No Relief Rally. Spanish Yields Spike Above 7%. This Is A Major Warning Sign.

June 18, 2012

Fear his returned and we need to tread very cautiously. Asset Managers are not aggressively bidding for stocks.

The EU was proactive and they gave Spanish banks $125B in aid a week ago. This was not a long and drawn out negotiation similar to Greece, Ireland and Portugal. They did not wait for the 12th hour and this was the first time the EU has been proactive.

The next day, Spanish yields rose even after the good news. Italian rates also moved higher.

Spain did not want to get bailed out, it wanted its banks to get bailed out. It got the outcome it wanted and now it still retains control over fiscal spending. This positive reaction sparked a very brief rally and prices quickly reversed.

Yesterday, another big concern was resolved. Greeks elected pro-bailout candidates and together they will form a coalition that will stick to austerity agreements with the IMF/EU/ECB. A default has been avoided (for now) and the market staged a brief rally last night. The S&P futures were up 8 points on the news and they have been drifting lower.

Yields in Spain have jumped to new highs and they are over 7%. This is considered by most to be the “point of no return”.

The reaction to the Greek elections and Spain’s bank bailout is very bearish in my opinion. I expected to see a nice rally today and we are not getting it. As soon as one fire is put out, the market shifts its attention to the next problem. Printing money is not a long-term solution and these bailouts are temporary in nature.

Six months ago, the EU said that it will forge fiscal policies and it will amend the treaty. There has not been any progress on this front. An agreement between all the members would take years to draft. Structural debt is the issue and entitlement programs have not been reformed. The market wants long term solutions.

China’s economy is slipping, but recent actions should encourage investors. The PBOC has lowered bank reserve requirements and they cut interest rates. A substantial infrastructure build out is scheduled and fiscal spending will also stimulate their economy.

This week, flash PMIs will be released. They will be “soft”, but monetary easing should keep investors focused on the future.

The FOMC will also release its statement. It should be “dovish”, but I’m not expecting QE3.

Earnings season will begin in three weeks (July 10th) and we could get a few warnings. I believe most of the bad news is factored in.

The economic releases this week are fairly minor and the focus will be European yields. I expected a relief rally today and we are not getting it. When the market can’t move higher on good news, it is a warning sign. I’m selling out of most of my call positions this morning. I have nice profits and in this skittish market, I want to lock them in.

If the SPY trades below $133 (below Friday’s low), I will exit the rest of my call positions and I will buy puts. Spanish yields are above 7% (all-time high) and this is a major warning sign. Eurocrats are putting out small fires, but they have not addressed long-term structural issues. Soon they will go on vacation and the market will grow impatient.

If stocks are able to recover, I will stick with my remaining call positions. Should the SPY take out Friday’s low, I will sell those positions and I will buy puts.

I hope that the market is able to find its footing. Keep an eye on Spanish interest rates; they are the key this week.
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