Can Santa Ride Through Frozen Credit?

Right now the equity bulls have a case for another leg higher, resting largely on technical conditions. We’re now into the best seasonal period of the year for stocks, and headed towards the end of a tough performance period that might encourage large financial institutions and hedge funds to try to juice some returns out of this lackluster market. Meanwhile sentiment has been gloomy for months, and a lot of cash likely sits on the sidelines that could potentially fuel a short term run. Given this backdrop, it’s not inconceivable that that we could see a Santa Claus Melt Up that heads for the old highs of about 1360 on the S&P 500.

But anyone following the credit markets lately could also come to the conclusion that the bulls have drunk too much egg nog. Recently the yield levels on European peripheral debt have risen to worrisome levels, the cost to protect European banks have been surging, and there are indications that the plumbing of the European banking system is clogging up in a hurry. Essentially the credit markets are showing some signs of a deep freeze in Europe, which ratchets up system wide risk and threatens to derail global growth over the next few quarters.

Yesterday the S&P 500 broke through the triangle pattern that Carl mentioned a few days ago, which would imply that the next stop for the market should be somewhere in the low 1160 range, if the patterns holds. Investors must decide what this correction means to their portfolio positioning. Those who believe Santa will ride to the rescue will likely use this correction as an opportunity to add risk, and those who believe the Credit Grinch will cancel the Christmas festivities have no reason to abandon their defensive posture. At Pinnacle we are positioned defensively, but have been eyeing up a way to get slightly less defensive, given that evidence we follow is less uniformly bearish than it was a few months ago. I’m not sure if this is time to buy or not, but you can bet there will be some interesting discussions on this topic as we approach the kick off of the holiday season next week.