The Overnight Report: No Turnaround Tuesday

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By Rudi Filapek-Vandyck

It has become a popular expression throughout a volatile 2011: Turnaround Tuesday. Traders on Wall Street and elsewhere had observed often when markets open the new week on a weak note, price action on Tuesdays tends to follow-up with a firm, offsetting rally. Not this week, however.

The day did start off on a positive note and equities in Europe and in the US -no doubt with traders having "Turnaround Tuesday" in mind- chasing higher prices on the back of successful bond auctions in Europe and a surprising improvement in German business confidence. The fact that German confidence booked a small improvement at all when all the news headlines are about doom, gloom and Armageddon was taken as a very positive sign (the index remains deep in the red, nevertheless).

Then it was time for Germany's leader, Angela Merkel, to once again put a dent in investor confidence. Chancellor Merkel rejected calls to raise the upper limit of the ESM rescue fund. It currently stands at EUR 500bn, which is unlikely to be enough to cover Spain and Italy if they need to retreat from the bond markets. The next thing was the release of rather disappointing US retail sales for November, sparking fears the improvement witnessed over the past few months may not last into the new calendar year. After a brief retreat, the focus shifted to the FOMC meeting.

Were we expecting anything else other than "no change"?

Apparently we were. This reminds me of a statement put forward by market strategists at Morgan Stanley earlier this year, one that I have borrowed a few times since: Hope Is Not A Strategy. Probably the biggest disappointment from the FOMC was a slightly more optimistic tone on the strength of the US economy, which puts any thoughts of QE3 firmly on the back-burner, for now.

So when the FOMC statement was released (no QE, not even a hint of it) US equities swiftly reversed course. They sold off leading into the closing trades of the day, with indices finishing the day on losses between 0.55% (Dow) and 2% (Russell2000) from small gains earlier. Both the euro and gold had another tough day at the office too.

In between, rating agencies had singled out Eastern Europe as the next shoe to drop in the euro-fallout, while retail benchmark Best Buy managed to disappoint investors – again. Best Buy shares tumbled 14% as the consumer electronics retailer's fiscal third-quarter profit dropped 29% in an obvious admission that heavy discounting does bring in the customers, but it doesn't heal the bottom line.

Here's one observation to highlight, showing just how much the current mindset of the investor is drawn to headlines and to technical support and resistance levels. Leading up to the FOMC statement, the S&P500 continued lingering just below the 1245 level, which was the previous support level that was breached on the way down in the previous session. Well, at least now we really know for sure support at 1245 has now transformed into technical resistance.

Oh dear.

European bourses had been unable to hold on to earlier gains as well. Long end US bond yields fell; 10-yrs down 4bps to 1.95% and 2-yrs steady at 0.23%.  West Texas crude oil futures initially rallied above US$100 per barrel, as investors are increasingly wary about the short term dynamics and risks in the global oil market, but ultimately disappointment prevailed. WTI oil still managed to hold on to a gain of 1.75% to US$99.48. Brent still managed a gain of 2% to close at US$109.50/bbl.

LME Base metals booked more losses, though smaller in nature. Copper closed down 0.1%. Gold fell another 2.4% to US$1628.80, but the real victims of this week's risk aversion are the euro and the AUD. The Aussie is back below parity and NAB analysts suggest the indicative range for today is 0.9935-1.0060. Earlier in the session AUD/USD had tried to rally back above 1.01. The new target seems to be 0.97.

No doubt EUR/USD will soon be testing 1.30.

Usually this time of the year is the easiest to be bullish on risk assets, equities in particular. Analysts at Barclays Capital published an analysis of historical data earlier this month and the observation was that, even over a longer term timeframe, the odds are simply stacked up in favour of rising share prices whenever the world moves towards a new (Christian) calendar year.

In Australia, Goldman Sachs' Head of the Insto Desk, Richard Coppleson has been reminding everyone for weeks that 25 years out of the past 31 have proved to be accommodative for traders looking to end the year with some extra pocket money. Moreover, for those who need the extra-convincing, the average gain booked during the final two weeks of the year is no less than 3% on Coppleson's calculations.

In more recent reports, "Coppo" has added an extra argument as to why Australian share equities must/should/will end the year on a positive note: the sheer weight of cash entering and re-entering the market at a time when volumes are low by default, and volumes are likely to be extra-extra-extra thin after what has transpired thus far in 2011.

