Diary of a Financier

Bull v. Bear

In Capital Markets on Tue 15 May 2012 at 23:04

At junctures like today, I find it important to lay out all the arguments that’re fighting for the market’s discretion. It helps me ignore biases and aggregate objective inputs in forming my market opinion…

~~~~

Bull

  1. Bernanke Put– Further stimulus had been unfeasible given the Great See-Saw, but inflation and interest rates are now fully suppressed, opening the door for more intervention.
    • Inflation has moderated with April CPI reporting a flat reading this morning (Headline unch, Core +0.2%).
    • Commodity prices have collapsed with the CRB index -8% ytd (-22% since 2011 high).
    • Interest Rates are back at lows with 10-year Treasury Yield (TNX) at 1.78 and 30-year (TYX) at 2.93.
  2. Europe a Known UnknownGrey Swans don’t crash markets. The Eurocrisis today is much different than in 2011, when the main-stream was largely ignorant (or in denial) of the PIIGS systemic potential. While we’re unsure of the outcome, we’re all positioned defensively. Grey Swans give investors and business leaders time to prepare for disaster, thereby mitigating the downside.
    • When Hollande & Merkel meet, there’s potential for an effort toward accelerating fiscal compact–the only real, sustainable solution beyond currency dissolution.
    • In their re-election, the Greek people may vote more for the centrist parties, giving pro-bailout politicians an opportunity to form a coalition, then renegotiate the terms of austerity & bailouts vis a vis the Troika. This provides Eurocrats an opportunity to defer crisis again, kicking the can down the road.
    • Revisiting my ERM I/Black Wednesday analogue, the sudden withdrawal of a core nation like Spain from the EMU could lift the pall from atop global markets and force the rest of the Eurozone to revert to sustainable economic policies.
  3. China Bull Case– Either the Chinese consumer redoubles his contribution to GDP or the government provides some fiscal stimulus. The latter is a reasonable expectation, considering inflation has waned and the Renminbi (CNY) has appreciated.
  4. Technical Analogue– SPX can continue tracking its 2011 analogue and rear an inverse Head & Shoulders that will take us from today’s lows (1330) to a neckline (1405) back to the right shoulder (1356) then to new highs (>1420).

Bear

  1. US Fiscal CliffTrifecta of Bush Tax Cut expiration, debt ceiling battle, and government spending looms at YE2012.
  2. Europe an Unknown Unknown– Mismanagement of the Eurocrisis is the most realistic downside scenario. Half-measures will deepen the panic, and insidious moves can catch investors (OTC derivatives) in a systemic daisy chain. Even an overnight seizure in financial markets can topple the global system, no matter how prepared policymakers are.
    • In November, Eurocrats were in desperate need of time to work on permanent solutions. While the LTRO provided them that time, they’ve accomplished nothing toward increased fiscal/political consolidation or ringfencing core nations.
    • Germany has done the math now. If Greece were to revert to its Drachma, the Germans have identified €76.6B in potential domestic losses from preexisting bailouts, plus subsequent contingent liabilities (32-56% of GDP) from the expansion of EFSF necessary to stem contagion. Finally, they’ve recognized my “6 cents/Half-dozen” notion that net-net, bailouts will cost as much as the losses from a breakup… except a breakup provides opportunity for long-term sustainability.
  3. US Fundamentals– The record-setting warm winter likely served to pull-forward 2q demand into 1q12. Everything since points to demand softness thus far this quarter: cautious earnings call guidance, high inventories, weak railroad traffic.
  4. China Bear Case– Chinese consumer cannot displace the lost national income from net exports & fixed investment, the domestic real estate bubble bursts, ripple effect impairs trade partners like Australia and the rest of the developed world that’s depending on emerging markets for growth.
  5. Technical IndicatorsIndicators are derailed from their 2011 analogue, communicating a different sentiment & psychology among investors. Long-term fractals show bear divergence too.

~~~~

The balance of the above helps me draw a base-case expectation, for which I’m positioning our portfolio. It’s not a tit-for-tat sum that helps me arrive at a conclusion, but rather it’s more of a risk-adjusted, probability-weighted calculation. Technical Indicators indeed communicate a crummy sentiment, which markets will reflexively discount over the coming months. I’m working on selling the last of our Beta–mostly gains that I’ve tried to let run. I see SPX trading down to 1300, at which point I’ll add equity exposure in defensive sectors like Healthcare (XLV) and Utilities (XLU). Because the Eurocrisis is a Grey Swan, I don’t expect a return to that SPX 1200-1100 panic range, which had effectively discounted all of SPX’s sales in Europe (20% of revenues). If there’s slippage lower toward final support at 1254 (resistance of the Eurocrisis 3q11 trading range), I’ll begin buying natural resource names that trade with good value, below net asset value.

–Romeo

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