The countdown clock is ticking on the Greek elections and the major parties are not letting up on their campaigns.
I am sure everyone reading this commentary is as sick of the Greek tragedy playing out in Europe as I am. Unfortunately we remain hostage to their headlines. I will try to keep this brief. The Greek elections are Sunday and the leading parties are neck and neck. This would normally be ignored by the rest of the world but this time around it is seen as a referendum on remaining in the euro.
The New Democracy party is pro-bailout and would uphold the agreement signed by the prior administration. Their leader, Antonis Samaras, has a degree in economics and was educated at Harvard.
The Syriza party is anti-bailout and would "tear up" the bailout agreement, which would likely force an eventual exit from the euro zone single currency group.
Neither party has enough votes to cinch the election and end up in power. Both the major parties won less than 20% of the vote in May. That means the winning party will have to form a coalition with another party or more than one in order to get the required majority to form a government. In the May election the winning parties could not form a coalition and a new election was required by the Greek constitution. If a coalition cannot be formed this time then another election will be called for 30 days from now.
Unfortunately Greece will be broke before that election can be held and a default on their debt is likely. It is imperative for Greece that the New Democracy party wins the election and forms a coalition with the Pasok party and affirms the bailout agreement in order to get the next round of payments from the troika consisting of the ECB, EU and IMF. A win by the Syriza party and rebuke of the bailout agreement means no further financial help from the troika and a Greek default.
The graphic below shows the major parties in Greece and their stance on the bailout and their percentage of the vote in the May elections.
Greek Political Parties
For the euro this election is critical for avoiding a lot of pain should Greece default and leave the euro. For the Greek people this is a matter of financial life and death. If the Syriza party wins and cancels the terms of the bailout, which include severe austerity for years to come, the country will crash. Greece will default and most likely reinstate the Drachma as the official currency. Whatever peg they put on the drachma, say 1:1 to the euro, will immediately be trashed. The new drachma will likely slip to 50% or less of the euro within days because everyone knows Greece is bankrupt and is going to be printing drachma's by the truckload.
For an individual this will be a disaster. Let's say you have a job making 60,000 euros a year and have 20,000 euros in the bank with debt of 20,000 euros. When the drachma falls to 50% of the euro your savings is now worth 10,000. Your 60,000 drachma salary is now worth the equivalent of 30,000 euros. However, your debt is denominated in euros. That means you now have to pay back your debt using twice as many drachmas. Your income and savings was cut in half and your debt basically doubled. Voting for Syriza is financial suicide.
In Greece 50% of voters are between age 30-65 and have jobs and assets of some kind. In theory they understand the dramatic consequences of rejecting the austerity. Overall unemployment is 21.9% but youth employment, those 25 and under, is over 50%. This group has no job, no money and no assets. They could care less if their money was worth 50% less next week because they don't have any and they don't have any real world experience to know that the economic choice they are making is disastrous. They are swayed by the powerful rhetoric of Alexis Tsipras promising them an end to austerity and reinstatement of their government jobs and salaries. He has a persuasive argument for young rebel minds who don't really understand the consequences.
Greek laws forbid official polls in the last two weeks before an election but the last polls released showed the New Democracy party and Syriza in a dead heat. Unofficially the New Democracy party appears to be pulling ahead as citizens are forced to weigh the potential outcomes. Two recent surveys found that 77% to 80% of Greeks want to remain in the euro. That should spell doom for Syriza. The Greek stock market was up +14% for the week on hopes a pro-bailout coalition can be formed.
Global markets seemed to be accepting the same outcome as the indexes rallied in the face of what could be a disaster. Basically investors looked into the face of disaster and decided the Greek people were not that stupid.
However, there are quite a few people who believe the Greek election outcome has already been decided by events in Spain. Last week Spain received a bailout commitment of 100 billion euros for its banks on relatively easy terms and with no austerity. The leader of the Syriza party, Alexiz Tsipras, has used the Spanish bailout as evidence he can void the existing terms of the Greek bailouts including the austerity and keep Greece in the euro at the same time. This will have a very big pull for those voters currently feeling pain from the Greek austerity.
