Is the Eurozone Waving a Red Flag at the Bull Rally?

 

Do the difficult things while they are easy and do the great things while they are small. A journey of a thousand miles must begin with a single step.”  – Lao Tzu

 

Wall Street has been traveling in a tight line this past week, a classic tightrope walk between greed and fear. Investors seem unwilling to take profits off the table resulting from the year’s uptrend, not wishing to miss any of current Bull Run, but also appear reluctant to allocate more cash towards equities, at least for the moment.

So is what we are seeing now merely investors acclimating themselves to the thin air of the lofty altitude in which both the Dow Jones Industrial Average (DJIA) and S&P 500 Index (SPX) find themselves floating? Or is it merely the moment that precedes a collective corrective nosedive?

As per usual, arguments can be made for both sides of this coin.

From the technical POV, the Dow may have a tough time cracking the 14,000 mark, as evidenced by the handful of both daily and intraday probes into that realm over the last couple of weeks. On the other hand, and of equal importance from a psychological perspective, the SPX appears to be getting comfortable with 1,500 as a support level.

But these levels are tenuous, of course, ready to be left behind either to the upside or downside in any given moment of shifting investor sentiment.

The CBOE Volatility Index, aka “the fear gauge,” hovered around its lows for the year, ending the week at 12.46. Of some significance is the fact that, on Friday, it also hit its intraday low for the year, a level that hasn’t been seen with any degree of regularity since 2007.

The consistently low VIX should be regarded with a certain degree of wariness. At the very least, it should serve as an alert for contrarians, who may not be convinced that these levels of market volatility accurately reflect the risk that remains out there, such as the current concerns around global currency wars and the potential impact of more Washington shenanigans, this time centered around the budget cuts that would result from an implementation of the sequester.

There is, certainly, a justifiable amount of skepticism as to the likelihood of the actual implementation of the sequester. After all, haven’t we just seen a similar movie play out just last month, titled “The Fiscal Cliff,” with months of huff-and-puff and the accompanying market angst ending with just enough of a compromise to allay the fears of all concerned and currently playing out amidst a sweet five-week uptrend?

But this time, the budget cuts could go into effect, and if they do the domestic economy could down-spiral back into recession, at least based on the projections of the Congressional Budget Office. It’s worth noting that not all the cuts would happen at once, but the psychological impact on the market might result in investors acting as if they do.

Whether or not the “sequester effect” hits Wall Street next month, there may be another issue lurking on the macroeconomic plane with the potential for derailing the current rally. That is the rather familiar face of the Eurozone sovereign debt crisis.

The Eurozone region, on relatively good behavior in terms of negative market impact over the last four months, may be reemerging as a bump on the bullish road, though perhaps still a bit down towards the horizon line.

The euro has been on a three-week skid, capped off with last Friday’s lowest level since late January. This reflects the reemergence of investor concerns about the health of the region in general, in this case predicated on projections of shrinking 2012 Q4 growth, most prominently for France and Germany. The region’s 0.6% drop was higher than economists’ projections and should, rightfully, raise the red flag that the austerity measures firmly in place in the region for the last several years may not be having the hoped for effect of growing the region’s economy.

One of the reasons that this could quickly develop into a negative issue is that many of the Eurozone countries will be holding key elections this year, and many of the current leaders, who have served as cheerleaders for the “cuts-at-all-costs” approach, may find themselves out of a job.

The subsequent uncertainty that would arise from a slew of new stimulus-oriented politicians having their grip on the Eurozone’s purse strings could easily upset any uptrend that the equity markets on both sides of the Atlantic may be enjoying.

In the meantime, ride the bull if you choose, but place a few well-stuffed cushions on your seat, in the form of a smart hedge or two, as you ride.

What the Periscope Sees

The Technology Sector remains atop the Sabrient SectorCast ETF Rankings leaderboard, but this week we’ll take a gander at the Financial Sector, which came in at #2. The Rankings rate each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score and are revised on a weekly basis.

Here, then, is a list of some of the year’s top performing Financial Sector ETFs year-to-date, as of the second week of February:

PSP — PowerShares Global Listed Private Equity Portfolio, +10.57%

KBE — SPDR KBW Bank ETF, + 10.03%

KRE — SPDR KBW Regional Banking ETF, +9.69%

IYG — iShares Dow Jones US Financial Services Index Fund, +9.09%

XLF —  Financial Select Sector SPDR Fund, +8.36%

For those who prefer to use options when available, consider buying call options as an effective tool for leveraging your portfolio’s funds. May expiration calls, two or three strikes out-of-the-money, are worth considering for the job.

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.

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