TBTF October 27, 2010 - 'Cause I've been away too long

Too Big to Flail

October 27, 2010

‘Cause I’ve been away too long, and every day I missed you more. You look like you did before, only prettier. And every day I missed you more, and more and more and more’ (Racoon – 2005)

I’ve been away fro a few days, hence my “Too Big To Flail” has not been published, and by god, the market looked like it did before, only prettier. It seems there is no possibility for the markets to close lower, although we seem to be running out of steam on the rally. Since Sep 1^st we have had 10 down days (of which 6 were only slightly lower closings), which is a phenomenal record. I say the rally looks like it is running out of steam because Mondays price action was to the downside most of the day and yesterday made it just barely into the green, and what both days had in common was that the VIX closed higher on both instances. And that is usually a sign that volatility, i.e. down days, are on the horizon.

Is there nothing the markets need to worry about? Well, yes, enough!

• Economic data that seems to be stabilizing or getting slightly better
• Corporate Earnings that are not half bad
• Mid-term elections in just over a week
• Germany getting fed up with the rest of Europe
• China talking tough on QE II
• Which happens to be announced next Wednesday

Economic data in the US and Europe seems to be at least stabilizing if not improving slightly. Industrial production in Europe for one keeps beating expectations. German factories must be buzzing with activity if we are to believe these statistics, but then again everyone believed the Greeks when they said GDP would grow this year and look how that turned out so far. But, as long as we are getting better macro-economic numbers QE II has less of a chance to get implemented and seeing as the market is expecting a lot of $1, $5 and $10 bills being thrown at it, that is not a good sign.

Same goes for corporate earnings. They might be improving, from very low comparables, but at this time it is not good for the market. That is the paradox we live in nowadays, a world where the FED’s expectations game has more impact on valuations than earnings and revenue.

The mid-term elections are coming up in a week, more seats are up for grabs or heavily contested than in the last few mid-term elections and perhaps it’s because tea-party candidates are making a stronger showing than expected, but we don’t seem to hear an awful lot about it. Wall Street seems to want a house and senate in gridlock. An environment in which new regulations will be either voted out by republicans, or vetoed by Obama. And who said ‘Change it Good’?

The most interesting rhetoric came from Europe this morning, where German government officials were making threats against their European brethren. They said ‘Germany won’t back the Euro stability fund after 2013’, ‘EU needs treaty change to avoid Euro crisis’. Just like Weber versus Trichet, German politicians seem to take a stand against their European colleagues. They want to clean up this mess, while the rest of Europe wants to sweep everything under the rug and pretend nothing ever happened. Question of the day is: will Germany make good on their threats at the end of the day, or will they soften their stance in the coming weeks/months, or is this all just a way to soften the Euro. It seems everyone ‘wants’ a strong currency these days, yet does their best to be the first to really weaken it.

China is getting more and more vocal about Mr. Bernanke cranking up the printing presses next week. After threatening to lower the exports of ‘rare earth minerals’ to the US, the Chinese commerce minister yesterday said “Dollar issuance by the United States is out of control, leading to an inflation assault on China”. Of course, if they really wanted to make a statement they would just dump more treasuries on the open market than the FED can buy, but as with most politicians, they can talk the talk, but walk the walk?

QE II. The expectation of the amounts of fresh, crisp, new money to be printed next week, is reaching laughable heights. If $700 billion - $1 trillion wasn’t high enough, there are now rumors circulating of an unimaginable $2 - $3 trillion. If true, I guess DOW 36.000 will be reached before the end of the year. The above number is highly doubtful of course, since no one on this earth can possibly be happy about the sudden, but all to true, collapse of the US Dollar. Not Europe, Not Japan, Not China and Not even Ben Bernanke himself. I think the markets are setting themselves up for a fall and the risk/return on a short trade just before the announcement of the amount of QE II seems to be getting better as the days go by.

The markets ended flat as previously mentioned. Noteworthy though was the lack of correlation between the $ and the other asset classes. With the $ substantially against the Euro and the Yen we would have expected to see Gold, Oil and the markets to end in the red, but all asset classes staged a late day rally to end the day virtually unchanged. Too much of a coincidence for my taste.

Dow +0.05% S&P500 +0.00% Nasdaq +0.26% EUR$ 1.386 WTI $82.50 Gold $1340

Happy Hunting & Let’s Be Careful out there!!!