Greece = Opportunity. Stock Market Scenarios for Q3

With Monday’s blog and Street$marts being on the long side, I decided to wait a day to offer commentary on how the markets’ reaction to the impending default by Greece, bank closure, referendum, etc. would impact the new month and quarter. To reiterate an important market tenet of mine which has been around for decades, it’s not what the news is, but how the markets react. We are constantly reminded of that with economic news. Is good news bad news for stocks? Is bad news good news? Is good news good news? Is bad news bad news?

I have already written for years that my personal belief is that Greece should leave the Euro. If Greece was the size of Spain or France, the conversation would be very different as those countries are too big to fail and almost too big to save. Greece’s economic output and contribution to the Euro is barely noticeable. Their political system, while democratic, leans heavily socialistic and even more so than most of their European counterparts. Greece has a culture of tax avoidance, fiscal irresponsibility and gross overdependence on the welfare state. It’s not working now; it hasn’t worked in the past; and won’t work in the future. Talk about doing the same thing over and over and over, but expecting different results! That really is insanity!!

Turning to the stock markets, Monday’s negative reaction was for the part, as expected. The longer the “crisis” lasts, the more likely we are to see stocks begin to rally on bad news. That’s something to look for down the road and not here. For now, we have to expect volatility to remain elevated with much of the news occurring in the overnight hours. As such, we should wake up to large moves in the pre-market several times a week.

Getting back to Monday, the Dow plummeted 350 points which sounds like a large number, but keep in mind, it’s only a 2% decline. 2%! And at the end of that day, the Dow had pulled back a little more than 4% from its all-time, intra-day high in May as you can see from the chart below. For months, I have been in the trading camp, looking to buy weakness and sell strength until the March lows were at least breached. Monday’s low revisited those levels almost to the point, a tad disappointing for intermediate-term bulls like myself. I would much rather have seen those levels firmly breached to cause a short-term trap door and shake out some weak handed holders.

At the end of the day on Monday, however, we saw some truly extreme, short-term readings in a host of indicators.

  • 90%+ of the volume traded on the New York Stock Exchange was down.
  • 99% of the volume in the S&P 500 was down.
  • 99% of the stocks in the S&P 500 traded down on the day.
  • Less than 10% of S&P 500 stocks were above their 10 day moving average.
  • Volume in inverse ETFs spiked as traders hedged and braced for more downside.
  • Put/call option ratios soared as investors scrambled for downside protection.

The list goes on and on. Had stocks already been in real decline, you could have argued that Monday was a short-term panic and that the final low was at hand. However, it’s hard to make that case with all-time highs so close. Rather, this pullback looks like yet another single digit bull market decline in a long series during this most hated and disavowed bull market of the modern investing era.

For months, I have been waiting for stock market sentiment to at least get back to neutral from levels we typically see before 10%+ corrections and that’s finally beginning to happen. Although 20,000 has been my next target for some time, I cautioned that it is highly unlikely for that rally to launch with sentiment so skewed to the bullish side for so long.

However, just because we saw extreme readings on Monday doesn’t mean that the ultimate low was seen. I would argue against that. Monday’s snowball day was an important piece, but far from the final piece. Wash out readings like I listed above typically do not coincide with the final low. There is usually more constructive work to be done by price. If history is any guide, a few scenarios open up now as you can see below.

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I am going to offer three scenarios in order of likelihood. The first can be seen in green on the right hand side of the chart above. It has the current bounce petering out next week, followed by another decline below Monday’s low where the ultimate bottom is seen. Fresh all-time highs would be seen later this quarter.

The second scenario in orange shows a deeper decline below 17,000 on the Dow, which would probably result in calls that the bull market ended and some nasty, long-term bear market had begun. In fact, I heard one former “1998 guru” proclaim yesterday that the bull market is alive and okay as long as the Dow is above 17,038, but once that “magic” number is closed below, stocks are firmly in a bear market. That’s one of the dumbest comments I have heard in a long while and I certainly hear my fair share of ridiculous statements! As if a single point or points really matter. Give me a break! If the Dow does decline below 17,000 I imagine that bearish sentiment would skyrocket and exceed what we saw at the Ebola bottom in October 2014 and really give the market rocket fuel for a run to 20,000.

