23^rd November 2009

Equity Index

Overview

Last Monday the S&P 500 future posted fresh yearly highs hitting 1112.25 before struggling for the rest of the week, finally giving up all the gains achieved on Friday, to end the week almost flat. In Europe equity indices struggled in comparison with both the DAX 30 and Eurostoxx 50 failing to post new yearly highs before losing a lot of ground on Thursday and Friday to finish significantly down on the week. 

Thoughts from the trading floor

From a technical perspective the US equity indices continue to look bullish backed by new yearly highs last week in the S&P, Dow and NASDAQ.  Having said this there are certainly signs that the markets are losing steam, the S&P 500 did manage to avoid a double top formation by breaking previous highs but the size of the breaks are getting smaller. We are also not seeing European markets keep up, the Eurostoxx 50 future has not seen yearly highs since mid October and certainly looks to be in the process of creating a topping formation. A similar situation is also apparent in the DAX this leads us to the conclusion that although markets may touch new highs next week and we are most likely approaching a medium term top.

The big question that everyone is keen to have answered is whether this rally is sustainable and truly matches the underlying fundamentals. As we mentioned last week we believe that the rally has benefited from a weaker USD and unprecedented fiscal and monetary stimulus. But has this simply created a liquidity bubble that will burst returning us to a wild boom bust cycle. Over the last 15 years the US consumer has been the backbone of world economic growth aiding the development of China and many other net exporting developing nations. In doing this the US has run up a huge deficit a large chunk of which is owned by China in the form of US treasuries. For growth to return someone needs to take up the consumption / spending slack, and it appears all hopes are still pinned on the US consumer. Are they ready for this responsibility? This question has to be met with a resounding NO!

House prices have been the cornerstone of the consumer confidence for the last decade and as they rose, savings fell and personal debt rocketed. Without a strong rebound in house prices it is very unlikely the US consumer will return to their old ways. Despite all the short term aid being given to the US house buyer at the moment with ever more generous and expansive fiscal policy, at some stage this will run out and the US taxpayers will have to pay the piper. At the same time we are likely to see the treasuries borrowing needs continue to be unsustainably large with monthly auction levels remaining highly elevated. Although they will continue to rely on foreign buying it is likely that one of two things will occur in reaction to the treasuries funding needs. Either we will see a large spike in long dated treasuries as supply concerns come home to roost pushing mortgage rates through the roof, or we will see the US taxpayer fill the void. In both of these scenarios we will see the US consumer again under pressure and unable or unwilling to achieve the level of credit that supported the previous decades spending.

Bull View

Bulls will be hoping to see the US return to job creation ASAP, without this it is unlikely the housing market will receive enough support to sustain a meaningful recovery.

Bear View

Bears will be thinking the higher we rise now on the back of artificial stimulus the greater the ferocity of the next move down will be. Over the next 18 months they will be eyeing a retest of the credit crunch lows in the US and European equity markets.

Futex View

We believe that the fundamentals do not support the recent run up in the equity indices and they are being artificially supported by state provided liquidity sloshing around the system. The economy is still very much on life support and once removed it will likely be a long arduous recovery. At the moment it appears to think it is ready to run a marathon, this will most likely prove a stimulus led delusion.

Tags: Dax, DOW, Equity Index, S&P

This entry was posted on Monday, November 23rd, 2009 at 9:41 am and is filed under Trader News Trader Views. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.