Will Santa Bring a Rally?

Stocks were under pressure again this week as the Euro zone continues to weigh on confidence. For the week, the averages fell about 3%, pushing them back into the red for the year and dashing hopes for the seasonal “Santa Claus Rally.”

At this point, it’s pretty obvious that the Euro zone is a total disaster. Bond yields continue to spike, growth remains anemic and uncertainty reigns supreme as the politicians, regulators and central bankers struggle to find any kind of meaningful resolution to the situation.

That means there are basically two paths for the Euro zone, and global economy in general, to walk down. The first path is to simply let the market function naturally and shake out all of these kinks on its own. But with mountains of sovereign and bank debt creating a huge, deflationary black hole that threatens the stability of the global financial system, it is highly unlikely that the previously mentioned politicians, regulators and central bankers are going to stand on the sidelines and let that happen.

That places the onus on the second option, which is for the politicians and central bankers to get even more aggressive on the monetary front and do everything they can to stimulate the economy and juice liquidity. That of course involves one of economists favorite words, monetize, which is just another way of saying print more money until smoke billows out of the printing press.

Inflation  Collapse?

So those are basically the two options on the table. Let the entire financial system collapse on itself under mountains of debt and unsustainable deficits, or let the politicians and central bankers get crazy on the monetary front to try and save the whole thing or at the very least kick the can down the road as long as possible.

If that’s the path we go down, it is highly inflationary, which would be good for stocks, gold and oil.

For the time being, we actually saw some restraint from the Fed and European Central Bank, both failing to announce any fresh rounds of monetary stimulation in their latest meetings. That is why stocks, gold and oil were down so much this week. But moving forward, if the central banks do choose to stimulate and try to save the dire situation in the Euro zone, expect to see stocks, oil and gold rallying pretty hard.

Let’s get into some updates.

Updates:

In a market where growth is anemic, you would think that a company that grew sales by 50% and earnings by 30% in just one year would be rewarded. But that’s not what happened this week with VeriFone Systems, Inc. (PAY), taking an 18% nose dive in spite of awesome Q2 results that came in well ahead of expectations. Revenue was up 48% from last year to $411 million. Earnings came in at 53 cents, up 30% from last year’s 40 cents and safely ahead of expectations of 51 cents. VeriFone also forecasted full-year, 2012 earnings between $2.53 and $2.60, also ahead of expectations of $2.48. So all in, as you can see, it was a great quarter, with the outlook coming in strong too.

So it’s basically a great example of how the market is treating any kind of growth oriented stock right now, regardless of what the numbers look like. Risk is off the table, with investors choosing capital preservation as uncertainty rules the day.

It was much the same story for energy stocks, with any kind of growth asset getting beaten into the ground as the market shifts into bonds and conservative segments of the market like consumer staples and utilities. That hit energy services company Baker Hughes (BHI), down 9% on the week.

Cimarex Energy (XEC) was also on the ropes, falling 9.5% and within $10 of its 52-week low at $50. At this point, being in the energy trade is all about conviction, because it has not been easy to own these stocks this year. If you believe in the long-term trend of growing demand and decreasing resources, then you live with the volatility and buy more shares. Because if the market regains its appetite for growth, there are few areas of the market that will rally as hard as energy.

We are also seeing some interesting movement in gold, with prices coming under pressure over the last two weeks as the Dollar strengthens due to weakness in the Euro (currency). That weighed on Double Gold (DGP), falling 14% on the week. It also showed up in the basket of Gold Miner Stocks (GDXJ), trailing the market with a 12% loss. Even more so than stocks and energy, gold ties into the conversation about the behavior of the central banks. If they choose to print, that is highly inflationary, so expect to see gold resume its upward trajectory. But for the time being, with the Fed and ECB showing a little restraint, it was a tough week to be in the gold trade.

So now that everyone is thoroughly depressed about the performance of the market and various stocks, let’s shift gears into some good news and try to end on a high note.

The down market will always make you appreciate having a diversified portfolio with defensive names in the mix. There not as sexy as growth stocks, but they will help keep you in the game when the market goes south. That’s exactly what we saw this week from CPFL Energy (CPL), gaining 2% as investors chased the company’s solid 6% dividend. We also saw that show up in McDonald’s Corp (MCD), handily beating the market with a marginal .5% decline. We’ve seen great things from MCD this year, up more than 30%, so let’s look for that trend to carry on and support the portfolio.

That’s all for this week, but until next time, here is an article related to our discussion above about the Fed and how its actions will affect the market in 2012. Enjoy!

What to Expect from the Fed in 2012

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.