Stocks rallied strongly on Tuesday for the second consecutive day, continuing their bounce off of technical support hit on Monday. This is the best run in weeks as investors cheer a reversal of recent trends, with the euro, crude oil and energy stocks moving powerfully to the upside.
In the end, the Dow Jones Industrial Average gained 1.8% to contend with resistance from its 50-day moving average, the S&P 500 gained 1.4%, the Nasdaq Composite gained 1.1%, and the Russell 2000 also gained 1.8%.
Energy stocks led the way higher, with a 2.8% gain at the sector level, while biotech was a drag. Office supply stores Office Depot Inc (NASDAQ:ODP) and Staples, Inc. (NASDAQ:SPLS) gained 21.5% and 10.9%, respectively, on a Wall Street Journal report that the companies are in advanced merger talks.
Crude oil rose for its fourth consecutive session, moving up 7% to close at $53.05 a barrel. This is the best level since Dec. 31 and represents nearly 20% jump from last week’s lows. There has been no specific catalyst for the move, aside from ongoing reaction to a drop in drilling rig counts.
Instead, the driver seems to be currencies, which remain wild and volatile amid a series of surprise central bank moves (with rate cuts in Australia and Denmark) and optimism over possible debt relief negotiations between Greece and its creditors.
These negotiations will not be easy. Heading into this week, the European establishment railed against the idea that Greece would get special treatment. Benoit Coeure, a member of the executive board of the European Central Bank, said last week that said that there are “rules of the European game,” adding that there “is no room for behaving unilaterally in Europe.”
Still, the calculus of the situation suggests that a “soft restructuring” of Greece’s debt load — which stands at a debt-to-GDP ratio of nearly 180% — is likely. According to Alberto Gallo, head of macro credit research at the Royal Bank of Scotland Group, even with an extension of the maturity of Greece’s bonds, any slowdown in growth or mild recession could push the debt ratio back over 170% — which is unsustainable over the long haul.
Long story short: a debt write off will eventually be needed; although this could be postponed until 2019 or so. Another solution would be to link bond repayment to the performance of the Greek economy.
For investors right now, the question is: How smoothly will the negotiations between Athens and the European establishment go? And then, once a deal is done, will countries such as Portugal or Italy start clamoring for debt relief of their own?
Politically, it will be hard to resist this — which is why Germany and the European establishment is hesitant to offer Greece anything and open Pandora’s box.
Gallo believes that Greece is not isolated, but that the problem of low inflation, high debt and tepid growth will suck other vulnerable countries into the tumult, with Portugal most at risk.
The Greek situation is in the driver’s seat for markets overall, with a rebound in the euro responsible for a drop in the U.S. dollar, which in turn sent crude oil soaring, which in turn powered energy stocks higher.
Click to Enlarge You can see this in the way investors looked past a very weak U.S. factory orders report, with new orders and shipments dropping to lows not seen since the recession. The drop represented the fifth consecutive decline in activity and was worse than analysts had expected.
For now, this looks like a classic oversold rebound in currencies, oil and energy stocks. Fundamentals remain challenging, with energy sector valuations blowing out to dot-com levels as crude oil has fallen much more than stocks such as Exxon Mobil Corporation (NYSE:XOM).
And with Greek negotiations far from resolved, caution is still warranted.
I continue to recommend a focus on precious metals and the related mining stocks via picks including the iShares Silver Trust (ETF) (NYSEARCA:SLV), which is up 6.8% for Edge subscribers since added on Jan 6.
Thanks to a defensive focus, subscribers enjoyed a 23.3% gain in January versus the S&P 500’s 3% loss.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.
