With September ending today, and the Congress leaving Washington, it’s time to lay out the two big themes for the next month.
The first is the election, obviously. No matter how certain people are of the outcome, nobody really has any idea what’s going to happen. And nobody knows at all how various outcomes will affect the market. Will split government actually help the market the way so many expect? We’re sceptical, but who knows. And if the Dems outperform, what does that mean?
The election is November 2, and it just so happens that that’s the day of a two-day FOMC meeting, wherein the next round of QE is expected to commence.
What will that QE look like? Nobody knows for sure, though the latest hint we got from the WSJ is that it will be small and open ended, not some huge $1 trillion scheme — at least not yet.
Uncertainty is always part of the landscape, but it will probably be especially so for the next 30+ days.
Here’s Mike O’Rourke of BTIG on QE expectations:
The market’s expectations for QE2 are currently fairly large due to the weak expectations about prospects for the economy. We are in a data dependent environment. There are only signs of the reflation trade because only certain asset classes are responding. Theoretically, assets like Equities, Gold and Crude should rise. Bonds will have a bid near term, pushing yields lower as players try to get ahead of the Fed. The Dollar should suffer as the monetary base is expanded in hopes of an expanding money supply. Since the August 10th course reversal, Gold has rallied 8.5%, the 10 year yield has dropped 25 basis points and the Dollar index has lost 2.5%. Those are all acting as one might expect in a reflationary environment. Equities have gained 2.1%, they are up but not even enough to offset the losses of the Dollar.
Finally, the missing link is Crude. Even after today’s rally, Crude is down 3% since August 10th. Additionally, the solid performance from Crude today was the result of a fundamental catalyst in the form of DOE inventory data, not reflation. Even if we expect the reflation today, the process should be different than the approach of consistent asset purchases over the span of just over a year. We will describe what we suspect is going on. We know others will have a different view so please take this as simply one opinion. We are of the view that the comfortable reflation trades are being put on in a speculative manner. In this environment, it is easy to justify buying Gold and Treasuries and selling the Dollar, so that is where the speculative momentum is headed. Those are positions that managers can sleep with and are likely getting a little crowded, at least until we see what QE2 really looks like. Stepping into Equities and Crude does not feel as easy or comfortable, therefore, they are not getting the attention. If reflation is the true catalyst behind the action, than Equities and Crude should participate as well. The divergence illustrates that either the three that are working need to consolidate their recent moves or the other two should join the party.
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