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No Virginia, There is No Santa Claus Rally

Mon, Dec 19, 2:24 PM ET, by ilene, Sabrient.com

Excerpts from this week’s Stock World Weekly

No Euros Please

Last week’s news continued to be dominated by stories of the eurozone debt crisis, rating agency downgrades, and political stresses everywhere.

The capper to the negative news flow came on Friday, with a statement by Fitch Ratings that it was placing Belgium, Spain, Italy, Ireland, Slovenia and Cypress on Rating Watch Negative. Fitch reported,

"Following the EU Summit on 9-10 December, Fitch has concluded that a ‘comprehensive solution’ to the eurozone crisis is technically and politically beyond reach. Despite positive commitments by EU leaders at the Summit, notably the decision to accelerate the creation of the European Stability Mechanism (ESM) and to place less emphasis on private sector involvement (PSI), the concerns held by Fitch prior to the Summit remain pressing and have not been materially eased by the Summit outcome… Of particular concern is the absence of a credible financial backstop. In Fitch’s opinion this requires more active and explicit commitment from the ECB to mitigate the risk of self-fulfilling liquidity crises for potentially illiquid but solvent Euro Area Member States (EAMS).

"…the systemic nature of the eurozone crisis is having a profoundly adverse effect on economic and financial stability across the region and for some EAMS poses near-term risks that are beginning to dominate the sovereign-specific risk fundamentals…"

Doug Kass responded to the ongoing debt crisis drama with a testy broadside lambasting European leaders.

I recognize that no nation is an island and we are all economically interconnected, but, seriously? A bunch of Europeans are upsetting a stabilized-to-improving situation in the United States' economy, creating a real threat of a worldwide economic double-dip and hurting our stock market.

"Like I give a crap about a bunch of German leaders who are intransigent and dogmatic in policy and are dangerously bullying the rest of the EU? As for the French, they are governed by a bunch of socialists in the Senate they don't believe in capitalism to begin with.

"German and French leaders and central bankers should all be given an ultimatum by our leaders: Immediately reverse your "tame and timid" approach to your debt crisis and replace it with "shock and awe" before the debt contagion spreads to others' shores.

"There. I said it. I and a lot of other Americans are getting really pissed off." (Doug Kass Rips Off a Primal Scream at Europe).

A lot of other Americans are getting really pissed off about other things as well.

Congressional lawmakers reached a tentative deal on Thursday to provide funding for government operations through late next year, averting a possible shutdown of government agencies that would have otherwise started this weekend. On Sunday, Bruce Krasting shared his reaction. "the Senate agreed to a bill that would A) extend unemployment benefits B) extend the 2% payroll tax deduction and C) delay a cut in Medicare reimbursement rates. The deciders agreed to do all the extending, delaying and pretending for two lousy months. In other words, Congress will be back at it over these critical issues in less than six weeks." (Throw the bums out!) Screen shot 2011-12-18 at 3.48.48 PM


The inverse correlation between the Dollar and the Dow persisted. As the Dollar climbed, the stock market declined. The chart of the Dollar over the last two years shows three key support/resistance levels: 73, 76 and 80. While the Dollar bounced between 73 and 76 this summer, it began breaking out of that channel in September, rising as high as 80 once in October and once in November before being slapped back down.

This week, the Dollar broke above 80 again, and now the key question is whether the 80 level will provide its usual resistance or whether that level will turn into support. Screen shot 2011-12-18 at 3.40.49 PM

Phil has repeatedly made the argument that, should the economic outlook turn sufficiently dire, the Federal Reserve will most likely launch a third round of quantitative easing (QE3). Moreover, Phil views QE3 as a key premise for his bullish position on the stock market.

One factor affecting the likelihood of the Fed deciding to ease, will change at the beginning of next year. The Fed Board of Governors is made up of six permanent voters and four voters that rotate every year. The 2011 batch of rotating voters consists of three strong hawks (against easing) and one strong dove (in favor of easing). The four rotating voters for 2012 include three doves and one moderate hawk. This will push the balance of the Fed Board of Governors well over to the dovish side, greatly increasing the likelihood of "easy money" policies. This change will increase the odds of some form of QE3 being adopted in 2012.

