Hope, Pray, Reality

Author: TG Asset Management LLC

Covestor portfolios: Tactical All Asset and Tactical Growth

All our strategy factors remain bearish, despite the recent optimism and hope for an end to the Eurozone crisis. With no solution for growing the economy faster, Italian debt will ultimately be the epicenter when the meltdown of Eurozone banks collapses the union. No fiscal policy by any country can get Italy out the death vortex it is caught in. Protection of assets is paramount currently. An allocation of 65% to the U.S. Dollar and 35% Long-Term Treasuries is preferable.

Long-Term Stock Pattern (3-5 yrs) – Bearish, Lower stock returns ahead

Intermediate-Term Stock Trend (1 year) – Bearish, Lower stock prices ahead

Short-Term Stock Volatility (30 days) – Bearish, Lower stock prices ahead

Inflation

Developed Economies – At or Above Target (except Japan)

Emerging Economies – Above Target

CURRENT ASSET ALLOCATION OBJECTIVE – PROTECTION

Fundamental, Technical, Trend, & Volatility Indicators

Fundamentally, the S&P 500 is trading at a 20.82 P/E (Shilller approach) as of November 30, a 30% premium over the long-term average of 16. Lower than average returns on stocks over the next 5-10 years are therefore expected.

Strategy Indicators

PATTERN: BEARISH; Each upward retracement since the May 2 high has been deep, with the current one conforming to this pattern. Once the upward momentum created by the most recent rally dissipates and peters out, stocks will continue their long-term pattern to the downside.

TREND: BEARISH; The S&P 500 came within just 18 points or 1.5% of its 200 day month moving average on November 30th. A break above it would turn this factor bullish.

VOLATILITY: BEARISH; The S&P 500 VIX “fear index” closed at 27.8 on November 30th, just 7% below the October 31 reading. A drop into the mid teens would be needed to turn this factor bullish.

Precious Metals

The differing paths that Gold and Silver are taking remain the dominant feature of the precious metals market. Both metals have been rising in conjunction with the stock market. If stocks are near the end of their upward surge, gold and silver should also be near the top end of their respective bounces. Gold has retraced 62% of the decline from the November 8 high basis spot prices ($1803.29). A break of $1672 would announce the onset of a significant decline, one that should eventually draw prices toward the area surrounding $1300.

Silver continues to lag noticeably. Here, a decline beneath $30.65 should result in a large increase in selling pressure. Silver’s next downside target range remains $19.50- $21.40, basis spot.

Hope, Pray, Reality

Stocks are being driven day to day by hope and reality.

Hope was one day in late November reflected in a manic 500 point rally based on the hope that the “coordinated action” liquidity pump of central bankers from developed economies, taken as a new sign that our prayers have come true that our central banks are finally going to fix the Euro Zone Crisis.

As we have seen in the past, that hope eventually gives way to fear. The harsh reality is that in the past, the subsequent stock rally from central banks pumping liquidity into the system eventually gave way to the reality that the underlying problem still exists.  In 2008 the major players in the system such as Lehman were broke and nothing short of the biggest of all backstops could prevent a global market meltdown.  See this chart for a visual DejaVu (doo):

Now the pigeons are coming home to roost and the crisis is now on a much greater scale, with the major players being Euro Zone banks and governments with the epicenter being Italy. The harsh reality for Euro Zone governments is well illustrated by the following chart:

The bottom line as the Reinhart & Rogoff research has shown is a 90% Debt/GDP ratio has in the past been a critical threshold for governments who are caught in the policy spiral of too much debt and too little growth. Italy’s Debt/GDP ratio is well beyond 90% and austerity is proving in other countries such as the U.K. that cutting back on spending doesn’t help grow  the economy is just slows it down. So unless the world is now planning on visiting the Pope for holiday every year until Italy can meet their yearly obligations while paying down their debt then the reality the developed is facing today will not go away no matter how much we hope and pray.

Strategy

The GDP component of the all-important Debt/GDP ratio for Italy is at 1%. With Debt/GDP ratio over 90% it’s only a matter of time before the country goes broke. The latest policy idea out of the Euro Zone is to coordinate fiscal responsibility. This does not change the situation in Italy which has debt growing faster than the economy. No fiscal policy or coordinated monetary policy can make this debt go away – only a write down will. If the market forces a write down then 2008 will be repeated and stock market losses will be well beyond the 53% loss taken between October of 2007 and March 2009. Maximum protection of assets is necessary as this crisis continues to unfold. Therefore a 65% allocation to the U.S. dollar and 35% to long-term 20 year treasuries is prudent.