The scenario I did not offer on the chart was the most bullish one where stocks already bottomed on Monday and are slowly starting a rally to the upper end of the trading range we have been in since February. While it’s certainly possible, I believe it’s less likely because of the extent of the damage already done. Stocks need some time to repair themselves. Of course, when the market ignores the scenarios I offered and does its own thing, I will respond appropriately.

Summing it all up, Greece is a short-term issue and the news will most likely have the most impact as we sleep. Care more about how the market reacts to news rather than what the news actual is. Watch for spikes in bearish sentiment to set the stage for another leg up in the bull market. The bull market remains old and wrinkly but very much alive.

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Birds, Salmon and Russell 2000

As the birds fly south for the winter and salmon spawn each fall, it’s time for the annual reconstitution and rebalancing for the Russell 2000 index of small cap companies. The Russell 2000 represents the smallest 2000 companies in the Russell 3000 index. The companies which no longer rank in the 2000 are jettisoned and the new ones are officially added on June 26th. This is all based on the rankings as of May 31st.

As this happens only once a year on a fully disclosed schedule, there are a few ways to play this event in the markets. The first is the easiest and doesn’t involve much work. Over the week leading up to the June 26 rebalance, the Russell 2000 tends to outperform the S&P 500. If you are long the market, you can shift your holdings towards exchange traded funds (ETFs) like IWM, or you can buy an ETF like IWM or its Rydex mutual fund counterpart and sell short the S&P 500 ETF like SPY or its Rydex mutual fund counterpart.

A much more involved and complex trade would be to anticipate which stocks could potentially be added to the Russell 2000 using the May 31st data and buy those while at the same time selling short those that could potentially be removed from the index. As with all trades, you need to recognize your own risk tolerance as external market shocks can sometimes trump all.

Having been overweight in the Russell 2000 versus the S&P 500 for some time, I am watching post June 30 for signs of the trade reversing and time to go back into the S&P 500.

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Grexhaustion… Leave the Euro Already

If you weren’t already exhausted by the constant stream of headlines regarding Greece’s inability to meet their financial obligations, you should be now! After more than five years of negotiations, deals, posturing and extensions, the situation in Greece seems to be coming to a head. I hesitate to use the word “crisis” because unless you’re living there and feeling the depressionary pain, this is really a fringe story. What I find interesting is that we are finally seeing all parties involved dig their heels in to play tough.

Here is an interview I did late last week before the events unfolded. CNBC India

This isn’t another Lehman Brothers. I am not worried about contagion like sub prime mortgages in 2007. I don’t fear counter party risk like with AIG. Greece’s creditors are at the top of the food chain where bailouts aren’t needed.

I won’t rehash the past five years, but I have written many times that Greece has actually been in default more than they have been current in their obligations over their long history. This is cultural more than financial. For example, Greek citizens have a history of unprosecuted tax evasion. It’s accepted as business as usual. Their socialist system simply does not work. You can’t have a full pension retirement age of 57 when life expectancies continue to grow and your country has no means to pay those people.

Over the weekend, two significant announcements were released. First, the Greek government scheduled a referendum for July 5th on whether to accept the new “deal” offered by its creditors. This is a very bold and fascinating move by Athens, essentially abdicating the decision to its citizens who have protested the deals in mass. They reject austerity. They reject raising taxes. They reject raising the retirement age. They reject pension cuts and reform. What they want is old fashioned business as usual, which has about as much a chance of happening as I do of becoming six feet tall! I am currently 5’8″.

Besides the referendum, the Eurozone finance ministers refused to a one month payment extension and the European Central Bank (ECB) announced that they would not increase emergency liquidity measures for the Greek banks, essentially forcing their hands by saying enough is enough without further concessions. As you might expect, this caused an immediate run on the banks throughout the night and potential collapse in their entire banking system. And, as you might expect, the Greek government then shut down the banks at least until Thursday to stem the tide (NOT) and begin to put capital controls in place on withdrawals.

So, what we have is a very high stakes games of chicken between Greece and the Troika. Troika being the ECB, IMF and European Union.  Greece remains in a lose-lose situation. Continue to accept austerity measures and remain in a deflationary depression, which is a bit redundant. Or, tell the Troika to go pound sand, default on everything, leave the Euro and issue drachmas, which would send the country into some type of modern day inflationary spiral where imported goods would grind to a complete halt.

Neither option seems appealing, but if I had to choose, I would take the latter, somewhat like Iceland did six years ago, except they had their own currency. Their stock market collapsed 90% along with their banking system and economy. However, five years later, the world was already loaning them money again and the recovery was brisk.

