Saturday, August 4, 2012

Take a Deep Breath and Exhale!

Markets rallied sharply on Friday following the latest US jobs report. The surge followed a volatile session on Thursday where ECB's Mario Draghi disappointed markets just like the Fed did on Wednesday.

There is no shortage of opinions on where we're heading next. In his latest comment, John Mauldin warns that we had a few good years but now it's time to prepare for a huge drop in earnings. Mauldin is a great guy, love reading his comments but there is no way I would ever allocate money to him to manage. Once again, he's way too bearish and dead wrong!

There are other economists warning that it will be worse than 2008, but they too are out to lunch, engaging in classic fear mongering. While concerns over Europe and China linger, the world isn't in dire straights as all these hopeless doomsayers lead you to believe.

Think it's time people take a deep breath and exhale. I'm very bullish on the US economy,which remains the true engine of global growth. Not China or other BRICs, not Europe, but good old USA. Those of you who bought that decoupling nonsense are dead wrong. The global game changer is just getting underway.

As far as markets are concerned, Michael Gayed, chief investment strategist at Pension Partners, wrote an excellent comment on Friday highlighting the most important charts in the world:

Markets sold off yesterday in what was quite a volatile day of trading, but as I noted in my Twitter feed throughout the session, the decline was deceptive. Draghi "disappointed" markets by not enacting any new policy measures but pretty much left the door open for monetization.

I have, on numerous occasions, brought up the idea that I believe the likely course of action now is an implied cap on Italian and Spanish bond yields, such that the pressure is maintained on the governments of those countries to continue to cut debt. But that the pressure doesn't get to the point where it sends the entire system into a tailspin.

I spoke about this at length right as the news was crossing in the morning in an interview which can be seen here .

Central bank paranoia remains alive and well, and as I've said before, either reflation happens organically, or “SuperBen and the League of Extraordinary Bankers” will make it happen.

What has prevented reflation from occurring organically in the face of bond yields below inflation rates has ultimately been fear of Lehman 2.0 through Spain. For reflation to occur, money has to be willing to take risk.

However, it is the memory of 2008 that’s held risk-taking back, even in the face of a strong year for stocks on a real return basis. As such, while the ECB didn't enact new policy measures, it is clear that they, as well as nearly every central bank in the world, will work to prevent an event.

Prevent the event and rally on as reflation expectations take hold.

I believe this is precisely the way markets are reading this. I say this because of the most important charts in the world — those of the bear trade. I have talked about health care, consumer staples, and utilities as being part of the "bear trade" given that these areas of the market tend to outperform when expectations are growing over a recession, higher volatility, and deflation. However, as I noted on CNBC , those areas are beginning to crack DESPITE no policy action INTO the decline.

Take a look below at the price ratios of the health care (top), consumer staples (middle), and utilities (bottom) ETFs all relative to the Dow Jones Industrial Average. As a reminder, a rising price ratio means the numerator/bear trade sector is outperforming (up more/down less) the denominators/DIA. For a larger chart, visit here .









First, notice that these three sectors tend to all outperform (trend higher) and underperform (trend lower) in unison, and that those advances coincide with difficult environment for stocks, while those declines coincide with bullish runs in market averages.

In each case now, the ratios are 1) hitting extremes last hit right before the “Fall Melt-Up” of 2011 without an actual event, and 2) are now ALL showing signs of rolling over as those ratios fall below their respective 20-trading-day moving averages.

Should these trends be just getting started as I suspect they are, it means risk-taking is under way internally within markets. This in turn means the environment favors stocks and the “Summer Surprise” thesis/”Fall Melt-Up” of 2011 redux I have brought up in my writings here before.

I am highlighting here what price is specifically saying, and continued weakness in the most important charts in the world means another pulse higher in stocks is highly likely. Intermarket price action must be prioritized above all else.

The Fed and ECB were right not to intervene with more quantitative easing. There is plenty of liquidity to drive risk assets higher, bolster bank balance sheets and get credit flowing again to spur real economic growth.

Moreover, according to Goldman's credit strategists, the next big European Central Bank effort to lower interest rates may not happen in the sovereign bond or bank funding markets like many have been hoping for and expecting. Instead, the ECB will intervene directly in corporate debt market. That remains to be seen (don't count on it).

All I know is that I'm tired of all the gloom and doom. Yes, there are problems in these rigged markets, the least of which are high-frequency trading glitches and abusive naked short-selling. But at the end of the day, markets always climb a wall of worry and when risk appetite shifts, watch out, it could bring about a violent melt-up.

There are always opportunities in the stock market, especially after a year of exaggerated pessimism which basically killed risk-taking. I am focused on US financials, energy, basic materials, and tech.

Here is just a small sample of stocks I am tracking closely for a potential breakout to the upside:

Financials: JP Morgan (JPM), Bank of America (BAC), Goldman Sachs (GS) and Morgan Stanley (MS).

Energy:
Encana (ECA), Canadian Natural Resources (CNQ), Continental Resources (CLR), Conoco Phillips (COP), First Solar (FSLR), Transocean (RIG), Haliburton (HAL) and Marathon Oil (MRO). Note that US refiners have already taken off on strong Q2 profits.

US Coal: Alpha Natural (ANR), Arch Coal (ACI), Cliff Resources (CLF), Peabody (BTU) and Walter Energy (WLT). I am particularly bullish on US coal stocks where it's so bad, it's good.

Steel and Copper: US Steel (X) and Freeport McMoran (FCX) are both on my radar.

There are many, many other stocks I like at these levels. Companies like Nokia (NOK) which are trading at ridiculous levels but others that are less well known, like Ellie Mae (EllI), the new mortgage master, one of the top performers over the past year benefiting from the recovery in housing and mortgage activity.

The point is there are plenty of opportunities in the stock market, just make sure you get the macro right or else you'll severely underperform as risk appetite comes back. The "summer surprise" could very well be a nice rally in stocks that leaves a lot of institutions who are positioned too conservatively in the dust.

Below, Michael Phelps wins gold in what was probably the final individual race of his Olympic career, the 100m butterfly. Along with Samuel L. Jackson (@SamuelLJackson on Twitter), I'm hooked on these Olympics and have been very impressed with Phelps, Lochte, Franklin, Ledecky and Douglas. Team USA certainly has a promising future, so cheer up everyone and stop downing it!!!

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