The assurances by the various governments and central banks that they stood ready to provide emergency liquidity "if needed" put a bottom under the markets. Whether this promise of liquidity is going to be enough to rescue the markets from disaster on Monday if the wrong party wins is unknown.
Greek banks are already insolvent and cash is being withdrawn at the rate of one billion euros a day. If Syriza wins this is going to be immediately become worse as citizens try to avoid disaster by cashing out in euros. If Syriza wins there will be bank runs in Spain, Italy, Portugal, Ireland, etc as customers worry about what the impact of a Greek exit will have on their bank and on their country. Yields on sovereign debt for those countries will rocket higher on worries they will follow Greece out of the euro zone.
The ECB said it was ready to provide liquidity "as necessary" to "solvent banks" in the event of a Greek disaster. The keyword there is solvent since quite a few European banks are insolvent or soon will be once the euro dominos begin to fall. With nearly one trillion euros of sovereign debt spread around in European banks the damage would be dramatic. Spain and Italy are already on the verge of 7% debt yields and further credit downgrades are on the way if Greece implodes.
In order to kick this can far enough down the road to head off a disaster in 2012 the pro-bailout parties will have to win and form a coalition of at least 151 of the 200 seats in Parliament. A win by Syriza or the inability to form a pro-bailout coalition will plunge the country into default and probable exit from the euro.
While the Fed has been quiet on this matter ahead of its meeting next week you can bet the odds are high they will take some form of action to offset the weakness in Europe if Syriza wins. In fact, should Syriza win there will likely be major European QE programs announced of as much as one trillion euros. The Fed will probably coordinate with the ECB and others in that program with additional currency swaps and guarantees.
That suggests there are two alternatives for next week. One, the New Democracy party wins and forms a coalition. Europe will rally because they dodged another bullet. The second option is a Syriza win and massive liquidity events are announced including some form of support for European banks and the market discounts a Greek exit as a done deal and rallies.
One thing for sure is that Monday is going to be a volatile ride in the markets. The European debt crisis will still exist and Spain and Italy will eventually come back into the headlines but Monday will be Greece 100% of the time.
In the U.S. the economic reports on Friday were terrible. The NY Empire Manufacturing Survey fell to 2.3 for June from 17.1 in May. This is not good news. New orders declined to 2.2 from 8.3 and backorders declined even further from -4.8 to -5.2. They have been negative now for the last 12 months. Inventories fell dramatically from 4.8 to -8.3. Employment fell sharply from 20.5 to 12.4 and the average workweek fell from 12.1 to 3.1. The six-month outlook declined from 29.3 to 23.1.
This report showed a dramatic change in business conditions in the NY area. Another indicator showing the decline in demand is the sharp drop in prices. Prices paid declined from 37.3 to 19.6 and prices received fell from 12.1 to 1.0. This means demand has fallen sharply and manufacturers are discounting products to move inventory.
This report should cause investors to use more caution ahead of the Philly Fed report next Thursday. The Philly report fell into contraction territory last month at -5.8.
NY Empire Manufacturing Chart
Consumer sentiment for June declined more than -5 points from 79.3 to 74.1 and well below consensus for 77.5. This is the lowest level for the year. This is surprising given the falling gasoline prices and strengthening housing market.
This drop in the headline number ended a nine month streak of gains. The declines were evident in both the main components. The present conditions component fell from 87.2 to 82.1 and the expectations component declined to 68.9 from 74.3.
Confirming the decline in the Michigan Sentiment the daily Rasmussen Index fell by half a point on Friday to 84.5 and the lowest level since February.
Consumers are more than likely becoming concerned about the fiscal cliff being mentioned in the headlines almost daily as well as the problems in Europe and the Greek headlines. Slowing job growth as reported in the nonfarm payrolls and rising jobless claims are also a drag on sentiment.
Consumer Sentiment Chart
Industrial production declined -0.1% in May compared to a +1.1% gain in the prior month. Analysts had expected a small gain. Manufacturing output declined -0.4% driven by a -1.5% drop in output in auto manufacturing. Nonauto production fell -0.3% and is now down an annualized -2.5% over the last three months. That is the weakest period since the recession. Weaker exports to Europe were likely the factor.
