Short Takes

Below are portions of Saturday morning articles providing the latest details on the seemingly never-ending saga in Washington. Links to the full articles are provided.

From the Washington Post - “A breakthrough”

President Obama and Senate leaders were on the verge of an agreement Friday that would let taxes rise on the wealthiest households while protecting the vast majority of Americans from historic tax hikes set to hit in January.

The development marked a breakthrough after weeks of paralysis. After meeting with Obama at the White House, Senate Majority Leader Harry M. Reid (D-Nev.) and Minority Leader Mitch McConnell (R-Ky.) said they would work through the weekend in hopes of drafting a “fiscal cliff” package they could present to their colleagues on Sunday afternoon.

Threading all the legislative needles now falls to Reid and McConnell, who pledged to work together to craft a package that can win significant bipartisan support.

Either way, the wheels are now in motion for the Senate to vote on New Year’s Eve, Senate aides said. If that vote were successful, the Republican-controlled House would have mere hours to decide whether to approve the legislation or take the blame for letting taxes rise next month for nearly 90 percent of Americans — and for potentially sparking a new recession.

At the White House, according to the House Republican briefed on the meeting, Boehner repeatedly deferred to Senate leaders on policy details, saying only: “Let us know what you come up with, and we’ll consider it — accept it or amend it.”

From the Wall Street Journal - “Increasingly concerned about being blamed”

The two Senate leaders now have to concoct a deal that has eluded Washington since the election, and it remained unclear how the two sides could bridge their remaining differences, in particular over the threshold at which higher tax rates would kick in. Mr. Obama left open the possibility at the White House meeting of going higher than $250,000, a senior administration official said.

How the House will respond to any Senate deal is a crucial unanswered question. According to a spokesman, Mr. Boehner told the president the House would consider whatever bill passes the Senate, either accepting or amending it.

Senate Republicans have indicated they could accept some kind of compromise that would raise the threshold for income tax increases to $400,000—the level Mr. Obama had agreed to as part of broader budget talks with Mr. Boehner that broke down last week.

The optimism expressed by Mr. McConnell Friday was noteworthy because until a day earlier he had been on the sidelines of negotiations.

Republicans are growing increasingly concerned about being blamed if the country topples over the cliff, and a GOP lawmaker suggested Friday they wouldn’t stand in the way if a deal can be reached.

From the New York Times - “I’ve got a positive feeling now”

Bipartisan agreement still hinged on the Senate leaders finding an income level above which taxes will rise on Jan. 1, most likely higher than Mr. Obama’s level of $250,000. Quiet negotiations between Senate and White House officials were already drifting up toward around $400,000 before Friday’s White House meeting. The two sides were also apart on where to set taxes on inherited estates.

But senators broke from a long huddle on the Senate floor with Mr. McConnell on Friday night to say they were more optimistic that a deal was within reach. Mr. McConnell, White House aides and Mr. Reid were to continue talks on Saturday, aiming for a breakthrough as soon as Sunday.

With the House set to return to the Capitol on Sunday night, Mr. Boehner has said he would place any Senate bill before his chamber and let the vote proceed and the chips fall. The House could also change the legislation and return it to the Senate.

If the Senate is able to produce a bill that is largely bipartisan, there is a strong belief among House Republicans that the same measure would easily pass the House, with a large number of Republicans.

“I’ve got a positive feeling now,” said Senator Kay Bailey Hutchison, Republican of Texas, who said a burst of deal-making talk broke out as soon as the leaders returned to the Capitol.

Mr. Boehner appeared to recognize that he was no longer dictating terms. According to the aide, the speaker said repeatedly, “Let us know what you come up with, and we’ll consider it — accept it or amend it.”

After the meeting, Mr. Obama and officials at the White House appeared visibly optimistic. The president was cheerful with his aides before he walked into the Brady Press Briefing Room to deliver his remarks before assembled reporters. A person briefed on the meeting described a “give and take” atmosphere.

