Another summer game of chicken

First off I'm glad to report that my mom seems to be on the road to recovery. She has beaten the odds. The doctors told us recently that when they first saw her condition they didn't think she'd make it.  They are very impressed with how she's progressed and she should be moving out of ICU soon. There is still a long road ahead in terms of recovery and rehab but now with my mom far more responsive, breathing on her own and able to take some steps on her own as well, it represents a huge, huge improvement from where she was just a couple weeks ago. I don't know what else to say other than we're lucky and thank God. Life for all of us is starting to normalize and for me that means getting back to the markets.

The Greek vote tonight has people breathing a sigh of relief but I had the feeling that it wouldn't be the disaster that many were thinking. First of all, such  highly anticipated "hold your breathe" moments usually don't turn out to be so bad. Think Y2k. Plus, the market had been rallying for the past couple of weeks just like it did prior to Y2k which suggests it was anticipating a non-doomsday result. But let's focus on the bigger issues here. 


Here we are now almost a year later and the same things that were plaguing the market last summer are doing it again.  Last summer I mentioned a few times how I wanted to see some "resetting" in some fundamental factors before I was a confident that the worst was over which included the following

1) Oil price in the 80's

2) All troubled Euro banks recapitalized

3) Emerging Markets switching from tightening to easing mode undoing the flat/inverted yield curve. 

Aside from oil briefly dipping in the 80's, we never did these things happen by the end of the year and because of this and a couple of other things, I was rather slow to embrace the big rally that started in November. Now though, it seems we are closer to seeing the fundamental reset that I wanted to see last year but we're not quite there yet; but if we get there, it means there could very well be more pain before it gets better. A bailout for Spain and it's banks have been granted but it is enough and what are the details? Are there any other troubled banks in Europe that will need bailing out? Probably. Emerging markets, namely China and Brazil, have been cutting rates but it's just the start of what's likely more to come. Let's focus on China since it's the biggest player in Emerging Markets which and has been a large, if not the the biggest, driver of growth during this bull market. 

As you can see, in recent months the yield curve in China flattened to a levels last seen during the heart of the crash of 2008. Towards the end of 2008, China respsonsed swiftly with rate cuts and fiscal stimulus which resulted in a favorable yield curve and their economy responded in the ensuing months which in turn helped kick start the global economy. The yield curve is on the rise again but it needs to rise more before monetary conditions are favorable again for China. Early last year China was worried about inflation as well as an overheated housing market and as a result they put on the monetary brakes. It took some time, but their economy did end up slowing. Since the 2nd half of last year China's economy has been on the down slope with lots of people now worried about a hard landing. For months their hands were tied because of high commodity prices but  now with prices off significantly, inflation pressures are going to be collapsing and that's going to give China and the rest of Emerging market countries the green light to ease more significantly. But, you usually don't see things turn around with just 1 rate cut much like you don't see things turn around with just one hike. It will usually takes a series of cuts or a couple of large ones before they becomes significant enough to impact the economy and then it takes some time before the economy responds. I suspect if we see a series of rate cuts in China and the rest which results in a steep yield curve, equity markets will start sniffing out a recovery and start rising big despite what negative economic headlines may appear. I realize I'm getting a head of myself here....fist let's see those rate cuts happen. 


In the short to intermediate term I don't see much upside in the market at this point. We had a relief bounce which seems dubious because I didn't see a few hold out indicators like the rydex ratio and NAAIM give the green light. Also, we're getting overbought and last week saw a sizable inflow. 


But on the positive side of things, despite all the 2008-type worries the SPX only corrected 10% off the high at its lowest point so far this year and is still over 5% in the green. Here in Canada and with many international markets it hasn't been nearly as good. The TSX is still down 4% ytd. Although upside seems limited, downside also seems limited as well at this point since the market has worked off all of it's longer term overbought condition. At the most recent lows, it was as oversold in both the ST and LT as much as it was during the lows that ocured after the flash crash of 2010. 


So, in conclusion, it seems we could be in a situation that is much like early last summer of 2010 and 2011 whereby the market saw it's worst of the year (or close to it) but had to chop around for months before a sustainable big rally to new highs began.  That chop was killer for both bulls and bears, so be careful out there. 
But could this year be different? Could the grumps who have been crying bear actually get it right this time??? I'm going to examine the bear case in the next post.