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How Bad Will This Get? Weekly Stock Market and ETF Outlook

How Bad Will This Get? Weekly Stock Market and ETF Outlook (DIA)

Courtesy of John Nyaradi, Wall Street Sector Selector

Get a Special Free Report from Wall Street Sector Selector 

I don’t know how bad things might get but here are the top risks on my worry list this week.

Do we have QE2, or don’t we?  And will it work?  How bad will the currency war get and how low can the dollar go?

Are insiders and corporate CEOs too bearish or do they have the real picture?

How wide and how deep and ugly can the “robo signing” scandal, also known as “Foreclosuregate,” get and how badly might it impact financial stocks and the real estate market?  (See also Foreclosuregate: Time to Break Up the Too-Big-to-Fail Banks? and Foreclosure-Gate)

We’ll talk about all of this in a moment but first let’s take a look at the technical picture. 

Looking At My Screens 

A quick glance at the Dow Jones Industrials shows us that markets remain very overbought with RSI near 70 and Stochastic well above 80 and on a “sell” signal. 

[chart courtesy of StockCharts.com]

A quick glance at the chart tells us that RSI and Stochastic in current configuration led to significant declines previously this year as outlined by the red elipses.

Furthermore, on Friday there was a quick move upwards at the open but not even Dr. Bernanke’s statement later in the day regarding his plans for refilling the punchbowl was enough to keep markets powering higher as they have in recent days.  Sentiment remains overly bullish and breadth and momentum remain weak.

So there are a variety of technical indicators pointing to the opportunity for an imminent correction in global indexes. 

The View from 35,000 Feet

On the fundamental side, several things happened Friday that should have powered domestic equities into a strong finish for the weekend.  Google exploded over the $600 mark on strong earnings and took the NASDAQ with it , but the rest of the market ignored that and the fact that the New York Empire Index advanced strongly and unexpectedly for October. 

Dr. Bernanke made a speech to the Boston Fed outlining his plans for more quantitative easing and even that was not enough to take the markets broadly higher.

So what’s the problem?

First of all, the financial sector has been pounded for the last two days over the “robo signing” scandal, also known as “Foreclosuregate,” and this could truly be a ‘black swan” event as we come to realize the potential ramifications of this situation. 

The details are still murky but the Attorneys General in all 50 states have launched an investigation to see if false documents and forged signatures were used in their foreclosure procedures.

All the big names could be involved, including Ally Financial, Bank of America and JP Morgan, among others, and the ramifications could be huge as this situation could throw the whole foreclosure process into question and uncertainty.

The best case scenario appears to be a delay in the foreclosure process as Bank of America has already halted foreclosure processing in all 50 states and many other lenders have halted them in other states, as well. 

Estimates of the cost of delays to banks run as high as $2 billion per month and with millions of homes in the pipeline, any delays could also slow the housing recovery and real estate market as inventory builds up and potential sales are put on hold. 

Worst case scenario would be a nationwide moratorium on foreclosures for some unknown time or even a total freeze up of the real estate market that could quickly spread to the banks and general economy.   

Beyond delays, there is also speculation of fines and legal action, all of which could have potential negative impacts. 

Finally, the entire problem might overflow into the mortgage backed securities market as banks could be forced back to take back these securities if it’s proven they were fraudulently issued or don’t have clear title to the homes backing them as security.

All of the big players are involved in this market including Deutsche Bank, US Bancorp. Wells Fargo, Bank of America, JP Morgan and Citicorp and so the fallout could be incalculable.

Everyone is getting into the act, including the FDIC, Congress, the Federal Housing Finance Agency, the states’ Attorneys General, the Justice Department, and of course an army of attorneys who stand to be fully employed for years as a result of this situation.

In response, investors have already gotten fearful about the potential effects of this fast spreading situation and so have sold off financial stocks and financial sector exchange traded funds.

