Euro-Crisis

The US equity markets finished strong last week on the heels of optimism that the Euro­zone has taken a step closer towards a solution to the lingering debt crisis. Earlier in the week, yields on Italian sovereign debt spiked over 7%, roughly the level where the debt profile for Greece, Ireland and Portugal started to rapidly deteriorate.

It appears that the bond market will accomplish what decades of stagnate political policy has been unable to do. Since March of this year, the yield on the ten-­year Greek bond has risen over 130% currently costing the Greek government approximately 28.5%. The ten-­year yield on Portuguese debt is up 56% since March yielding 11.6%. The yield on the ten-year Italian debt is up 32% since March yielding 6.5% as of last week. With borrowing costs up dramatically, European leaders are finding it harder to avoid the necessity of fiscal reform and the United States should be closely observing where the path of excessive fiscal mis­management will lead us.

Alternatively, Yields on German and US bonds are down significantly over that time span. We will be watching this closely and have pointed to continued “risk-­on” rotation back in to US equities. For that reason we remain near-term bullish and will continue to buy in to market strength.

Our Behavioral Indicator -Bullish Bias

Our Behavioral Indicator attempts to capture human trading emotions mathematically. It combines years of data from various indicators and aggregates it into an easy to understand model that assists in the investment decision making process. Our indicator encapsulates the put/call ratio, the volatility index, pricing and volume analysis, new high/lows and point and figure analysis to report the daily scores used in making decisions

Our indicator will score within one of five basic Market Cycles. These cycles include “Extreme Euphoria”, “Greed”, Rational Market”, “Fear”, and “Extreme Panic”. Depending on where we are in the market cycle determines how aggressive our portfolio structure. Typically, the best time to aggressively buy US equities are when we are rising out of Extreme Panic. The best time to be conservative is when we are falling from Extreme Euphoria.

Delving further in the interpretation, our models comprise of two lines. The first is the “Trigger Line”. This line tracks the general movements of the market and provides us with a “heads up” that a time to act is approaching. The second line is the “Trend Line” and provides us with the actual actionable entry or exit into the market.

Our current behavioral reading reveals that on October 5, 2011, the trigger line rose from the extreme panic level into the fear level. On October 10, 2011 the trigger line rose from fear to rational. This is an indication that the fourth quarter of this year has a high probability of providing us with a yearend rally. The trend line was sitting in the extreme panic zone towards the end of August and has risen and is currently in the rational zone.

The important thing to note is that the trend line has been trending higher since October 12, 2011 signaling the bottoms may have been set for the year. We use our behavioral model not as a trading technique but for portfolio rebalancing. When we receive the appropriate buy signals, it means that we will move to an over­weight position when buying equities as we starteddoing in mid­October. Quotes of the Week

Europe lacks all Credibility. "Moreand more we're convinced that a break­up of the European Union and/or another severe recession would have one very ugly effect and encompass just about the whole of this aching planet. According to Michael Darda of MKM Partners, a bad recession is what the euro zone bond markets say we're in for.

And while investors and just about everyone else breathed a sign of relief last week after Italy promised to try to straighten up and fly right, Michael points out that Friday morning spreads between the European Financial Stability Fund and German Bunds were the widest ever. Something less than a vote of confidence that everything was A­OK." ­Alan Abelson, Barron's, 11/14/11.

My "I Can't Believe I Just Read That" moment. "There are dozens of initiatives President Obama could undertake to strengthen our economic security. Here is one: He should enter into closed­door negotiations with Chinese leaders to write off the $1.14 trillion of American debt currently held by China in exchange for a deal to end American military assistance and arms sales to Taiwan and terminate the current United States ­Taiwan defense arrangement by 2015." ­Paul V. Kane, New York Times opinion, 11/11/11.

This needs to be watched closely. "Prime Minister Benjamin Netanyahu and Defense Minister Ehud Barak are already reportedly making military contingency plans for taking out Iran's nukes. The British Daily Mail's online edition for Wednesday quoted a "senior (British) foreign office figure" as saying, "We're expecting something as early as Christmas, or very early in the new year."" ­Investors Business Daily opinion, 11/11/11.

Oops #1. "Standard & Poor's mistakenly announced the downgrade of France's top credit rating on Thursday, frightening investors already anxious over Europe's worsening debt crisis. The erroneous alert, which S&P said was sent to some of its subscribers, fed concerns that Europe's debt problems had engulfed the region's second­largest economy. It contributed to the worst day for France's government bonds since before the euro was launched in 1999. In a statement issued nearly two hours after the fact, S&P said the message resulted from a technical error and not from any action it intended to take against France." ­ Reuters, 11/11/11.

Oops #2. "French President Nicolas Sarkozy, who has labored to improve French relations with Israel, said he "can't stand" Israeli Prime Minister Benjamin Netanyahu and called him a liar in a chat with President Barack Obama.

The conversation between Sarkozy and Obama was overheard by reporters last week at the Group of 20 summit in southern France, via headsets that were to be used for simultaneous translation of an upcoming news conference.

In the remarks Thursday in Cannes, Sarkozy said: "Netanyahu, I can't stand him. He's a liar."

According to the French interpreter, Obama responded, "You are sick of him, but I have to work with him every day."" ­ Fox News.com, 11/8/11

Oops #3. "In the CNBC economic debate in Michigan, Mr. Perry was asked about his tax and spending plan and proceeded to falter painfully, unable to list the three federal agencies he's proposing to abolish.

“And I will tell you, it is three agencies of government when I get there that are gone,” he said. “Commerce, education, and the — what's the third one there? Let's see .... OK. Commerce, education, and the —”

He looked helplessly toward the elderly Ron Paul, standing next to him on the stage, who added helpfully: “The EPA?”

Mr. Perry replied: “EPA, there you go.”

The moderator pressed on, asking if, indeed, he was proposing to cut the Environmental Protection Agency. He said no, but admitted he could not name the third agency.

“The third one, I can't. Sorry. Oops.”

About 15 minutes later, Mr. Perry told the moderator that the Department of Energy was his third target, but by then, the damage was done." ­ Lee­Ann Goodman, The Globe and Mail, 11/9/11.

Joseph S. Kalinowski, CFA