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Last week, the S&P 500 broke out to a new five-year high. The ECB did not provide any new information and the market believes that officials will do whatever it takes to avoid a financial crisis. Even a soft Unemployment Report did not dampen spirits. The news this week is light and the upward momentum should continue.
European banking officials will meet this week and they will outline their plan for a centralized banking system. EU members will have shared deposits and sovereigns will have to give up some of their banking control. The ECB will have an expanded role. Officials are still deciding if all banks would be regulated, or simply the largest ones that pose systemic risk.
German Prime Minister Merkel is convinced that the EU needs to keep Greece in the union. She is putting together a plan that would make that possible. Greece will not come close to hitting budget targets and tension is building.
The IMF commented that Spain and Italy have “done enough already”. This means they are satisfied with austerity measures. The IMF has $1 trillion in its slush fund and it could provide assistance. Neither country has asked the EFSF for a bailout because they don’t want to relinquish control over fiscal spending.
The bottom line is that European credit concerns have subsided. When this happened in September of 2010 and December of 2011, the market went on a sustained run. Interest rates in Spain and Italy have pulled back dramatically and they would have to reverse substantially to pose a problem.
China posted economic results over the weekend. Retail sales were strong, but industrial production was light. Imports and exports were generally in line. This could be the next dark cloud that plagues the market, but economic contraction for the world’s growth engine should not be an issue this week.
The FOMC will release its statement. The Fed Chairman just spoke in Jackson Hole and I don’t believe the rhetoric will change. The Fed is monitoring conditions and it will take action if needed. As long as credit concerns in Europe are held at bay, I don’t believe the Fed will take action. The stock market is strong and they don’t need to fire their last bullet. The Fed knows that each subsequent round of easing has had a smaller economic impact. They also don’t want to appear “politically motivated” ahead of the November elections.
I am turning bullish. The single biggest market influence (European credit concerns) has resulted in a “green light”. Asset Managers are under allocated and they will aggressively bid for stocks. They do not want to miss a year-end rally. Any dip will present a buying opportunity.
I realize that there are weak underpinnings. The ECB has simply provided lip service and structural deficits still exist. China’s economy is contracting and I believe they are headed for a hard landing. The fiscal cliff (US and Japan) is approaching. As long as we are mindful of these issues we can prudently play this rally.
I am buying calls on basic material stocks. The valuations are attractive and we are in “risk on” mode. Asset Managers don’t like to chase and this group looks attractive. Financials and tech also look good.
After a nice run last week, the market needs to take a little breather. I expect to see an overnight “pop” in the next day or two and stocks will extend their gains. Look for prices to firm up throughout the day.
Scale into call positions; this should be a good week for the market.