Thursday, August 5, 2010

Everything You Need and Want To Know About Market Dynamics.....

…..but were too confused to ask.

People keep asking me why are the markets rallying? What is going on with the economy? Who do you think is right? The market or the economy? Am I missing something?

First of all the market does what it does. It does its own thing. It goes up and down regardless of race, creed, origin, sexual orientation, and most importantly opinion. The market does its thing for numerous reasons.

Even though there are numerous reasons....

....I will save you the trouble and simply it for you.

There is only one reason and one word that keep’s rallying the stock market as of today.

That word is Stimulus. Stimulus is just another sexy name for liquidity. Its the liquidity that moves markets either up or down. Markets generally move in the path of least resistance, and its the liquidity that paves that path.
Why does the market continue to ramp up in the face of increasing adversity, worse economic data points, and even worse overall news? Why? STIMULUS.

When one can’t think of a reason to be bullish than one has to be bullish. This is why sentiment is so important and why the markets are in such flux at the moment. The sentiment switches so quickly between extremes that many are simply caught on the wrong side of trade. The biggest moves we have seen over the years are when sentiment is at extremes. When sentiment gets very bearish this is the time we see huge up moves because of short covering. When sentiment gets to bullish, we have many who have simply bought stocks blindly on margin, when the selling hits the market, pretty much indiscriminant liquidation selling across the board is what you see. It’s at these moments where the most money is made. This is called the market turn. When selling and buying hit a capitulation level and stocks reverse course.

When you start talking about more mortgage modifications, more free money for State Governments, and more debt monetization via QE2, we see huge spikes in liquidity. Liquidity coupled with sentiment are what makes markets function. It’s not earnings or analyst recommendations. This is the underlying current market dynamic. This is where the word stimulus comes into play. More Stimulus means more liquidity. More liquidity keeps sentiment strong. But it’s this strong sentiment that always overshoots, this is why we see markets go down on occasion. Over time, markets go up 2/3rd’s of the time, so markets go down a little less than 1/3rd of the time taking into account even days. So why are markets not higher? This is because when stocks go down they go down with a sense of urgency. The down days are like justice in Texas, swift and quick. When investors need to sell, they don’t ask questions. The pain of owning a stock on margin is too much. Most times they are forced to sell to create liquidity.

It’s the liquidity stupid.

Financial market liquidity stems from monetary policy’s dual track: Quantitative easing increases high powered money affecting primarily financial market liquidity, while Zero Interest Rates increases allocated liquidity. Zero interest rates punishes risk aversion and savings with negative real returns forcing investments out the risk spectrum in either maturity and or risk.

But it’s the liquidity called by its sexier name Stimulus that is dangerous. It is Dangerous because it is disconnected from reality, disconnected from all forms of logic and reason. Scottish Philosopher David Hume once stated that logic and reason are not the determining factors in human behavior, but that blind faith, devotion, and belief are. This is why we have billions of “Jesus Freaks” running around with black ash on their foreheads on random Wednesdays. This is also the reason we have “Bullish Market Freaks” running around bidding up stocks because they have some weird perverse belief that the Federal Reserve will come to the rescue. This may have been thru for the last 25 years, but the gig is up. It’s not going to work. As soon as the tank is empty its new world order time. The Fed doesn’t have the necessary bullets left to save this market or economy anymore. The past few weeks we have heard many rumors and statements made by Fed officials that make the case for more Stimulus. The Fed clearly is in panic mode at this stage. Nothing they have done has alleviated the problems plaguing the economy. The Fed acts as a proxy for Wall Street and that ruling elite class has greatly benefited from the Fed’s actions, but there is no economic recovery for most Americans. This is very problematic for the Obama Administration and this has put tremendous pressure on both Treasury as well as the Fed for immediate action. The Fed knows nothing except for that printing more money is the answer to what ails the economy. This is correct in that printing money helps the financial economy, but it wrecks the real economy in the process. Here lay the disconnect. What is good for the financial economy is poisonous for the real economy. The Fed is 100% complicit in the raping of the real economy to benefit the financial economy. They have been doing this for the last 25 years. Wall Street has gutted the real economy and will continue to do so well into the future, and you can be sure that the Fed along with Treasury will be complicit all the way to the bottom.

