Many economists are suggesting that the climax of the Euro Zone drama is quickly approaching with the October 23rd Euro Summit coming this Sunday. Regardless of the opinions one might hold on this matter and regardless of the political rhetoric or public protests, business is still taking place and the markets are still trading. This has left individual investors overly concerned with the next news event and fund managers only lightly invested. Clues are surfacing that suggest the stock markets may be preparing for a period of strength by decoupling from the economic conditions and world politics.
The economic downturn of the last three years has taught domestically based companies to do two things. First, they’ve had to operate more efficiently. They’ve done this by cutting less productive workers and keeping their best. The prolonged downturn in the job market has allowed companies to cherry pick the very best and brightest employees. These employees eager to prove their worth have sought to establish new, profitable markets and production efficiencies. The philosophical argument of the productivity of the American worker has shifted to the back burner as corporations have culled their work forces.
The result of this ongoing effort to recreate the American workforce and decouple individual companies from the broader economic dismay has created a slimmed down, flexible and actionable corporate system from the top down. The survival instincts of the American entrepreneur have not been lost on large-scale commercial traders who have been actively buying stock index futures in the face of European uncertainty.
We noticed the effect of this shortly after the S&P downgrade of the U.S. in early August. The stock market sold off 20% as the cumulative effect of a souring economy, European debt woes and the S&P downgrade all became a reality. Counter intuitively to the world coming to an end, commercial traders immediately doubled their bets that the stock market would recover in the following week. Conspiracy theorists suggested that the massive buying in stock index futures was the result of Ben Bernanke’s black ops, “Plunge Protection Team.” The stock market did make a new low for this period of consolidation on October 4th. Once again, commercial traders stepped in to buy the market.
Over the last week the relationship between the U.S. Dollar, the Bond market and the stock market has formed a very bullish scenario. There are two primary keys to this. First of all, sentiment between individual investors and commercial traders is diametrically opposed. Individual investors have shifted to net short the stock market and long the U.S. Dollar. This fearful position would profit if the Euro unravels, the stock market falls and global cash seeks the safety of the U.S. Dollar.
Secondly, mutual funds managers have been holding more cash than normal as their management style has been reduced to mitigating unexpected losses due to Euro fears rather than deploying cash into good companies. This has placed them in catch up mode, as they’ll be forced to put cash to work if the market rises in an effort to match their returns to their benchmark indexes.
Fund managers’ fears may become reality as we’ve seen commercial traders come in to buy the stock index futures once again, this time above the 1185 consolidation level in the S&P 500. When we throw in speculative short positions, which have now surpassed their ’07 highs, we can see that both sides of the trade have taken on major positions. Technically, we can see that we have already traded above the August rebound highs and we are also approaching a very strong seasonal period for the stock market.
While I leave room for a news event driven panic ridden sell off I expect it to be short lived, as there really isn’t much selling power left in the market. This obviously means that I am siding with the collective knowledge of the commercial traders who have far better access to the inner workings of global banking meetings, the ECB and the Federal Reserve Board. This could very well lead to the S&P 500 futures testing the July levels around 1300 in spite of a deteriorating economy.
