When the Bad News Finally Matters – Oct 19, 2012

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

When the Bad News Finally Matters…

For the last five months, the market has been ignoring any and all risks in its headlong pursuit of collective price momentum. The rational? Nothing matters as long as the Fed “put” is in play – so party on. Sometimes, though, the speculation gets ahead of itself, reaching levels that not even the Fed can handle efficiently.

This may be one of those times. With QE to infinity in the pipeline, corporate earnings continue to deteriorate. After a series of lackluster earnings reports and a failed EU Summit conference, stocks tanked on Friday, sending bonds and the dollar higher at the expense of the metals (see box scores).

Last quarter, the banks, for the first time in three years, were the source of disappointment. This quarter, they have been joined by the tech sector – and not just the unfortunate souls in the PC industry. Google, IBM, Intel, Apple, and others are on the injured list this quarter – with either flat revenue growth or a drop in earnings.

Financials would be weak if not for the Fed’s aggressive mortgage buying program, in the process of which it spent more than $27 billion over the past week. What’s interesting to observe is that mortgage rates are rising as the Fed injects liquidity into the system. In the case of the 30-year mortgage, yields have ascended to levels not seen since QE3 was initiated. Perhaps the Fed should stick to jawboning…

The earnings season isn’t producing any surprises beyond these two sectors. Results have generally been in line or better for companies such as CSX Corp (rail), Johnson and Johnson, Coca-Cola Corp, and PepsiCo. McDonald’s fell short of expectations because of unfavorable currency translation, i.e., a stronger dollar.

The EU summit came and went without a bang. Leaders could not agree on the terms of a bailout fund for Spain or on how an ECB bond-buying initiative would be implemented. German lawmakers are once again pushing for “proof” that the programs would work before a commitment is made, which is in sharp contrast to Spanish authorities stalling for more favorable terms (a bailout without austerity).

Efforts to create a banking union have been divided, as well. Top legal aides declare it to be “beyond the powers” granted under EU treaty law to form a single bank advisory, while those under pressure – the French, at present – clamor for speedy solutions no matter the cost. In any case, the rebound in European markets (including a sizeable rally in Greek bonds) may have reached its zenith. Hopes for solutions to problems within the EU are running into the growing realization that issues in the region may never be resolved equitably.

Last week, we mentioned that the metals would be caught up in the selling of stocks, if it were to occur. This did in fact happen this week, as gold shed a little over a percent of its dollar price by the close of Friday’s trade. That said, gold managed a fairly sizeable midday bounce off its 50-day moving average (at the time of this writing, though it finished the week at 1721.80).

This may not be much to say, but stocks did not behave in the same fashion. The S&P 500 hugged its 50-day line for the entire trading session – perhaps to suggest that, unlike the metals, stocks may be ready to sink through their moving averages. For the S&P, that’s 1390 – 3% below current levels.

Of course, if a version of this (or something worse) were to befall stocks, we think the Fed would begin to exercise its newfound powers of “infinity” to stabilize markets (as other central banks have done). As we have surmised here before, additional QE may in fact hurt stocks more than help them, whereas the exact opposite may (eventually) be true for the metals.

Best regards,

David Burgess
VP Investment Management
MWM LLLP

2014-10-02T18:26:41+00:00