Tuesday, February 14, 2012

Topping Process?

The topping process has begun. I mentioned yesterday that a correction is expected to start from today and so it did. If you are short from January, you may continue to hold on to the short but if you are thinking of opening a new short position, I would recommend waiting a while longer. The momentum is very strong and lots of investors are convinced of a new bull run. Many are thinking that any pullback is a buying opportunity and the last fifteen minutes of price action will re-confirm their belief.

But they have not priced in the Greek default. Notwithstanding the vote or expected letter, there is simply no exit from the debt mess. Greece is at the point of no return. I am fairly certain that Germany will not give any more money to Greece and this drama will go on till end of March at which point everything will unravel.  If we are rejoicing because our stock indexes have reached certain level after eleven years, we must be delusional. As of now, we are only looking at Europe and hoping that the fallout from the Greek default will be manageable. What about Portugal. It is next in line. Don’t forget Spain and the pink elephant in the room, Italy. And as John Mauldin says, Japan is the next bug searching for the windshield to crash. The biggest black swan is our own US of A. Those who think that US debt is below 100% are just the ostrich with head in the sand. The following is a chart from Hoisington Investment Management.

And we have not included the unfunded liability of Medicaid, Medicare and many other programs.

At some point of time fundamentals with catch up with the technical and in the big scheme of things six months to a year is not a big deal. This story of excess is being repeated over and over again and every time we think “this time, it is different” . Whether it is “Tulip Mania” of two centuries ago or “Dot-Com Bubble” or “Housing Bubble” the underlying factor is the same. Excess. Today the excess is credit and liquidity. The regulators have pained themselves in a corner. They have to go on printing and pumping in more liquidity in the system just to remain afloat. It is like the situation in “Alice in Wonderland”, where if you want to stay where you are, you have to run.  You may remember QE1 and QE2. When the effect of QE1 started to fade, they came up with QE2. When QE2 started to fade, they came up with LTRO. But LTRO is not going to be sufficient to save Europe. So Ben will come up with QE3. May be as soon as June of 2012. Because this is a Presidential election year and politicians know only one way to get elected. To buy the votes. Consequences be damned.

The believers of this rally have many reasons. Corporate earning is one of them. But apart from Apple, none of the tech companies have reported any spectacular earning. GOOG and AMZN both missed. Financials are in dumps.  The rally, if based on earning, does not make sense. If it is based on QE, then of course it does.  They are talking of growth in US as if it is a different planet apart from Europe. I say what growth? BLS numbers?

So we have to take everything in perspective and in timeline. What we can expect to happen in three months, six months, in one year. Coming back to short term market, today’s market action confirms that it was a double top yesterday but the inability to take out the low last Friday is little worry-some.  So we may see a bounce tomorrow but that will be just a bounce, to help the dip buyers get fully invested. On the other hand, the trend line has not yet been broken and so a trend change is not confirmed yet. In the last 30 minutes, the market ramped up on the rumour that Greek conservative party leader will deliver letter of commitment to lenders on Wednesday, as per unnamed government source. How many times the market reacts to such rumours and when they resort to rumours to prop up the market, you can be sure that there is trouble ahead.

 The FX proxies are also moving in tandem. AUD jumped and tested 1.07 but failed to hold it. Since it made the high on February 7, it is making lower highs and lower lows. I think by tomorrow we will have a sell signal in AUD.
 Euro jumped 50 pips on the rumour but is now giving back the gains. A closed below 1.31 will be  a sell signal. The cycle for Euro has topped or about to top now.

Everything points to a grand topping by 20th March. Can the SPX go higher? While everything is possible, it looks highly unlikely at this point of time. 

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