Long-time readers know that I spend the vast majority of my time trying to determine and decipher the current drivers of the stock market. And after more than 25 years in the game, I’ve learned that the market is basically a discounting mechanism of perception versus reality, or, put another way, what is expected to happen versus what is actually happening.
I believe strongly that it is vital to understand what is driving the action in the market on a daily basis (hence the reason for our Daily State of the Market missives). Although I’ve mentioned this a time or thirteen, I’m of the mind that if you can stay on top of what is happening on a daily basis, you aren’t likely to get fooled from a big-picture standpoint.
Cutting to the chase, the current edition of the game sees traders struggling with the question of which is more important: strong earnings and economic growth here in the U.S. or the worry of what could happen due to the events across the pond?
This question effectively sums up what drove the market action this week. Any and all good news from a corporate or economic standpoint once again took a back seat to the sovereign debt and credit concerns in Europe and the potential for the current “debt mess” to cause economies around the globe to slow.
Whereas a month ago all was right with the world as investors focused on the upbeat outlook for both the U.S. economy and corporate earnings going forward, it now appears that the focus has shifted to the macro view, which is not a pretty picture at the present time. The key question is if the game plan to deal with the mountain of debt in the Eurozone is going to halt the global economic rebound.
What Could Happen
To hear the bears tell it, the answer is clear cut. In light of the fact that the EU won’t let the PIGI’S take a page out of the United States’ playbook and try to “spend their way out” of their troubles, the current austerity plans will undoubtedly reduce, if not kill, economic growth in the region. And with less tax revenue coming in due to a slowdown in economic activity, it appears that one of my favorite economic clichés may soon apply: When your outflow exceeds your income, your upkeep will be your downfall.
There is little argument that at least parts of the Eurozone is heading for a self-induced depression, which could easily last for several years. And given that this is not exactly a popular solution amongst the populations of either the countries being forced to cut back (Greece, Spain, and Portugal) or the countries sponsoring the bailout (Germany), the political aspects of the game could also become a problem.
The massive demonstrations and riots in Greece are a perfect example. While it is easy for economists to come up with a big-picture solution, the impact of the plans on the population appear to be creating public unrest. And while we may just be posturing here, it isn’t much of a stretch to see that this could lead to a change in leadership and, in turn, a question as to whether or not the EU can stay together.
In short, the market is currently trading on fear and uncertainty. And given that hedge fund managers got toasted for big losses during the last go round with the bear, the current buzz words in the fund management community are “liquidity” and “de-risking.”
Getting straight to this point, managers don’t ever want to get fooled again by a macro issue. If memory serves, the average hedge fund got cooked for losses in excess of 30% in 2008 (so much for the “hedge” part of hedge funds). And with the average growth mutual fund losing more than 40%, the bottom line is that managers of all colors, shapes, and sizes may be taking a sell-first-and-ask-questions-later approach to the current uncertainty.
From a local perspective, the general takeaway (at least from the media’s perspective) right now is that corporate America is likely to react to the current macro concerns and uncertainty by becoming more cautious. For example, one employment firm told CNBC this week that companies are already reducing any “at the margin” hiring plans. And as everyone is aware, if the jobs market does not begin to improve, the economic recovery here in the U.S. may be at risk of slowing.
Versus What IS Happening
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Great recap, so which way do you think Monday will go? I think Friday's partial rebound was basically due to short covering ahead of the weekend and also due to delta hedging of option positions before expiry. I bought some June call spreads on the SDS at the close and am going to sell them Monday at a gain or loss once the direction becomes clear.