Investors Flock To Small Cap US Value Stocks As The Euro Falls Lower

Financial Market Report for December 20, 1010 by theyenguy

I … Small cap shares rose to a new high; but this was not confirmed in the S&P, suggesting that the S&P has topped out.
Small Cap Revenue Shares RWJ rose 0.7%. Small Cap Revenues Shares rising included Community Bank Sys, CBU, Synnex, SNX

The Russell 2000, IWM, rose 0.4% manifesting three white soldiers, a reversal signal, to close at 78.48.

Homebuilders, ITB, rose 2.74%

Real Estate, IYR, rose 1.1%.

Environmental Services, EVX, rose 1.3%

Biotechnology, PBE, rose parabolically 0.7% and formed a lollipop hanging man candlestick.

Nasdaq Community Banks, QABA, rose 0.95%.

The ratio of the financial shares relative to the S&P, XLF:SPY, fell lower suggesting that both will be falling immediately lower.

The Value Growth Yield Curve, RZV:RZG, steepened as small cap value shares rose more than the small cap growth shares. The strong rise in the value-growth yield curve documents the demand for small cap value shares over the growth shares, and documents how investors are seeking a safe haven, if it be called that, in US based bank and revenue shares. It is also a measure of tension in carry trades, that is to say that carry trades are greatly wound up; when these release there will be a terrific deleveraging and fall in asset value of the small cap shares.

The small cap value shares, RZV, rose 1.2% manifested three white soldiers, suggesting that a sharp stock market reversal is at hand.   

Small Cap Value Shares rising included Delta Financial Group, DFG, and Options Express, OXPS.

The leverage S&P, BXUB, rose to a new high.

Telecom, IYZ, rose to a new high.

Small Cap Energy Shares, XLES, rose to a new high.

The S&P, SPY, closed up at 124.60 but short of its recent 12-16-2010 high of 124.82.

Comstock Partners: The Market Is Overbought, Overextended And Overvalued: After an 86 percent gain in 21 months the market looks overbought, overextended and overvalued.

Fallers of the day included, Wind Energy, FAN, 1.5%, South Korea Small Caps, SKOR, 1.2%, and Nasdaq Clean Energy, ICLN, 0.9%.   Andrea Wong and Saeromi Shin Bloomberg reports: Korean securities slump on bank levy, conflict risk

II … Commodities
Asjylyn Loder of Bloomberg: Hedge Fund Bullish Gas Bets Collide With Dropping Prices: Energy Markets. Hedge funds raised bullish bets on natural gas to a four-month high just as weather warmed, pushing heating fuel to its biggest weekly decline since August. The funds and other large speculators increased net-long positions, or wagers on rising prices, by 7 percent in the seven days ended Dec. 14 to the highest level since August, according to the Commodity Futures Trading Commission’s weekly Commitments of Traders report. While forecasts for cold weather in the eastern and central U.S. and dropping stockpiles drove futures up 4.9 percent to $4.606 per million British thermal units on Dec. 8, the outlook changed, causing prices to fall 8 percent for the week. Natural gas may fall again this week as warmer weather limits demand, a Bloomberg News survey showed Dec. 17. Chart shows natural gas prices, UNG, recovered 3.9% today.

Commodities, DBC, rose to a new rally high, on rising food commodity, FUD, grain, GRU, oil, USO, base metal, DBB, and precious metal, JJP prices.

III … Carry Trades
Matthew Brown of Bloomberg: Aussie Leads ‘Extreme’ Currencies Deutsche Says Avoid. In the last two years there has been no better place for foreign-exchange investors than in nations whose economies are tied to commodities. Now the rally has left those currencies at least 9.5 percent overvalued based on the relative costs of goods and services as measured by the Organization for Economic Cooperation and Development.

The AUD/JPY seen in chart of FXA:FXY shows pent up carry trade investment.

The iPath Optimized Carry ETN, ICI, rose to close at 46.87, that is above its past December 13, 2010 high presenting tension that will likely be released with a massive and sudden fall lower in stocks.