From Bloomberg - “An opportunity for a real result”

“For the first time, you’re seeing an opportunity for a real result rather than the phony-baloney acts that they’ve been engaged in,” said Senator John McCain, an Arizona Republican. “Republicans know that they’re losing the PR battle but the president knows that history will judge him.”

If Congress doesn’t act, taxes would rise by more than $3,400 per household, automatic spending cuts would start taking effect and expanded unemployment benefits would lapse. If there is no resolution soon, the economy would likely go into recession in the first half of 2013, according to the Congressional Budget Office.

The absence of a debt ceiling agreement would make the limit on U.S. borrowing authority the next major event forcing a fiscal debate. Republicans plan to use it as leverage to force Obama to accept spending cuts.

From Reuters - “Deal can easily be retroactive”

“Regardless of whether the government resolves the issues now, any deal can easily be retroactive. We’re not as concerned with January 1 as the market seems to be,” said Richard Weiss, a senior money manager at American Century Investments.

S&P rating agency said on Friday the fiscal cliff impasse did not affect the U.S. sovereign rating. That lifted the immediate threat of a downgrade from the agency, which cut the United States’ triple-A rating in August, 2011 in an unprecedented move after a similar partisan budget fight.

Updated charts and comments available via Twitter (@CiovaccoCapital).

Weekly VIDEO - click here

This leans bullish and could help propel Europe over resistance levels; from Bloomberg:

Chancellor Angela Merkel opened the possibility that Germany may ultimately accept a write-off of Greek debt, as policy makers this week attempt to engineer a buyback that’s crucial for Greece to receive more funding. With Greece announcing bids today to repurchase bonds issued earlier this year, Merkel told Bild newspaper yesterday that euro leaders might consider writing off debt once the country has a budget surplus. Germany has until now ruled out such a scenario as violating European Union treaties.

Our comments from Friday still apply on Monday morning: From a bullish perspective, the markets have been “sticky” near resistance, meaning a significant and sustainable imbalance between buyers and sellers has not materialized yet. The longer a market “sticks” near resistance, the greater the odds it will eventually breakout in a bullish manner. Still, we would like to see the breakout occur.

Tech stocks have been laggards in recent weeks, which has been a little concerning for the current rally despite the numerous bullish signals we outlined on July 16. Earnings may provide a needed push for tech stocks. From Bloomberg:

EBay, the world’s largest Internet marketplace, jumped 5.7 percent in pre-market New York trading. IBM gained 2.3 percent as the biggest computer-services provider also raised its full- year profit forecast. Qualcomm (QCOM) Inc. increased 4.9 percent after results showed consumers in emerging markets are trading up to next-generation mobile-phone handsets.

The relative weakness in tech stocks may be yesterday’s news with downside momentum vs. the S&P 500 waning relative to the height in late April. A positive or bullish divergence occurs when price makes a new low and an indicator makes a higher low, which is indicative of slowing bearish momentum. A clear bullish divergence in favor of tech stocks can be seen below by comparing the slope of the red line near point A to the slope of the green line near point B. The chart shows the performance of tech stocks (QQQ) relative to the S&P 500 (SPY).

In early July, we presented the chart below as part of our rationale for re-entering the oil market. Clear bullish divergences were in place for oil on June 28, similar to the QQQ/SPY chart above. Including early trading on July 19, crude oil has been up for five straight days and is significantly above the price shown in the June 28 chart below. In the case of oil, the bullish divergences helped spot an opportunity to profit.

We remain bullish, but short-term we would like to see how the S&P 500 handles the possible overhead resistance below.

The S&P 500 has also reached the top of the alternate trend channel shown below. The current technical landscape, as measured by our market risk model, is similar to early January 2012 (near point A). The breakout near point A was followed by a strong rally. The previous breakout below point C was a bullish head fake. Given the readings on our risk model and the market’s recent action near point E, we believe the odds favor a more sustained breakout in the present day, rather than a bull trap similar to the price action near point C. Notice prior the “C” breakout, price was congregating in the lower half of the blue trend channel, which is an indication of weakness (left of point D). Recent price action has taken place in the upper trend channel near point E, which is indicative of a stronger market. A successful breakout has not taken place as of Wednesday’s close, which is the next logical step before we become overly concerned with the post-breakout probabilities. For now, the chart below shows overhead resistance.

