A few major factors/events have conspired recently to meet up at a singular point in time.
1. Either QE2 disappointment or death of USD
It's been a textbook case of "bad news is good news" in the past few weeks, entirely driven by QE2 expectations. The expectations are so high that inflation is finally being priced in (see 30-yr bonds, commodities, and gold), and Bernanke would have to do it even if he had a change of religion tonight, or else. The only question is when and how much. While I don't know the answer, I'm sure it lies somewhere between a dog and a fire hydrant. If QE2 is not big enough to cause another 10% drop in the dollar index, it'll snap back 10% along with equities/gold/commodities crashing through a significant correction. If it is big enough to meet the markets' insane expectations, it will most likely kick the currency war into full speed and start the sequence that leads to the dollar's death as the international reserve currency.
Of course, theoretically it's possible to stand a pencil on its point. I just don't think it's financially wise to bet on it.
Funny thing is, despite the overwhelming cry for QE2 and the markets' seeming enthusiasm, few expect it to produce meaningful real growth. In other words, the Sept rally in equities has been driven by depreciating dollar and expectation of inflation, not necessarily growth. This is truly a nightmare scenario.
2. Currency war
In the race to the bottom of competitive currency devaluation, Japan has been elbowed to the back and Fed has been the hands-down winner, so far. But all major players are close to the edge, even the usually quiet and conformal (well in terms of economic/monetary policy) Brazil. QE2, even if not big enough to kill the dollar by itself, may be the brilliant spark of inspiration in the powder keg. The ensuing currency war, trade war, and all kinds of political circus will surely be comical, to future generations who don't have to live through it.
Mainstream media have taken the foreclousregate with remarkable calm, I'm just not sure whether it's due to ignorance or willful deceit. But there've been many excellent analyses in the blogosphere. I have nothing original to add on this topic, instead would just summarize my readings here:
- Foreclosure sales, which has accounted for 1/3 of housing market in recent months, have slowed to a crawl and may come to a complete stop soon.
- Virtually every mortgage in existence today is subject to the question of title ownership. It doesn't even matter how thorough a job the original lender did. If it has gone through the mills of securitization, which the homeowner would not know and it would take substantial effort to clarify, the question is there for someone to ask.
- Recent sales of foreclosed as well as regular houses are suddenly subject to unknown kinds of legal risk. Future buyers should be extremely cautious.
- Not only past and future sales of houses and commercial real estates, but all past and future sales of baskets of securitized real estates may be in legal limbo. This is independent of sloppy/missing/forged paperwork. There may be a valid legal question of ownership in set-ups like mortgage CDOs.
What will happen next? How paralyzed will the real estate market be? For how long? Should everybody stop paying mortgages? Will everybody get a free house? Will banks be destroyed, for real, this time? Will Fannie Mae (and by extension tax payers) be the designated bag-holder again? How much will all these affect the dollar? How much ammo/water/canned-food to stock up? Will RPGs be considered excessive force? Nobody knows. Well, at least lawyers in various related fields won't need to worry about jobs for the next five generations.
Why a rational being would long equities, especially financials, at this juncture is beyond my limited imagination. Even gold is vulnerable to a correction should QE2 be judged a disappointment by the market. I remain very bullish on gold longer term. But I've taken profit on most of my GLD calls recently.
This (Friday) morning's Bernanke speech should be interesting. He has a hell of a fine line to toe in rhetoric and expectation management, or else he may make history today. We'll find out soon enough.
But isn't there something wrong about the system when one person should have such a huge impact on the market? Prior examples of such overwhelming prominance include Hitler, Mao, and Greenspan.
Disclosure: Long puts on SPY and FAS, calls on GLD