Unless you’ve been living under a rock for most of 2011, it’s been hard to escape the European debt crisis that’s ravaging the U.S. stock market. Of course, if you’ve been living under a rock this year, your portfolio may be better off than most investors.

Today, I want to break down the European debt crisis into more manageable pieces, and show you why you should turn off the financial news for the rest of the year…

Like the rest of the developed world economies, European nations have been enjoying a spending spree for a long time, building a massive debt load. Unlike the rest of the developed world economies, Europe’s financial system is tied together with the euro — an important distinction. So while PIIGS countries such as Greece, Portugal, and Spain could leverage the strength of the eurozone to get ahold of mountains of debt, they can’t print money to solve the problem. At least not by themselves.

So while the debt fountain was flowing freely for the last decade, servicing that debt was no big deal; Greece could just take out a new credit card to pay off its latest credit card bill. When the financial crisis hit Europe, though, borrowing became a lot more difficult…

The word contagion has been a popular buzzword throughout the European debt crisis. It’s the idea that the connected nature of the eurozone could cause a financial crisis to spread from the weaker PIIGS countries to the more stable economies of Germany and France. To prevent that sort of a scenario, European countries adopted a Stability and Growth Pact, which restricted member countries’ budget deficits and debt-to-GDP levels. In the real world, the pact has proven unenforceable, and eurozone debt has rocketed as a result.

Apparently, lawmakers’ grasps on reality aren’t any better across the pond…

Today, contagion is a serious concern. While Greece is relatively small potatoes for the eurozone, the prospect of bailing out Italy (Europe’s third-largest economy) would be a different story. The complicated nature of the crisis is exactly why we’re stuck in uncertain territory this month. The jury is still out on the best way to handle the problems in Europe.

Meanwhile, U.S. stocks have been getting shellacked consistently as the impact of the drama in Europe trickles down to U.S. investors. You see, the eurozone is our biggest trading partner, and countless U.S. companies earn euros for their operations overseas. Some prominent analysts have even suggested that the impact of the euro on U.S. stocks is the reason for the high correlations that have existed in the market for the last year.

Frankly, there’s no escaping the fallout from Europe’s debt debacle. Reading most mainstream financial media, you’d think that the fate of Europe was being decided from one day to the next — and that the market was swinging wildly in reaction. Too many investors are “buying” the most recent resolution in the eurozone and “selling” the most recent misstep.

Today’s a perfect example: As I write, stocks are down nearly 2% on worries that Europe is headed for another credit crunch. Headline risk remains too high right now, and investors who try to trade around Europe are bound to get caught up in it all.

Instead, I’d suggest turning off the financial news for the rest of the year. Ignore the headlines, and instead, focus on price action that’s taking place in the broad market. From a technical standpoint, stocks still look reasonably bullish — a low risk-buying opportunity for the S&P 500 comes on a push above 1,292.

Sincerely,

Jonas Elmerraji
for The Penny Sleuth

The Problem With Europe was originally featured in the Penny Sleuth.

For the first time since the August correction, small stocks are leading the household names. Over the past four weeks, the Russell 2000 is up more than 9.3%, while the S&P 500 has risen 8.2%. It’s not a massive difference, especially considering how impressive overall performance has been this month. But it does show the market’s willingness to once again add riskier names on the long side — a marked improvement compared to the August sell off.

However, stocks aren’t out of the woods just yet…

Over the next several weeks, the markets will need to prove to investors that October’s rally is for real. In order for an end-of-year rally to stay intact, the stock market will need to answer three important questions.

Can the market survive more European sovereign debt squabbling? If summit talks break down again this week, will U.S. markets continue to rise? These are questions geared more toward investor sentiment — as in, will investors buy stocks in spite of negative events? For several weeks, I’ve been writing that we will need to see the markets rally against the headlines. So far, we’ve seen some evidence of fatigue toward downside action. Now, we will have to see if positive momentum can continue after such a sharp rally off the lows.

Will earnings become a market driver? As of Friday, less than 20% of S&P companies had reported earnings. Of these, approximately 67% have beaten estimates. These are solid numbers, especially when you consider that the majority of the financial media has determined the economy to be on the brink of recession.

Despite solid preliminary numbers, the market has also chewed up several momentum darlings. Former Street favorites Netflix and Green Mountain Coffee Roasters have both been completely gutted during the October rally. Adding to the carnage this morning, Amazon gapped down 10% after predicting a potential fourth quarter loss. Other popular stocks will need to throw out solid third quarter numbers. If not, investors might have little reason to buy this rally.

Will stocks attack important resistance zones? The major indexes remain below their 200-day moving averages. Will this longer-term moving average become strong resistance? Or will stocks easily break these important barriers and resume their previous uptrends?

