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The Pain From Spain

S&P 500 Index With 1370 Support Line

On Sunday, the Greek and French voters threw out the reform governments and elected governments that promise to return to the old deficit spending policies that put their economies far into debt. That caused the Asian markets to tumble overnight, but by the time the US markets closed on Monday, we were in positive territory on the S&P 500 Index. It looked as though US investors were taking the news in stride and basing their investment decisions on the much better than expected earnings season to date.

By Tuesday, news from Spain that their banks would likely need a capital infusion of 30 billion Euros sent US markets down, with follow-on downward pressure today so far.

The question for us is: is this a buying opportunity or is it the start of a longer deterioration in the market that will repeat what we saw last summer.

Looking at the fundamentals:

1. Corporate earnings have been good with the exception of companies that get a significant amount of their revenue from European sales (like McDonalds) or from natural gas (like Conoco Phillips).

2. News from China shows that they have likely engineered an economic soft-landing, with news that their manufacturing index expanded in the previous month.

3. Both short and long term interest rates are low. Bond yields, which had increased during the first quarter, have fallen. The 10-year treasury yield is now 1.80%, very close to the 1.71% low that dates back to the 1950’s. And the Fed continues to restate its position that it won’t be raising short term rates until 2014 at the earliest.

4. And, 30 billion Euros is a small amount of money compared to the near-$2 trillion that the various agencies have available to shore-up European banks and governments. The capital can be put into the Spanish banks from these funds held by the IMF, ECB, etc., and they will still have significant balances on hand for other problems.

If you look at the graph above, you can see that today is the second day where we are below our 1370 support level. If we close below it three days in a row, then we will have broken that support and it will take effort to move back above it – and we cannot expect a sustained advance higher if we do not sustain the support level.

I’ve circled two important short term indicators on the graph. Both show that the market is oversold near-term and due for a bounce higher – but there is no guarantee that it will happen in time to avoid a breaking of support or be strong enough to move the market back above the support line.

In general, I’d characterize the market as in a short-term pullback, but at this point not yet into a full correction.

We are sitting on a lot of cash, and are selectively buying certain companies that get punished by the market – the cyclical stocks (those tied to the economy) have gotten hammered recently so we are buying some selected ones with great fundamentals. However we are not committing significant funds until the market gives us a sign as to whether this short term pullback will resolve itself or turn into something greater. There seems to be enough positive tailwinds to push the market higher to the pre-crash levels around 1500 in the course of time – but rest assured it will be a struggle to get there.

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