Thursday, July 15, 2010

Is Europe Playing Kick the Can?

European Sovereign Debt
The Kick the Can Game

A hot summer evening, an old can and a bunch of kids—that’s everything you needed for a good ol’ fashioned game of Kick the Can.

Kick the Can evolved out of the game Hide and Seek. A group of kids would gather and pick someone to be “It.” Whoever was “It” had to sit down and cover their eyes with their hands. The rest of the kids then chose somebody else to kick a can away from the person who was “It.” This honor usually fell to the most talented kicker of the group who could send the can farthest down the road.

Once the can was kicked, the rest of the kids would scatter to find hiding places while the person who was “It” would count to 100. Reaching 100, he or she would try to remember in which direction the can was kicked and go retrieve it.

Only after the can was retrieved and returned to home base (usually in the center of the cul-de-sac, parking lot or other wide open space) could the person who was “It” seek out the hiders. Kids would play this game until dark or until Mom called for dinner, whichever came first.

From this children’s game, pundits created a memorable phrase for a common occurrence in politics. “Kicking the can down the road” has become a metaphor for anyone employing a delay tactic in order to deal with a problem at a later date (and often by someone else).

Did Europe Kick Their Can Down the Road?

Across the globe, most equities markets are down for the year. Many analysts have pointed to the strong potential of several European countries’ sovereign debt default as a primary factor for the downward pressure on the markets.

With the recent compelling lift off of the early July lows, however, it’s fair to ask if the markets have simply discounted this issue for the moment or if Europe truly did what was required to mitigate the markets’ fears. While it would be extremely short-sighted to think that the sovereign debt crisis is over, there is a strong possibility that the European Central Bank (ECB) has appeased the nay-sayers in the near term and successfully delayed a true reckoning of the problems.

Some compelling factors support the view that Europe successfully kicked the sovereign debt default can down the road:

* The Euro has had a decent rally from its lows in early June.

* Both Spain and Portugal have had very successful bond sales.

* Greece has managed to keep from going into a debt death spiral. (This is in large part thanks to the ECB buying massive amounts of Greek debt on the secondary market to provide liquidity.)

In addition to these factors, my friend and hedge fund manager Marshall Auerback made the call almost two weeks back that Euro denominated assets would outperform U.S. dollar based assets. The charts certainly support his point of view at the moment.

Europe250 iShares SP500
The red line shows the iShares S&P Europe 350 Index Fund had a return of 9.89% in the last month while the S&P 500 (blue line) has lagged significantly behind with a 2.35% return.

Though not definitive, the chart certainly indicates that a significant recovery could be starting in European equities.

Now What?

Last week I saw some extreme oversold measures in the markets that suggested a near term snapback rally, which we got with a vengeance. Early indications are that the equity and fixed income markets may be shrugging off European debt default fears. If so, this could further solidify the notion that we hit an intermediate bottom early this month.

Where can we go from here? The following chart of the S&P 500 provides some targets to consider.

The light blue highlighted area shows a convergence zone of three important indicators: the 50 day simple moving average, a trendline drawn off of the April highs and a Fibonacci retracement of 0.382 drawn from that same high to the July 1st low.

If the bears are going to maintain control for the rest of the summer, this area has to hold and repel the current move up. If the bulls can breach this zone, however, more upside should follow.

By D.R. at D.R. Barton of International Institute of Trading Mastery

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