Thursday, October 07, 2010

Stock Market Update

UPDATE 9 Oct 2010: The DOW Jones Industrial Index has risen past the 11,000 mark and it did so after pretty dismal job numbers were announced:

http://finance.yahoo.com/news/Stocks-rise-on-hopes-of-Fed-apf-3699233512.html?x=0&sec=topStories&pos=main&asset=&ccode=

NEW YORK (AP) -- Stocks rose Friday after another weak report on unemployment added to expectations that the Federal Reserve will step in to prop up the economy. The Dow Jones industrial average climbed above 11,000 for the first time since early May.

High unemployment remains a major hurdle as economic growth continues to be sluggish. The Labor Department's report, considered the most important piece of news on the economic calendar, did little to alter the view that the economy remains weak.

Investors are saying : the economy is weak but that is good for stocks because it means the Federal Reserves will have to print even more money. Someone in the comments section reminded me not to underestimate liquidity....that is precisely how I have been looking at medium term moves in the market....liquidity drives it. However, the longer term picture is not so sanguine. Bernanke's (helicopter Ben as he is sometimes known) money printing is very risky, because inflation can bring as much misery as a weak economy and you may end up with both a weak economy and runaway inflation.
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In my last stock market update[Link], I wrote:

"The market is indeed running up to a peak from end Jul to Aug 2010 and I expect pretty good gains in the near term."

I expected the market to peak in end Aug 2010. For market watchers, you will know that is not the case and I was wrong - all part of the hazards of the inexact science of forecasting stock markets. The market after a brief but sharp correction Aug run up all the way in Sep 2010 and was still going up as of yesterday. For those who think that it is because the US economy is doing better, companies are making more profits and global economy is looking up that we are seeing this rally. ....think again.



The red line shows the Dow Jones Industrial and blue line the EURO/USD exchange rate.

In the 1st cut, it looks like a highly correlated lock step movement. However, if you look more closely, you will notice the exchange rate movements lead the US stock market slightly. The other thing that is very clear is the US economic recovery is weakening[Link] as seen from a broad number of indicators. Like I mentioned in my previous posts, Singapore stock market is outperforming because of favorable allocation to emerging markets - thanks to countries like Indonesia, the Indonesian stock market is hitting all time highs. What is actually going on is the weak US dollar is holding up markets ranging from gold, oil, commodities to emerging market stocks. The US stock market bottomed on 26 Aug 2010, when Ben Bernanke announced on 27 Aug that the US Fed is willing to print more money[Link] (known as QE2), the US dollar weakened and stocks around the world rallied. This new printed money or promised printed money is what threw my forecast off. This "weak dollar" trade [Details here Link] in which traders borrow US dollars cheaply convert them to other currencies to invest in risk assets is self reinforcing - it further weakens the US$, push up assets to which liquidity is flowing which in turns encourages traders to borrow more US$ in a self-reinforcing cycle. Although this results in big trends (up) for risky assets, what happens at the end of the day is large built up of short US$ positions, highly leveraged positions in various assets. The large short position in US$ can result in abrupt short covering and deleveraging of other assets sometimes known as "de-risking". The rule of thumb is the longer the markets rise due to this weak dollar trade, the more abrupt and deeper the falls are.

Under the above situation, the longer the markets rise, the riskier things becomes but the psychology of investors is such that they perceive risks fading and take bigger risks. It is not clear how far the current rally will go, but I feel is can get nasty when the whole thing reverses. Printing money cannot be a panacea...somebody is paying as Bernanke debases the US$ - this is an old trick[Link] going back to the time mankind used salt and sea-shells for money.

17 comments:

Anonymous said...

It is not at all surprising that ICI's latest weekly flow report confirms what everyone with half a brain has known for a long time: the 22nd weekly outflow from domestic mutual funds is now in the history books. One more month, and we will have had an unprecedented 6 months of consecutive outflows, even as the market continues to levitate ever more incredulously on nothing but Fed POMO action (and Brian Sack's much more stealthy "collaboration" with Citadel), vacuum tube upward feedback-loop momentum on no volume, and the custodian banks' terrorist forced buy-in action in ETFs like SPY and IWM. Absent these three factors stocks would have been around 50% lower. In the meantime, and contrary to what CNBC was misrepresenting on national TV, the 22 weeks of consecutive outflows now amount to $76 billion in capital taken out by retail investors from domestic stock funds, and $75 billion YTD. And here is the scariest statistic for the administration, the Fed, and bankers around the world: in September $20 billion was pulled out from domestic stocks. This occured despite the nearly 9% surge in stocks. Which means that the bankers, the HFTs, the Fed, and whoever else may be accumulating stocks in expectation of retail jumping in for the latest round of passing the hot potato, is out of luck. With the failure of this latest attempt to sucker retail "dumb" money into stocks, cannibalization time for the big boys has finally arrived. Have fun passing the steaming bucket of explosive feces to each other, boys.

http://www.zerohedge.com/article/22nd-weekly-outflow-mutual-funds-contradicts-earlier-statement-bob-pisani

Anonymous said...