Industrial Production Chart
The regional employment data released on Friday showed employment declined in 22 states in May compared to 19 declines in April. Unemployment in the West rose to 9.4% and the highest region in the US. The Midwest was 7.2% and the lowest region.
The biggest report for next week is the Philly Fed Manufacturing Survey on Thursday. The biggest economic event is the two day FOMC meeting on Tuesday and Wednesday. The Fed is expected to announce an extension of Operation Twist and depending on the outcome in Greece there could be multiple policy changes.
The U.S. economy is definitely slowing. The Fed has said they stand ready to take action if needed. If not now, when? I doubt they want to wait until the economy falls back into recession before taking additional action. Since the impact of future actions could be less than in the past there is a need to be proactive rather than reactive. The market is coming down off progressive sugar highs from prior programs and with rates near zero they are limited on what they can do. It may take a large change in policy to have any material impact. Unfortunately the Fed does not appear ready to pull out the bazooka just yet but a Syriza win in Greece could give them the cover they need to reach for the big gun. They are facing a political quiet period where they can't make any changes without being seen as helping the current administration. With 143 days until the election their time to act is running short.
Also running out of time is the Supreme Court. They are committed to rendering their verdict on the Affordable Care Act before the end of June. They typically release decisions on Mondays. There are only two Mondays left in June. Time is growing short and you know that whatever decision is reached it will be controversial.
There was actually some stock news that slipped in between the headlines on Greece on Friday. Facebook (FB) filed a motion with a judicial panel to consolidate more than 40 suits covering the losses in the Facebook IPO. In the filing the company threw the Nasdaq under the bus claiming it was technical problems at the Nasdaq that caused all the losses in the IPO. The Nasdaq has admitted it was at fault for some of the problems so it is a safe bet the biggest winners here will be the lawyers in all the suits.
FB also defended its pre IPO disclosure on mobile user revenue growth and said it was not to blame for the analysts disclosing the lowered revenue numbers to selected clients. The SEC also admitted they had questioned Facebook before the IPO on the timing of its disclosures.
Facebook's Chief Technology Officer (CTO), Bret Taylor, announced he was leaving to start his own company. This was the first high profile exit of talent at Facebook but it shows the problem the company will have holding its key people now that they are all millionaires. Taylor left Google after that company went public in 2004. He started his own social networking company FriendFeed, which Facebook eventually acquired in 2009. He said he is starting a new company (no info) with his friend Kevin Gibbs, currently still at Google. I am sure Taylor is the first in a long line of exits as more stock unlocks in August.
FB shares spiked +6% on Friday to close at exactly $30. Several analysts claimed this was due to the high volume of puts and calls at the $30 strike going into expiration. This "pinned" the stock at the $30 strike price as investors bought/sold shares to cover their short option positions.
Microsoft (MSFT) sent out invitations to a "major" event on Monday afternoon without disclosing the topic of the event. Normally they mention the details like a new operating system or a new platform for developers. Worst case they would give reporters some background on what to expect so the event could be reported correctly. This time it is total secrecy. Microsoft is taking a page out of the Apple playbook and it may be more than just a page. That means tech reporters from all over the country will have to book last minute expensive flights to LA without a clue why they are going.
There are strong rumors that Microsoft might be planning to announce a new tablet to compete with the iPad. Since Microsoft already partners with Samsung and Hewlett Packard a standalone Microsoft product could compete with its partners. It is still possible since Windows 8 is very tablet friendly and Apple's success is begging for competitors.
Microsoft could be announcing a tablet based on the ARM processor. That would be a move away from Intel chips in the Wintel model. Microsoft has not been successful with hardware products. The Zune music player was a flop. The Kin phone was dropped soon after its introduction. Even the Xbox was a challenge and suffered from a high rate of faulty units before catching on and turning profitable. The company had a "slate" prototype called Courier in 2010 that was dropped saying the technology may be reintroduced in a different form later.
