Archive for October, 2010

Quantitative Easing and Asset Price Inflation

Friday, October 29th, 2010

A common misconception on Wall Street is that the goal of quantitative easing (QE) is to flood the banking system with additional reserves in the hope it will lower interest rates and spur traditional bank lending. In reality, QE has very little to do with traditional banks, or traditional bank lending. In fact, QE’s primary goal is not to lower interest rates. In order to make the best investment and asset allocation decisions possible, investors need to understand the Fed’s QE motives and objectives. They also need to understand how QE works in the real world and how the freshly printed money makes its way into a wide range of global asset markets.

QE attempts to flood the global financial markets with fresh cash in an attempt to reinflate asset prices. When the stock market goes up, people and businesses feel more wealthy, and are thus more apt to spend, invest, and take risks (in theory). Rising asset prices can improve the asset side of impaired global balance sheets, which the Fed hopes can rekindle the wealth effect. It is very difficult to get a loan when your personal balance sheet is impaired. If the Fed can boost asset prices, balance sheets become more attractive in terms of the ratio of assets to liabilities. Why do businesses and consumers need to deleverage? The answer is their balance sheets have too much debt and too little equity. Deleveraging was not a hot topic when asset prices were rising.

Our perspective of quantitative easing at CCM is not all that relevant. An individual investor’s perspective of QE is not all that relevant. What is important is the Fed’s perspective of QE and the perspective of the firms, companies, individuals, and entities who will be receiving large quantities of U.S. dollars created out of thin air by the Fed.

At CCM, we are not fans of money printing. However, the Fed believes money printing is they way to go and they are the ones making the calls that impact asset prices and the purchasing power of the U.S. dollar. You may or may not agree with QE, but it is happening and will most likely continue to happen for years to come. If we are printing money now, what do you think will happen when the Medicare and Social Security situations really get dicey in a few years? The political will is not there and will not suddenly surface to tackle our problems head-on as we should. It is much easier for those in power to print money hoping they can goose the financial markets and economy long enough to get reelected or reappointed one more time. As long as central bankers are running the show, money printing and inflation are here to stay. The problems with debt are going to get worse in the future, not better. Unfortunately, once policymakers start to play with the money supply, it becomes very difficult to stop.

Today’s video in our six part series on quantitative easing discusses who gets the Fed’s printed money and how that money can find its way into the global financial markets. The flow chart below shows the basic topics covered in the fifth QE video. To best prepare for QE2, QE3, and QE4 (which will all probably come over time), we need to understand the lines of business and clients of the Fed’s eighteen primary broker-dealers. PNP Paribas is one of the eighteen dealers; they are based in Europe and their clients include alternative asset managers and pension funds. Their wide array of business interests span from foreign exchange (currencies) to asset protection structures.

Quantitative Easing How Does It Word - QE Explained

Part five of our six part video series on quantitative easing and QE’s possible impact on the financial markets outlines the global reach, lines of business, and clients of the Fed’s eighteen primary dealers.

Stock Market Blog - technical analysis

Stock Market Blog - technical analysis

Above is part five of the six part series, below are links to parts one through four:

Dollar Weak Today, But Not As Weak As It Looks

Thursday, October 28th, 2010

The U.S. Dollar is weak today, but the desire to sell weak dollar assets recently has been greater than today’s desire to buy weak dollar assets as reflected in today’s trading volume vs. recent volume. The point is there is no stampede by big money to protect against a weak dollar today. This is not what we would expect if the dollar were about to make another big move lower. If volume picks up late today or in the coming days, we would become more concerned – we are watching the greenback very closely.

S&P 500 Risk Reward Analysis

Bulls In Control, But Stock Market Has QE Fatigue

Thursday, October 28th, 2010

The quantitative easing (QE) talk on the street this week has been along the lines of (a) is quantitative easing baked into asset prices?, (b) will the Fed’s announcement on November 3rd trigger a “sell the news” event, (c) the perception of too much QE could spark inflation fears and push interest rates up, and (d) too little QE could result in a “disappointment sell-off” in stocks and commodities.

With the information we have in hand now, the market is set-up for a “sell the news” event next week. Prior to reviewing some concerns, we should note a convincing break above 1,185 on the S&P 500 (SPY), occurring on strong volume and positive market breadth could clear these “sell the news set-ups” below. Another bullish possibility, in the short-term, is a weak break above 1,185 that is retraced within a in week or two.

