The return of 'tail risk'
After a quiet summer, Wall Street is barraged with fresh geopolitical woes and new economic worries.
Beleaguered traders enjoyed their first quiet August since 2009 this year as volatility and volume dropped off, thanks to a cooling of the eurozone crisis and soothing reassurances of fresh central bank stimulus. But that's all ended now as the economy stalls, Spain stumbles and geopolitical hotspots in Asia and the Middle East flare.
The risk that something unexpected and very bad -- what statisticians dub "tail risk" since they are unlikely events far out on a standard distribution bell curve -- is rising. That's making Wall Street uncomfortable, resulting in tangible signs of caution including a weakening of cyclical, economically sensitive stocks, a strengthening in "safe haven" assets like the dollar and Treasury bonds, and a drop in market breadth as buyers find fewer and fewer issues interesting at these prices.
Will the malaise continue?
It certainly seems that way.
Europe is quickly sliding from bad to worse. Citizens in Spain and Greece are protesting new proposed austerity measures as their elected officials fight against resistance to new support measures from the AAA-rated "core" eurozone countries of Germany, Finland and the Netherlands. Whatever political unity there was in Europe after the contested Greek election and the adoption of the German-led fiscal pact (limiting budget deficits) has faded.
Now, there is bickering and backsliding over the €100 billion Spanish bank bailout (Germany wants Madrid to be on the hook for any liabilities), conditions attached to the use of the new European Central Bank bond buying program (Italian prime minister Monti said there should be "no further conditions" and that the International Monetary Fund shouldn't be involved in an oversight role), plans for a eurozone-wide bank regulation and recaplitazation scheme, and what, if any, additional debt writedowns are given to Greece.
There is also the not-so-insignificant problem of troubled countries like Spain and Italy ponying up their share of the eurozone's new bailout fund -- monies that will likely eventually be used to bring down their borrowing costs as part of a formal bailout agreement -- at a time when Spain is being forced to tap into pensions and raid retirement savings to address "liquidity issues."
Essentially, the country is running out of both cash and time. Alberto Gallo at RBS estimates that Spain needs $172 billion to support its faltering banks -- choking on bad mortgage loans -- over the next three years. Yet protests are gripping the country as it forces through another $51 billion worth of budget austerity measures on top of the $80 billion squeeze already coming.
We also have saber rattling in the Middle East (Iran vs. Israel) and in Asia (Japan vs. China vs. Taiwan). And here at home, the economy has hit a wall. The final, third reading of the second-quarter GDP was unexpectedly weaker while the August durable goods order posted its steepest monthly decline since January 2009. You can see the extent of the decline in the chart above.
Along with all these political risks, we also have a weakening technical market picture with breadth coming in, cyclical economically-sensitive issues suffering, commodities under fire, and a euro that seems to be embarking on a new medium-term pullback -- something that will weigh on the entire "risk on" complex of stocks, risky bonds, commodities, and precious metals.
For now, I recommend we continue to hold a large allocation of cash mixed with targeted short positions and a little income-focused defensive long exposure.
One of the new short holdings I've recommended to my newsletter subscribers, Nike (NKE), is working well thanks to a worrisome earnings report featuring unhappy results out of Europe and Asia for the athletics and footwear giant. A fall in new orders in China, rising input costs, and inventory accumulation have combined to send shares down out of a multi-month bear flag pattern. Not a good sign.
Disclosure: Anthony has recommend NKE short to his newsletter subscribers.
I found NKE with the help of technical screens developed with Fidelity's Wealth Lab Pro back-testing tools, which you can find here. (Fidelity sponsors the Investor Pro section on MSN Money.)
Check out Anthony's investment advisory service The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up. Contact Anthony at email@example.com and follow him on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
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Another article about Europe?
Let's talk about trucks. I like trucks!
excellent article Anthony, with one exception? in a risk-off environment that is likely to last at least 3-12 months, why would you suggest a large cash position in a no-return holding. putting ones spare cash under the mattress is rarely a good idea in today's world of quick in-out etf's.
imho, a better alternative would be a diversified "holding position" to include a solid intermediate bond fund, a solid foreign bond fund, TIPS, some energy MLP exposure, and a high-yield fund. the yield should offset any short-mid fmv downturn.
just sayin' .... money that sleeps is not good stewardship ...
A friend of mine got in on IRE when he recommended it to his newsletter subscribers and pulled out when advised there. He made money overall on the transaction.
I waited 3 days after his recommendation on this message board and pulled out a couple of days ago. I lost money on the transaction. So, unfortunately, it is all about timing. When you see his recommendations here, they have already been to his subscribers for a few days. You get what you pay for (at best)...
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