Except for the liquidity impulse, QE2 will do nothing but jack up inflation
Steve Cook on Disciplined Investing

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The Market
    
    Technical

    The Averages (DJIA 11020, S&P 1169) had a volatile day but closed up on the day.  Both remain within their current trading ranges (9645-11257, 1042-1220).  The boundaries of an up trend off the March 2009 low (which I am suggesting could be happening) are 10314-13525, 1080-1482.

    Volume improved slightly as did breadth; the VIX finished the day down.  If it stays below the recent lower boundary of the current pennant formation by the close today, our time and distance discipline will have been satisfied.  In technical analysis, a break out of a pennant pattern generally results in a sustained move in the direction of the break--in this case down, which is positive for stocks.

    Bottom line: with the help of a stronger dollar and poor over night performance of the Asian markets, the bears tried to take this Market down in the early hours of trading yesterday--and just couldn’t get the job done.  This is all the more surprising in the face of a lot of yakking about stocks being over bought.  So for the moment, it looks like this Market has a bid under it.  If stocks test the 10725, 1149 level and bounce, I will be tempted to put a bit more money to work.

    Short interest remains near record highs.  You can decide what that means. (short):
    http://www.zerohedge.com/article/shorts-refuse-capitulate-end-september-nyse-short-interest-near-record-highs

    This is a great pictorial history of bull and bear markets since 1871. (medium and today’s must read):
    http://dshort.com/articles/SP-Composite-secular-bull-bear-markets.html

    S&P 6 month trading range chart:
    http://www.bespokeinvest.com/thinkbig/2010/10/12/sp-500-and-sector-6-month-trading-range-charts.html

   Fundamental

    Another quiet day for economic data, though weekly retail sales (a secondary indicator) were surprisingly strong.  The pin action seemed to be determined by:

(1)    the movement of the dollar which bounced strongly off of a support level in early trading, As a result of the current strong inverse correlation of the dollar and stocks, when the dollar traded up, stocks went down [the DJIA was off 90 points],
 
(2)    the release of the minutes from the last Fed meeting.    Later in the day, the Fed minutes were released, the bottom line of which was that QE2 is coming soon.  Investors responded by whacking the dollar [more liquidity = lower interest rates = lower dollar] and pushing stock prices back up
http://www.zerohedge.com/article/fomc-minutes-appropriate-provide-additional-monetary-policy-accommodation

    Bottom line: while the current fundamentals don’t argue for a move in stock prices in either direction, investor attention isn’t focused on the fundamentals.  QE2 and the election appear to have center stage.  I needn’t repeat my take on but I would add:

(1)    the universe seems to share my opinion on the workability [or lack thereof] of QE2. I have been including the opinions of some major heavy weights on QE2 in the Economics section over the past week and I am wondering who out there actually thinks it will do anything other than crank up inflation. To be sure, investors seem enthralled with the notion that all that new liquidity will be great of asset prices.  Which may be true, but it has nothing to do with the Fair Value of a stock.  But to the extent that this liquidity impulse assists stocks reaching Fair Value, then I suppose that is a positive.  However, (a) the reverse occurs when the liquidity is removed; so in the end nothing is gained and (b) the potential damage QE2 could do in fueling inflation, in my opinion, more than offsets any short term positive impact it has on stock prices.  It the Fed goes through with this, I believe, it will not end well
http://www.zerohedge.com/article/different-week-same-joke

The one positive scenario for QE2 is that it either never happens or is reversed so quickly that it doesn’t have time to do any damage.  What circumstance could lead to such an outcome?  GOP wins big in November, immediately begins reversing the policies of the last 10 years, business morale improves and it starts to invest and hire.

(2)    speaking of which, everyday we get another poll suggesting that the elections could result in something more than gridlock.  Unfortunately the elections are not my issue.  My issue is whether or not the republican establishment has sufficiently embraced fiscal/regulatory/trade reforms.  Equally unfortunate, I have seen less evidence of that than I have that the elections could result in a GOP sweep.  I hope that the GOP core has learned its lesson.  Apparently, the Market believes it has. 

Unquestionably, if it has, our Economic and Valuation Models change for the positive; but as you know, I have strong reservations.  That said there is a high enough probability of me being wrong that I have had to grit my teeth and add modestly to our stock holdings.  Nevertheless in the end, hope is not a strategy; so I am as skittish as cat on a hot tin roof.

John Hussman on expected future equity returns (medium):
http://pragcap.com/are-you-ready-for-equity-returns-of-0-07

Economics

   This Week’s Data

    The International Council of Shopping Centers reported weekly sales of major retailers rose 0.6% versus the prior week and 2.6% versus the comparable period a year ago; Redbook Research reported month to date retail chain store sales up 2.5% versus the similar time frame last month and up 2.5% on a year over year basis.

    Weekly mortgage applications rose 14.6%; however, new purchase applications fell 8.5%.
    http://www.calculatedriskblog.com/2010/10/mba-mortgage-purchase-activity_13.html

   Other

    Stephen Roach on competitive devaluations and QE2 (4 minute video):
    http://www.investmentpostcards.com/2010/10/12/roach-qe-wont-work/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+wordpress%2FVYxj+%28Investment+Postcards+from+Cape+Town%29&utm_content=Yahoo!+Mail

    Another (disparaging) look at QE2 (long):
    http://www.ritholtz.com/blog/2010/10/time-loves-a-hero/

    The pension liabilities of municipal governments (chart):
    http://www.businessinsider.com/chart-of-the-day-city-pension-accounting-2010-10?utm_source=Triggermail&utm_medium=email&utm_term=Clusterstock+Chart+Of+The+Day&utm_campaign=Clusterstock_COTD_101210

    The other side of QE2 (medium):
    http://www.minyanville.com/businessmarkets/articles/quantitative-easing-qe2-savings-based-companies/10/11/2010/id/30485?camp=featuredslide&medium=home&from=minyanville

    Here is a somewhat different take on the lessons from the financial/economic crisis (medium/long):
    http://www.thefiscaltimes.com/Issues/The-Economy/2010/12/Missing-the-Teachable-Moments-from-the-Economic-Crisis.aspx
   
    More on the possible outcomes of the mortgage fraud scandal (long):
    http://www.zerohedge.com/article/citigroup-call-implications-foreclosure-crisis-just-tip-iceberg

    Dylan Ratigan is one of my favorites.  Here is his take on the mortgage fraud problem (medium):
    http://www.zerohedge.com/article/dylan-ratigan-property-rights-gone-wrong-and-americas-descent-central-planning-hell

    More thoughts from Café Hayek on how the government and bankers screwed the country via the financial crisis and the subsequent bailouts (short):
    http://cafehayek.com/2010/10/how-bailouts-and-political-power-destroy-markets.html


    In case you are not following the developments in France (medium):
    http://www.zerohedge.com/article/35-million-streets-and-rising-french-strikes-escalate-just-how-serious-situation

Politics

  Domestic

More on the mounting paralysis of municipal government (medium):
http://www.nytimes.com/2010/10/12/opinion/12brooks.html?_r=1&ref=opinion











Posted 10-13-2010 8:12 AM by Steve Cook