For Thursday, Nov 10, the market forecast is uncertain

If you choose to sell your stock holdings, avoid money market funds as a cash alternative due to exposure to European sovereign default risk.  Please see our commentary below for additional insight.

Technical Comment:

The S&P 500 plunged on Wednesday, closing down 3.7% near the low for the day.  Volume was higher than Tuesday and barely above the 30-day moving average.  This drop was sufficient in magnitude to trigger the stop-loss algorithm of our forecasting process.  If the S&P 500 moves higher on Thursday by approximately 6 points or more (0.5%) our forecast will return to growth.

Subjective Comment:

In the past 60 years the S&P 500 has dropped by 3.7% or greater only 52 times.  The average duration between such large drops is about 300 days, but it was only back in mid-August when such large drops last happened.  The S&P 500 dropped 4.8% on Aug 4th, 6.7% on Aug 8th, 4.4% on Aug 10th and 4.5% on Aug 18th.  During that time there were large bounces up, including 2.2% on Aug 15th, 4.6% on Aug 11th and 4.7% on Aug 9th.  More recently on Oct 31st and Nov 1st the S&P 500 dropped 2.5% and 2.8% respectively, followed by a near complete recovery in the past 5 days (excluding Wednesday of course).  Such large one-day movements in the market are rare, but in the past three months many of these days have occurred in clusters.  The reason for such large swings up and down from day to day are the incredibly powerful opposing monetary forces from the Eurozone and the US.  The debt crisis in Europe is getting very bad.  Italian bond prices are crashing, causing their yields (interest) to skyrocket.  Such high interest rates will cause Italy’s borrowing costs to become unplayable.  When a nation reaches this point the only options are bankruptcy by defaulting on bonds, or printing up money to pay their debt.  Since Italy is in the Eurozone, they can’t print.  They need the European Central Bank to do that.  European politicians are out of options.  Some countries will likely leave the Eurozone.  If the highly indebted nations abandon the Euro and reintroduce their own currency, they will likely print to pay their debts, subjecting their citizens to massive price inflation.

How is all of this putting downward pressure on the US?  Some of it is psychological.  After years of a recession in the US, high unemployment and constant bad economic news, any additional bad news spooks investors.  A lot of it is technical.  Many institutions who trade and invest have to cope with the losses from holding European bonds.  In order to stay in business, they sell other assets to raise cash, including US equities.  This is how the spillover occurs.  After European markets closed on Tuesday there was an increase on the margin requirements for many investors holding Italian bonds.  This forces them to raise cash to cover the margin calls, putting more selling pressure on other assets.

Nothing has changed regarding our subjective outlook on the US economy and stock markets.  The rapidly growing US money supply is happening as banks lend as fast as they can.  This is fueling another bubble-boom and is putting upward pressure on US stocks.  It is this rare occurrence of the beginning of a new bubble-boom in the US at the same time Europe is crashing that is causing such wide and frequent single-day swings.  Massive money printing in Europe would be needed to kick their can down the road.  High levels of volatility are likely to be with us a while longer.  These high single-day swings are triggering our stop-loss algorithm, and this is why our forecast switched to uncertain.  The same thing happened last week on November 1st.  We encourage you to review our post on that day.  Everything we wrote there still applies, including the technical support in the 1216 – 1226 range of the S&P 500.  It is our best guess the market will bounce up, flipping our forecast back to growth.  If the S&P 500 does not grow enough (6 points) on Thursday, then it might be time to consider a defensive move by moving into a cash (or risk-neutral) position.  Our official forecast is “uncertain”, which means to move to a cash position.  Our stop-loss algorithm was not designed to handle this large single-day volatility.  This is why we’re subjectively suggesting to wait and see what the market does on Thursday before placing your sell order.  You must decide for yourself what is best for your situation.

One Response to For Thursday, Nov 10, the market forecast is uncertain

  1. Craigmc says:

    It appears to me that the European debt crisis is playing to big of a roll in America’s stock prices. I think it is more Chicken Little than actual market forces.