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Sunday, November 27, 2011

Market Thought... market assessment

The fast moving Geo-political issues forces investors to change their market thesis every time a new headline develops. Its craziness.

The scenarios:

1. A slower Global GDP growth.

EU sovereign debt yields rising with weak economic data.  A weak economy, from an area of the world with the largest combined GDP, will subdue Global GDP growth.  I do not expect a Global GDP contraction, unless there is a credit freeze.  America is doing better than the headlines suggests because there is better private sector data, while the public sector is doing poorly. (This is exactly what the Tea Party, conservatives and market players want to see. Public spending go down, while the private sector moves the economy.)  The increasing rise of the middle class in the BRICs, along with their own capacity to improve their economies is generally underestimated as everyone gets caught up with the EU negativity.

A slower Global GDP growth will lead to subdued corporate profits, obviously affecting the markets.  Trailing SP 500 eps is around 89.  Placing a trailing PE of 12-14 to the SP500 give a price range of 1068-to-1246.  However, with the constant threat of a EU inspired credit freeze, I do not think we trade with a multiple of 14.  Since the year is almost over, the year end estimates should be observed.  Assuming zero eps growth into the 4rth quarter, which is a bit harsh considering the sales numbers from this weekend. This leads to a year end SP500 eps of around 92. Placing a trailing PE of 12-13 to the SP500 gives a price range of 1107-to-1200.

2. A EU inspired credit event.

If this happens, obviously all bets are off. The markets will see extreme valuations pegging valuations closer to asset prices, similar to 2009.  I still do not expect this contagion to happen.  All the global corporations and banks already know this risk.  And the American banks have close to a trillion in reserves to ease the blow of a large EU bank blow up. The American banks maybe able to take advantage on the corporate lending side if they are willing to step up.  The risk to the American banks is if there are activations in CDS'. (However, the only real threat to this scenario, at the moment, is if Greece takes the extra 25% cut in their bonds.)

Based on what we have already seen within Europe, the troubled banks will get nationalized, to prevent a credit event. But that nationalization will take a toll on the sovereigns with downgrades, pointing to the first scenario, a slower Global GDP growth.

3. Domino effect of negativity.

The negativity will allow for false chatter.  Basically a loop of negativity that will facilitate a low multiple environment.

Seems like there is negativity everywhere anyone looks, but there are some positives that emerged last week.

1. Retail sales were strong.  Hard to argue with raw data.

2. Interesting subtle divergence between the Euro and the SP500 took place on Friday. (I am not putting heavy emphasis on this yet, but I did find it interesting.)

The markets turned around 10:20am, and looking between the two charts (SP500 top, FXE bottom) the turn was obviously Euro related. But as the Euro declined, the market held up for a few hours.

This may suggest a break in the Euro/SP500 correlation. Fundamentally this should be caused by the ECB 'printing' Euros.

3. Headlines of the IMF preparing a 600billion Euro loan for Italy. There is really only one place the IMF can get this kind of money, and that's the ECB. (If true this is also good news for the US banks as those sold CDS' will not get triggered for Italy, at least for 12 months or so.) Hopefully this is true as it will alleviate some EU concerns, but will not prevent the slower global GDP.

The emerging positive data and headlines should give the markets an oversold pop. But the push upward maybe limited due to the above negative scenarios.

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