February 22, 2012 Day two post Greek deal Futures this morning projected a modestly lower opening on the heels of weaker than anticipated economic data from China, and the Fitch downgrade of Greece to “C” from “CCC”. European services and manufacturing output unexpectedly contracted in February, and a gauge of China’s manufacturing appeared to be lower for the fourth consecutive month. Yesterday we noted that the Dow Transportation Average was lower on the heels of downgrades of some of the rail stocks. Yesterday, however, was merely one day in a nearly three-week-long drop in the highly cyclical index. This has happened as other major market indexes moved higher. The negative divergence between the Transportation Average and the rest of the market is not a sure sign of problems, but it is worth monitoring. The Transportation Average, however, today edged modestly higher in early trading. Greece remains in the news as many people review the agreement reached yesterday between the EU and Greek officials. A common theme seems to be emerging, which is that the current deal merely is another postponement of the ultimate resolution to Greece’s economic and budget woes. Greece’s precarious situation was highlighted in a front page story in the Financial Times yesterday. The article suggested that, “even under the most optimistic scenario, the austerity measures being imposed on Athens risk a recession so deep that Greece will not be able to climb out of the debt hole over the course of a new three-year, €170bn bail-out.” The article went on to point out that the austerity measures the recent deal demands could end up worsening the Greek economy, which in turn could worsen the nation’s debt situation. The Times cited a ten-page report that was prepared for Eurozone ministers as a reason it took as long as it did to gain approval of a Greek deal since the report pointed out the numerous pitfalls in Greece’s finances even after another injection of funds. The recently exuberant market investment advisors’ sentiment tempered in the most recent week. The Investors Intelligence advisory sentiment measure released today showed that bearish sentiment increased to 26.6 percent from 25.8 percent. Bullish sentiment fell to 51.1 percent from 54.8 percent, and advisors expecting a market correction increased to 22.3 percent from 19.4 percent. Existing home sales reported at 10 AM today rose 4.3 percent in January. There was a notable downward revision to December sales, but based on current estimates, sale were at their highest level since May 2010. The January sales data showed that single-family sales rose 3.8 percent, and condos and co-op sales increased 8.3 percent. The supply of unsold homes dropped to 6.1 months from 6.4 in December and an average of 7.0 in the entire fourth quarter. It was widely reported today that the White House will propose a significant reduction in the corporate income tax rate that would accompany the removal of significant corporate deductions. Already some people looking at the proposal concluded that the net of the move easily could be to raise the amount of corporate taxes paid and not cut them as a reduction in the tax rate suggests. This earnings season has not produced results as strong as previous periods, but in the last few weeks numerous firms have felt comfortably enough about their prospects to raise their common stock cash dividends. Many of the dividend boosts came from firms that have a long history of raising their cash payouts. While earnings for the fourth quarter may not have been as strong as they were in prior quarters, we see the wave of dividend hikes as confirmation that corporate America has more confidence in the economy than many investors do. It was purely wishful thinking that a deal to handle Greece’s most pressing short-term debt problems would be anything more than another Band-aid for a fiscal wound that is sapping the life out of the Greek economy. It is difficult to foresee a period when Greece will be healthy enough not to be a consistent drag on the Eurozone. The biggest positive perhaps in global terms and the EU is that Greece is inconsequential relative to GDP growth. The bigger problem is what a Greek collapse or default could do to some banks. We continue to have a great deal of skepticism about the long-term prospects for Greece. Whether or not this leads to Greece’s exit for the EU is irrelevant. On-going issues related to Greece and potentially other nations like Portugal will continue to occupy space in financial headlines. Short-term timing of the market is especially difficult right now. There are numerous technical factors, which we have detailed in many reports lately, that suggest the market is vulnerable to a pullback that we think would be relatively modest. At the same time the amount of cash assets that could be deployed into equities is substantial. This is particularly relevant considering that the market’s most recent move caught many money manages by surprise. Their desire to catch up to the market could give rise to a wave of buying that for a time completely would ignore the technical factors. On balance we are inclined not to make large-scale adjustments to portfolios since a pullback in our view would be shallow and set the stage for another leg higher, which we think puts 1425-1450 in sight as a viable target for the S&P 500. Sector activity has been skewed strongly away from defensive areas like utilities, staples and telecoms and toward economically sensitive groups. Other than temporary short-term shifts, we do not think this sector bias will change notably. A pullback followed by another move up in our view will be led by the same sectors that have led the market so far this year. As we noted yesterday a continued rise in the price of crude oil and the resulting increase in refined energy price products could be a headwind at some point. Energy remains one of our favored S&P 500 sectors, but this is true without considering higher energy prices. Have a great day.
