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Gary Smith’s Market Take

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Here’s my take on the markets today, July 20, 2012. If you’d like to read more of my articles, click here.

Credit gauges are deteriorating meaningfully today. The FRA-OIS Spread is jumping +6.7% to 28.75 bps. The 3M EUR/USD Cross-Currency Basis Swap is falling -5.4% to -46.88 bps. The 2Y Swap Spread is gaining +4.6% to 24.2 bps. The European Investment Grade CDS Index is gaining +4.9% to 168.94 bps. The European Financial Sector CDS Index is rising +4.7% to 284.45. bps. The Germany sovereign cds is gaining +5.0% to 77.87 bps. The France sovereign cds rising +2.9% to 170.51 bps. The Italy sovereign cds is rising +4.1% to 525.50 bps(+6.1% in 5 days). The Spain sovereign cds is gaining +4.9% to 608.61 bps(+9.1% in 5 days). The Spain 10Y Yld is rising +3.8% to 7.27%(+9.3% in 5 days). The Italian/German 10Y Yld Spread is jumping +5.0% to 502.52 bps. The Spanish 10Y Yld is breaking out to a new record high and the Italian/German 10Y Yld Spread has broken free from its recent range and is only 52.0 bps from its all-time high set on Nov. 9th of last year. This is extremely concerning given the perceived recent can-kicking. Overall, credit gauges remain at stressed levels.

Major Asian indices were lower overnight, led down by a -1.4% decline in Japan. The Shanghai Property Stock Index fell another -1.0% and is down -6.8% in 5 days. Major European indices are sharply lower, led down by a -5.8% plunge in Spain. Spanish stocks are down -27.1% ytd as they approach their June 4th lows. As well, Italian shares are falling -4.4% and are now down -13.4% ytd. The Bloomberg European Bank/Financial Services Index is dropping -3.6% and is breaking back below its downward-sloping 50-day moving-average.

The euro is breaking to the lowest since June 2010 today and I still see substantial downside in the currency from current levels over the intermediate-term. The 10Y T-Note continues to trade too well, which remains another large red flag, as the yield is falling -5 bps to 1.46%. Copper is falling -2.3% today after getting turned away again at its 200-day. It remains in an intermediate-term downtrend. The China benchmark Iron/Ore Spot Price Index is falling another -.5% today as it picks up downside steam again and has plunged -30.9% since Sept. 7th of last year. The UBS-Bloomberg Ag Spot Index is rising another +.8% today despite its recent sharp gains, US dollar strength and equity weakness. This index is now up +28.5% in less than 2 months as it now sits just -2.5% below its Aug. 31 all-time high which sparked riots in emerging markets.

There appears to be a fairly high level of complacency among US investors regarding the still deteriorating macro backdrop, in my opinion. Moreover, three of the main reasons US stocks had been rallying were the beliefs that QE3 was imminent, China would embark on another massive easing campaign and Europe had successfully kicked the can once again. However, soaring food prices/rising energy costs make QE3 much less likely, in my opinion, as the Fed would not want to risk getting blamed for partly spurring global social unrest and a gasoline price spike before the election, in my opinion. Recent comments by Chinese officials suggest a more subdued approach to easing and an unwillingness to let their real estate bubble begin re-inflating. Soaring food prices also put a large dent in emerging markets easing plans. Finally, the surge in Spanish yields to records and breakouts in other European debt angst gauges suggests the recent European debt crisis can-kicking may have already run its course. I added to my index trading hedges this morning and I am positioned 25% net long.

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Gary D. Smith

Gary D. Smith

Gary Douglas Smith actively trades his portfolio as well as the portfolios of family members. In addition, Mr. Smith maintains Between the Hedges, an investment-oriented blog. Previously, he was founder and managing member of Olympus Capital Management, an alternative investment firm. Olympus consisted of a long/short diversified hedge fund and a long/short technology sector hedge fund. Prior to the formation of Olympus, he spent five years as Vice-President of Research and Portfolio Manager for an independent money management firm. Mr. Smith has been engaged for the past 23 years in the analysis and selection of equity and other investments. His expertise is in long/short U.S. equity investing across all market sectors with an emphasis on technology stocks. He uses a top-down investment approach, investing in securities at a reasonable price relative to their growth prospects. As well, technical analysis plays a role in the timing of his investment decisions. He received his undergraduate degree from the University of Tennessee and subsequently received an MBA, with a concentration in finance, from Vanderbilt University’s Owen School.
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