Stocks Fall On EU Woes

Wednesday, December 28, 2011
Stock Market Commentary:

Stocks spent most of the day in the red after a report showed that European banks deposited a record amount of cash with the European Central Bank (ECB).  From our point of view, Wednesday marked Day 6 of the current rally attempt which means the window is now open for a new follow-through day to emerge [as long as Tuesday’s (12/20/11) lows are not breached]. The benchmark S&P 500 index is back in negative territory for the year and below its 200 DMA line which is not ideal.

Home Prices Fall But Consumer Confidence Tops Estimates

On Wednesday, stocks and a slew of other risk assets fell after Euro-zone banks deposited record amounts of cash at the ECB. The news came one week after the ECB provided unprecedented levels of liquidity to help alleviate a credit crunch. Last week, the ECB lent 520 EU banks a record 489B euros for three years to help reduce tension in the financial system. The report showed that EU banks deposited a record 412B euros ($539bn) over the Christmas holiday to take advantage of the attractive spread (For those that are interested, the previous record was 384B euros deposited in June 2010). An easy way for banks in the current central bank friendly environment to profit is to make money from the spread between how much they pay for the loan and how much the collect when they deposit the money with their central bank. Normally, a central bank lowers its lending rate to help stimulate the economy. The idea is that banks will lend more money to the public because they are paying less for it. However, in recent years the banks have not really been lending the money to the public and instead deposited the money back with the central bank to capitalize on the spread, due to excessively low lending rates at the ECB and U.S. Fed. Currently, the ECB deposit facility offers an attractive 0.25% interest rate which is much lower than the 1% offered for the three year loans. Another reason why banks are reticent to lend is because they do not have “faith” in the economy/the public at this juncture.

Market Outlook- In A Correction

Risk assets remain under pressure as gold continues trading below its 200 DMA line and other capital markets continue to fall. We find it very disconcerting to see other (leading) risk assets flirt with fresh 2011 lows in recent weeks. China’s Shanghai Composite (normally a leading risk on/off indicator) has fallen below its October low and hit a new 2.5 year low. The euro, which is strongly correlated to U.S. stocks and other risk assets also took out its October low on Tuesday (12/13) which is not ideal. Meanwhile, Gold sliced below its longer term 200 DMA line on on Wednesday (12/14) for the first time since August 2008 (1-month before Lehman failed) and remains below that critical level. Other risk assets such as Oil, Silver, Copper, etc are also under pressure which suggests the global risk off trade is getting stronger.  As an easy reference point, if the benchmark S&P 500 would simply fall to its Oct low, that would be 1074! Sometimes, caution is king.

What we have seen from the October 4, 2011 low was simply an over sold bounce into a logical area of resistance (200 DMA line). Now that the 200 DMA line was taken out it will be important to see how long the market can stay above this important level. If you are looking for specific help navigating this market, feel free to contact us for more information. That’s what we are here for!