Potholes Mar the Way to QE Heaven

by: Wall Street Sector Selector

by John Nyaradi

Global markets hit a few potholes along the way to “QE” heaven this week, and now the question is if the rough ride will continue or not?

It was a bumpy ride around the world for U.S. interests and investors ranging from the municipal level all the way up to the highest international levels at the G-20 meeting in Seoul. Tensions bubbled everywhere, so let’s take a look at these from the local to international level.

Looking At My Screens

China was making news all week, and on Friday the Shanghai Composite rattled world markets with a sudden 5% drop.

Chart courtesy of StockCharts.com

Often viewed as a bellwether for coming attractions in the United States, the index plunged 5% on inflation fears and the threat of tightening by the government. While still in an uptrend, it’s easy to see the damage inflicted on Friday and the ongoing tussle between the United States and China over the yuan and dollar served to make things even more uncertain.

On the local level, municipal bonds took a huge hit and could be flashing danger signals for further problems to come.

Chart courtesy of Stockcharts.com

In recent days muni prices have plunged as concerns about municipal debt and default continue to grow. So far this has been a back burner issue as everyone has assumed that the Federal government would bail out the states and municipalities, but with QE2 and a new House of Representatives in town, confidence in this outcome seems to be on the wane.

The View From 35,000 Feet

U.S. policy makers had a bad time at the G-20 meeting and while they were getting beaten up there for QE2 and devaluing the dollar, global equities markets were in retreat.

In Seoul, President Obama failed to get a much ballyhooed trade agreement with Korea, and the U.S. delegation took heat from countries like China, Brazil and Germany for devaluing the dollar at their expense. Later in the week, the Chinese again expressed their displeasure with current affairs as Commerce Minister Chen Deming said they didn’t support quantitative easing and espoused on the risks of growing more global bubbles.

Across the world, problems seemed to bubble to the surface with Ireland edging closer to a financial crisis and China’s composite index taking a 5% hit on the fear of rising interest rates and inflation.

At home, Cisco (NASDAQ:CSCO) took a 17% hit on earnings worries and Boeing (NYSE:BA) dropped 11% on problems with its Dreamliner.

Most interestingly, Friday was a Fed “POMO DAY,” a day on which it bought $6.8 billion in its “QE2” program of Permanent Open Market Operations, and the market still saw big declines. This was something of an anomaly as POMO days generally see positive closes.

Bond yields edged higher in spite of “QE2″ while investor sentiment remains at extreme bullish levels. However insiders didn’t share the same optimism and set records for selling at a 12-1 ratio, perhaps sensing an interim stock market top.

Next week we’ll see the Fed buying bonds on every trading day with an expected weekly total of between $25.5 and $35.5 Billion.

What It All Means

Things remain tense across the globe as countries react to the continued and unwelcome monetary easing on the part of the Federal Reserve. In a display of their new found economic power, China made its presence known at the G20 meeting and more and more analysts are looking to the Shanghai Composite as a bellwether of future global stock market action.

The big thing to watch for in the coming week will be whether or not the Fed bond purchases will be able to continue to lift equities prices higher. If not, then we could be set for a big decline as QE2 hits the rocks and flounders. If Dr. Bernanke can press asset and commodity prices higher in spite of the withering global criticism of his plans, we could still see higher prices ahead.

The Week Ahead

Aside from the POMO action, we have a full slate of economic reports in the coming week.

Economic Reports

Monday: October Retail Sales, November Empire Manufacturing

Tuesday: September Business Inventories, October Producer Price Index, October Industrial Production, October Capacity Utilization, November NAHB Housing Market Index

Wednesday: October Consumer Price Index, October Housing Starts, October Building Permits

Thursday: Initial Unemployment Claims, Continuing Unemployment claims

Sector Spotlight

Winners: Energy

Losers: Australia, Brazil, Aerospace