Nothing to Worry About …

It was clear that stock markets would sell off and US treasuries would catch a bid on the news of the failure of negotiations between the former "troika" and Greece. What was less clear was that gold would actually fail to catch a bid, but we are putting this down to the fact that another surprise event occurred: the euro, after initially declining, actually ended the trading day slightly higher.

Some of this has to do with positioning: there were already lots of speculative shorts in the euro, and speculators added some 24,000 contract to their long position in gold futures ahead of the weekend. When a big move higher failed to make an appearance, some of these positions in gold were evidently sold again, while euro shorts welcomed an opportunity to cover on a dip caused by widely unexpected news.

However, in spite of some brief displays of bravado early in the session, the US stock market did close near the lows of the day, with the DJIA losing 350 points. This isn’t really all that much anymore these days, in fact it is a move of less then 2% – hardly what one would call a "panic". However, it did leave the average poised somewhat precariously just below its 200 day moving average and slightly below short term lateral support:

The DJIA falls by 2% and ends just below its 200 dma and short term lateral support – click to enlarge.

The daily candles left behind by the SPX and the Nasdaq look similarly ugly, but have failed to violate their respective 200 dmas or any noteworthy support levels so far. All in all, the reaction was probably worse than many had expected earlier in the day, but in percentage terms it really is no big deal. Overnight, Asian stock markets have put in a small bounce and at the time of writing, European stock markets are trading slightly higher as well.

What we find astonishing though is the complacency that is accompanying recent events both in anecdotal and positioning terms. For instance, the pure Rydex bull/bear asset ratio stands at 27.26, with bear assets only a smidgen above a new all time low – at less than half their level of early 2000, and that’s in nominal terms. To state that "no-one is looking down" is an understatement looking for an appropriately sensational sounding descriptor. We have discussed market sentiment and positioning data about a month ago (see "The Stock Market – A Picture of Excess" for details) and there is definitely no need to update these charts just yet – so far, they don’t look much different.

However, we were nevertheless struck by the utter nonchalance with which the suddenly much higher “Grexit” potential was greeted in the financial press as well as among EU officials. Here are a few examples:

CNBC: Greek debt crisis leading to investment opportunities in U.S.?

Marketwatch: Why Greek crisis won’t hurt U.S. Economy

Barrons: Greek Drama not Tragedy (to be fair, Michael Kahn is concerned about waning breadth in the US stock market, but the headline was still striking)

Ekathimerini.com: ECB’s Noyer: Greek exit? No problem for eurozone

You get the drift. Noyer’s view is in fact echoed by many EU officials, and there is no need to list all of their statements here – Noyer is quite a good representative of the current majority view.

It may well be possible that all the arguments made in these articles turn out to be correct – we aren’t trying to dispute the argumentation as such, we only want to point out how astonishingly little concern there is. To our mind, what is currently happening in Greece has to be seen as a warning shot. Incidentally, the recent sharp decline in China’s stock market also represents one, and the upcoming default of Puerto Rico is a warning as well. The latter is a reminder that there are large vulnerable debtors out there in spite of record low interest rates and huge monetary pumping efforts by central banks.

The problem as we see it is that there is enormous leverage in all "risk asset" markets. There is record high margin debt in stocks, and experience teaches us that low interest rates on "safe" government bonds represent an open invitation to jack up leverage to the maximum in order to produce a half-way decent return (Ronnie Stoeferle and Mark Valek have discussed some of the methods employed in the recent “In Gold we Trust” Report). We believe that all these markets are quite dangerous for this reason alone.

We still recall that the Russian crisis was met with equal equanimity when it began. The market even made what were then new all time highs smack in the middle of the crisis. However, as the crisis reached its peak, the market quickly got into a great deal of trouble.

Keeping an Eye on GREK

As we have mentioned previously, the Greek crisis may actually create one specific opportunity, namely in the Greek stock market itself, which is already down some 90% (give or take a few) from its bubble highs, while valuations are extremely low. As we have stressed, there is no hurry: it is best to wait and see how things will shake out, as a currency discount may yet intrude should Greece abandon the euro. However, the time has certainly come to play close attention. With the stock market in Athens closed, the US-listed ETF GREK was down almost 20% yesterday. At some point in the not too far future it should probably be cheap enough – however, those considering this opportunity must keep in mind patience will be required both before and after one pounces.

GREK gets smashed to a new low for the ETF – click to enlarge

In this context it will also be important to observe political developments in Greece if the referendum ends with a “no” vote. We wouldn’t recommend buying into Greek stocks if Syriza were to suddenly begin to nationalize various industries. In fact, the best opportunity will present itself if Greece manages to remain a member of the euro area.

Conclusion

Our impression is that there definitely isn’t sufficient concern out there at the moment. In highly leveraged markets, one should definitely heed warning shots. While initial declines are often retraced in the near term , these warning shots very often precede major declines by a few weeks or months. Moreover, the stock market is overvalued and appears technically vulnerable as well, as trend uniformity and breadth are looking ever weaker.

Charts by: StockCharts