While earnings have been significantly mixed; Walmart, IBM, Chipotle and others getting crushed and Google, Amazon, and others beating – we are seeing huge volatility. There is one common theme that is a little concern, is that the net forecasts and top-line revenue results are weak. Yet, the implied volatility is getting crushed and the market is rallying, having a break-out into the upper resistance band.
The term easy money when it relates to the central banks really means low interest rates, cheap, money, and accommodative (stimulative) policies. The term is frequently cited, “easing monetary policy” or “Fed is easing” – which means lowering rates and increasing the money supply.
So big news that is helping driving markets higher is not just the three big upside earnings with Google, Microsoft, and Amazon – all driving the NDX futures higher in the pre-market, it is also the renewed easy money policies being announced in Europe and China.
courtesy of wikipedia
Unexpectedly during the press conference yesterday, the European Central Bank (ECB) President, Mario Draghi signaled that MORE stimulus is on the way (including more bond buying) and even suggested negative interest rates. The news sent markets rallying and help rocket the Dow Jones by 300 points. Eurozone bond yields fell to new lows, the German 2-year yield dropped to a record NEGATIVE .3% interest rate.
The shot in the currency war was fired by Europe as the Bank of Japan is still ramping up their large asset-purchase program (including buying their own stock market) and England is setting rates to record lows.
Expectations for the launch of more easy money from the ECB is likely at their December meeting.
China Fires back
Not to be outdone by Draghi’s Thursday’s surprise easy money announcement, China’s central bank announced another rate cut, cutting their one-year lending bench mark rate by 25 bps to 4.35% in an effort to help boost their own economy.
If the market rally yesterday from Draghi’s money bomb wasn’t enough, this morning futures are moving higher on China’s easy money rate cut.
It’s the US against the rest of the world right now. The US dollar has rallied against the world currencies when the Fed announced the end of QE3 and began setting rate hike expectations.
A strong dollar is a good news / bad news story.
courtesy of FRED
It is great news if you are an American, earning dollars, saving dollars, and have dollars to spend. A strong dollar keeps a lid on inflation and in some cases creates deflation pressure.
The bad news is that if you are a multi-nation U.S. company it means your exported goods and services will become MORE expensive to foreign buyers and they will seek business elsewhere. We are seeing that story play out in the earnings reports with contraction in top-line revenue, much of it blamed on the strong dollar.
The strong dollar will also keep wages depressed.
Lastly, the Fed is concerned about disinflation (a contraction of inflation) and mortally fears deflation. They have set a target to 2% inflation, but right now we are in a disinflation (contracting inflation) economy with deflation upon us. That is if you trust and believe in their models.
Currency War Doctrine
The doctrine of this currency war comes from the Keynesian playbook. Keynesians theory believes low interest rates, increase in the money supply, and direct government intervention to boost asset values will spur borrowing, which will translate into more spending and that will somehow jump start an economic boom.
What it really does is inflate asset prices on borrowed money. The Fed is encouraging debt formation, while participating.
This Keynesian mantra is being played out not just in the United States, but has been adopted by the global central banks. It is a race to borrow and spend, but in a competitive environment it also means that you need to DEVALUE your currency to make the products you are trying to export more attractive. You may hear the term “race to the bottom”, which means devaluing your currency faster than the next country to boost your exports faster. Devaluing creates inflation and that is what they want.
If the weak jobs report and disinflation indicators were not enough for the Fed to NOT HIKE rates, the foreign central banks ramping up Easy Money policies are the nail in the coffin – there is going to be NO RATE HIKES!
courtesy of FRED
In fact, with Draghi’s radical announcement of negative interest rates, combined with Japan’s central bank actually buying market securities – what is becoming a higher probability is another round of our own easy money, whether that is QE4 or something similar or even perhaps our own negative rates.
Well we saw yesterday’s market rally higher – even before the big earnings announcement after the close. That was a Draghi rally as he is about to take rates negative and dump more money into Europe. This morning, while we had a couple of big strong earnings, it was China announcing their Easy Money cutting rates, sending the over-seas Yuan spread to the dollar lower – that is sending pre-market futures higher.
Don’t get caught up into thinking the general market rally that last two days is from strong earnings, it is not. Sure there are a couple of big ones, but the core driver is the announcement of more Easy Money and that is lowering expectations that the Fed will raise rates.
The market is rallying – again – like it did during QE1, Operation Twist, QE2, and QE3 – on Easy Money, not because the economy is doing wildly better or that earnings have been amazing.
Support & Resistance
We blasted through the resistance yesterday on the Draghi rally. I would look at 17,400 as either a straddle strike, with possible short-term support. While the futures are higher – we could see some intra-day volatility. Watch 17,400 for support and if it can hold into the close.
The NDX is getting an extra boost from AMZN, GOOG, and MSFT. Look at 4500 as a possible support, I think we should close above it.
The SPX fell a little short of getting above that 2060 area. I would look at 2040 as low support, but a solid close above 2060 means it could turn into support.
The disappointment was the Russell Rally was far weaker and didn’t see a break-out. We didn’t even get back above 1160 or test the 1165 resistance area. We look to open above 1165 if the pre-market futures hold strong. I would look at 1180 as the real test. If we can break above 1180 and close above it, it might signal the end of the bear market that has been with us since June. If we cannot close above 1165, then it might mean this recent broad market rally could be seeing some weakness.
If we see the VIX get below 13 and stay down there, it means the market is underpricing risk and starting to become complacent in this rally. The VIX may be right and we could get a short-term Fed fueled Easy Money rally – if they don’t raise rates. In the 12 range, it is time to start hedging 1:1, if we get below 12, then I would hedge greater than 1:1. This is just general rules of thumb.
We could be and I think it is very possible to be ramping into a Fed fueled rally into the end of the year. No, not a Santa Rally, a Fed Rally. If the Fed starts talking or hinting at easy money policies, we could move higher, if they actually launch another easy money program – we could rocket higher.
Of course this rally is based on easy money, not strong earnings or a strong economy. Remember correlation is NOT causation. The market is not a measure of the economy, nor is the market a pure measure of the business fundamentals. We are in a midst of declining revenue and sales forecasts, yet we are in the middle of a rally.
We remain, as we have for years now, in a Keynesian Interventionist Rally. Don’t fight the Fed, participate, but remember the WHY and HOW. Don’t get fooled into believing it is anything other than what it is. People get hurt when bubbles burst and they don’t know WHY or HOW the bubble was created. Ride the Fed train, but stay hedged and watch out for signs of inflation – which will come from an increase in the velocity of money.
courtesy of FRED