Weekly Key Reversals Speak Louder than Central Bankers

Posted by Victor Adair

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VictorCQGMarkets were knocked around…and experienced several Weekly Key Reversals (WKR) this past week as Central Bank (CB) policies became increasingly unconventional…and as Market Psychology (MP) began to anticipate that CB’s may go totally “off the reservation” as chronic weak employment foreshadows never-ending populist government entitlement programs…which will be “funded” with debt and taxes…as the Ruling Elite struggles to maintain some semblance of the status quo.

MP seems to be in the mood to start “seeking safety” despite the liquidity flood from the CBs…and something from the European Theatre, be it Italy or another Cyprus, may cause MP to embrace the “Sell in May and Go Away” theme.

The BOJ, the BOE and ECB all had scheduled meetings this past week. The BOJ took more-dramatic-than-expected steps to expand their monetary base (i.e. buy assets: bonds, stocks etc.) in line with their stated goal of moving the country from a deflationary state to a level of 2% inflation…and therefore the Yen had a very dramatic WKR down while the Nikkei had a very dramatic WKR up. (The Nikkei is up ~53% since the Key Turn Date of Nov 15, 2012 – a date when Market Psychology realized that Abe would become the new Japanese PM and begin to implement his inflationary policies…the Yen has fallen ~18% against the USD to its lowest levels in 4 years.)

The BOJ actions drew considerable media comment: for instance both George Soros and Bill Gross noted that this was very dramatic action…and implied that the law of unintended consequences might kick in. The BOJ apparently feels as though they have no choice but to take extreme measures. Japan has been in deflation for 2 decades…their population is shrinking…their demographics are dreadful…the “drama level” of their actions are reminiscent of Paul Volker in 1979 breaking the back of inflation (and inflationary expectations) in the USA.

The BOE meeting had little market impact but the ECB meeting (and the following Draghi press conference) saw the Euro trade to 5 month lows Vs. the USD then turn sharply higher with a WKR.

Big Picture Questions: Ambrose Evans Pritchard of the Telegraph asks the question, “What if QE from the Central Banks never ends?” Fair question. We were led to believe that QE was designed to get economies going again…their activities would be an interim substitute for private sector spending…and once the private sector revived then QE would end. Well…what if the private sector doesn’t come back? High unemployment may be chronic…and government entitlement spending may keep increasing…some would see that leading to a major bust…stagflation…but what if the Central Banks just keep QE going? What if they just monetize the government deficits? How would the markets respond if that became the predominant Market Psychology? Would that mean ultra-low interest rates for a very long time? Would that mean even greater “reaching for yield” as the public and the pension funds need more income?  Would that mean Dow 36,000 etc.?

Big Picture Response: I have had nearly all of my net worth in cash for a long time…which has meant that I’ve missed some bubbles…and some crashes. I’ve divided my cash into two parts: short term trading accounts and long term savings accounts. I actively move in and out of the markets with my trading accounts while my long term savings sit idle in the bank. I’ve been reluctant to “reach for yield” with my savings (perhaps because I haven’t had to) and I’ve been reluctant to “buy into” what I see as potentially illiquid assets…principally real estate. I’ve anticipated that asset prices would likely have a major “wash-out” and that would be the time to buy. That’s still my opinion…but…if CBs get really determined to turn cash into trash then I may have to “go to the market” and swap my cash for “stuff.”    

Currency wars: In earlier blog posts I speculated that the Koreans might get “cranky” if they lost export market share to the Japanese because of the falling Yen…well, in line with the old mantra, “Don’t get mad, get even” I note that the Korean Won has fallen ~8.5% Vs. the USD since mid-January…which means that the Won has stayed about level with the Yen since then. “Currency wars” have moved off the front page…but be prepared for more “competitive devaluations.”

Markets: Several WKR across asset classes (stocks, commodities, currencies) may mean that this past week was a Key Turn Date…it’s too early to say…but the reversals may be an early indication that MP is changing. Stocks: WKR down in the S+P and the FTSE. TSE had a terrible week, now negative on the year. WKR up in the Nikkei. Commodities: WKR down in Brent, WTI and Gasoline. Note: Nat Gas is at its best levels in 18 months…trading about double last year’s lows. Gold: Not a WKR but it rebounded $40 Thurs/Fri after touching the lows of the last 18 months. Gold shares dropped to new 12 year lows Vs. gold bullion. This blog has warned several times over the past two years against trying to “find a bottom” in gold shares. Currencies: WKR down (Big Time) in the Yen, up in the Euro, Pound and pretty well everything Vs. the Yen. Bonds: Japanese bonds dropped (briefly) to an all-time low yield…yields on “top quality” government bonds have fallen for the past three weeks…really fell the last three days…US and CAN 10 year yields are at 1.75%, German 10 years are at 1.2%…and Japanese 10 years are at ~0.50%.

Short term trading: On Feb 20 I covered a short gold position I had maintained for over a year…I bought gold in early March…added to that on the Cyprus story…but covered this past Tuesday at a small loss. Gold had a great opportunity to rally on the Cyprus story…and didn’t take it…so I covered my long positions…went short for a day and then went to the sidelines.  I had short term profitable trades long CAD, short NZD and short S+P this past week…went flat ahead of the Friday employment reports and remained flat into the weekend.

Anticipating:  WKR’s across a number of markets may be signaling that this past week was a Key Turn Date…too early to say…but…for my short term trading accounts I’m anticipating that Market Psychology may start to “seek safety.” I’m therefore looking for an opportunity to short the stock market, buy the USD and…perhaps…buy gold.

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