Trading Thoughts for Week of January 30

Central bankers have once again decided to take matters into their own hands. They are getting ready to print more money, and it seems that there will be no end in sight. It is clear that they are afraid to let equities decline any further.

Did they know early?

I continue to think that RMBS-targeted QE3 is not a bad idea, because it is going to help ailing U.S. housing market. But what Fed did on Jan 25 was not that at all. FOMC further extended the "extended period of time" of "exceptionally low" rates, but more importantly, gave a grim economic outlook.

Fed chairman continued to provide more downbeat assessment at subsequent press conference, asserting that economy has not improved that much, to the chagrin of some arguing reporters.

Only two days later, preliminary 4Q2011 GDP report has revealed the reason for Fed's worries. If you do not like digging into economic numbers, I will provide a few highlights. Underlying data was much weaker than headline number (which slightly missed the expectations): inventory build accounted for 69.3% of total GDP growth, because of that real final GDP sales were the lowest since 1Q2011 and grew at only 0.8%, govt spending contracted severely by 7.2%.
Do you think a little birdy flew an early message to FOMC, just in time for their meeting on Tue-Wed? Or has Fed chairman developed an ability to see through walls, after totally missing Financial Armageddon, resulting from the "contained" sub-prime crisis? Everyone was shocked by FOMC's dovish statement - Fed obviously knew. Their interest rate decision cushioned the ultimate outcome of disappointing 4Q GDP.

Fighting this sea of liquidity is considered (by many) to be a money-losing proposition, but it really felt right this time, at this trendline resistance on SPX. Perhaps one has to take profit on this trade more often and earlier than usual, because it is so against the trend. This is not a suicide mission though, as the stop is already at break-even. There is no strong conviction on charts to support this trade. Daily and even weekly Stoch is now embedded in buy mode. Should they disembed and provide a further sell signal, adding to position would be prudent. One has to remember that in U.S. presidential election year equities typically oscillate the flat line by 5%, until it is clear who wins. At 1333, on Jan 26, SPX was up 6% YTD.

Across the pond, more central bank madness...

Things are getting worse in Europe, economically speaking.

In UK preliminary 4Q2011 GDP contracted 0.2% (worse than expected). BOE may need to do another round of QE to reignite the economy. That will put pressure on GBP.

In Spain unemployment has risen to mind-boggling 22.8%. This is prompting Spanish govt to ask EU for some easing of austerity measures (according to some officials).

The worst development may perhaps be occurring in Portugal. Its debt is now rated junk, unemployment is projected to reach 14.2% by 2013, GDP contraction forecast for this year has deteriorated to -3.2%, and debt to GDP will surpass 100% in 2012.
So it looks like market has found its new victim - Portugal's 10 Yr Bond Yield closed above 15% on Friday, and CDS blew out to historic highs.

But most of the news above are no worry to heroic ECB, which is now flooding EU banks with cheap liquidity. Another round of LTRO is scheduled for February, and rumors are that there will be more takers at that marvelous handout party. Banks will bring their worthless collateral - sovereign bonds of insolvent EZ govts, and get all the euros they need at 1%. Folks, there is one big problem with all of that - money will end up as deposits back at ECB or even worse - go into the same sovereign bonds of insolvent EZ govts, which are yielding a hefty carry over LTRO rate. What a nice ponzi scheme, Bernie would be proud!

Of course, ECB will make us believe that it is not so, and that this refinancing operation will improve lending in EZ, therefore returning the growth to recession-bound region. We will see, I say. In the meantime, loans to consumers and businesses in Euro Area have contracted the most on record in December of 2011.
Mr. Draghi (ECB president) himself said it is not certain that LTRO has resulted in any new lending by participating banks. You are correct sir, but we will give it some time, nonetheless. Somehow I think that LTRO is going to end up just like TARP in U.S.

All LTRO will do is alleviate bank liquidity problems, leaving the sovereign insolvency well in effect. It is only through new private lending, which will result in pickup of growth, that Eurozone can solve its debt crisis.

Due to these continuing negative developments, it is hard to believe that current euro rally is anything more than just a retrace in overall downtrend. Bears want to think that Wave 4 should be ending soon and a retest of lows will ensue. Market though is a discounting mechanism, with much of the bad news seemingly already priced in. The newly reported short interest, largest ever on record, may cause short covering last longer. Once this retrace is over, wave 5 down should begin and prevailing downtrend may continue. But it is hard to call for much lower levels below 1.2625 until monthly symmetrical triangle is broken on closing basis. With two trading days left in January, it looks like we would have to wait for February's close to tell us what happens on that particular front (chart below).