The Pain in Spain is Unlikely to Stay on the Plain

 

“There are only two mistakes one can make along the road to truth; not going all the way, and not starting.” – Buddha

 

You may forgive Wall Street if it is acting a bit giddy as of late. It has just come off one of its best first quarters in over ten years, and after the wild ride of 2011, who can blame it for a round or two of light-headed celebration?

The numbers are, on the face of it, admittedly pretty impressive.

The Dow Jones Industrial Average (DJIA) swung upwards to the tune of 8.1% for the first three months of 2012, which, at least in terms of total points gained for a Q1 period, placed it at the very top of the heap. Not too shabby, when you consider that the Dow’s history encompasses a timeline of roughly 128 years.

As for the S&P 500 Index (SPX), it ended Q1 up 12% through the end of March, a first-quarter performance not seen by the benchmark index since the heady days of the dot.com era, a good 14 years back. The most stunning performance of the quarter by a far margin, however, was the Nasdaq Composite Index (COMP), which gained 18% over the same time period. Apple’s otherworldly 40% gain over the course of the first three months of the year certainly served as the fuel that blasted the Nasdaq into the stratosphere, though the tech heavy index certainly had a lot of room to move up, having been something of a laggard during the current Bull Run that stretches back to ’09.

As for the Dow, 13,000 seems to be the developing as the latest testing ground for the Blue-Chip index’s next potential leg up, and that psychologically important horizon may e eventually serve as a textbook example, in terms of technical analysis, of a level that segues from critical resistance into crucial support.

Which side of the line the Dow ends up spending the majority of its time on in the immediate future will depend on the same two factors that have served as the primary influence on the equity markets for the last year: the domestic economy and the Eurozone.

If it’s true that a reasonably accurate take on the U.S. economy is reflected in the health of its corporations, then the next wave of earnings reports for Q1 2012, officially beginning with the “first pitch” tossed out by Alcoa (AA) next week, should affect the mercury in the barometer in fairly short order. If a positive trend emerges in the overall earnings arena, then the Bulls can downshift, regain traction, and resume the current year’s momentum.

A strong round of earnings reports may also be what it takes to coerce all those bystanders on the sidelines, holding cash positions and harboring doubts of the equity market, to start buying stocks and boost the relatively anemic volume that has been one of the hallmarks of Wall Street so far this year.

As for the Eurozone, anyone who has bought into the notion that the structural problems of that monetary union have been addressed with the Europe Central Bank’s own version of quantitative easing, introduced through the vehicles of LTRO 1 & 2, may be somewhat surprised when the next round of serious problems breaks out among the PIIGS (Portugal, Ireland, Italy, Spain and Greece) in 2012.

Oh, perhaps you are subscribing to the notion that all is well on the Continent? You might want to recalibrate your objectivity meter.

There should be serious doubts remaining that the deeper sovereign debt issues of the region have really been put to bed. As Exhibit A, you need not look much further than out to the Plains of Spain, where it just might be possible for one to notice that a slow moving train wreck may be well in the works.

Spain’s government had agreed just last month to the demands of the European Commission, which insisted that the country with the fifth largest economy in the European Union (EU) cut back on its 2012 deficit by a staggering 3.2% of GDP. Considering the fact that the Spanish economy is estimated to shrink by close to 2% this year, an \indicator of recession by just about any measure, and that the Mediterranean country has the highest rate of unemployment in the EU, it is hard not to figure out that additional austerity measures may
not be wildly popular with the locals.

Recent national strikes have been called in response to the belt tightening, and, with almost half of those who are 25 and under currently unemployed, it is not a stretch to anticipate some level of social mischief to manifest in response to the deteriorating economic
situation.

Needless to say, Wall Street will get understandably skittish at the site of a staggering PIIG(S).

Spain’s citizens may yet choose to vote out the current deficit-cutting leaders at first opportunity, and vote in a group of more growth-friendly politicians. Eventually, Spain may opt out of a union that, at the moment, hardly seems to be following through on the promise that was hoped for when it first opted into the EU.

As for the level of pain Spain can entertain before spreading out to the broader region? Hard to say, but you can bet that, if the song of more austerity at the cost of growth remains the same, the Dow 13,000 line will assume the role of a sturdy level of resistance.

What the Periscope Sees

If you are of the mind that the calm over the Eurozone is the one before the storm, there are a number of ETFs that you can play to the short side in anticipation of a drop in the market. These include VGK (MSCI European ETF), IEV (iShares S&P 500 Europe 350 Index Fund) and, for those who want to go for a more laser focus, EWP (iShares MSCI Spain
Index Fund).

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 Daniel Sckolnik and/or Sabrient. Neither Daniel Sckolnik nor Sabrient makes any 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.