Asking The Hard Questions

Daily State of the Markets 
Wednesday Morning – May 26, 2010  

When in the midst of a waterfall decline such as we’ve seen over the past month, it is easy to become disengaged from the bigger picture environment and to assume that the selling is never going to let up, even temporarily. In this type of a market, support and resistance don’t matter, moving averages don’t matter, and all anybody can talk about is how low it can go. However, at some point during the decline, you have to ask the important question: Is this degree of selling really warranted?

If this sounds like an exercise in subjectivity, give yourself a gold star. The key point is that during emotional times in the market, moves can become based on fear and fear alone. And during these times, it is your job to figure out when enough is enough in terms of the market’s discounting of what “could” happen.

When the world is crashing down around you and it feels like any and all holdings are simply “long and wrong,” it is vital to be able to identify the drivers of the action. The question becomes: What is the likelihood of the worst case scenario actually coming to fruition? In other words, you need to identify what is real and what is based on uncertainty.

These were the questions I found myself faced with within 15 minutes of the open on Tuesday. With the market suddenly down ANOTHER 300 points, and any and all support zones snapping like toothpicks, it was time to ask the hard questions. You see, with the S&P 500 down something on the order of -14.5% from its high of April 23rd, my thinking was that if the market was simply discounting what “might” happen, then we deserved a bounce – and soon. However, if I was missing something, and the market was instead discounting what “was” happening, then it was time to sound the bear alarm and stand aside.

In 2008 and early 2009, the market dove hard and then dove some more based on things that were actually occurring. Bear Stearns going down, Lehman filing bankruptcy, AIG (AIG) needing a government bailout, the Prime Reserve Money Market Fund breaking the buck, credit markets freezing up – these were all things that actually occurred. And as such, the market was busy trying to discount the impact of these events, which turned out to be what is now known as The Great Recession.

So, is the same thing happening across the pond right now? Will the debt mess in Europe create another economic slowdown around the globe? Again, these were the questions that needed to be asked Tuesday morning at 9:40 am eastern time with the Dow down -292 points.

Cutting to the chase, the answers I came up with were as follows. First, the PIGI’S are not Bear/Lehman/AIG. While things can definitely get worse in Europe, it is critical to understand that this time around, policymakers know what is happening and what to do. So, while the swap spreads in Spain and overnight LIBOR rates are definitely on the rise, they are nowhere near the levels seen in 2008. While credit markets are tightening, they are still functioning. And understand that if conditions in the credit market tighten much further, there is VERY strong chance you’ll see the Fed, the ECB, and just about every other central bank around the world step in and take action to reinforce the idea of “don’t fight the fed.”

Based on my answers, I came to the conclusion that we did indeed deserve a bounce because I assumed that a 14.5% decline discounted an awful lot of stuff that “could” happen. I’m not sure how far it will go or how long it will last, but things might have gotten a little excessive yesterday.

Is this a subjective conclusion? You betcha! So, please don’t take my word for it; ask yourself the important questions right now and play the game accordingly.

Turning to this morning… The strength seen in the last 90 minutes yesterday appears to be spilling over into today’s trading as the futures are up nicely.

On the economoic front, orders for long-lasting goods were up nicely in April. The Commerce Department reported that Durable Goods orders gained 2.9% during the month, which was well above the consensus expectations for an increase of +1.3%. March’s reading was revised significantly higher to unchanged (up from -1.3%). When you strip out the volatile orders for transportation, orders in April fell by -1.0%, which was below the consensus for +0.5%. However, March’s reading was revised significantly to show a gain of +4.8% (from +2.8%).

Finally, remember to think positive today…

Pre-Game Indicators

Here are the important indicators we review each morning before the opening bell…

• Major Foreign Markets:
  • Australia: +1.02%
  • Shanghai: +0.12%
  • Hong Kong: +1.11%
  • Japan: +0.66%
  • France: +2.65%
  • Germany: +1.86%
  • London: +2.03%

   

• Crude Oil Futures: +$1.92 to $70.70
• Gold: +$15 to $1213.00
• Dollar: Higher against Yen, Euro, and Pound
• 10-Year Bond Yield: Currently trading at 3.13%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: +12
  • Dow Jones Industrial Average: +97
  • NASDAQ Composite: +21  

Wall Street Research Summary

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