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Notes to myself, possibly of interest to others.
-- Bill Northlich

Monday, October 31, 2011

Market views

Rosenberg today:
In a sign that perhaps the euphoria over the EU “comprehensive” plan was overdone, we see that the euro is back below the 1.40 mark this morning as well. Elsewhere, the Bank of Japan intervened in the FX market (aggressively too) for the first time in around three months and for the third time this year as the yen had continued to firm to new record highs (hitting 75.35 intra-day against the U.S. dollar and then sold off 4% after the intervention)...

While the S&P 500 did manage to enjoy its best month in 37 years, it did follow five losing months in a row and is still down 6% from the 2011 peak posted in the spring. It is also hard to believe that a whole lot of good news isn’t priced in right now, begging the question as to what incrementally can possibly take the market higher beyond year-end performance chasing...

With one day to go before the end the month, we have the major averages up anywhere between 12% and 15%. The Dow is set for a record advance in October in terms of point advance — it has risen now for five weeks running and is up 5.7% for the year — and the S&P 500 is on track for its best percent gain since October 1974. Much is being made that, once again, more than 70% of companies are beating EPS estimates, but that should be losing some of its allure given that Q3 forecasts had been steadily trimmed since mid-summer...

We went into the month deeply oversold, and looking at the surge in the number of stocks trading above their near-term averages (95% above their 50-day moving averages), it appears that this market is now hugely overbought.  ...

The reality is real incomes are under pressure. For three months in a row now, we have seen every measure of real personal income erode, with the headline number excluding government handouts contracting at nearly a 2% annual rate.  This is a memo to the crowd that believes recession odds have dwindled because that’s what they think the stock market is telling them in this latest rally: in the past 50 years, whenever real income excluding transfers declined at such a clip over a three-month horizon, the economy was either in recession or soon heading into one 75% of the time.

Beyond the EU zone [mess], there are a few factors worth noting:
• Fund manager catch-up:  The S&P500 is up a mere 2% YTD, and plenty of funds managers are still down for the year. Merrill Lynch notes that “Only 31% of active large cap mutual funds have beat the Russell 1000 so far this year, and equity long-short funds are down 17% year to date. There is some evidence that during years in which performance is subpar heading into the fourth quarter, an end of year “catch-up” beta rally is more likely.” (“Hail Marys” are more likely when trading OPM rather than your own).
• Valuation Attractive?:  The key to valuation depends upon the probability of a recession driven earnings collapse. Thursday’s GDP report gave comfort to the bulls that a recession is less likely, and therefore stocks are cheap. (I suspect this calculus was what drove US stocks Thursday, and not Europe).
• Seasonality:  October 2011 is the 10th best month for market performance since 1929. Following the prior top 10 rallies, momentum continued, with median 3-month returns about 6.3% (that is double the average 3-month return).
• VIX Collapse: CBOE Volatility Index futures for Q2 2012 plunged 8.7% since last Wednesday. That is the biggest drop on record, according to Bloomberg. During Thursday’s rally, VIX futures of all maturities fell below 30 yesterday, the first time that’s happened since Aug. 17, the data show. This suggests some complacency when it comes to tail risk of major outlier events, such as an EU bank crisis or sovereign collapse.
• Sentiment still depressed: The other side of the VIX story is Merrill’s Sell Side Indicator, a gauge of Wall Street sentiment. It is still underweight equities and is therefor constructive for stocks.
Some consolidation is in order following last week’s huge move. The above bullet points suggest that following some consolidation, the year end rally can continue. How high is anyone’s guess; mine is that we are about halfway though the move upwards.

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