Short Week = Little Insight

Before, delving into this evening's commentary, I wanted to say I'm sorry for the lack of posts last week.  Stacy and I journeyed to Lubbock to see our new niece, Kyndal, in the University Medical Center NICU.  While she's not yet strong enough to leave intensive care, I am pleased to report that things appear to be improving with each passing day.  While she's certainly not out of the woods as yet, we are all optimistic that Kyndal will overcome these challenges and grow up just like any other kiddo.  Thanks to you all for your thoughts and prayers.  I have no doubt that they are one of the contributing factors in her continued improvement.

Now on to the nitty gritty of the financial markets.  Today's trading embodied the environment I've been anticipating for the remainder of the year.  Lots of intra-day volatility, but little, if any, outright movement.  To be sure, stock bulls have to be encouraged by the market's ability to reverse a 16 point drop in the S&P 500 and close the index largely unchanged for the session.  However, as the title of this post implies, I believe that the price action we will see this week will shed very little light on equity's ultimate direction.  With volumes likely to be down (only 3.2 billion shares trading on the S&P 500 today), many investors already on vacation, and a relatively light economic and earnings calendar on tap, share prices are primed for a see saw trade that will prove more reflective of short-term program trading than overall investor sentiment.  This will probably be the case across all major markets.

So if this week's trading is going to be somewhat meaningless from a longer-term trend perspective, the natural question is of course, what should we be looking for?  For my money, look to Europe, Dubai, and China for a sense of how the markets are likely to trade in the coming month.  Sure, Ireland has gotten a bail out from the EU, but, as has often been the case with Europe since the onset of the Great Recession, what has really changed?  CDS spreads continue to remain quite high as investors remain skeptical of Euro nations' ability to pare down public debt levels while maintaining economic growth, thus raising the prospects of default.  And with looming crises in Portugal, Spain, and Italy gaining more and more attention from investors, the overall mood of the markets is one of growing concern.  This is to say nothing of Greece and its problems.  While the Greeks may be in the midst of a drive towards austerity, the fact is that their financial situation is tenuous at best and still highly dependent upon outside interventions by EU-led Germany.  If/when the Germans believe that their investment in Greece (and any other EU nation for that matter) no longer serves its interests, there is little doubt that Greece will find itself in an outright crisis that will likely leave sovereign debt investors holding the short straw.

With respect to China, it's clear from the government's recent actions that there is a concerted effort to slow the economy's growth over the next few quarters.  Much of the policy shift is purported to be in reaction to a pick up in China's overall inflation rate, especially in commodity prices.  And while this is no doubt part of policy makers' calculus, my sense is that this is not a shift in monetary/fiscal policy but rather a continuation of restrictive policies that have been enacted routinely over the past 18 months.  With both the U.S. and European economies still mired in slow to stagnant growth, the engine of China's explosive growth has stalled as well.  However, real estate prices in the major coastal areas have continued to climb at a break-neck pace, setting the stage for a sub-prime like crisis.  With government-owned banks holding much of the debt that has driven the boom to this point, it is in the government's interests to curtail as much of this activity as it can.  This is partially due to prudent central planning, but also related to internal stability as the gap between coastal and interior living standards continue to widen.  So while corporations and developed economies have repeatedly pointed to China and other developing economies as the solutions to current fiscal problems (by exporting goods to them and, thereby raising revenues), the fact is that if/when China gets a cold, Western economies could be in for a serious bout of the flu.  As such, this is a situation that bears watching quite closely and, like Europe, is not likely to resolve itself quickly.

Simply put, it will be virtually impossible for equity markets to breakout meaningfully to the upside so long as these concerns remain at the forefront of investors' minds.  And, unfortunately for the bulls, this is not a problem that will be swept under the rug in short order.  Even if investors are willing to believe that another round of government intervention (whether it be QE2, an EU bail out, or some other government-backed program) is needed to shore up the economic environment, it is clear that the euphoria that once followed such moves is fading fast.  Just look at the markets since the Federal Reserve announced its latest policy intentions.  I think it's fair to say that investors have greeted this move with a fair bit of skepticism.  And with policy actions already sitting at record levels, the question becomes one of dry powder:  how much more can governments really do?  And, more importantly, what will be the marginal benefits of additional stimulus?  If economic theory has gotten nothing else correct in its troubled history, it's the notion that marginal returns diminish over time and can even prove more harmful than helpful at some point.  Can we really believe that marginal returns would be greater than their costs at this point?  I don't think so.

Until tomorrow.....