attempt to sell-off occurred in the late morning yesterday but stocks promptly recovered closing positive for the day. Shorts are trapped and it seems likely we see higher prices sometime very soon. I will look to buy a drop in equities for a swing long should a change in the Fed's statement cause selling pressure.

"After paying back about $51 billion from the two most recent transactions, AIG still owes about $50 billion." (The Week)
-What a long road for AIG. Though I am amazed they've paid back half so quickly. But, it comes at the cost of two profitable units of the AIG empire.

The Real Reason Stocks Have Rallied

Being on a trading floor everyday I often hear explanations for why the market is rallying or why stocks just won't go down. Frankly, many of those comments are downright silly. I read about 30 different blogs on a daily basis and the majority of them tend to be on the bearish side of things. There was a guest post over at naked capitalism yesterday entitled "6 Theories On Why the Stock Market Has Rallied." The post basically lists the following reasons: dumb money is buying, government stimulus, inflation, algorithm buying, the Fed is on the bid and fraud based on overvaluing assets. This writer misses the most crucial, and actual, reason stocks have rallied: earnings growth!

Source: The Big Picture

Stocks will, forever and always, follow earnings growth over the long-term. Earnings were decimated in 2008 as financial companies took massive writedowns on their bad bets and many went out of business altogether. Risk was drastically mispriced by financial firms and for their errors they suffered large losses. But, earnings of S&P 500 companies have rebounded sharply and are approaching all-time highs once again. This is the reason stocks have rallied. According to this chart, stocks are pricing 19 times 2010 earnings expectations. Granted, that is on the high side, but it's far from extreme.

The market is also a forecasting machine which, as we know, typically overshoots to the upside as well as the downside. Ultimately, market prices are dependent on the long-term economic growth yet filled with massive gyrations as participants continually re-evaluate their expectations for the future. The March 2009 lows were marked by extreme pessimism so simply becoming more optimistic allowed stocks to turn and rally sharply. Then, June 2009 earnings season rolled around and the earnings picture supported the move higher. Stocks continued their rebound throughout the rest of the year as the economic landscape improved.

Fourth quarter earnings season started with a sell-off in equities in mid-January. Yet, nearly 3/4ths of S&P 500 companies beat their estimates. Is that not amazing? After a 70% rally in US equity markets, one would expect optimism abound. Yet, analysts are still underpricing their earnings expectations. Stocks bottomed in early February and rallied right back to highs, where we sit today.

Going forward, based on estimates for future earnings, stocks can continue rallying. If analysts are correct, we are looking at 28% year-over-year earnings growth in the first and second quarter. That's huge and should this materialize, a further rally may be supported.

Source: Bespoke Investment Group

In the end, I have no idea where the market is going tomorrow or the next day. I am not arguing that the market will go up from here. Given the forecasting nature of the market, we could even see a downturn as participants begin pricing an end of year slowdown in the economy. But, short-term trader or not, market participants should always recognize the growth of earnings and not fight it. This is clearly akin to "don't fight the tape". In sum, don't fight the tape especially when earnings support it.