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State of the market: Cyprus still dominates, but keep an eye on the Fed

Given that stocks came into the week in a very overbought condition, that just about everyone in the game has been calling for a correction, a pullback, or at the very least a “sloppy period” to commence, and that the situation in Cyprus appeared to give the bears the catalyst they needed to get control of the game, our furry friends have to be disappointed with their efforts so far.

Although there has been a fair amount of intraday volatility this week surrounding the headlines out of Cyprus (the S&P fell 13 points in about 15 minutes yesterday on word Cyprus's Fin Min had resigned and then dove another 8 when the country's Parliament rejected the bank levy proposal), it is important to recognize that the total damage to the stock market so far this week has been minimal. If my $8 calculator is functioning properly this morning, it appears that the S&P has fallen just -0.95% from Thursday's high point and the DJIA has only given up 83 points, or -0.57%. So, at least at this stage, we can't exactly call the situation in Cyprus a crisis for the U.S. stock market.

In terms of identifying the drivers of the current market action, we will have to stick with Cyprus as the frontrunner at the present time. Although with an announcement from Bernanke's bunch on tap today at 2:00 p.m. eastern with a quarterly press conference to follow, the focus could easily and quickly shift this afternoon.

Recall that equity and bond traders alike have been keen on any hint (subtle or otherwise) as to when the Fed might consider pulling their QE punch bowl from the party. The general thinking is that any indication that Bernanke might be thinking about making a move sooner rather than later could be a big problem for the prices of both stocks and bonds.

But before we get to the Fed announcement, the algos will be focused on the situation in Cyprus. As such, here is an executive summary of where things stand this morning:

  • The Eurozone stands ready to help Cyprus – On Tuesday evening, Eurogroup head Jeroen Dijsselbloem released a statement saying that the Eurozone “stands ready to assist Cyprus in its reform efforts”. However, the demand that Cyprus contribute 5.8 billion euros to the effort has not changed.
  • The ECB promises to provide liquidity – After the Cyprus Parliament rejected the initial bank tax Tuesday afternoon, the ECB announced that it remains committed to providing liquidity as needed. However, it also said that it would do so “within the existing rules”. And THIS is the tricky part. ECB rules do not allow the central bank to lend to insolvent banks. And the ECB's Asmussen said Wednesday that banks in Cyprus are not solvent without them being quickly recapitalized via a bailout program.
  • A deal with Russia may still be on the table – Cypriot Finance Minister Michael Sarris (who tried to resign yesterday but the resignation was rejected) said that his country and Russia have not reached a deal on a loan. However, the talks were described as “very constructive”. He added that discussions are expected to continue. The latest headline this morning indicates that Cyprus and Russia are discussing a possible exchange of bank assets and islands.
  • Cyprus Bank Holiday may be extended further – While Cypriot banks are currently scheduled to reopen on Thursday, Bloomberg reported Wednesday that the bank holiday may be extended through the end of the week.
  • Speculation of an exit from Eurozone – Comments from ECB Governing Council member Nowotny have brought up the possibility of an exit from the Eurozone. Nowotny said in an interview that “It is in the interests of the euro zone, and of course the interests of all members states, (for Cyprus) to stay in. But you also have to say that membership in the euro zone demands a kind of discipline and the readiness to act rationally.”
  • THIS JUST IN… European indices as well as U.S. futures have moved higher on rumors of an initial agreement with Russian investors to buy Cyprus Popular Bank. This could be viewed as a first step in the resolution of the bank recapitalization plans.

So, while the drama is likely to continue and the algos will likely react to each and every headline, I think it is safe to say that so far at least, the situation in Cyprus is not (yet?) the debacle that the bears have been looking for. Stay tuned.

Dave Moenning

David Moenning is Chief Investment Officer at Heritage Capital Management, a Chicago-based registered investment advisory firm. Mr. Moenning began his investment career in 1980 and formed Heritage Capital in 1989. Dave’s firm focuses on “active management” and focuses on managing market risk on a daily basis. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Mr. Moenning is the 2013-14 President of NAAIM (National Association of Active Investment Managers) an organization dedicated to active management strategies. Follow Dave on Twitter at @StateDave.