In my view, the most important issue facing the markets is the European sovereign debt crisis. This issue is the breeding ground for so many other factors facing the global economy being that the EU collectively represents perhaps the most significant trading partner for China and the U.S. With this in mind, last Friday, I sent out a survey containing 5 simple questions to a small portion of my contact list with the intent of gauging what sophisticated, institutional investors believe the market is telling us about resolution of the crisis. Admittedly, the sampling was small in terms of respondents but the dollars under management significant. I supplemented the written survey with conversations soliciting responses to the same questions. Fortunately, not one of my friends added me to their Do Not Call List. Now, in full disclosure, I am not a graduate of Quinnipiac University nor a former employee of Harris Polling, but this did not stop me from understanding the clear message of the data. The overwhelming majority of the respondents believe that the market is discounting the most positive scenario and that if this were not delivered, albeit with a time frame for compliance of 3 to 6 months, that the indices would hit new lows. Giving credence to this view is the fact that the recent rally in the S&P began contemporaneously with the Sarkozy and Merkel speech wherein they stated that they have a meeting of the minds regarding what needs to be done to stem the crisis. November 3rd was the drop dead date they offered for presenting a unified plan although recent chatter and an increased sense of urgency has served to have brought the date for resolution closer by a week.
Today, this changed, as Germany threw cold water on a shock and awe solution resulting in a 2% decline in the S&P. It would not be inappropriate to argue that the market went from an oversold to overbought and today’s action was normal consolidation but I disagree. Now, in fairness, I applaud the Germans for reining in expectations that became much too optimistic. I had, in fact, pointed out in prior notes that the news flow would create peaks and valleys in the averages along the road to November 3rd. Today was the first valley but I feel there will be more to come. I also mentioned late last week (Have We Seen The Future: The European Solution… October 13th) that I had taken off some long exposure and right now I have no interest in revisiting my strategy. That was the right move and I further reduced my net long exposure early in today’s trading session.
I hope the Europeans continue to reset expectations but even if they do, it will only forestall the inevitable because I do not see shock and awe coming anytime soon. I remain cautious on the market overall and continue to see the Euro short as a compelling investment.