On July 6, we noted the Fed has the political and economic cover to launch QE3 in the coming months. This morning’s weekly jobless claims report did nothing but improve the odds for another round of quantitative easing. From the Wall Street Journal:

The number of U.S. workers filing applications for jobless benefits rose sharply last week, as seasonal factors play havoc with the data. Initial jobless claims grew by 34,000 to a seasonally adjusted 386,000 in the week ended July 14, the Labor Department said Thursday. It was the largest weekly gain since April 2011. Economists surveyed by Dow Jones Newswires had forecast 365,000 new applications for jobless benefits last week.

From an intermediate-term perspective, the bears have a difficult case to make. If economic data and earnings come in better than expected, that favors the bulls. If stocks were to pull back over the next two weeks, that would increase the odds of a favorable Fed statement, which is bullish. If the economic data comes in soft over the next two weeks, that too favors a bullish Fed statement on August 1.

We have been open to bullish outcomes for almost eight weeks, as outlined in a May 25 bullish divergences video. We will continue to stay with the current uptrends as long as they remain intact. While not the preferred scenario, we can still envision another rather significant pullback in stocks. Given what we know today and in the context of an upcoming Fed meeting, intermediate-term weakness would be viewed as an opportunity to invest cash at more favorable prices.

The markets got some better than expected news from Asia last night, but the news from Europe this morning has toned down bullishness. From Reuters:

An eighth straight month of contraction in the euro zone’s manufacturing sector eclipsed brighter news from Asia on Monday, dimming chances of a strong rebound in the global economy. The downturn in Europe’s periphery members has spread to the core countries of Germany and France, according to purchasing managers’ indexes (PMIs) for March. The outlook is grim as new orders fell across the region for the tenth month.

We noticed the IYT:SPY chart (not shown) has a giant bullish engulfing candlestick intraday. If it holds into the close, it will increase the odds of further gains in IYT. Below are some positive developments on the daily IYT chart.

From China Daily:

BEIJING — Business activity in China’s non-manufacturing sector slowed sharply in February on waning market demand after the Spring Festival holiday, the China Federation of Logistics and Purchasing (CFLP) said Saturday. The non-manufacturing sector’s Purchasing Managers Index (PMI), a key economic indicator, fell to 48.4 percent last month from 52.9 percent in January, the CFLP said. A PMI reading above 50 percent indicates expansion from the previous month, while a reading below 50 indicates contraction.

The Economic Cycle Research Institute (ECRI) is not backing off their controversial call for a U.S. recession.

From a distance, it may seem as if the situation in Greece has been “solved”. While the threat of an imminent default has been reduced, risks remain. The Wall Street Journal talked with representatives from the IMF (excerpts below - 02/22/2012):

International Monetary Fund officials said that while a new financing agreement for Greece reached earlier this week can set the ailing economy’s debt on a path toward healthy levels, perils in the days ahead could capsize the program.

“All the cards have been stacked up for it to succeed,” said a senior IMF official in a telephone briefing. “Of course there are huge implementation risks over the next few days. We have to be realistic. It’s not yet in the bank,” he said.

A second official on the call said that program is “a strong package and major step forward” that buys Greece considerable breathing room to implement a raft of major economic reforms to make the country competitive again within the euro zone. But, there’s little wiggle space for Greece.

Think about the “wiggle space” concept; it implies near-perfect implementation is needed for the program to remain aloft. As noted by Reuters below, the odds of Greece delivering on its promises are not good if you use history as a guide (02/19/2012):

Greece has a long history of promising reforms to its creditors and not delivering, and this time looks set to be no different.

“They probably won’t be able to implement everything and (April) elections make it more difficult,” ALCO pollster Costas Panagopoulos said.

International lenders, the IMF and the EU, blame the failure of the rescue plan so far on slow implementation of structural reforms, such as the opening up of markets and professions. There is widespread scepticism because of a long history of missed targets.