The take away here is we plan to proceed with caution relative to stocks and cyclical commodities until these yellow flags are displaced in some shape, form, or fashion. The comments below are also relevant to the NASDAQ (QQQQ) and the Dow (DIA). The NASDAQ is the clear leader at the moment, but it is unlikely the QQQQ’s would sidestep a market correction for more than a day or two.

Market breadth refers to the number of advancing issues and the number of declining issues on a given market. Healthy markets have positive breadth or broad participation in rallies. The Summation Index, shown below, is an intermediate-term measure of market breadth. The S&P 500 is shown at the top of the chart. A strong market has a Summation Index line with conviction and a steep slope. Notice the lack of conviction in the Summation Index since roughly mid-September, over a month ago. Also see how the market can react after the Summation Index turns down. Markets can advance for a time with weak breadth, so this represents a yellow, not a red flag presently.

Stock Market Looks Tired - Up Down Volume

There is an expression on the street, “price follows volume”. Volume is a way to measure the conviction of buyers and sellers. $NYUD, below, shows the volume of advancing stocks less the volume of declining stocks; strong markets have rising lines – weak markets have falling $NYUD lines. The line below could easily turn back up, but notice it has been rising for roughly eight weeks as the market advanced. It is stalling out and turned negative recently, which is another yellow flag as long as the condition remains.

Volume shows a tired market

The CCM Bull Market Sustainability Index (BMSI) uses historical market profiles to better understand the current market’s risk-reward profile. The current reading on the BMSI is bullish for the longer-term, but also shows some concerns in the shorter-term (see orange and yellow boxes in one to three month outlook). The BMSI has been falling in recent days, also showing a tired market.

Bulls in Control, But Stock Market Looks Tired

The CCM 80-20 Correction Index uses historical market profiles to better understand when the risks of a correction in the present day are elevated. The 80-20 Index is also flashing some “be careful” warning lights as the daily value has dropped from a high of 675 on October 8th down to yesterday’s close of 366.

We see additional concerns relative to a pullback occurring sometime in the next two weeks when we examine the S&P 500 Index. Technical charts can look intimidating, but the concepts are relatively simple. When healthy markets make new highs, technical indicators also make new highs showing the market’s momentum remains intact. Weaker markets, that are losing upside momentum, see price make a new high, but the indicators make a lower high. Compare the green arrows (price) to the orange arrows (indicators).

Stock Market Looks Tired - Up Down Volume

The third indicator from the bottom in the chart above is the Bollinger Band Width. Bollinger Bands deal with market volatility. The concept is when volatility contracts, markets are consolidating. Often periods of consolidation are followed by periods of volatility or big moves in price. The orange box shows a sleepy Bollinger Band Width, which almost like a coiled spring waiting to release its energy. The energy may be released with a move to the upside or downside. On the precious metals front, it has been two weeks since gold made a new high. Until some of these conditions described above are cleared, we are more concerned about either a false move to the upside (short-lived) or a break to the downside. This analysis speaks to risk and reward, meaning bullish outcomes are possible – they are just paired with increasing short-term risk.

You can access the next video in our six part series by clicking on the image below. The video gives some insight as to why the Fed is printing money. If we understand some of the Fed’s motives relative to QE, we can make more informed investment decisions.

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Dollar Attempts to Make Bullish Turn

Wednesday, October 27th, 2010

The U.S. dollar is attempting to complete step three of a trend change, which would increase the odds of a correction in stocks, gold, oil, silver, and risk assets in general. Step one (see labels in chart) was a break of the downward-sloping trendline; step two was making a higher low; step three would be to make a higher high. The dollar bull ETF (UUP) is shown below a proxy for the U.S. Dollar Index.

U.S. Dollar Attempts to Make Bullish Turn - Chart - Technical Analysis

Even if the dollar cannot muster a rally in the short-term, a weak move lower would probably foreshadow a move higher; meaning the odds are good the dollar will begin a rally sometime in the next week or so. There is no need for us to guess here – we can monitor markets and see where we close over the next few days. A close in gold below 1,328.50 (see chart in post) would increase the odds of a correction in risk assets. One more push higher in gold/stocks/commodities cannot be ruled out, nor another round of weakness in the dollar. Regardless of where we go in the short-term, we remain on correction alert for risk. Notice all comments relate to “odds”, which speaks to keeping an open mind.