So the brotherhood guy was spot on after all. He advised to stay invested. But last night, I heard they got out of the market. They seem to have a very funny idea of the stock market, when everybody flees a burning house, they go in and buy up everything. When everybody thinks it's safe to buy in, they sell.

Anonymous said...

Anytime there is information, there is the opportunity for analysis. I don't listen to CNBC, or any of the "expert" analysts. I've been investing and trading profitably in the stock market for the last 7 years, based on a proven system, not what other folks are saying.

Aneshia Smith
ITATI.typepad.com

DanielXX said...

never underestimate the power of liquidity.

Anonymous said...

"Printing money cannot be a panacea...somebody is paying as Bernanke debases the US$ "
- Lucky Tan

The trick is to ensure there is somebody willing or forced (no choice) to pay in order to protect their own interest. Because if that somebody or bodies don't pay, they will end up worse off.

If this is ensured, they can continue to print money without it becoming toilet paper.

So far so good, on printing money, that is.

Anonymous said...

Between inflation and deflation, which is the lesser of the evils ? Then given the huge debts on the books of the Western nations, which is the best way to reduce the debts ?
So it is clear that the solution to the current Western Problem is to print more and more money. By diluting the value of money, the debts on their books becomes comparatively smaller.
Those who are assets poor will pay dearly. High inflation must come. World resources are limited while the population and rate of consumptions gallop away.

Anonymous said...

That seems to be the problem with technical analysis. It all seems to make sense on hindsight.

Yet, predictions can be thrown off-course by unexpected human behaviour; from terrorist attacks to decisions to print more money.

It seems that fundamental analysis might be a much safer bet, as long as the books aren't cooked.

Fox said...

The Feds don't print money or create money out of thin air. They usually inject liquidity by buying up securities, government or private. That's how central banks all over the world increase money supply. Maybe not in Zimbabwe.

Lucky Tan said...

Fox,

That is precisely what people mean when they say the central banks are printing money or monetising the debt. It is not physical printing presses working overnight.

Lucky Tan said...
This comment has been removed by the author.
Anonymous said...

Dear Mr Lucky

I think your pet Fox was trying to explain the technicalities which you dun quite seem to grasp. But I take you word any day based on your track record of superior returns.

So buy or sell? Next week's forecast is good enough.

Anonymous said...

I think the anon was only trying to say that your technical charts seem to make perfect sense on hindsight.

Technical charts do not accurately predict human behaviour which could include injecting more liquidity into the market or crime or contrarian behaviour or something out of the blue.

It's a pity your answer revolved around whacking his "printing of money" term.

Fox said...

"Printing money cannot be a panacea...somebody is paying as Bernanke debases the US$"


Actually, I don't understand what you are saying here, Lucky. The Feds are just buying securities from the Treasury and the private sector.

Consider the reverse situation. Suppose the Treasury sell more T-Bills and the Feds don't buy any of the T-Bills. This means that Treasury will be sucking liquidity out of the money supply. In that case, does it mean that your USD account is now more valuable?

Lucky Tan said...

Fox,

I'm really trying to understand the question you're asking.

The Fed to buy up US treasury bills = monetises the debt. It is also commonly known as printing money. Where does the Fed get the money to "buy" the treasury bills? It creates this money out of thin air - the technicalities may be some electronic book entry at the Fed but basically it creates money that previously doesn't exist. Hence, it is equivalent to printing fiat money.

Printing money debases its value just like the Japanese banana money in WW2. Initially, you need a pocketful to buy something then you need a truckload to buy the same thing.

Buying securities=printing money because the money used to buy those securities is created out of thin air.

Here are some references:

http://www.economist.com/economics/by-invitation/guest-contributions/if_feds_going_monetise_debt_nows_time_do_it

http://www.marketoracle.co.uk/Article23185.html

Anonymous said...

Creating something out of nothing is akin to mankind creating gods.

Mutual Funds said...

We're here to stay too, Greta! Thank you for your honest words said with love.


Best Regarding.
Mutual Funds

Stocks and investments said...

Nice informative article. thanks for sharing and keep sharing such kind of articles, as these articles really helpful for experienced and new comers..