As Zero Hedge reported "this rotation will probably be the most dramatic in Fed history as three diehard hawks (and one dove) are eliminated only to be replaced with a panel which is almost exclusively Dovish. In fact, at the end of the day, the only modest Hawk on the Fed's voting committee will be Richmond Fed's Jeffrey Lacker (the only member to vote against the drop in FX swap line rates), and even he in the past has shown his dovish wings. Which means that for all intents and purposes, the major delay in global events, and market uncertainty, merely has to last until the end of the year when the doves take over." (When Doves Laugh: 4 Weeks Until The Quiet Coup In The Fed Gives QE3 A Green Light)

The Fed's taking a "Dovish" turn and promoting "easy money" policies should be bullish for stocks and commodities. However, after last week's FOMC announcement, which made no hint of additional easing, chances for a "Santa Claus" rally seem slim.

Lee Adler, publisher of the Wall Street Examiner, contributed an extended excerpt from the WSE's Professional Edition. Lee believes that “panic buying” in the U.S. Treasury market reflects short-term cash looking for a safe place to hide, and that it is pushing the U.S. Dollar higher. In his recent Treasury Report, The Last Ponzi Game, Lee wrote:

"A heavy Treasury auction schedule with a big settlement on Thursday was enough to contribute to keeping stock prices (SPX) in check this week, but not to knock down Treasuries. Demand for US Government paper is so great it simply engulfs even heavier than expected levels of new supply. The massive capital flight out of Europe is now confined to the only game in town, the US Treasury market, the last great Ponzi game still operating.

"This won't end well, but it won't end until it ends, and the technical signals suggest that won't be in the short run. Yields appear to be still headed lower, and that's bad news for stocks given the recent correlation between lower yields and lower stock prices. As I've illustrated in the accompanying Fed Reports, there isn't enough liquidity to power both markets toward higher prices simultaneously. It's either one or the other. Eventually I expect a shortage of liquidity to negatively impact both markets, but we're not there yet.

Tidal waves of panic capital flight have been flooding into the Treasury market in never before seen amounts, both in terms of the indirect bid and the bid by Primary Dealers, of whom 1/3 are European banks. (The Last Ponzi Game)

Capital flight out of Europe is yet another symptom of the seriousness of the financial crisis plaguing the EU. Repercussions are reaching around the globe, with manufacturers in Japan becoming more pessimistic as the eurozone's "Black Debt" crisis drags on. Yoshimasa Maruyama, an economist with Itouchu Corp. in Tokyo, commented, "The outlook completely hinges on what happens in Europe. If the debt crisis worsens further and spreads to the U.S., that could spark a recession there too, and that would mean a recession for Japan as well." (Japan Tankan Slides as Investment in China Drops on Global Slump: Economy)

China is also seeing manufacturing activity slowing, with the HSBC "flash" Purchasing Managers' Index for December coming in at 49, below the median level of 50 that separates expansion and contraction. According to Qu Hongbin, co-head of Asian economics research at HSBC, "China's economy still faces notable downside risks from slowing exports and the further weakening of property-market activity that is yet to come. China's government can and should ease more aggressively on both the fiscal and monetary fronts to stabilize growth and jobs… Hard landings should be avoided, as long as easing measures filter through in the coming months." (China manufacturing cools further: HSBC data)

The rest of the Week Ahead Section is a "Year in Review" of Pharmboy's Virtual Biotech and Pharma Portfolio. Pharmboy presents two tables showing his closed and still open positions, discussess an important lesson (do not to buy outsized positions compared to the size of the portfolio), and shares which positions he’d close out completely and which ones he would adjust by adding “buy-writes” to the currently held shares. (The “buy-write” strategy is often used at PSW to reduce the cost of buying shares of stock by also selling a call and a put against the position.)

To read Pharmboy’s biotech review, take a free trial to Stock World Weekly.

*****


SDI Glossary: "Debt" Definition
SDI Glossary: "price" Definition
SDI Glossary: "the Fed" Definition
SDI Glossary: "Stock" Definition
SDI Glossary: "Yield" Definition
This Article's Word Cloud:   China   Dollar   Europe   European   Fitch   Japan   Last   Ponzi   Summit   This   Treasury   against   between   both   bunch   crisis   debt   easing   economic   eurozone   financial   flight   from   further   government   last   leaders   lower   made   market   only   other   over   shares   should   still   stock   that   there   this   three   turn   voters   week   well   which   will   with   would   year

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