IV. … European Shares had a sympathy rally with the small cap shares

European Shares, VGK, rose 0.2%

The European Value Shares, Repsol, REP, Austria, EWO, Spain, EWP, Italy, and Banco Santander, STD. rose.

The European Growth company, Siemens, SI, rose to a new high of 124.05; but Europe’s growth shares, Germany, EWG, fell.

V … The Euro
The Euro, FXE, fell lower to 130.73

VI … The European Financial Institutions, EUFN
Germany’s Deutsche Bank, DB, has lost a significant amount of value since August 9, 2010 and November 4, 2010.

The chart of the European Financials, EUFN, shows that they reside on the edge of a massive head and shoulders pattern and that they entered an Elliott Wave 3 Down on December 14, 2010, that is immediately before the Leaders Summit, of which John Mauldin remarked they “kicked the can down the road”, as reported below. Gary of Between The Hedges reports the Euro Financial Sector CDS Index is soaring to the highest level since late June and the Western Europe Sovereign CDS Index is very near its record high set last month.

EuroIntelligence: The Crisis Is Back Already Eurozone bond spreads have shot up since the European Council on Friday, due to Moody’s downgrade, and disenchantment with the eurozone’s political leadership; Spanish and Portuguese spreads are up by 50 basis points, Irish spreads by 70 basis point; the euro tanked against the dollar; another factor has been the IMF’s assessment of Ireland, in which it expresses doubts about the country’s solvency;

Frankfurter Allgemeine, which also prominently carried this story this morning, said German banks have the highest credit risks in Ireland. The exposure of German banks was €113bn, while the largest exposure to Ireland in terms of the bank’s host country’s GDP came from Belgium.

In an interview with Die Welt, Andrew Bosomworth of Pimco says the euro crisis is far from over, however much Europe’s political leaders may celebrate their agreement. He predicts further financial tensions in 2011. He said the idea behind the crisis mechanism was solid, but it starts far to late.  He says investors have lost confidence in Ireland and other peripheral states, and the short-term financial packages are not a solution. So they are selling the  bonds, pushing up interest rates, not only for the periphery, but also for Spain and Italy. This tension will remain for as long as there is no evidence of a resumption of economic growth. He says the denial of solvency problems is at the heart of this crisis. Delaying the solution until 2013 is not the answer. The EU should recognise that Greece, Ireland and Portugal will not get back on their feet without a currency of their own, or without transfer payments.

The editor-in-chief of La Tribune, Philippe Mabille, argues that the eurozone is in danger of disintegration for as long as interest rates in the periphery are as high. Yet, no matter how bad the situation may be, it makes no sense for countries to leave. The only way of this dilemma is political union – including a single bond, and a single budget.

John Mauldin writes in Business Insider Hooray! Europe Just Kicked The Can Down The Road  The PIIGS collectively owe over $2 trillion to European and US banks. German, French, British, Dutch, and Spanish banks are owed some $1.5 trillion of that by Portugal, Ireland, Spain, and Greece by the end of June, 2010. That figure is down some $400 billion so far this year, which means that the ECB is taking on that debt, helping banks push it off their balance sheets.

Robert Lenzner notes something very interesting about the latest BIS report, out this week:

“What’s curious, though, is that for the first time the BIS has broken out a new debt category termed ‘other exposures’, which it defines as ‘other exposures consist of the positive market value of derivative contracts, guarantees extended and credit commitments.’ These ‘other exposures’ – quite clearly meant to be abstruse – amount to $668 billion of the $2 trillion in loans to the PIIGS. “So, bank analysts everywhere; you now have to cope with evaluating derivative contracts that could expose lenders to losses on sovereign debt. Be on notice!”

What did I write just last week? That it is derivative exposure to European banks that is a very major concern for the world and the US in particular. It is not just a European problem

A collapse of a major European bank could trigger all sorts of counterparty mayhem in the US banking system, at least among our major investment banks. And then people would want to know which bank was next. This is yet another reason why the recent financial-system reform was not real reform.

