Heading for a Turn? Trade Accordingly

Posted by Victor Adair

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For the past couple of months I’ve been anticipating that the rally in “risk assets” would run out of steam but I have been waiting for confirmation…I think we are seeing that confirmation over the last two weeks or so…trade accordingly.

Over the past couple of years I’ve frequently asked the question, “What are we trading?” And my answer has been “perceptions of central bank liquidity.” I think the rally in stocks since the lows of Oct 4 has been fuelled by liquidity injections from the G4 (US, Euro, UK, Japan) and by anticipation of more liquidity injections to come. These injections have created false optimism in the markets.

The LTRO injections in the Euro zone in Dec and Jan created a “Lull” in the Eurozone bank/sovereign debt crisis….it appears the “Lull” is over as yields rise on the weaker credits, Spain in particular. I think we will see stress build in Europe in reaction to austerity programs, weak economies, elections, and high unemployment. The weaker Euro countries are headed into a vicious cycle of faltering economies and higher interest rates. Social unrest will rise, populist politicians will call for “re-negotiations” and possibly a withdrawal from the Euro.

The S+P 500 and the DJI made a “M” double top around the end of March/early April with (very nearly) perfect weekly key reversals down last week…both have fallen ~3.5% from last week’s highs to today’s close.

The psychology change this past week was interesting. Stocks fell sharply on Monday in response to the weaker-than-expected UE data released on Easter Friday. On Thursday, stocks rallied sharply on anticipation of fresh Fed liquidity injections (two Fed Governors made dovish speeches) but today those gains were reversed as the Euro crisis moved back to centre stage.


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