Political, Financial Forces At Work

12/13/2010


With economic trends mixed, financial regulators on both sides of the Atlantic have unleashed considerable firepower in an attempt to tip the balance to the bullish side.

The Federal Reserve has pledged to pump $600 billion into the bond market by June, while the European Union has committed to a $113 billion bailout of Ireland and accelerated its purchases of the sovereign debt of struggling countries at the periphery of the euro zone.

While the dollar amounts are staggering, market watchers question the efficacy of both moves. Both European stocks and the euro currency fell on news of the bailout, though stocks bounced when news of the bond purchases broke.

Bailouts of Greece and Ireland combined to cost $250 billion, but similar actions in Spain could require twice that amount. Spanish Prime Minister Jose Luis Rodriguez Zapatero said there was “absolutely no chance” that the euro zone's fourth-largest economy would seek a bailout from the EU. “Alas, Zapatero's attempt to calm the markets had little effect,” says Marketmail, “since the euro tumbled . . . and the selloff in Spanish and Portuguese sovereign bonds continued all week.”

On the Western side of the Atlantic, critics warn that the Fed's bond purchases may have little effect other than to boost inflation. “Don't fight the Fed, especially when they're using a $600 billion club,” says The Primary Trend. The newsletter contends that while the Fed hopes to stimulate lending and spending, “it eventually will stimulate inflation. And, unfortunately, there is more quantitative easing where this came from.”

Strong corporate profits contributed to stock-market gains in October and early November. Signs of life from the labor and housing markets, along with seasonal influences, received credit for a cheery start to December. However, the November employment report, released Dec. 3, curbed some of the enthusiasm. Private payrolls increased by 50,000, well below expectations, and the unemployment rate rose to 9.8% from October's 9.6%.

Newsletter editors in general remain optimistic, according to Investors Intelligence, with 56.2% of editors bullish versus 21.3% bearish. Bulls typically outnumbers bears, but the 34.9% spread between bulls and bears is well above the average of 19.0% over the last 10 years. Investors Intelligence classifies spreads above 30% as “dangerous.”

“While the (S&P 500) index remains well above its 200-day moving average, which is an encouraging sign, other technical indicators suggest that risks of a correction in equities are elevated,” says The Bank Credit Analyst. “In particular, the percentage of stocks above their 30-week moving average is hovering at extreme levels. And while the uptrend in the advance/decline line is intact, the cumulative measure appears overextended.”

The S&P 500 Index jumped 18% from the end of August to the high in early November, and it would not be unusual for the stock market to take a breather. After a roughly flat November, the index has risen 3.6% in the first five trading days in December.

Of course, the spread between bears and bulls topped 42% in October 2007, so it could certainly expand further in the near term. However, many of today's bulls are creeping forward rather than charging, damning the market with their faint praise.

“In contrast to three months ago, we no longer believe the odds of a double-dip recession are rising,” says The Value Line Investment Survey. “In fact, we sense that such an outcome is now less likely. Still, we are staying cautious in our outlook for the year ahead, reflecting the fact that the normal components of a fast-charging economy — falling unemployment and rising home sales — remain elusive to a large degree.”


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