So where does all this cash come from? There's an estimated $7.6bn that will be paid out in dividends this month, of which an estimated $6.3bn will be paid out in cash (estimated figure – nobody knows what the uptake of Dividend Reinvestment Plans will be at the big banks, for example). Then there's a monthly $2bn from the institutionalised Australian superannuation system. Plus there will be an extra $9.48bn paid out this month from four corporate events; the Foster's ((FGL)) acquisition, the Macquarie Airports ((MAP)) capital return, the off market buyback by Commonwealth Property Office trust ((CPA)), plus the Coal and Allied ((CNA)) buy-out by parent Rio Tinto ((RIO)).

The logic here is that the weight of all that cash being put to work in the local share market will push prices higher.

Another close market observer who has turned uber-bullish is JP Morgan's US-based market strategist Thomas Lee, who this week offered his eight reasons as to why investors should be optimistic about prospects for 2012. These eight reasons are:

– J.P. Morgan Fixed Income Strategists are constructive for 2012 on High Grade, High Yield, MBS, ABS, and CMBS. Given equities are the junior piece of the capital structure, this is positive for equities.
– Market consensus is cautious about 2012 (time to be "contrarian").
– The J.P. Morgan base case is for the Euro crisis to abate by 2H12, with Europe potentially exiting recession by mid-year. Historically, equities have bottomed 6- 9 months ahead of a return to growth.
– EBIT margins for US companies should expand 100-150bps in 2012, bolstering net profit margins by 60-90bps to 10%, setting a new high for profit margins and driving 2012E/2013E EPS of US$105/110.
– US corporates are likely to ramp up total cash return by as much as US$250bn in 2012. For the past five years, corporates have represented 97% of the incremental inflows into equities.
– US housing should see a further advance in its recovery in 2012, driven by expanding household formation rates. Vacancies are at five-year lows and other factors are also supportive.
– The 2012 US election cycle should be positive for equities. Stocks have historically done well when an incumbent has had low approval ratings going into an election year (positive returns in seven of eight years).
– Plus China entering selective easing cycle sets the stage for a cyclical upturn in EPS.

Lee has a 1430 price target on the S&P 500 for the end of 2012, suggesting about a 16% gain from recent levels, with beaten-down financials his top pick for the year.

On the other hand, one of the better known uber-bears, Glushkin Sheff's David Rosenberg, has repeated his view that investors best remain defensive and safe, regardless of whether we see an end of year rally, or not. Rosenberg's theme for 2011 has been "Safety and Income at a Reasonable Price" -acronym: SIRP– which means he advocates buying shares in companies with defensive and relatively safe underpinnings paying big, solid dividend yields, plus selected corporate and government bonds, and gold.

Now that we've mentioned gold…

Yesterday's warning issued by US-based trading guru Dennis Gartman is reverberating around the world, as religious gold bugs cannot believe the news, and some have been quick in pointing out that Gartman has been proven wrong before in his calls on gold. Others, however, acknowledge the technicals are not looking good for the precious metal.

All that was even before Gartman's follow-up in today's edition of his daily newsletter. Consider, for example, the following statement: "We have the beginnings of a real bear market, and the death of a bull."

Where many blogs and newsletters overnight point in the direction of Chinese gold buying (as a supportive event), Gartman strongly disagrees. "One of the oldest rules of trading is simply this: a market that cannot or does not respond to bullish news is a bearish market not a bullish one. This [Chinese buying gold] was manifestly bullish news and it was received very bearishly indeed."

No doubt there's going to be a lot of discussion around the world following such strong statements (also note that share prices for most gold producers this year have not performed in line with expectations and not even remotely in line with the gains booked by the precious metal).

One of the headlines today from The Wall Street Journal: Is Gold The Answer To Europe's Crisis?

There was some good news regarding debt auctions that markets quickly forgot about. Spain and the Eurozone rescue fund, the EFSF, had successful debt auctions earlier. Spain sold E3.4 bn of 1-year bills with a yield of 4.05%, while investors charged 4.22% to hold 18-month debt. The EFSF managed to place E2bn at 0.22%.

The German ZEW index was slightly better than expected, rising to minus 53.8 in November from minus 55.3 in October. However, this index is still far below its long term average of +25.

US Retail Sales for November were up by 0.2%, from 0.6% last month, but below market expectations of a 0.6% rise. It was, nevertheless, the 11th consecutive rise in 2011. Also, the NFIB Small Business Survey for November, rose to 92.0, above forecasts of 91.5, but the good news was in hiring intentions, which climbed to a 38 month high. Sailant detail: small business employs 50% of the US workforce.

Today in Australia sees the release of the Westpac Consumer Confidence and a speech by RBA Deputy Ric Battellino. SPI futures are signaling another down day ahead.

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