Roll with the Bounce and the Currency Printing Presses

By Dr. Duru written for One-Twenty

March 19, 2008


 Subscribe in a reader, subscribe by Email, and/or !
click here to suggest a topic using Skribit


Whew! What a ride in just over a week, in a month, in just one quarter! Even though the Fed did not deliver to the highest of expectations, the market chose to rally on monstrous proportions. The S&P 500 and the NASDAQ are roughly back to flat for March - where they have spent a good amount of time even with all the bouncing around. Most importantly, Tuesday's rally smashed the VIX, the volatility index, right back to around the mid-range of the past 7 months.

VIX


Given that we did not get a new closing high on the VIX, and given the general up-trend is intact, I remain far from convinced that we have found a true bottom. However, just as we needed to take last week's Fed-induced monster rally seriously and roll with the bounce, we also need to take this rally seriously. If the market finally puts on some follow-through, then all of us will be compelled to ride the momentum of the currency printing presses or just get out of the way. A launch from here will have at its back two major buying days of strikingly similar intensity.

S&P 500


Although the Fed's latest statement on interest rates followed the standard template, I found some features very interesting. First and foremost, we actually had TWO dissenters: "Voting against were Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at this meeting." This suggests that further rate cuts will be harder to come by without some extremely pressing need. The Fed has determined that "[r]ecent information indicates that the outlook for economic activity has weakened further." This suggests that the Fed's optimism about a 2nd half recovery is in real danger. Finally, the Fed acknowledge that inflation is increasing and that they are less certain that inflation pressures will moderate and expectations remain contained: "Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."

All and all, there is plenty here in the Fed statement to give the markets some serious consternation. The case for stagflation has only increased. But let's follow the Fed's actions and not its words. The Fed has repeatedly tried to talk inflation out of the economy while at the same time scrambled to inflate the economy, bolster housing prices, and support debt. We all know that you cannot have your cake and eat it too. Once the market absorbs the true meaning of this statement and takes on a more realistic outlook on inflation, we will see any ensuing bear market rally come to a screeching halt. Until then, enjoy the ride!

Another interesting development has been the Bear Stearns (BSC) debacle. I feel bad for the employees who were encouraged to own plenty of company stock only to see those holdings wiped out. I do not blame them for looking for a better deal than the $2 JP Morgan squeezed out of them. The stock is now at $5.91 after being as high as $8.50 on Tuesday's monster day. Amazing to say that BSC stock has almost tripled from its lows to highs in two trading days, but such is the action of the day. Anyway, what makes this story even more interesting is that the Fed may be working behind the scenes to rally the troops to put on a united, uh, front. The United Kingdom's Daily Telegraph reported in "Wall Street rallies to aid Lehman" that the Fed has warned other brokerages to stop talking bad about each other and to put on a good face in order to prevent (forestall?) another run on a bank, similar to what dogged BSC. In other words, if this story is true then we will not hear about any more dirty secrets until the very last second. Consider yourselves warned. The Fed may have unofficially sanctioned collusion and reduced transparency in our fragile financial system. Anything to keep the printing presses hot I guess.

Finally, speaking of inflation, China is ramping up its rhetoric and backing words with action in its fight against inflation. Perhaps these inflation fears are showing in the relative poor performance in the Chinese stock market as represented by the FXI, the FTSE/Xinhua China 25 index ETF. This index broke its 2008 low last week and remains below that low.

FXI


Unlike the S&P 500, the FXI remains well-above its low for 2007. So, some interesting questions. Will the FXI soon "decouple" from the US major indices and finally begin testing its important 2007 lows? Is China leading the way lower? Or will the U.S. now retake its global leadership and lead the way higher? Time should soon tell. The decoupling theory in general has not been working well for the globe's stock markets. There are very few stock markets that have been able to zigzag higher while the U.S. has slipped and slid lower. One potential exception is Brazil (EWZ) which actually made new all-time highs a few weeks ago. To kick things off on this next phase of ups and downs, we find the dollar has enjoyed a one-day snapback rally even with the rate cuts. I suspect a lot of this has to do with some rebuilding of confidence in the U.S. financial system. Once that move is over, the fundamental pull of gravity will resume as we debase our currency with every quickening turn of the currency printing press. Only faster printing presses in Europe, Japan, China, etc.. may save our dollar now...and perhaps that is what the Treasury is trying to wait out?!

Be careful out there...!

© DR. DURU®, 2008