Research in Motion (RIMM) proved once again it can still aggravate shareholders. Shares are down more than 70% thanks to the incompetence of the co-CEOs, Mike Lazaridis and Jim Balsillie. The two were ejected from the company recently and RIMM just announced Lazaridis got a severance package of $4 million and Balsillie's was worth $8 million. Actually these two people probably deserved more than that since the Blackberry revolutionized the wireless industry under their reign. Sales rose from $294 million to more than $20 billion before Apple exploded on the scene with the iPhone. It is easy to be daring and brilliant when you have the only product of its kind but when competitors appear with a revolutionary product it requires fast action and out of the box thinking. The pair were heroes years ago and now they are castoffs on the pile of broken dreams. If you don't stay in front of the pack you get run over.
Apache Corp (APA) is probably embarrassed with their abundance of riches. They already have one of the strongest portfolios of oil and gas reserves and they are active explorers. They announced on Friday they made a monster discovery in Canada that is so big they don't even know what to do with it. They drilled three wells in the Liard Basin in British Columbia just south of the Yukon and Northwest Territories. They found "recoverable" gas reserves of as much as 48 trillion cubic feet. That is enough to power the entire USA for two years. The company's VP of worldwide exploration said, "This is probably the best shale gas reservoir in the world."
Only one of the three test wells was fracked using a multistage process to perform a production test. The well produced an average of 21.3 million cubic feet (MMCF) per day over the first 30 days of production. Apache said this was the most prolific shale-gas test well ever drilled. The other two wells confirmed the formation but were not completed.
Apache owns 430,000 acres surrounding this new find and the wells have already been connected to existing pipelines in the area. However, Apache is not planning on rushing into development of this field due to the surplus of gas today. They said this will be a "huge resource for the future." It could eventually be connected to the Kitimat LNG facility currently planned by EOG and Encana on the northern coast of BC.
As if that was not enough Apache told investors it now controlled 580,000 acres in the Mississippian Lime field in Kansas and Nebraska and those reserves could hold an additional two billion barrels of oil. Leased acreage in the Bakken is estimated to contain another billion barrels, western Oklahoma 5.4 billion and their Permian assets are estimated to contain 3.4 billion barrels.
Apache has been known as a serial acquirer but with these high quality assets they are moving into more of a production focused company with decades of drilling opportunities ahead. They literally have more than 100,000 drilling locations plotted. That is a lot of pipe and a lot of hours and they will produce a lot of oil. Friday was a good day to own Apache shares but the sector is so beaten down the stock only gained +1.79 but this is a keeper for the long haul.
OPEC met on Thursday and maintained their "official" production quota at 30.0 mbpd. Unofficially they are currently producing as much as 32.6 mbpd. Reportedly "all" the participants agreed to cut out excess production in order to bring global inventories back in line and provide a bottom for prices. While that makes a good sound bite for the news it is probably not going to happen until after the six nation meeting with Iran on Monday. This is the last meeting before the EU embargo on Iranian oil goes into effect on July 1st. Once the damage to Iran's sales is known we can expect Saudi Arabia to decrease production slightly to just what is needed to keep a small excess in the market and prevent any shortfalls in supply.
Iran's president has already said the meeting will fail because Iran is not willing to give up its sovereignty and its nuclear ambitions. The embargo along with the U.S. sanctions is expected to cut Iran's exports to 1.5 mbpd, down from 2.6 mbpd.
I believe we have seen the bottom in oil prices. It is always possible we could see $75 but that depends on data from Europe and China. Demand will increase over the summer as various countries burn oil to generate summer electricity. Summer driving will also boost demand. Cheap gas should reinvigorate vacation travel.
I believe this is a buying opportunity for oil. This will be especially true if the New Democracy party wins in Greece and the threat of EU disruption dissipates.
Crude Oil Chart
Gold prices rallied on worries Greece will chose the wrong path and collapse the euro. If Greece did chose wrong the central banks have pledged to provide oceans of liquidity and probably much of that with QE programs. That would be bullish for gold. However, even if Greece chooses the right path the euro will rally, pushing the dollar lower and gold higher by default. In theory this is a win-win for gold unless some combination of events spikes the dollar. Gold has risen six straight days.
