Differentiating an Inflation Induced Rally From a Normal Retracement

 |  Includes: SDS, SPY, TBT, UUP
by: Brett Owens

Just a retracement?

Or is the bull really back?

Maybe inflation?

Deflation Camp - Anyone Left?

Outside of a few lone voices, the deflation camp sure seems to be getting lonely. This is interesting, because the US markets have only now retraced 60% of their previous losses. An impressive rally, for sure, but still within the 38-62% "Fibonacci range" that is generally expected of retracements.

For what it's worth, the Great Depression retraced a little over 50% of its initial leg down - so we're ahead of the 1930 rally, but just by a bit.

It DOES feel like this rally has been going on forever - over 13 months old, it's sure been impressive in it's magnitude and duration. BUT, it is important to realize that nothing has been decided - at least yet - regarding whether this is a technical rally off of extremely oversold lows, or a brand new bender driven by trillions of new cash.

click to enlarge images

Click to enlarge

Viewed with 5 years of hindsight, the current rally looks a bit more "normal" than when you're living it day-to-day.

(Chart source: Yahoo Finance)

The Early Symptoms of Inflation?

What's tricky, though, is that governments around the world ARE printing money as fast as they can. And the first symptoms of inflation typically show up in either asset prices, or commodity prices - or both.

Today, we've got asset prices rallying, with financial stocks leading the way - exactly the first place you'd expect to see this "new money" showing up. A lot of financial commentators I've heard recently - good ones too, not just CNBC talking heads - believe this rally is now being driven by newly printed money.

Personally I think it's too soon to tell - we've retraced 60%, not 100%, after all.

But, if we're trading short term, we...

Gotta Respect the 200-Day Moving Average

And revisiting the S&P chart once again, we are indeed still north of the 200-day moving average. Check out the last five years too - you could have done a lot worse than being long stocks when the S&P is trading above the average, and being short when it's below:

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According to the 200-day SMA, you should ignore my calls for an impending decline. Instead, you'd set stops around this mark.

(Chart source: Yahoo finance)

So while I may continue to hoot and holler about the odds of a downturn far outweighing upside potential, to be honest, you should probably ignore me, and just respect your trailing stops!

And for more on the power of respecting the 200-day moving average, check out this excellent article from Steve Sjuggerud in Daily Wealth.

If Everything Tanks, What Would Hold Up?

Judging by the price action across the board last Friday - not too much...

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Almost everything is getting kicked in the teeth today.

(Source: BarChart.com)

Crude oil and precious metals got taken to the woodshed along with stocks on Friday - no place to hide there.

One bright spot - actually I should say one dim but not dark spot - are the grains. They haven't rallied much this year to date, so there may not be much downside from here.

Grains, by the way, are still one of my favorite secular plays - I just think it's best to avoid them right now. If the Great Depression is a guide, then grains should lead the way out of the Greater Depression as they did last time around.

Though Maybe We Should Just Short American Stocks Right Now

What's the most damning future indicator for America's near term economic outlook?

How about the latest cover of Newsweek?

Uh oh!

PS: Hat tip to MarketFolly for the tip here.

PPS: If you're into contrary investment thinking, I'd HIGHLY recommend The Art of Contrary Thinking by Humphrey B. Neill, which I reviewed here (ironically the same week we interviewed MarketFolly for the blog too!)

Another Bernanke "Guru Moment" - An Instant Classic?

The man who proclaimed the subprime problem was "contained" in March 2007 (after which Jim Grant hilariously quipped "yeah, to planet earth") - is back in the news again with another "guru moment".

The Wall Street Journal reports:

The U.S. economy should continue to recover at a moderate pace this year, but it will take time to restore all the jobs lost during the recession, Federal Reserve Chairman Ben Bernanke said Wednesday.

In his latest assessment of the economy, Mr. Bernanke told a congressional committee the pace of the recovery this year will depend on if consumers spend and companies invest enough to make up for fading government support.

"On balance, the incoming data suggest that growth in private final demand will be sufficient to promote a moderate economic recovery in coming quarters," the Fed chief said to the Joint Economic Committee.

Any fellow contrarians want to take the "under" on Ben's latest gem?

Disclosure: Author holds a long position in SDS and UUP