Despite a very negative turn on the unemployment front last week, Friday saw the markets all end on an up-note and very close to the 2010 highs, as day after day of $7 billion POMOs and hints of even more easing (dare we call it QE3?) hit the rumor mill and contribute to the "hopium" built rally. So do we rally on into the end of the year, or are we heading for a fall? With all of the global events influencing the markets, is it even fair to pose this question in such simple terms? I'm not sure either, but I'll lay out what I'm seeing, and let you make up your own mind.
Let's start with the S&P 500.
As mentioned in the intro, we closed on Friday near the 2010 highs, and over the past 3 trading days, we have broken-out of the previous month's trading range. If we break-out to new highs this week, look for 1250 as the next resistance. Also note that the Aroon has crossed back over to a bullish trend.
Before making further comments on the direction of the S&P and other markets, I think we also need to take a look at the VIX, or volatility index. The chart below shows the short term history, and as you can see, Friday's bullish move in the markets has taken the VIX down to the bottom of it's recent range, indicating a distinct possibility for a short term sell-off in equities on a bounce off the $18 trend line.
As you can see, this now marks the fourth time that the VIX is testing $18, with each previous occasion resulting in a bounce, with corresponding sell-off in equities. Before jumping to conclusions however, let's look at the longer term picture and see where we stand.
This chart shows us that the market's most recent "height of complacency" comes at a VIX reading of $15.50 - $16.00 back in April...just prior to the last crash. I personally feel that we will likely see a test of this level again, prior to any new sell-off of any significance. With more POMO this week in the US, coupled with Trichet buying stability in Europe (in the form of monetizing every Irish and Portuguese bond hitting the market), not to mention the overall historical bullishness typically observed in December, I would personally be hesitant to short this market. The one big wild-card still outstanding is whether or not we see an extension of the current tax code for 2011. The most significant element of the tax code pertaining to equities is the Capital Gains clause. If the current code is not extended, an increase in Capital Gains taxes for 2011 would very likely result in a huge sell-off in December, as long-term investors seek to take profits while the tax liability is lower. As this isn't exactly a State secret, I'm betting that the current tax codes do get extended, if for no other reason than to prevent a December sell-off. After all, how would a market crash look in the face of a Bernanke-induced ramp job??
Now a quick look at the Euro...first via the EUR/USD pair.
As mentioned in my posts earlier in the week, the Euro has put in a remarkable reversal against the US dollar, and further investigation has revealed that this has come on the back of two things. One - although Trichet did not announce a monetization program for European sovereign debt, he has commenced a buying program anyway, gobbling up everything coming out of Ireland and Portugal last week; and two - the leak late in the week of the 60 Minutes interview to be aired Sunday (today), where US Fed Chair Ben Bernanke hints at additional quantitative easing in excess of the $600 Billion already on the docket. These two actions have proved sufficient enough to calm European markets for now, but I fear more ugliness ahead. To wit - take a look at the EUR/CHF pair (Euro/Swiss Franc) below.
The Swiss Franc is the European version of "flight to safety" during troubled times, and as you can see above, and in distinct contrast to the EUR/USD, the direction of this pair has resumed it's downward trajectory. To me, this is far more indicative of the true state of affairs for the Euro...at least until the Swiss National Bank (SNB) gets pissed off again. The negative effects that a strong Franc has on Swiss exports will likely result in another attempt by the SNB to intervene in the forex markets. At that point, we may see the Swiss start buying Euros again, but considering the huge loss they have taken by employing this strategy already this year, I wouldn't expect to see them get active on the intervention front again until the pair hits 1.25 or so.
Since this post is already pretty long, I'll just comment on one stock tonight....another follow-up to the Cisco saga.
As annotated above, we finally hit $19 during Friday's session, which is the top of the range that I have been discussing as a target for a potential bounce. We closed at $19.07, but I'm not quite ready to take a long position here, as the selling action in Cisco continues to concern me when you compare it to the NASDAQ and other major indices putting in major rallies over the past three trading days. This tells me that we haven't yet hit the capitulation point with Cisco, so I will continue to observe this stock, keeping an eye out for a reversal pattern before getting long.
Conclusion: Europe is calm for the moment, as are the Koreas, while Bernanke's QE2 has another week of POMOs on the horizon. These are all bullish indicators for US equities. On the negative side we have the US tax code issue described above, worsening unemployment, and prices for crude oil now tickling $90/barrel....all potentially bearish for US equities. The one relatively sure bet, at least long term, are precious metals, as gold and silver both continue to rise in the face of money printing by the Fed and debt monetization by the ECB. Personally, I will be looking to buy more physical silver, and focusing my speculative attention on the forex markets. If you haven't read my three posts on silver from last week, I highly recommend that you do so....here, here and here.
Good luck this week!
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