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The EU Ratings War And Its Repercussions

12/14/11 12:32:04 PM
by Billy Williams

Several credit agencies have been rattling their sabers over the EU debt crisis but in the end, who will be the winners or losers and, more important, how do you profit?

Security:   SPX, DG, PRGO, HMSY
Position:   Hold

Major indexes headed lower today as fragile hopes in the market felt the weight of the decision by the eurozone as they proposed tighter fiscal controls on its members along with the tentative agreement that details those fiscal measures. This agreement still has to be ratified by the individual parliaments of the individual EU member and is unlikely to reach a consensus in the near term. Skepticism is high among ratings agencies such as Fitch that criticized the deal and predicted a significant economic downturn in Europe.

Added to that, Moody's reported that it planned on reviewing each of the individual country's credit rating in the first quarter of 2012 that have signed off on the EU deal but have yet to ratify it in their own countries. But concerns are wider as the investment community worries about the effectiveness of European decision-making and the risk of recession in the eurozone. See Figure 1.

FIGURE 1: S&P 500. The SPX is trying to emerge out of a steep retracement to break above its former highs set in late October but is running out of steam as it dips into a pullback ahead of EU debt troubles.
Graphic provided by:
However, do the credit rating companies' opinion matter? After all, the US lost its top-notch rating, but the bond market doesn't seem to care as the US is still able to borrow for 10 years at roughly 2%. The eurozone is in a very different position, though, as yields on 10-year Italian bonds stand at 6.4% and Spanish equivalents are 5.8%.

While the looming budget and debt crisis in the US is looming, the markets don't seem to discount future prospects for the SPX and Dow Jones Industrial Average (DJIA) as well as the US bond market itself. Scared money is rampant across the globe with a lot of capital looking for a safe refuge and running to the eager embrace for US fixed securities and, to a lesser extent, dividend-paying equities.

FIGURE 2: DOLLAR GENERAL. DG has offered a couple of mixed buy signals in early December but finally offered a compelling mixture of fundamental and techncial conditions that developed into a strong buy signal on December 12, 2011, as price reached all-time highs. However, in the current market correction, it is advisable to avoid buying stocks until the larger market bottoms and turns upward.
Graphic provided by:
Even growth stocks have fared better than foreign equities as American equities offer the future prospect of growth and safety of high relative strength. While companies such as Intel have fallen more than 4% on the recent market downturn, stocks such as Perrigo (PRGO), Dollar General (DG), and HMS Holding (HMSY) have held near their highs and offered buy points even as the overall market remains in a downturn.

Dollar General Corp. (DG) operates as a discount retailer of general merchandise in the southern, southwestern, midwestern, and eastern United States. With a market cap of $14 billion and revenue almost equal to that as well as return on equity of just under 17% and quarterly growth in excess of 33%, DG offers several compelling fundamental factors that should attract the attention of any trader or investor. See Figure 2.

On the technical side of the trading equation, DG has recently offered a buy point just over $40.71 as the stock's price traded to a new all-time high, a key indicator that the stock may go on to higher highs as well as lead the stock market higher once a bottom has formed. However, it's important to note that a buy signal was not confirmed on December 1, 2011, as the volume was not high enough to show strength as price attempted to move higher, while on December 5, 2011, price attempted another setup. Though volume was higher on that price bar, the bar itself was not strong enough to warrant an entry.

But on December 12, 2011, both the price bar and volume worked in sync to produce a strong entry signal just over the intraday high established on December 5, but in the current market correction, it is not a good time to buy stocks.

DG should be on your buyer's list as a strong buy candidate once the SPX and other market indexes confirm that a bottom has been formed and the market turns back to the upside. Until that time, as well for the EU's debt crisis to stabilize, it would be advisable to stay on the sidelines and stay in cash until the above conditions are overcome.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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