The 'Good News' Rally Doesn't Make Sense

Includes: SDS, SH, SPXU, SPY
by: Turtle Management

The Wall Street Journal reported today (October 17, 2011) that:

Spokesman Steffen Seibert said a "package" of measures would be agreed upon at the European Union summit in Brussels this coming Sunday, but "the chancellor reminds [everyone] that the dreams that are emerging again, that on Monday everything will be resolved and everything will be over, will again not be fulfilled," Mr. Seibert said.

The past two weeks have seen some of the fastest and largest gains ever in major equity indices. The gains came on unusually light trading volume relative to previous rallies. Over the past two weeks not a single statement lending any credibility to this rally has come out of the mouth of any European leader. The entire rally was based on unrealistic optimism and hope stemming from Sarkozy and Merkel announcing that they have a plan to make a plan to solve the crisis. This announcement has been made many times over the past 2 years, if that tells you anything. Why the market would rally is beyond my comprehension, which is why I have been writing articles with recommendations to short the rally in any way you see fit (through put spreads, futures, ETNs like SPXU or SDS, ETFs like SH, etc).

It is my belief that Merkel and Seibert’s announcement that the October 23 meeting will not solve the crisis will keep us within the range of 1,080 and 1,220 that we have seen the S&P 500 trade over the past few months. The rally was on light volume for a reason as the smart money recognized that nothing substantial had changed in Europe for the better. The fact that Seibert indirectly refers to the rally as “dreams emerging again” is very telling in and of itself as every leader in Europe (the German leaders in particular) do not want to encourage volatility in the market and help cause a sell off that worsens their situation.

Going forward, I believe that the market is more likely to fall over the next few weeks than gain ground, as it will experience some hard tests, starting Thursday with a Greek vote on whether or not to cut even more spending and government programs by a government that is becoming increasingly torn over how to handle the current crisis. The market risks further disappointment October 23 as it has priced in a solution to the problems as if somehow everything negative that has been lingering unsolved for the past 2 years will miraculously disappear in one week.

I have said many times that there are only two ways out of this mess -- to print money or to default -- and neither of them will be pretty. Everything you heard about bond buying programs, the EFSF, the troika, the ECB or IMF or EFSF guarantees, haircuts and write-downs, are all fancy smoke-and-mirrors ways of saying, ”we are going to print money and monetize our debt and bail out the banks” or “we are going to let some countries default and bail out the banks.”

I understand that corporate earnings are not awful and that we have seen some (I emphasize some) improvement in the near term in regards to the chance we enter a recession. However, the market has been and will continue to trade on Europe, as Europe and the choices made by politicians both here and abroad will determine the direction of the market and who inevitably takes the loss and suffers at the expense of the PIIGS' unsustainable greedy and lazy behavior of the past decade.

This rally was built with no foundation, and based on hopes and dreams, not facts and reality. Printing money would eventually help push markets higher. However, it is my belief that Germany will put up a fight to avoid printing and the prospect of inflation as inflation was a main catalyst to the rise of the Nazi regime thanks to the pain it caused Germany after WWI. Don’t invest your hard earned money on hopes and dreams, especially when European leaders tell you not to.

Disclosure: I am long SPXU.