What is Quantitative Easing? Fed’s Perspective & Writings

Wednesday, October 27th, 2010

Part 3 in a 6 Part Video Series on Quantitative Easing

A Wall Street Journal article (10/27/10) on quantitative easing (QE) hints the Fed will take a middle of the road approach in terms of the size and duration of QE2. As we would expect, the stock and commodity markets’ initial reaction is negative. A middle of the road approach to QE seems counter intuitive to the Fed’s own historical analysis of why quantitative easing was ineffective in Japan. In CCM’s July 2010 review of James Bullard’s Seven Faces of “The Peril”, our read between the lines interpretation of Bullard’s take on QE included:

In order for quantitative easing to sufficiently increase future inflation expectations, market participants must believe the Fed will do “whatever it takes for as long as necessary” to obtain the objective of sufficiently positive inflation. This means the Fed must be willing to leave balance sheet expansion in place for as long as necessary to create expectations of higher future inflation by market participants (consumers, investors, companies, etc.). This reminds us of past “bazooka-like” policy moves, where policymakers would say, “You think we can’t create positive inflation? Just watch.”

The key to next week’s Fed statement on QE will be how they address the concept of “whatever it takes for as long as necessary”. We can use gold and the U.S. dollar to monitor the market’s reaction to QE2. On October 11th in U.S. Dollar Could Rally In Coming Weeks, we hypothesized QE2 could be a “buy the rumor, sell the news event” relative to risk assets. Since October 11th, the dollar index has moved from 77.18 as high as 78.36; a move above 78.36 would increase the odds of the U.S. dollar having a multi-week countertrend rally. On October 13th with the S&P trading at 1,169, we listed 1,196 as a possible short-term upside target. The S&P 500’s intraday high on October 25th was 1,196, which means we have entered a zone where the odds of a short-to-intermediate-term reversal have increased (emphasis on odds). Stock market breadth on October 26th was weak, adding to the list of concerns over the next few days. We recently mentioned some yellow flags in the gold market. Thus far, gold is holding up well enough that a push to new highs still could be in the cards. From a short-term bearish perspective, a break of the thin blue trendline below would increase our concerns about a correction in gold. The long-term fundamentals for gold remain sound.

Quantitative Easing - What is it?  Gold as a way to monitor QE

What is quantitative easing? - Video: In part three of our six part series on quantitative easing, we examine Fed statements, writings, and publications related to the objectives of, and rationale behind, QE2. The analysis of some key Fed commentary on quantitative easing allows us to better understand the Fed’s perspective relative to QE’s possible impact on the financial markets, investing, the economy, interest rates, asset prices, and the wealth effect. Today’s quantitative easing video also touches on the following:

  • Duration of QE program
  • Consumption
  • Investment
  • Ben Bernanke’s “printing press” speech
  • U.S. dollar devaluation
  • Fiat / paper money system
  • Spending
  • Inflation
  • Dividend-paying securities (video player below)

Stock Market Blog - technical analysis

Stock Market Blog - technical analysis

Above is Part 3 in the QE series; previous QE videos:

Quantitative Easing (QE2): Who Gets the Fed’s Printed Money?

Monday, October 25th, 2010

Part 2 of a 6 Part Video Series on Quantitative Easing: In Part 1: Quantitative Easing Targets Asset Prices, Not Bank Reserves, we discussed how Mr. Bernanke’s quantitative easing program is implemented via the Fed’s eighteen primary dealers, not traditional banks.

We do not know the size of the Fed’s program, nor do we know how the markets will react in the short-term. However, one thing we know with near certainty – a large quantity of newly printed money is going to flow from the Fed to the eighteen primary dealers. We also know a significant amount of the electronic greenbacks will flow from the primary dealers into the accounts of their clients.

Since the Fed encourages the primary dealers to offer client bonds in the QE competitive bidding process, it is helpful for investors to know more about the clients of the primary bond dealers. Sovereign wealth funds, who do business with numerous primary dealers, will be one of the most influential groups who may participate in QE2. A sovereign wealth fund is a state-owned investment fund, which holds a wide variety of financial assets, including stocks, bonds, commodities, currencies, precious metals, and real estate.

One of the largest sovereign wealth funds is the Norway Global Government Pension Fund, which holds somewhere in the neighborhood of $400 billion in assets. Others include the China Investment Corporation ($300 billion), Singapore Investment Corporation ($250 billion), Hong Kong Monetary Authority ($225 billion), the Russia National Welfare Fund ($140 billion), and the Australian Future Fund ($60 billion).

