By: Elliot Turner
As technical traders, we do not fight the tape; however, we believe it is very important to be cognizant of the interrelations of markets and to gain a general sense of risk tolerance both in the U.S. and abroad. This allows us to anticipate the next move before it happens. While the market seems to have shrugged off the Dubai news, warning signs of another bout of global deflation continue to appear. The XLF, led by Goldman Sachs, put in its first significant lower high since the rally off of March lows. Goldman bottomed in November of 2008, cementing its status as a market leader.
I would like to call attention to ING, another financial, to help provide context for the headwinds faced by the global banking sector, the stock market, and the macroeconomy. ING received significant aid (10 billion Euros and a government guarantee on debt) from the Dutch government in order to prevent a collapse in last year’s credit crisis. The Dutch have mandated a reorganization of the bank and called for the repayment of debt from ING. The bank priced the $11.2 billion offering at $6.40 per share, a 40% discount to the company’s share prices on that day. The 40% discount came on the heels of what had already been a 40% haircut in the share price since its mid-October peak.
Of note for us is the fact that ING peaked out at the same time as the XLF and Goldman Sachs. Before the Dubai Crisis unfolded, I alerted traders to the potential of another deflationary spiral on the global level. The lack of regulatory clarity provides significant headwinds for the U.S. financial sector and will continue to do so in the near future. Recently the Treasury and Fed indicated that they would like TARP recipients to concoct a plan to repay the emergency capital injections.
What we are seeing is that without the government backstop and guarantee, banks have a very limited ability to raise capital. This is problematic in several respects–how can the banks possibly repay the TARP when without it they cannot raise money in the first place? It is a tautological dilemma for the financial institutions and policy-makers alike. To repay these loans at a time when deflation remains a persistent threat (see Japan after two decades of 0% interest rates) provides yet another major hurdle for the banking industry.
We need to continue watching the financial sector as it battles with the 50-day moving average and a downtrend line in place from the October peak. Yesterday, the financial sector opened up right at the confluence of the two levels and could not attract buyers. Should the XLF breakdown below the $14 area, the next move for the broader markets will most likely take us significantly lower. Additionally , we need to continue watching the Russell as a sentiment indicator for global risk tolerance. A continuation of weakness in the Russell and strength in gold and Treasury bonds is indicative of a move away from risky assets and towards safety.
