The Elections and QE2 are in the Bag - What Now?

From Phil's Stock World - this pretty much sums it up....

"After putting over $2Tn into our Dead Parrot Economy since the crash and getting no response, Bernanke is upping the ante with another $600Bn round of Quantitative Easing ON TOP OF the ongoing $250-$300Bn round of POMO commitments for a total of about $110Bn per month dumped into the economy between now and the end of Q2.  This represents a 10% increase in the money supply over 8 months and, therefore, a planned 10% decrease in the purchasing power of your dollar-denominated assets or, to put it bluntly – a 10% tax on everything you own.

That is the joke of this country.  People sit there arguing about whether or not to extend a tax cut that will cost 3% of a year’s salary while the Fed, with no electoral oversight, is simply taking 10% of your LIFETIME savings – AGAIN!  They did it last year, they did it this year and now they promise to do it next year too.  That’s 30% folks! "

What can I say?  He's absolutely correct, and the sad part about it is, most Americans are completely oblivious to this concept. 




Let's begin with the actual news release yesterday from the New York Fed

On November 3, 2010, the Federal Open Market Committee (FOMC) decided to expand the Federal Reserve’s holdings of securities in the System Open Market Account (SOMA) to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. In particular, the FOMC directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.

The FOMC also directed the Desk to continue to reinvest principal payments from agency debt and agency mortgage-backed securities into longer-term Treasury securities. (SingleMalt - this is the POMO component) Based on current estimates, the Desk expects to reinvest $250 to $300 billion over the same period, though the realized amount of reinvestment will depend on the evolution of actual principal payments.

Taken together, the Desk anticipates conducting $850 to $900 billion of purchases of longer-term Treasury securities through the end of the second quarter. This would result in an average purchase pace of roughly $110 billion per month, representing about $75 billion per month associated with additional purchases and roughly $35 billion per month associated with reinvestment purchases.

Now let's consider the election results....a route for the Democrats and a blatant slap in the face for the Obama administration and their policies over the past two years.   Now we have the Republicans promising "change", with news sound-bytes alluding to a repeal of Obama-care and an end to excessive Government spending.  On the surface, it sounds pretty good...it always does...but let's not forget some of the other Republican policies that were partially responsible for leading us into the financial crisis to begin with - like loose to non-existent regulation and control over the banks and capital markets.  This quote from Phil (Phil's Stock World) that I found yesterday on Zerohedge captures it perfectly -

Already the commodities are flying in celebration of the return of control of the House to Republicans.  There will be no legislation, there will be no investigation, there will be no restrictions at all and oil already jammed up to $85 in pre-market trading along with gold back over $1,360 and copper back at $3.85.  Isn't that great?  $5 more per barrel costs US consumers $100M a day and there's NOTHING they can do about it. They must spend it and that's more credit card transactions and more retail spending on gas, which we'll use as data to pretend the economy is improving - BRILLIANT!

Click here for the full article...

So now that all of the recent uncertainty is behind us, what should we expect?  If last year's QE1 is any indication, we should see a significant rally in stocks over the next 8 months, but let's start with the more immediate reaction.  So far, and a bit to my surprise, we have not seen a "sell the news" reaction in stocks, in fact, quite the opposite, as the markets all ended higher yesterday and have gapped up big this morning.  Below is a daily chart of the SPY.  Note the very defined channel that has been established over the past several months and how we ran into the top trendline this morning just after the open.  (All charts below are clickable.)

As you can see, there is strong support and resistance along both sides of the channel.  We also have the 2010 highs from April coming up shortly, and one would expect some initial resistance at this area prior to the rally moving forward. 

But remember what I previously posted....the direction of the stock market will likely be defined much more by the currency markets than corporate performance, and lately it has been all about the US Dollar, so let's take a look at what's been happening in Forex-land since yesterday's Fed announcement. 

Above is the US Dollar index, and as you can see, the immediate reaction is a continuation of the USD's downward spiral, as we took out the Ocotober lows this morning and appear to be headed much further.  Next support is 74.   Below is the Euro-USD currency pair, and as can clearly be seen, the Euro has resumed its ascent, currently trading at $1.42 against the USD. 

There are two things to keep in mind here as the Euro starts going parabolic again.  First off, as I mentioned in a previous post, the Europeans are not at all happy with a strong Euro, as it has a negative impact on their exports.   Secondly, don't forget that although the Euro has shown recent relative strength, it is a far weaker currency than the dollar, and it won't take much for it to get clobbered again, a la the Greece debacle earlier this year.  To wit - Ireland is getting ready to implode, as the spread of their sovereign debt vs. the Bund hit historic highs yesterday.  See here for a short blurb courtesy of Zerohedge.

The one area that I haven't yet spoken to over the past several months is how all of this activity in Forex and stocks relates to the price of precious metals, specifically Gold and Silver.  Unless you've been living in a cave over the past several months, you are all probably aware of Gold's performance, as it has made new all time highs.  As can be seen in the chart below, Gold has been taking breather over the past couple of weeks, but in the wake of the QE2 announcement, looks to be resuming its climb this morning. 

Now take a gander below at Silver.  While Gold has been getting all of the headlines, Silver has been enjoying an even greater parabolic ride, and this morning has already broken out to a new, relative high (silver's all-time high was somewhere in the $40's back in the early 1980's). 

So why am I making mention of this now?  Well take a look at when both Gold and Silver started going parabolic up, and compare it to when stocks started their latest rally - end of August/beginning of September.  Do you remember what also happened at that time?  If not, I'll remind you.  That is when the Fed announced the resumption of POMO, which began the latest crushing of the USD.   There is no coincidence here folks.  Precious metals are and will always be the ultimate flight to safety when countries devalue their currencies.  At the end of the day, 99.99% of all global currencies are fiat - nothing but useless paper, backed by nothing, and they only retain any sort of value if their respective Governments act in a responsible manner.   Printing trillions in new dollars is anything but responsible, especially in the eyes of the rest of the world who rely on the USD as the global reserve currency, and medium of exchange for most international transactions. 

I could write volumes on fiat currencies vs. precious metals, but let me get back to the original point of this post - what to expect from here.  Ben Bernanke expressed it best himself in this Washington Post article:

"...higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."

So there you have it....Ben, like his predecessor, Alan Greenspan, fully believes that ramping the stock market will lead to economic recovery, so expect to see another rally in stocks over the coming 8 months.  Does this mean there is now zero risk, implying that you should leverage up and go all-in?  Some people will clearly think so, but I think risk is always present.  Over the coming months I will definitely be positioning myself to profit from what should be another parabolic move in stocks, but I will always be hedging with precious metals and low cost insurance that can be found in bearish, multi-month forward, far out of the money options.  For those who still believe there is no risk, the best of luck to you, but here are a few parting thoughts to consider....

1.  Only 10% of the "consumers" mentioned above in the quote from Bernanke's article have any contact with the stock market, so while the Fed's actions will continue to feather the nests of Wall Street investors and insiders, it will have no impact for the majority of Main Street.  As Phil mentions in his quote at the beginning of this post, we have already seen $2 trillion +  in QE thrown at the system, and we are still faced with a sluggish economy and high unemployment.  I personally think that it is ridiculous for Bernanke to still believe that QE2 and a rising stock market will do anything to resolve the problems on Main St.

2.  All is not well in Euro-land and another crisis over there will likely trigger a dollar rally and a stock sell-off.

3.  Don't forget about the ever increasing flash-crashes that we've seen over the past several months in individual stocks, and the potential for another major flash across the markets like we experienced in early May. 

I could list a few more, but I'll let it go for now.  Good luck trading.