Video: Quantitative Easing Explained

Quantitative Easing Process

To give a hypothetical example of how the Fed’s newly printed money can make its way around the globe, assume the following: (a) concerned about the currency risk associated with holding too many U.S. Treasuries, the Singapore Investment Corporation (SIC) decides to sell some bonds to the Fed via the QE2 program, (b) the Fed takes the Treasuries and the SIC gets newly printed U.S. dollars in return, (c) since holding U.S. dollars also entails currency risk, the SIC decides to diversify into gold, global stocks, and emerging market bonds. This hypothetical example shows how the Fed’s printing press can, in theory, create demand for other assets and thus, help drive asset prices higher. Higher asset prices can help improve strained balanced sheets which can, in theory, spark more spending, investing, borrowing, and hiring (emphasis on in theory).

Understanding the global footprints of the primary dealers and their clients allows us to visualize the broad geographic reach of the Fed’s printing press. Understanding the buying power and investment influence of large clients of the primary dealers, like sovereign funds, helps us understand how QE2 may potentially impact a wide range of markets from currencies to commodities.

The flow chart below shows how the Fed’s newly printed cash can flow from the Fed to the primary dealer, then to the primary dealer’s clients.

Quantitative Easing Explained How Does It Work - QE Explained

With the million dollar question relative to QE2 being the magnitude of the Fed’s planned bond purchases, we can expect some volatile trading sessions for the next week or so. According to a Forbes/CNN article:

Economists at Goldman Sachs estimate the Federal Reserve may need to buy a staggering $4 trillion worth of assets such as Treasury securities to get the economy rolling again. The Goldman economists, Jan Hatzius and Sven Jari Stehn, don’t expect the Federal Reserve to go nearly that far when it resumes its asset-purchasing quantitative easing policy. Citing many officials’ unease with the prospect of adding significantly to the Fed’s already bloated balance sheet, Goldman expects the Fed to end up buying around $2 trillion worth of assets over the next few years.

Traders, money managers, and active investors may want to get some extra rest this weekend; with mid-terms and a Fed announcement coming early next week, both stress levels and market volatility will most likely be elevated.

Hesitant Stock Market Passing Opportunities to Sell-Off

Monday, October 25th, 2010

The market is doing exactly what we would expect near overhead resistance levels; hesitating and looking undecided. Last Tuesday’s (10/19/20) surprise hike in rates by China gave an overbought market an opportunity to sell-off and an opportunity for the bears to take control. Instead of opening weak last Wednesday, the dollar sold off and risk assets found their footing, which is not what we would have expected as of last Tuesday’s close. When the market does not do what you expect it to do, you need to pay attention. Last Friday, the market also had a few opportunities to sell-off, yet the bulls gathered themselves going into the close.

Monday’s action was a mixed bag, much like Friday’s. From a bearish perspective, the markets gave back a good portion of their intraday gains. From a bullish perspective, Monday’s market breadth was healthy. Volume was up vs. Friday’s on both the NYSE and the NASDAQ, but some of that is paired with the afternoon give-back. The U.S. dollar was weak Monday, which gave risk assets a little tailwind as we approach next week’s elections and QE2 announcement from the Fed. We put a relatively small amount of cash to work today, but also kept a decent amount of powder dry given the market’s hesitant stance.

Stock Market Hesitant Breadth

We will be posting the second in a series of six quantitative easing videos either tonight or tomorrow.

Preparing for More Stock Market Upside: ETFs, Rydex, and Dividend Stocks

Sunday, October 24th, 2010

We have recently mentioned our concerns about possible corrections in stocks, gold, silver, copper, and the euro. We also have recently looked at the possibility the stock market may have decent upside into year-end. In the event markets break to the upside this week in a fairly convincing manner, we want to be ready to redeploy some of our cash. In the past three days, we have reviewed all the major ETFs, comparing them head-to-head using our proprietary models.

On Sunday, we are reviewing all the Rydex funds head-to-head. Rydex has some very versatile and flexible funds in terms of trading costs (low to zero) and the ability to enter and exit markets quickly. We want to remain very flexible from both a bullish and bearish perspective based on how things unfold on the economic, political, and QE/Fed fronts in the coming weeks. If the markets fail to break above 1,185 in a convincing manner, we may do nothing with the ETF and Rydex rankings; we just want to be prepared for all outcomes in what promises to be a volatile few weeks between now and the middle of November.

