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Gary Smith’s Market Take

Here’s my take on the markets today, December 21st, 2012. If you’d like to read more of my articles, click here.

Credit gauges are deteriorating today. The FRA-OIS Spread is rising +1.5% to 21.05 bps(+18.5% in 5 days). The TED Spread is gaining +2.0% to 26.4 bps. The 2Y EUR Swap Spread is rising +2.0% to 38.6 bps. The North America Investment Grade CDS Index is jumping +4.8% to 92.95 bps. The European Investment Grade CDS Index is gaining +2.6% to 112.09 bps. The European Financial Sector CDS Index is rising +3.1% to 138.83 bps. The Germany sovereign cds is rising +1.7% to 40.4 bps. The Spain sovereign cds is rising +3.0% to 292.37 bps. The Italian/German 10Y Yld Spread is rising +3.0% to 309.56 bps. The China sovereign cds is rising +1.6% to 65.0 bps(+12.1% in 5 days). The Brazil sovereign cds is rising +4.7% to 108.15 bps. Overall, gauges are mostly maintaining their recent improvements, but remain at stressed levels.

Major Asian indices were lower overnight, led down by a -1.1% decline in India. Major European indices are lower, led down by a -.5% decline in Germany. The Bloomberg European Bank/Financial Services Index is falling -1.0%. Brazil is down -1.1%.

The euro is pulling back -.5%. Oil is down -1.5% and still trades poorly. Copper is rebounding +.9% today, but also trades poorly from an intermediate-term perspective, especially given all the perceived upside catalysts. The China benchmark Iron-Ore Spot Index is down -.07%. Gold is rising +.44% back to its 200-day, but still trades poorly. Lumber still trades well and is rising +2.8% to the highest level since Jan. 2006. The UBS-Bloomberg Ag Spot Index is gaining +.6%, but still trades poorly.

Last night, the MNI Flash China Business Sentiment Indicator for December fell to 52.23 from 53.78 in November. Nike(NKE) said sales in Greater China dropped -11.0%. Oil and copper, as mentioned above, still trade poorly and have historically been used as a gauge of Chinese demand. The China Containerized Freight Index continues to weaken. The Baltic Dry Index has plunged -35.9% in less than one month and is back near crash lows(-66.7% since 10/12/11). The China sovereign cds has been rising of late despite “better” economic data. The dispute with Japan shows no signs of easing. Moreover, the China Securities Journal ran a commentary last night saying that China will likely introduce new housing curbs after prices rebounded in Nov. and some regions saw “irrational exuberance.” I do not believe China’s overall economy is rebounding to the extent that most investors seem to believe despite another round of state-induced infrastructure spending that will only add to their overcapacity/bad loan problems over the intermediate-term. Notwithstanding all the bullish commentary and recent rebound, the Shanghai Comp is still one of the world’s worst-performers, down -2.1% ytd(-30.0% since 8/7/09).

Also, overnight Insee lowered their forecast for French gdp to -.2% during 4Q and said France won’t meet its target for .8% growth next year. I still think France will start to become a real problem for Europe as next year progresses and that French sovereign bonds offer some of the worst values in the world right now.

I have said for some time that the market’s discounting mechanism appears to be broken. Last night’s futures plunge on Boehner’s plan B vote debacle was just more evidence of this, in my opinion. Due mainly to the Fed’s reckless actions and the rise of algo/high-frequency trading, investors seem to almost always price in the most optimistic outcome to an event rather than the most likely one. Despite the market’s “reasonable” valuation, intermediate-term risks for investors are likely greater than perceived, as a result. I still believe a “small deal” or can kicking is the most likely outcome to the fiscal cliff crisis, which will still leave significant uncertainty for investors/consumers/business and likely lead to a US sovereign downgrade next year.

Gold & silver, defense and drug stocks are holding up relatively well today, while homebuilding, restaurant, coal, alt energy, oil service, steel, internet, disk drive and construction shares are under meaningful pressure. Due to the market’s technically extended state, excessive investor bullishness and next week’s likely thin trading I am sitting tight for now and I am positioned 25% net long.

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