I enjoy this kind of market; selfishly, because I typically do very well with inflection and friction points. It’s what I like to refer to as, Bear Market Driving. See (here).
The cerebral angle can pay off; whereas at times you really can over analyse what is staring you right in the face.
Today, it’s a – you need to be anticipating three steps ahead – proactively positioning (or not trading at all), kind of market.
Eventually it will end and we will go back to the monotonous trend where the momentum junkies look like geniuses and the herd opines the virtues of Apple and Silver Wheaton. But for right now – its just a lovely trading environment.
The market in all its infinite wisdom has forced traders into a Mexican standoff with Bernanke and the conclusion of QE2. Throw in a little European sovereign debt contagion – the one where Chevy can’t speak the native tongue, a prickling of the commodity bubble – and you arrive at an equity market under pressure from all sides. Surprisingly, the market is down less than 4% from it’s intraday high three weeks ago. That will likely start compounding as the Euro continues to melt and we approach the June Fed meeting.
So will Bernanke blink?
There are many dependent variables between now and then, considering Europe’s sovereign debt travails and the dollar’s swing reversal higher. I do believe that structurally speaking, the economy is in much better shape than it was one year ago. That is most evident in the improving jobs picture and the diminishing deflation risks once visible in the Producer and Consumer Price Indexes. The recency effect will likely work its bipolar madness as we bounce from staring back into the abyss to the relative improvement in the overall economy. It is also responsible for the swings in investor sentiment surveys and the daily headline risk the market absorbs and digests.
I would argue that Bernanke will not blink from the telegraphed ending of QE2 at the June and subsequent August meetings. Once the market comes to terms with this realisation (albeit as gradual as possible), commodity pressures should subside and provide a tailwind – instead of a headwind for earnings going forward. I have always maintained that if and when the Fed perceived the economy was resilient enough to stand on its own – the psychological boost itself would help replace the extraordinary monetary stop gap measures. That was always the Fed’s intention because the psychological and material will of the private sector receded. I described that dynamic (here) in the Congruent Market Theory.
Ultimately, and assuming this time is no different (how ironic), the market should receive a positive psychological boost that we are in fact stepping away from the brink (for now) and headed towards a trading environment that is driven fundamentally by positive, rather than negative feedback.
With that said, between now and then – buckle up for what will likely be a very fast and volatile market. At this point the greatest risks for further downside in the equity markets would be the degree of European debt contagion and China’s decelerating economic growth.
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