The Troika fears Greece exiting the Euro because it sets the stage for other, much larger and more economically and financially important countries to leave, like Portugal, Spain and even Italy. That’s a story for later this decade.

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More Nonsense with Greece

Just wondering aloud if a single week can go by without any talk about will Greece or won’t Greece exit from the Euro. They are already in default, and historically, they have been in default more than they have been current, yet they behave as though they are in full control. Maybe they are! You know the old adage that if you owe the bank $100,000 and can’t pay, you have a problem. If you owe the bank $100,000,000, the bank has a problem. I don’t see it that way with Greece, but clearly, bad behavior is being rewarded.

The markets are once again celebrating the “news” with a big stock market rally. And the media loves it! What they don’t see or want to discuss is how poor participation is today so far. There aren’t even two winners for every loser. That shows some short-term weakness or lack of conviction. From my seat, it looks more like another short-term selling opportunity or do nothing over committing money to stocks right here and now. That time will come soon, but not now.

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And the Tea Leaves Were Right

Earlier this week, after weeks and almost months of continuous concerns about the bulls’ ability to step up, I wrote about the short-term tea leaves indicating a rally beginning by Tuesday or Wednesday. The bulls definitely did their part so far this week with the small and mid cap indices scoring all-time highs and the NASDAQ 100 close to fresh highs. The Dow and the S&P 500 have rallied, but are still being dragged up by their counterparts.

Software, consumer discretionary, healthcare and biotech remain the sector leaders with banks taking a much needed rest. This all bodes well over the intermediate-term. I mentioned that I was keenly watching utilities the other day, partially because we just bought them, and they stepped up in a huge way. For now, it just looks like a counter trend move after a huge decline, but they are still worth watching. It would be very telling if we start to see utilities, telecom, staples and REITs all begin to lead from the defensive side.

Now that the market has exhibited some strength, I am going back to my theme that this is not the launch to 20,000 I foresee down the road. It’s a nice little rally that is unlikely to go much farther than another 500 Dow points, best case. For the nimble, it’s time to have a plan for defense. On the downside, 17,000 or so should be the floor so the risk/reward ratio still isn’t all that exciting.

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Fed Statement Day Trend

Once again, the markets have come to the day when the Federal Reserve Open Market Committee (FOMC) releases their statement regarding interest rates and their economic forecast. Today, we also get to hear from Janet Yellen during the post meeting press conference.

What to expect?

Absolutely nothing on the interest rate front. As I have said before every meeting since rates went to essentially 0%, the Fed is not going to raise rates today. That day will wrongly come sooner than later, but not today. Rather, we will hear about the uneven recovery, weather, wages, trade imbalance, employment growth and inflation. There’s enough ammunition for both hawks and doves to sell their case.

In the markets, the trend for today is to see a range of plus or minus 0.50% until the 2pm announcement and then a few wilder swings in both directions until the bulls take over the rest of the day. With the current set up, there is a 75% chance of a green day in the stock market based on data since 1994.

In yesterday’s piece, I wrote about how the bulls had a fairly good short-term opportunity right here and needed to step up right away. They did a decent job of that on Tuesday with solid leadership and there should be more upside coming although I still don’t believe the next intermediate-term blast off begins now.

If I had to put a single sector on my watch list for today, it’s utilities. They have been among the weakest groups all year (contrary to what I thought as the year began) and are a direct victim of the economy getting a little better and longer-term interest rates rising.

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Short-Term Tea Leaves Say Bulls About to Step Up

The stock market remains on the defensive as I have written about for some time, not that this is a repeat of 2008 or even 2011. It’s not even your garden variety 10%+ correction. Stocks remain in the range they have been in for most of 2015. From a bullish perspective, it’s a good intermediate-term sign that after the huge run up we have seen, the bears can’t even muster a 10% correction. From the bearish perspective, stocks have stalled and there has been internal damage done. As you know, I strongly side with the former.

Too much bullish sentiment has been one of my chief concerns over the past few months and while that has not totally abated, it’s not as bad as it once was. Behavior from the Dow Jones Transportation index has been poor since late last year and for the most part, that continues today. I do believe that when the market launches the next significant rally, the transports will be in a leadership position.