“Past history does not give us a lot of hope,” said Diego Iscaro of IHS Global Insight.

“Every time Greece has to receive a tranche of the money we’re going to have the same problem. If they keep missing targets, sooner or later they won’t get the money. There is a chance this is just delaying the inevitable.”

Even the quick-to-bail-anyone-out IMF has become reluctant to pump more money into Greece, which is reflected in the “excessive risk” statement below via the Wall Street Journal (02/22/2012):

The first IMF official said that while the board will ultimately decide how much the fund contributes to the new Greek program, it likely won’t loan more than EUR30 billion at its peak, roughly the same amount it planned under its old lending program.

“The fund credit to Greece would remain broadly unchanged … versus the peak credit that we would have achieved under the current stand-by arrangement,” he said. Still, “that would imply still the largest exposure ever by the fund to any country by many metrics.”

“We have to make sure that we are even-handed across countries, and also that we avoid excessive risk-taking,” the official said.

If the IMF felt confident in the sustainability of Greek debt, we would not see a statement with a reference to “excessive risk-taking”. Nobody, even the creators of the most recent bailout plan, believes everything has been “solved” in Greece.

With China announcing over the weekend they plan to pump even more liquidity into the system, and with Greece on the verge of getting another loan, an opportunity to make money in the markets may remain for a time. However, under the surface problems remain.

Money printing has bought the markets time, but it has not solved the fundamental problem, which is one of solvency rather than liquidity. As we mentioned in a recent video using Kyle Bass’ math, the problem across Europe is the banks need to be recapitalized. When you add bank recapitalizations to the balance sheets of governments, the numbers do not work. The excerpts below, from a Bloomberg article, sum up the big picture problem.

“The problem with Spain lies with the hidden risk from the potential transfer of banks’ debt to the state’s balance sheet,” said Thomas Costerg, an economist at Standard Chartered Bank in London. “The government is skating on thin ice.”

“For now, abundant liquidity is overwhelming fundamental concerns such as deficit over-shooting, but the latter will again come into sharp focus later this year,” said Michael Derks, chief strategist at FXPro Financial Services Ltd. in London.

“The markets have been paying insufficient attention to the fundamentals,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “The recent uptick in the secondary market could be a foretaste of things to come if the Greek crisis escalates further.”

The sad part is we are still talking about bank bailouts and transferring risk from the balance sheets of private banks to the balance sheets of governments (a.k.a. the balance sheet of the taxpayers). The bankers keep their bonuses from the risky bets and the taxpayers foot the bill to bail them out, as described previously in this video.

The original terms for Greek bondholders did not carry what is known as a collective action clause (CAC). A CAC allows writedowns to occur if the majority of bondholders agree to it. No problem - governments can just change the terms of the contract after the fact, which is something that should scare all of us. Who is to say what other rules will be changed - contracts have become meaningless. Zero Hedge posted these comments from a well-known bond trader, who is obviously angry at the lack of respect for contracts and agreements :

DOW JONES REPORTS THE ECB GREEK BOND SWAP IS NOW DONE. THIS MEANS THAT EACH AND EVERY EUROPEAN BOND THAT YOU OWN IS NOW SUBORDINATED TO THE ECB AND THE EUROPEAN UNION. IF THEY CAN SWAP THEIR BONDS FOR NEW BONDS WITH DIFFERENT TERMS, NO CAC CLAUSE IN THIS CASE, THEN THEY CAN SWAP THEIR BONDS FOR ANY TERMS AND CONDITIONS THEY LIKE WHILE THE BONDS OF PRIVATE HOLDERS ARE HELD TO THE ORIGINAL INDENTURE. THE EQUITY MARKETS MAY RALLY ON THIS NEWS BECAUSE THEY ARE FOCUSED ON A DEAL GETTING DONE BUT ANYONE IN FIXED INCOME SHOULD NOW CONSIDER RETCHING UNDER THEIR DESKS AS WE ALL JUST TOOK ONE OF THE BIGGEST SCREWINGS OF OUR LIVES THAT MAY WELL NOT BE A SINGULAR EVENT.