The Fed has two more bullets left in its chamber.

1-Eliminate the 25BP paid on excess reserves.
This is an empty bullet. They are shooting blanks if they think the banks will start lending if the interest is eliminated. The banks would like to lend. Why wouldn’t they? Look at the yield curve! The problem is that there is no private loan demand. Most Americans are in debt detox. They are paying off debt not adding new ones. The days of buying 60” plasma’s at Best Buy because the neighbor has a 55” are over. The banks will simply move their excess reserves to US Treasury debt. This is sound smart business. The banks can make an easy arbitrage profit by borrowing from the Fed and giving it to Treasury. This is risk free. Why try and lend to make more of a spread when the jobs picture is brutal?

So really the only bullet left is…..

2-Full blown monetization of toxic debts.
This is Russian roulette pure and simple. In fact this needs to be a coordinated effort by all ponzy central banks around the world as we are talking about trillions upon trillions of ruinous toxic assets. This will be the end of market capitalism as we know it. This will be the end of paper currency markets as we know it. The price of gold will be an infinite number when all is said and done. Worldwide hyperinflation will lead to mass chaos and food shortages. This will be the time when the Romans will not be able to placate the citizens with more food, wine, and games. This is the end game for capitalism and the Fed which has never been shy about its fatalistic tendency to print more worthless money will achieve full blown debt monetization even in the face of this likely outcome. Of course markets will rally in front of the news and after until someone wakes up and realizes that it’s been a scam from the beginning.

The rising liquidity tide once again has become the dominant, and only factor to which investors are waking up in the morning for. Investors have become disconnected from the macro fundamentals, fund flows, and overall economic picture. Its stimulus and liquidity that is raging inside of the animal spirits of equity investors. Too much liquidity much like too much sex is a major problem. It causes people to become disconnected from reason, logic, and reality. This is why we have asset bubbles, but the Fed doesn’t believe in bubbles, they don’t exist. I digress. Sigh!!!!! These bubbles pop because they are forced to be popped not because they want to pop. Each and every bubble in our lifetime has been created by the Fed and every bubble has been reinflated back by the Fed, all for the benefit of Wall Street.

When the talk is all about more stimulus, more steroids, and more liquidity, the investment zeitgeist always ignore market fundamentals, ignore technical’s, ignore everything they know about asset allocation and selection. This Zeitgeist (Portfolio Managers, Hedge Fund PM’s, Pension PM’s 401k PM’s, and HFT) puts your financial well being in the hands of the same people (Fed) who have time after time proven that they are the biggest wealth destructors of the US middle class year after year. They put your money in the hands of the Fed which at the end of the day is a proxy for pure unadulterated greed. This dual kleptocracy that is the Fed/Wall Street, then use the main stream media as their messenger to the masses.

The market was obsessed with the European debt situation for the first half of the year. Euro Sovereign Debt problems slowed global growth which slowed US growth via exports. The USD became a stronger currency hurting exports during the sovereign debt crisis. For the moment, European debt issues are on the back burner and a weaker US Economy is back in focus. US fixed income markets have returned to their pre-crisis dynamics where strong liquidity conditions, and the absence of yield in the front end of the curve, have investors reaching for yield. This is leading most investment professionals to deduce that markets are getting better. It’s like nothing has changed.

Liquidity is a powerful drug, worse than crack cocaine in the inner cities. Most investors have given up on the narrative and or just drinking the Fed/Wall Street liquidity potion. The only thing that matters is the belief and hope that the Fed can recreate and reinflate another asset bubble. The markets are very complacent and have too much blind devotion and belief to a group of people that are bottom-line Charlatans.

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