We still have investment banks committing bank capital to derivatives trading overseen by regulators who don’t really understand the risk. Who knew that AIG was a counterparty risk until it was? Lehman was solid only a month before until it evaporated. On paper, I am sure that every one of our banks is solid – good as gold – because they have their risks balanced with counterparties all over the globe and they have their models to show why you should go back to sleep.

At first, the political types came up with the stabilization pact in conjunction with the IMF. But this was never a real solution, other than for the immediate case of Greece … and then Ireland. It has some real problems associated with it. It could deal with Portugal but is clearly not large enough for Spain. It is worth nothing that the political leaders of both the latter countries have loudly denied they need any help. Hmm. I seem to remember the same vows just the week before Ireland decided to take the money.

One of my favorite writers, Michael Pettis penned this note: “Its official – Spain and Portugal will need to be bailed out soon. How do I know? In one of my favorite TV shows, Yes Minister, the all-knowing civil servant Sir Humphrey explains to cabinet minister Jim Hacker that you can never be certain that something will happen until the government denies it.”

VII … Austerity cuts come to America’s poor
Laura Bassett of the Huffington Post: Federal Government Cuts Off Recession Relief Money To States Despite soaring unemployment and the 19 million Americans currently living in “deep poverty,” federal funds for the Temporary Assistance For Needy Families (TANF) program have entirely dried up for the first time since 1996, leaving states with an average of 15 percent less federal funding for the coming year to help an ever-increasing number of needy families.

TANF, the federal program that replaced welfare under the Clinton Administration, provides a lifeline for families and workers who have exhausted all of their unemployment benefits. According to a new report by the Center for Budget and Policy Priorities, “more homeless families will go without shelter, fewer low-wage workers will receive help with child care expenses, and fewer families involved with the child welfare system will receive preventive services” now that Congress has passed legislation that will end funding for the TANF Contingency Fund in 2011.

Congress also failed to reauthorize an emergency fund for a subsidized job program on September 30 that would have allowed states to provide emergency help to needy families and place low-income people in subsidized jobs.

In fiscal year 2011, every state except Wyoming will experience up to a 20 percent reduction in recession relief funds. The CBPP reports that many states have already drastically reduced their subsidized job programs after being cut off from federal funding, costing tens of thousands of people their jobs. Some states are also considering substantial cuts to programs for low-income families with children, including child care subsidies for working parents and programs that address substance abuse, caring for a disabled child, and other challenges.

“This is not what Congress intended when it reformed the welfare system in 1996,” said Liz Schott, Senior Fellow at CBPP. “Helping welfare recipients find work in this economy requires more help from the federal government, not less.”

VIII… Summary

Tyler Durden in article, US To End 2010 With $13.9 Trillion In Debt, Total Debt Incurred Since Great Financial Crash: $4.4 Trillion, says “This is in essence the cost to US taxpayers to keep the financial system solvent, as the US has become the biggest marginal leveraging actor in the world.”

There is a limit on all things, such debt leverage cannot be maintained.

The stimulus given to the small cap US companies, that is the Russell 2000, traded by the ETF IWM, appears to have maxed out as it rose 0.4% manifesting three white soldiers, a reversal signal, to close at 78.48.

The global investment bubble was likely pricked December 16, 2010, when the European Leaders, as John Mauldin said, kicked the can down the road, having failed to provide a comprehensive solution to the European Sovereign Debt and Bank Debt Crisis.

Debt deflation is the contraction and crisis that follows credit expansion.  One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

Global Debt Deflation commenced on April 26, 2010, when the value shares failed to outperform the growth shares with the onset of the European Sovereign Debt Crisis. Now with the European Leaders having failed to provide a comprehensive solution to the sovereign crisis, we have likely entered into the age of deleveraging. I expect debt deflation to get underway soon, with the small cap value shares, RZV, falling very rapidly in value, marking a new and dramatic bout of Global Debt Deflation.

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