The S&P 500 is edging closer to its 200-day moving average (red line/red dotted line) every week. If it breaks above this mark, stocks will be back to where they were before the August correction began in earnest.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 Rally-Killing Questions? was originally featured in the Penny Sleuth.

However, the “sell in May and go away” mantra didn’t gain popularity for no apparent reason. For reasons unknown, markets tend to perform better November through April — and they tend to fade during the summer months. Notice that I said “tend to perform better.” This is not a concrete rule. It’s merely an observation that tends to be right just enough to carry some meaning amongst market watchers.

See for yourself:

Above is a weekly chart of the NASDAQ in 2010. If you sold your positions in May and bought them back in October, you would have easily outperformed the buy-and-hold crowd. But what about the year before?

Oops… If you had sold your NASDAQ holdings in May 2009, you would have missed out on a furious rally. As you can see, the adage is not set in stone.

All rhyming aside, I do believe these next two and a half weeks will be critical for the market. Earnings season kicks off this week, giving us a decent barometer with which to measure investor sentiment. The numbers themselves don’t tell the story as much as Wall Street’s reaction. If the market is able to shrug off mediocre numbers and find higher ground, we could very well see a test of February’s highs.

However, if the Street is unable to rally on strong earnings, it could be a hint that a more substantial correction is imminent. If the market fails to show us a positive reaction as earnings season unfolds, it just might be time to sell in May…

Sincerely,
Greg Guenthner
Penny Sleuth

April 13, 2011

Should You Follow This Strange Wall Street Saying? was originally featured in the Penny Sleuth.

– John Kenneth Galbraith

The year of the American Contagion, the year of chickens coming home to roost, the year of the bailout, 2008, went into history as a momentous time of tumultuous market moves in: stocks, commodities, currencies, and interest rates.  The year witnessed the onset of a worldwide economic panic with an assault on the global economic system and our form of democracy.  The forces of deflation and inflation continue to slug it out in a titanic struggle for dominance.  We’ve managed to navigate the stormy seas with a steady hand on the tiller.  One of the keys to our success is keeping a sense of perspective.  As my Options Hotline is in its twentieth year of advocating sensible speculation, I’d like to share some seemingly impracticable musings you may find useful.

In 2008, volatility skyrocketed beyond belief.  Most market participants, even professionals, were caught by surprise.  Big money was made and lost, both up and down, with astonishing speed.  It’s long been known speculators make their fortunes from changing prices and leverage is an important tool for speculators.  Leverage involves using OPM (Other People’s Money) to try to make more money than you can with your own funds.  Using OPM may augment your reward when you are right; but it may also greatly accelerate the risk of additional loss when you are wrong.  That’s the aspect of leverage that so many forgot during the heady times of money trees growing to the sky.

Even some of the market’s smartest participants are done in by blind arrogance.  The famous story of the 1990s rise and fall of hedge fund giant Long-term Capital Management, excellently chronicled in Roger Lowenstein’s When Genius Failed, comes to mind.  That cautionary tale is particularly apropos to today’s financial crisis.  Successful trades blinded the firm’s brilliant partners to the possibility of failure, ultimately sealed their fateful demise, and threatened the stability of the entire financial system.

In this business, I believe you are better served by checking your ego at the door.  Having a complete game plan includes preparing for the worst in every trade.  Remember to always speculate based on what you can lose, not what you can gain.   Applying sound money management principles (such as never adding to a losing trade) and utilizing the tools of Superleverage (buying exchange traded options) allow you to stay in the game and avoid being knocked out through inevitable times of losing trades.   If you have anticipated the possibility of loss, and are prepared to withstand it, no matter the severity, because you positioned with always known and completely limited risk vehicles; never be surprised when the market moves against you.

Over the years, I’ve compiled an impressive record of forecasting the twists and turns of market price.   The publisher is happy to provide you with every trade I’ve ever recommended, since taking the helm in October of 1999.  People invariably ask me what I think the market is going to do.  I always say that if I knew what the market was going to do, I wouldn’t have to work.  Use technical levels of support and resistance to set your exit strategy for each trade.  Make sure that you, or your broker, monitor your positions closely.  The market doesn’t ring a bell when it’s time to get out.  Have your plan in place ahead of time and you can smile, laugh, take your profit a step ahead of the crowd, and enjoy your accomplishment with a sense of wonder.  No matter your success, always be surprised when the market goes your way.

So, like me, never be surprised and always be surprised.  Don’t forget that forecasters, even those with good reasoning and strong opinions, are practitioners of uncertainty.  That view will serve you well.  I hope you found the abovementioned thoughts helpful and wish you all good fortune as you vie for fun and profit for the rest of 2009.

Sincerely,
Steve Sarnoff

March 13, 2009

Profiting from Superleverage was originally featured in the Penny Sleuth.