Other problems swirl around “QE2,” Dr. Bernanke’s plan to “go where no man has gone before” with these unconventional methods designed to stimulate the economy. 

The Fed has continued buying back bonds to the tune of $5-8 billion every week and now plans to increase that number at their November meeting.  Dr. Bernanke was decidedly cautious in his remarks on Friday because no one, not even he, understands for sure how this might or might not work and what the downstream repercussions might be. 

While there can be no question that quantitative easing puts a floor under asset prices, it appears not to have any effect on overall economic activity.  If it did, QE1 would have already jumpstarted the economy and QE2 wouldn’t be needed and we wouldn’t be where we are today if QE1 had “worked” as intended.   Furthermore, nobody is quite sure how it will be possible to “exit” from all of this easing when the time comes to execute that maneuver.

The market’s response to his statements was particularly muted, unlike the celebratory tone of previous QE announcements and so it appears that the effects of Dr. Bernanke’s punch are wearing off sooner and having less and less effect with each serving. 

On less sweeping subjects, things are scary as well with the October Michigan Consumer Sentiment Index declining to 67.9 from 68.2, weekly unemployment claims jumping unexpectedly to 462,000 from the previous week’s 449,000  and insider selling outpacing insider buying by more than 2,000 to 1, a truly frightening figure.

Reuter’s reported that the Business Council, made up of the CEO’s of 150 largest U.S. companies, says that the “acceleration phase of the recovery is over” and the “momentum in US and global economy evident in recent surveys has subsided.”  Only 1/3 of the CEOs see improvement in the next six months down from 2/3 in May which bodes ill for the army of our fellow unemployed citizens.

What It All Means

It’s obvious to everyone that the economy is slowing dramatically and that Dr. Bernanke and his colleagues are getting desperate in their search for ways to kick start things back into gear. It’s also obvious that it’s unlikely they have any tools left that will stimulate demand as the consumer continues to deleverage and demand remains week.

The risk of deflation and a double dip recession remain high.

The “robo signing” scandal could morph into a true monster with the potential to inflict severe damage to the real estate and homebuilder markets as well as major and regional banks, mortgage lenders and the general economy. 

One only need look at the composition of the S&P 500 to see the impact of the financials on that index and remember back to the “too big to fail” warnings of the great credit crisis of 2008 to realize what this could mean in its worst incarnation.

The Week Ahead 

Some important economic and earnings reports lie ahead this week along with the continuation of ‘foreclosuregate,” all of which will make for an interesting week ahead.

Economic Reports:

Monday:

0915: September Industrial Production, September Capacity Utilization

Tuesday:

0830: September Housing Starts, September Building Permits

Wednesday:

0700: MBA Mortgage Applications

1400: October Fed Beige Book

Thursday:

0830: Initial Unemployment Claims, Continuing Unemployment Claims

1000: September Leading Indicators

1300: October Philadelphia Fed Report

Earnings Reports:

Monday: Citicorp before market open; Apple and IBM after market close

Tuesday: Coca Cola, Bank of New York before market open; Yahoo after market close

Wednesday: Boeing, Wells Fargo before market open

Thursday: Caterpillar before market open

Sector Spotlight:

Winners: Silver, Peru, Turkey

Losers: Bonds, Regional Banks, Financial Services

I’m writing this on Friday afternoon in the car as my wife drives us around Mt. Hood and towards Hood River for a swim meet with my second son and the annual Hood River Harvest Festival.  The Cascades are blazing with bright yellows and reds and it’s a beautiful setting in the late afternoon sun as we come down the Cascades and into the orchards of Hood River. 

Autumn is a time of transition as the leaves change and the salmon and steelhead swim up the Columbia towards their spawning grounds.  It’s a time of birth and death and winter is on its way. 

October could be scary because in our economic and financial world we are in deep winter and many potential threats abound. I’m looking forward to working our way through this dangerous season together.

Wishing you a wonderful weekend wherever you may be, John

 


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