If you ignore all the overseas headlines and crummy economics in the U.S. you are left with the real fundamentals. Those will be headlined by the Q2 earnings which start in a little more than two weeks. We are heading into the warning cycle next week and companies with major exposure to Europe could be in line to miss estimates. For instance McDonalds (MCD) gets 40.3% of their revenue from Europe. Kraft (KFT) gets 31.7%, Johnson & Johnson (JNJ) +26.3% and Alcoa (AA) +2.46%. McDonalds has already warned. In fact there have been numerous warnings but they were ignored because of the European crisis headlines.
These warnings may have depressed earnings estimates and the reporting cycle will end up with a decent beat because of over compensation by analysts to the downside. However, there is also the risk that too few companies warned on the hopes that business would suddenly improve in the last half of June. This is a tossup but once past the Greek side show and the Fed meeting the earnings cycle will take center stage.
One factor impacting the market could be quarter end and the end of the first half. Funds riding short positions down from the early May peak will need to reverse course and go long ahead of the quarter end. Consumer investors don't like shorts and they want to see long positions in the quarterly statements. The calendar could be another reason the market might rally once Greece has voted.
I believe the concept of shorting the Greek election was crippled when the Greek market began rebounding and the central banks started talking about a massive coordinated injection of liquidity. Resistance levels on the Dow and S&P fell as shorts scrambled to cover but the same resistance on the Nasdaq and Russell remains solidly in place. The highly liquid blue chips were finding buyers while the techs and small caps were being ignored.
Investors began exiting shorts and setting up for a liquidity bounce once resistance broke to the upside.
The S&P broke over two important resistance levels at 1325 and 1335 to stop abruptly just below 1345. The 50-day average is 1348 and the 100-day at 1358. The next minor resistance is 1355. This entire range from 1339 to 1358 is congestive but I seriously doubt technical levels will have any impact on Monday's trading.
Monday will be all about Greece and the central banks and nothing else will matter. Volatility should be high regardless of the vote outcome.
S&P Chart - Long Term
The Dow eased over resistance at 12,750 on short covering into the close. This represents a new four week high and in theory the Dow would be poised to move higher if there were no pitfalls in our path. The biggest is of course Greece. Like the S&P the technicals for the Dow will not matter on Monday.
The next material resistance is 12,900 and then 13,000. We could easily blow through both of those levels in a reaction move depending on the results in Europe. Support is well below at 12,400 and short of a terrorist attack on the Greek parliament I seriously doubt we will see that level again on Monday.
Dow Chart - Short Term
Dow Chart - Long Term
The Nasdaq has underperformed the blue chips. Despite a decent gain on Friday of +36 points it failed to break out to a new four week high or even test strong overhead resistance at 2880. Apparently investors are looking for safety in the blue chip dividend payers rather than growth in the tech sector.
The Nasdaq has strong resistance at 2880 that dates back to April and July of 2011. A break over that level should trigger some short covering but Monday is not going to be a technical trading day. Support is 2805.
Nasdaq Chart - Short Term
Nasdaq Chart - Long Term
The Russell 2000 is another example of risk aversion ahead of the Greek vote. The index has failed to even retest the strong resistance at 880 but it did close near the top of its recent range.
Russell 2000 Chart - Weekly
The NYSE Composite Index broke out of congestion on Friday to close above the 200-day average. Under normal circumstances this would be a bullish signal. The NYSE has a lot of ADRs and ETFs and the market gains in Europe on hope for a positive outcome probably lifted the ADRs and the ETFs were boosted by short covering.
NYSE Composite Index
The TSMI rallied to resistance at 13,975 and has a very good chance of breaking through on any good news from Europe.
Dow Total Market Index
Do you remember last Monday? On Friday the market spiked on expectations for a bailout for Spanish banks. The S&P futures were up +16 points on Sunday night. On Monday the Dow spiked +97 at the open and then proceeded to sell off sharply for a -147 point loss. The good news was already priced in on Friday and there was plenty of bad news to go around on Monday.
It is entirely possible we could see the same trend this Monday. Over the last two days the markets have rallied on hope for a Greek revival and a pro-austerity win. Since the parties have about two weeks to form a post election coalition we might not have a decision for more than a week. We could easily get another sell the news event on Monday even if the pro-austerity parties win.
Enter passively, exit aggressively!
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"You have brains in your head. You have feet in your shoes. You can steer yourself any direction you choose."
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