Weekly Update-May 11, 2012

By: Michael Vodicka

“Everyone knows that if one of the investment banks blows up not only will it rock the entire global economy, it will be the taxpayers left picking up the bill as the executives scurry away with millions of dollars.”

The bears took firm control of the market this week, pushing the averages into the red on more weakness in the Euro zone and JP Morgan’s bombshell $2 billion loss. For the week, the Dow Jones fell 1.7%, the S&P 500 dropped 1.2% while the NASDAQ beat the Street with a .8% gain.

There were two big stories ruling the Street this week.

The first was more weakness out of Europe. The more we learn about these countries the worse the story gets. This is not an encouraging trend. Spain, Portugal, Italy, it’s all the same; too much debt and no real desire to cut spending. It’s a system that can’t be broken quietly. We haven’t seen any major market disruptions yet but with Greece rejecting more financial aid it’s very possible we could see a “disorderly” move.

But beyond the black hole known as Europe, the market also fielded some interesting news out of the financial sector. JP Morgan calls a late afternoon conference call to reveal a trading loss valued at $2billion. So much for too big to fail, so much for Frank Dodd, that sure did a lot of good. The story is that one of the biggest whale traders in the world had a multi-billion dollar position blow up in his face. The division and company took huge losses when it was time to mark the books.

A Warning Signal?

It wasn’t a very stabilizing message coming out of the financial sector. Because everyone knows that if one of these places blows up not only will it rock the entire global economy, it will be the taxpayers left picking up the bill as the executives scurry away with millions of dollars. That’s called moral hazard, and our financial institutions are swimming in it.

It was a stark reminder to a lot of people that the banks are still betting big and taking huge risks while the taxpayers back the whole operation.

We saw a little relief late in the week, with stocks up decent on Friday morning after consumer sentiment came in at a 4-year high. That bullishness has been the trend all year, with consumer confidence staying resilient in the face of higher gasoline prices and unemployment.

But that small blast of optimism didn’t last long, with the averages reverting back into the red by the end of the session and rolling into the weekend on a fairly sour note.

So big picture, sentiment is not looking good right now. Europe looks like as big of a mess as ever and this JP Morgan story is big news. Is it a warning shot that the financial system is frail and full of risk? And that if something blows up in Europe, it will send massive shock waves across the entire financial system. The prognosis doesn’t look good. And it all comes as the market is trading at record low volatility. As we have seen from weakness and outflows, a lot of people are taking a conservative approach and rolling into cash.

Updates:

With a lot of the recent “Fed premium” sinking out of the market this week, gold was on the ropes, with Double Gold (DGP) falling 4%. Market Vectors Junior Gold Miners (GDXJ) was also weak, falling 8% in spite of some gains on Friday. This trade has cooled a lot this year, which is interesting since we have seen unprecedented activity from the central banks of the world. But this is actually fairly similar to last year, where stocks sold off in May, and when the Fed started hinting at more stimulation, gold once again surged higher. So in the big scope of things, the trend is most definitely still higher as the path of least resistance is to print and devalue.

Interestingly, we saw a strong out performance from energy this week, with Baker Hughes, Inc. (BHI) adding 1.21% and Cimarex Energy Co (XEC) falling just .02%. These energy stocks have been brutalized over the last year, so maybe we are finally seeing an inflection point as the market realizes there aint that much of this stuff laying around.

Other than that, we also saw some stability from Apple, Inc. (AAPL), adding .26% on the week for a fairly strong out performance. A lot of people keep talking about Apple being really “expensive” at $600. But that’s not the right way to look at this stock. You have to look at what’s happening with earnings. If Apple was jumping higher while earnings held steady, there would be cause for concern. But Apple’s earnings have exploded over the last few years with the share price, where the company is expected to make $60 in 2013. So by that standard, AAPL is a huge bargain trading below $600.

That’s it for this week, but until next time here is some color on the JP Morgan trading loss. My question is whether this is an isolated incident or an appetizer from an ailing financial sector? Sounds like this guy from Bloomberg is worried about the same thing.

What Jamie Dimon Doesn’t Know is Scary

Your Investment Partner,

Mike

ABOUT THE AUTHOR

Michael Vodicka

Michael Vodicka is the president and founder of the Vodicka Group Inc., a licensed investment advisor (Series 65) and a financial journalist.