MorningWord 6/6/14: I For One Welcome Our New ECB Overlords

by Dan June 6, 2014 9:02 am • Commentary

It’s not lost on most Americans that June 6th, 1944 was a day that changed the course of history. Today on the 70th anniversary of D-Day, C.C. and I, sons of U.S. Army veterans (C.C. also a brother of an Air Force vet) are humbled to remember the sacrifices of the men and woman who have served in the Armed Forces and have the utmost respect for those who remain in harm’s way today in all parts of the globe.


On June 6, 1944, more than 160,000 Allied troops landed along a 50-mile stretch of heavily-fortified French coastline, to fight Nazi Germany on the beaches of Normandy, France. Gen. Dwight D. Eisenhower called the operation a crusade in which, “we will accept nothing less than full victory.” More than 5,000 Ships and 13,000 aircraft supported the D-Day invasion, and by day’s end, the Allies gained a foot-hold in Continental Europe. The cost in lives on D-Day was high. More than 9,000 Allied Soldiers were killed or wounded, but their sacrifice allowed more than 100,000 Soldiers to begin the slow, hard slog across Europe, to defeat Adolph Hitler’s crack troops.

I have been to Normandy.  It is a truly amazing place, not just to envisage the mortal challenges faced by those who landed that morning, but to also see the thousands of graves that mark many of their final resting places on the bluffs that they courageously liberated thousands of miles away from home.


On a far less important front in the grand scheme of things, let’s turn to the markets.  With May Non Farm Payrolls out (in-linish), and the unemployment rate unchanged at 6 year lows, I can say honestly I had no clue what would have been a good number for U.S. equities at all time highs.  Weak data would have reinforced the Fed’s continued commitment to lower rates for longer (one number should not change much at this point)?  The worst case scenario would be a sort of perfect storm of domestic slowdown and a geopolitical situation to get the Fed off of “the Taper”.  Today’s “strong” jobs number, coupled with May auto-sales and some manufacturing data of late suggest that the Fed’s guarded optimism as it relates to the current recovery is on track.  Corporate earnings have not been growing gangbusters, but the positive macro backdrop (with the ECB’s added nudge yesterday) could support current multiples and possible continued expansion.

At this point, the pain trade seems higher (for the very near term) with the SPX leading the way, Apple doing the heavy lifting in getting Nasdaq back to prior highs, which just leaves the much maligned small cap index, the Russell 2000.  During the rolling sell off of high valuation stocks for the better part of the first four months of the year, the IWM (Russell 2000 etf) was the poster-child for risk off in equities as investors preferred the safety of lower valuation, stable growth and strong balance sheets of companies set to benefit from the re-emergence of global growth.

I do think it is important to note that the IWM is slightly above the midpoint of its March 4th to May 15th peak to trough drawdown of roughly 11%, and looking poised to revisit the prior highs:

IWM 6 month chart from Bloomberg
IWM 6 month chart from Bloomberg

Regular readers know that we remain skeptical as to the health of the recovery, but are resigned to the fact that trying to short a dull summer market with record low volatility could be hazardous to your portfolio’s health.  We remain steadfast in the belief that the lesson so far of 2014 is that rising tides will NOT lift all boats as they did in 2013, On the flip side, if small caps were to recapture the prior highs, economic data continues to come in incrementally better, ECB remains focused on causing some inflation and there are no geopolitical events to cause concern, then the SPX could be up 10% for the year at some point this summer.

Just because it could go up another 3, 5, or whatever % doesn’t mean it is a great spot to commit new capital to equities.  It is my view that the risk/reward of capturing the next 3-5% to the upside does not outweigh the potential for a quick 10% decline (which we have now not had for the longest stretch since 1996).  It’s coming, but from where? 1950, 1975, 2000??  I have no clue.  I will continue to short stories that don’t make a lot of sense for a whole host of reasons (CRM, WYNN), and look for opportunities to play from the long side in large cap laggards to re-test prior 52 week highs where I see slightly limited downside (relative to crowded trades) in a 10% broad market correction (CSCO, F, GE, VZ).