We also recently completed a very detailed study and head-to-head comparison of dividend paying stocks. Our final step will be to compare the best risk-reward ETFs, the best risk-reward Rydex funds, and the best risk-reward dividend-paying stocks.

Video: Quantitative Easing Targets Asset Prices, Not Bank Reserves

Friday, October 22nd, 2010

With markets coming off of overbought levels, bullish sentiment high, and gold backing off a vertical ascent, we believe investors need to be ready for a quantitative easing (QE) disappointment pullback. A “buy the QE rumor, sell the QE news” event needs to be considered from a portfolio management perspective. Having said that we also believe most investors and many financial professionals do not fully understand how QE works in the real world and that one of QE’s primary objectives is to inflate asset prices.

After hearing “QE won’t matter, the money will just sit at banks as excess reserves” from talking heads several times over the past three months, we decided to put together a series of brief videos describing how quantitative easing will be implemented by the Fed and the eighteen primary broker dealers in the coming weeks and months. You may be surprised to learn the Fed is encouraging the clients of primary dealers, including hedge funds and sovereign wealth funds, to participate in the QE2 process. We have studied the quantitative easing concept in detail in order to improve the odds of producing successful outcomes for CCM clients.

Common sense tells us money printing is probably not the path to long-term prosperity and low unemployment, but common sense also tells us after a possible QE disappointment pullback, newly printed U.S. dollars will be finding their way into the global stock, commodity, and currency markets. The big questions are (a) how much QE is coming in terms of a dollar amount, and (b) how much of that money will find its way into the financial markets.

After watching the video below, you may decide quantitative easing is more about inflating the money supply and asset prices, and less about bank reserves and interest rates. We will post five additional videos on quantitative easing over the next week or so, expanding on the concepts presented in the first video, “Quantitative Easing — How Does it Work in the Real World?” A larger version of the flow chart in the video is available below the video player.

Stock Market Blog: Technical Analysis of stocks, commodities, and currencies

Stock Market Blog: Technical Analysis of stocks, commodities, and currencies

Click on image below to view large version of flow chart shown in video (opens new window).

Quantitative Easing: How Does It Work - QE Explained


Stocks May Have 4% to 6% Upside Into Year-End 2010

Thursday, October 21st, 2010

Yesterday, in Dollar, Euro Concerning for Stocks, Gold, and Commodities, we looked at the correction or bearish side of the short-term outlook. Today, we will review the longer-term outlook, which shows the bull/bear debate possibly at a crossroads near 1,185.

The next three charts are very important to the bull market/bear market debate. If the S&P 500 can clear the long-term trendlines shown in the next three charts, then the bull market scenario becomes much stronger and the bear market scenario much weaker.

Stocks May Have Upside Into Year End - Chart

Looking at numerous factors, charts, and timeframes, if the S&P 500 can close above 1,185, the odds of a move toward the 1,230 to 1,255 area will improve significantly. A weekly close above 1,185 would be a win for the bulls; closing above it for one day is not as significant.

Market May Have Upside Into Year End - Chart

If we are in a bull market, we should clear these trendlines on the first or second attempt. A failure on a second attempt, as we are making now, would not be a good sign for stocks. We believe the odds favor a break to the upside, either now or after a correction.

Stocks - Upside Tarkets Into Year End 2010 - Chart

The last two charts show upside potential (if we can break to the upside) coming in between 4% and 6% above Wednesday’s close. The potential upside congregates around 1,230 and then 1,255 on the S&P 500.

StocK Market Upside Targets - Chart

Equties - Upside Tarkets Into Year End 2010 - Chart

More specific areas to monitor if we can close above 1,185 this week are 1,190, 1,200, 1,212, 1,219, 1,229, 1,245, 1,254, 1,256.

The CCM Bull Market Sustainability Index (BMSI) closed Wednesday at 3,583, well into bull market territory, and now showing some improvement relative to the outlook for the next three months.

Risk Reward for Stock market Year End 2010 - Chart

Today’s gains may take the BMSI above 3,675, which would significantly improve the risk-reward ratio for the next two to three months over where it was on Tuesday of this week. The market needs to hold today’s gains, but as of 11 am ET, breadth looks positive.