The macro picture remains ambiguous. Outperformance from the U.S economy and the prospect of worldwide loosening monetary policy remains counterbalanced with a worsening Eurozone crisis and a slowing global economy. This confluence of factors will likely yield increased volatility as investors become flummoxed over which macro trends triumph. Over the short-term and after a 20% rally from the October lows, the S&P 500 seems increasingly vulnerable to negative headlines. A lot of good news has been priced in.
Over the past couple of weeks, U.S. manufacturing surveys (Empire, Richmond, Kansas City) have improved, signaling a firm start to 2012. These readings are confirmed by transportation activity. The 6.8% December spike in the ATA’s Truck Tonnage Index as well as positive YoY readings in rail traffic indicate that the nation’s economic arteries remain active. Meanwhile, an improving housing market and the lowest level of initial jobless claims in almost 3 years have turned investors optimistic that a sustainable recovery is at hand.
On the global front, German confidence, as tracked by the Ifo and ZEW surveys, is defying pervasive economic gloom throughout the Eurozone. Record low unemployment has resulted in a resilient consumer. Furthermore, the Eurozone Composite PMI showed an unexpected expansion in January. While activity continues to contract, improved metrics point to a mild recession in the region. In Asia, central banks have increasingly focused on growth over inflation. Loosening monetary policy, state the bulls, will lead to a soft-landing throughout the bloc. Indeed, an upside breakout in copper prices certainly confirms this view.
Markets have been pricing in this good news since October, which leads to the first bearish point. Investor sentiment has reached euphoric levels among retail investors. While excessive bullishness may persist for sometime, I see it as a sign of complacency, confirmed by a sub-20 VIX reading. Investors will encounter increased turbulence in the weeks ahead, resulting in limited gains at best.
For starters, the prospect of a hard Greek default has become increasingly accepted as a relatively innocuous event, incapable of sparking contagion throughout the Eurozone. However, many are ignoring the ongoing contagion engulfing Portugal. Sovereign bond yields there have been hitting record highs all week, as mutterings of a needed bailout grow. The next scare is likely to come from the Iberian Peninsula.
Furthermore, as I stated in my macro outlook, we are currently in a lull in regards to Eurozone protests. The next wave is set to begin in the coming weeks. Indeed, Monti’s government is undergoing its stiffest test yet, as truckers have begun blockades throughout Italy. Moreover, unions are planning a pan-European protest, slated to take place on the eve of the “fiscal compact” summit.
In France, the stage is quietly being set for a wave of uncertainty regarding Eurozone economic policy. President Sarkozy is realizing that he may actually be eliminated in the first round of the presidential elections on April 22nd. Mr. Hollande, who currently has a substantial lead in the polls, has said that he would push Germany to approve Eurobonds as well as increased ECB involvement. I believe that such a wide disparity of policy prescriptions between the two strongest nations in Europe will not sit well with investors.
Finally, news out of China has been lacking. While we’ve seen some stabilization in PMI surveys, I believe that the current headwinds, a Eurozone slowdown and a weakening property sector, will strengthen in the months ahead. Whether loosening monetary policy results in a soft-landing is still subject to debate; however, I would err on the side of caution.
Against this macro backdrop, I remain cautiously bearish and am looking to increase my short positions in the coming week if we break support levels. Leading technical indicators are showing weakness. While they may only signal a breather from what has been a torrid rally, upcoming macro events are likely to negatively surprise investors and induce a wave of bearish sentiment. Volatility seems pretty cheap at these levels considering what’s to come in my view.
S&P 500 Levels I’m watching:
- Support Band: 1,300-1,306
- Resistance: 1.335 then 1,370