Exit Stage Left?

Daily State of the Markets 
Wednesday Morning – November 10, 2010  

With a substantive intraday decline and a decent red number up on the board at the close, our furry friends in the bear camp likely went home feeling pretty darn good about their efforts yesterday. But while I hate to put a damper on the bear party, it is probably a good idea to remember that we have yet to see a correction of more than -1.5% during the current run for the roses, which, by the way, is nearly three months old. Therefore, unless things get ugly in the near future – and they certainly could – we’re not going to exit stage left from the rally just yet.

In short, what we’re saying here is the glass-is-nearly-empty crowd was due. And given that everybody in the game knows it, we wouldn’t be surprised if the buyers decide to simply stand aside when the next piece of bad news hits the tape. This would likely embolden the bears even further and the pullback could get nasty. Well, unless the dip buyers get impatient, that is.

However, yesterday’s resurgence by the bear camp wasn’t based on anything terribly substantive (okay, there was a fair amount of chatter about the CDS spreads in Portugal and Ireland and some rumblings about China complaining to the G20 about QE II) and other than when the Dow flirted with being down triple digits, there wasn’t much fear involved. From where we sit, Tuesday’s tumble represented a run-of-the-mill bout of profit taking.

Long time readers know that I abhor the term “profit taking” as it is generally a cop out used to avoid searching for the real drivers of the action. But in this case, it might actually make some sense. You see, trading the stock market these days isn’t just a matter buying or selling stocks. No, we’re of the mind that trading is part of a larger “risk on/risk off” trade. And given the wild swings seen in some of the risk assets yesterday, it wasn’t surprising to see the stock market get taken along for the ride.

Exhibit A in our argument this morning was the action in Gold and Silver. Traders were all abuzz yesterday afternoon about the massive “key reversal” day put in on the two precious metals. The “fast money” crowd talked about the importance of the move from a technical standpoint and how this was a clear cut sign that it was time to get short everything and anything that might be considered a “risk asset.”

While a pullback of 2% – 5% in the stock market is long overdue and could begin for just about any reason, the gold bugs failed to mention that the reason behind the wild swings in gold and silver (pull up a chart of SLV and try not to let your jaw drop), was the fact that the CME had increased the margin requirement for silver and there was talk that gold was next. So, given that anyone holding silver was now faced with putting up an additional $1500 per contract and that gold and silver might be the most crowded trades of the decade, a quick bout of profit-taking (which could easily continue for a few days) is to be expected.

What about the move up in bond yields, you ask? Let’s keep in mind that the Treasury is auctioning off another big batch of longer-term bonds (10’s and 30’s) this week. Thus, given all the furor from places like China and Germany about our decision to monetize our debt, the demand for higher yields may be an attempt by a few of our foreign friends to send us a message. In fact, with the 30-year up this afternoon, we may see some more of this today.

The bottom line is that a pullback would be completely normal right about now, as is some buyer’s remorse now that the QE II has been launched. However, let’s remember that so far at least, the pullbacks have been short and shallow. And unless something changes, there is no reason to believe this will change. So, we will be watching how both the bears and the dip-buyers react today.

Turning to this morning… Stock futures are hovering a little below breakeven so far as traders digest the rate increase in China, the sovereign debt concerns in Europe, and the improving jobless claims report.

On the economic front… The Labor Department reported that initial claims for unemployment insurance for the week ending November 6 fell by 24,000 to 435K. The week’s total was 15K below the Reuters consensus for a reading of 450K. Continuing Claims for unemployment for the week ending October 30 were below consensus at 4.301M vs. expectations for 4.343M.

Next up, the government reported that Import Prices for the month of October rose by +0.9%, which was lower than the consensus for an increase of +1.3%. Export prices rose by +0.8%, above expectations for +0.5%, and above last month’s unrevised +0.6%.

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: -0.86%
  • Shanghai: -0.63%
  • Hong Kong: -0.85%
  • Japan: +1.40%
  • France: -0.67%
  • Germany: -0.49%
  • London: -0.60%

   

• Crude Oil Futures: – $0.20 to $86.92
• Gold: – $8.20 to $1401.90
• Dollar: lower against the Yen and Pound, higher vs. Euro
• 10-Year Bond Yield: Currently trading at 2.72%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: -0.50
  • Dow Jones Industrial Average: -1
  • NASDAQ Composite: -0.4  

Wall Street Research Summary

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