Greece is about the economic size of Connecticut (GDP) at close to $250 Billion: about a third of a percent of the Global economy. So why has the world been fixated upon its fate? Why have stock markets around the world fallen 5% over a potential debt default? Contagion! Greece is not a risk if it defaults. It’s a risk if its creditors take a haircut and forgive a portion of the Greek debt. Italy, Spain and Portugal it’s feared would line up for similar debt relief sweetheart deals and they would easily win if Greece was allowed a pass. Today Greece passed the last austerity hurdle for bailout money without any reduction in outstanding debt, so all is well. Sort of. The IMF has to find a way to alter its criteria for joining the Eurozone in contributing to the Greek bailout. Normally the IMF requires creditors to share in the losses with a debt reduction, but Germany adamant that there will be no debt reductions to avoid contagion risk. We’ll see.
Upon the news that the Greeks caved into all the the demands made upon them, US stocks have rebounded sharply from their 5% losses a few days ago and are fast approaching breakout thresholds to new all time highs. It seems that only the IMF could derail such a breakout given the strong oversold readings achieved last week.
Last week the 10 day equity put to call option ratio reached oversold sentiment levels achieved only about once a year. As you can see the last 2 times it reached these levels stock prices began very strong rallies to new highs. The logic here is that high readings over 0.73 indicate excessive put option purchases relative to calls. Puts rise in price as stocks fall, thus a relatively high put divided by call option ratio means pessimism is elevated and that a market price low is near.
The Arms Index by Market-Harmonics below reveals that breadth also reached extreme oversold levels last seen at the 10% correction lows of October 2014. The Dick Arms Index measures advancing issues divided by declining issues over up volume divided by down volume in various moving averages.
One more technical inclusion here to support the thesis of an oversold stock market is shown below with the small investor sentiment measured by the Bull/Bear survey of AAII individual subscribers. Normally a couple times a year overly negative sentiment Buy signals are triggered. It has been over 2 years since AAII has come close to typical oversold Buy signals. There is room to become even more oversold at lower prices, but the odds favor a low being registered last week.
Assuming the Greek concerns or other news events are kept at bay, then we would look for these Buy readings to generate new highs in the 2,200’s basis the SP 500 Index and 19,000 basis the DJIA. The caveat of course is that any event that triggers a failure at the recent 5% correction low support line will likely send prices into the 10% correction zone.
One last piece of evidence for the rising stock market and inter-market relationship is this chart below of falling Yen prices. Carry Trade flows usually favor higher Japanese and US stock prices as the Yen depreciates seeking higher yielding investment returns. Our long term negative outlook for the Yen has again resulted in support for US equities. Should the Yen retest its lows under .8000, then we would be looking for the stock market rally to be ready for a pause.
We are not Bullish on the economy, we are not positive about earnings; we merely recognize that markets move upon expectations first and foremost while earnings, valuations and growth rates are merely symptoms to benchmark. It’s difficult to become overly optimistic about stock market investments this year, but the 1st half of 2015 has been weak with zero gains until the rally this week. Expectations have become overly pessimistic allowing positive surprises to elevate stocks as most of the short term selling has been washed out over the past 6 to 8 months of sideways price action. We were actually expecting a larger price correction in 2015 that may yet manifest, but for the near term we would be investing some of the cash holdings for short to medium term investors and look for new highs.