Bears keep pointing to the declining number of stocks participating in the rallies as a serious warning sign. If that number was much worse, I would be much more concerned. Remember, the New York Stock Exchange advance/decline line, saw all-time highs in April, a good sign, although it fell off when the Dow hit its most recent peak in May.

Sector leadership has been very bullish. No one can argue that point. If the economy was on the verge of recession, we would typically see defensive sectors like consumer staples, utilities and telecom leading. They are all lagging while banks, discretionary, semiconductors and biotech are in charge. Bad markets usually don’t begin with this kind of leadership. I will concede that I am concerned about the poor performance in high yield (junk) bonds as they are one of my favorite canaries in the coal mine.

In short, I believe we are in for more of the same for now. Stocks remain range bound where strength can be sold and weakness carefully bought. In the very short-term, there is enough to support a rally in stocks beginning today or tomorrow. I don’t think it will go very far, but for the nimble, it’s worth watching. Should stocks not be able to head higher by the end of day on Wednesday, I would take that as a sign of more weakness and a potential downside break of the smaller trading range. On the Dow, that’s 17,600.

Eventually, I continue to believe that the ultimate resolution of this multi-quarter period of sideways movement is higher on the way to Dow 20,000.

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Selling the Bounce

Let’s start with my conclusion and then work backwards. Nothing has changed over the past few days, weeks and even months. I still view stocks positively the farther out you go. The short-term remains murky, uncertain, questionable and any other adjective that is less than flat out bullish.

One of my chief concerns, sentiment, has begun to reset itself at least to neutral from the overly enthusiastic category. Sentiment surveys have improved as have the put/call ratios in the options market. On the flip side, stock market internals have been downright putrid. When I say “internals”, I am referring to the number of stocks going up and down each day along with how many stocks are hitting fresh 52 week highs and lows. Additionally, high yield bonds, one of my favorite canaries in the coal mine have seen five straight days of heavy selling, which is not comforting.

While it’s possible that the market pullback ended yesterday with stocks off to the races again today, I just don’t think that’s the most likely scenario. Rather, it looks like most of the major indices will remain in their trading range with perhaps one or two popping quickly to new highs. If that’s the case, I would rather be a seller into such strength than a fresh buyer.

Sector leadership is very favorable right now for future gains, with the exception of the transports, once we get by this continued period of digestion and consolidation. It’s not the time to get bearish, just to be a bit more cautious and selectively prune into strength. Better opportunities are not that far off.

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Don’t Believe the Negative GDP Print

Short and sweet as I am traveling today.

Last Friday, the government reported that Q1 economic output contracted by 0.70%. To the casual observer, that smells awfully close to the accepted definition of recession, two straight quarters of negative GDP growth. Stocks barely reacted on Friday and I attribute the weakness to geopolitical news in Europe.

The first quarter has been the worst GDP as far back as the eye can see. The government’s seasonally adjusted data needs to be seasonally adjusted again. They are flat out doing a horrible job! This contraction was actually better than the -0.90% expected and due to the tough winter in the eastern U.S. along with very poor trade data. In my view, you can almost completely dismiss the report as an anomaly.

I am anything but an economist. I do believe, however, that Q2 economic output is going come back very strong compared to Q1 in the 2-3% range and Q3 should be equally as strong. “Strong” may not be the best word, but I think you get my drift.

For further proof of no recession besides the stock market just yawning, look no further than the consumer discretionary sector which is but a whisker from ALL-TIME HIGHS. If the horsepower of our economy is this strong, it is so unlikely to see a “normal” recession without some external shock.

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Bulls Not Ready to Surge Just Yet

In what seems to be the trend for most of 2015, price breakouts above previous high points have largely been rejected. While that’s not to say that the bears have come in and taken control over the intermediate-term, we have seen small pullbacks until the bulls get ready to step up again. Eventually, as I have written about all along, this three or six month trading range will resolve itself to the upside; it just doesn’t look like it’s right here and now.

spMy from the bullish camp, I think it’s a strong positive that the bears cannot make any meaningful headway on declines. The bulls may step aside at new highs, but they come right back to work into any pullback. Eventually, the economy and fundamentals will catch up with price and then we will see stocks blast again to the upside.

The bears, on the other hand, are leaning on the market being on the expensive side as well as sentiment being too positive. They also are hanging their hats on the strong dollar and the Fed about to raise rates. I don’t buy any of their arguments for more than the short-term.

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