Selling the Draghi Rally

 | Jul 27, 2012 | 12:00 PM EDT  | Comments
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The market staged a large rally Thursday after European Central Bank head Mario Draghi promised to do "whatever" is necessary to save the euro and the eurozone. Color me skeptical, but until that phrase comes from the Germans, investors should sell the rips. I also was not impressed with the nature of the rally: Defensive sectors -- telecom, utilities and consumer staples -- were the sectors showing outperformance, and the 10-year U.S. treasury yield hardly budged. That isn't exactly the nature of a real "risk-on" rally.

I think there are just too many problems in the market and the economy right now for a sustainable rally to appear. Investors should use these one-day updrafts to lighten up on some of their high-beta positions and build some cash, as I think we will have better entry points by the end of summer.

In fact, here are no less than 10 disturbing signs I'm seeing for the market (and it was hard not to jot down 25).

1. The slowdown in Europe is really starting to impact the earnings of S&P 500 companies. In the last day or so, both Dow Chemical (DOW) and Ford (F) reported earnings that fell short of expectations due to the slowdown in their operations in Europe and the fall of the euro. Both stocks traded down Thursday despite the large rally.

2. Here's a more realistic opinion on what will happen in Europe vs. the happy talk generated Friday from ECB's Draghi's comments: Citigroup's chief economist Willem Buiter, who coined the phrase "Grexit," puts 90% probability on a Greek exit from the euro by 2013. Buiter also believes Italy and Spain will have to go, hat in hand, to the "Troika" by the end of the year.

3. Speaking of Italy, the situation in Sicily is raising concerns that Italy has problems with financially unstable regions, similar to Spain's troubles in Valencia and other regions.

4. Europe has massive overcapacity in its auto manufacturing sector. Plants are operating at 60% to 65% of capacity and hemorrhaging cash. Rationalizing production will cause huge fights with the unions and, eventually, huge additions to unemployment, when Europe no longer has the funds to bail out this industry.

5. It is not only the auto industry that has significant overcapacity. Steel production also needs to ramp down substantially on the continent. ArcelorMittal (MT), the largest steelmaker in the world, has already shut down nine of its 25 blast furnaces in Europe, and more cuts are likely.

6. Even the U.K. is having problems as austerity has started to bite. The country's gross domestic product shrank 0.7% in the second quarter, worse than expected.

7. Turning to the domestic side, U.S. pending home sales fell 1.4% in June, worse than expectations. This comes on top of Thursday's report on new home sales that came with the worst numbers seen since June 2011. The housing market may be bottoming, but hope is minimal that housing will add to economic growth.

8. Zynga (ZNGA) joins Groupon (GRPN) and Facebook (FB) in being worth a fraction of their value vs. when they recently came public. Investors have "social media egg" on their face, and any hopes of robust activity in initial public offerings is unlikely until the market forgets about this latest craze that ended up with a debacle.

9. The June durable-goods report, sans transportation, came in Thursday at down 1.1% against targets of 0.1%.

10. Guidance and revenue have been dismal in second-quarter earnings. In the span of a little over three weeks, third-quarter earnings for S&P names have gone from a projection of 3% growth to under breakeven, and they have not stopped falling.

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