Don't Be Too Eager To Get Bearish

by: Cam Hui, CFA

While the stock selloff in the last two days has been breathtaking (just as the rally last week was breathtaking), even if you are bearish, I wouldn't be too eager to commit to a bearish trade here. There are just too many bullish triggers over the next few days that could rip the face off anyone positioned to the short side.

First of all, the market just kissed the 50% retracement support level as shown by the chart below [click to enlarge images].

Another short-term bullish data point came from Marty Chenard at He showed that, as of Monday night, institutional investors haven't panicked and the positive momentum seen last week appears to be intact.

The Greek referendum a domestic power play?

The news of the Greek referendum called by prime minister Papandreou caught investors by surprise yesterday and the markets sold off. Upon closer examination, the referendum story just didn't make sense. He caught his own cabinet by surprise with the news and even his own finance minister wasn't briefed on the plan. Joseph Cotterill of FT Alphaville wrote that it wasn't clear that Papandreou may not have had the votes to pass the referendum bill in parliament. Moreover, the Greek constitution specifically prohibits referendums on fiscal matters. So what would the referendum question be?

If the question were to be phrased in the form of, "Are you in favor of knuckling under to the EU and the IMF?," the answer would be an overwhelming "No." On the other hand, if the choice was to be accepting the austerity package as a price for staying in the eurozone, or to leave the eurozone and be ejected from the EU, then the outcome is much harder to predict.

Beware the Bernanke Put

I also wrote that bears should be careful about the possibility of central bank intervention (see Defying gravityand When will bad news be good news?). We have the FOMC decision today and press conference afterwards. Consider, for example, this analysis of how far the Fed has strayed from its dual mandate and tell me that there's no Fed intervention risk.

What about the Draghi Put?

Not much is known about the views of Mario Draghi, but there are some insights to be had in a speech (pdf) he gave in July 2011. First, he gives lip service to the idea that EU states must stand on their own [emphasis added]:

For years interest rates in the various parts of the euro area did not diverge significantly from those obtaining in Germany. For a long time the spreads between sovereign securities and German Bunds remained narrow and the interest rates charged by banks reflected the credibility of the public securities of the euro-area countries. This is no longer the case: the solvency of sovereign states has ceased to be a foregone conclusion but something that has to be won in the field with rapid and sustainable growth, which is only possible with sound public finances. Interest rates reflect today’s new situation: they are higher for countries with low growth and weaker public finances. The cloak of credibility provided by the stronger euro-area countries has been lifted; we must grow without relying on its shelter. The structural reforms invoked for years are now even more crucial.

In the next breath, Draghi goes on to talk about "innovative" monetary policy and "more appropriate set of economic governance tools," which is a signal that he may be more pragmatic than his predecessors in their approach to central banking:

On several occasions I have noted that Europe reacted to the global financial crisis by drawing on the credibility of the ECB and the latter’s timely and innovative conduct of monetary policy and by equipping itself with a more appropriate set of economic governance tools. We now have a system of autonomous authorities for banking and financial supervision, a European body to monitor and mitigate systemic risks, and new procedures for the coordination of fiscal and structural policies.

On last Wednesday, just as the eurozone summit was about to convene, Draghi "independently" released a statement that he supported the continuation of the ECB program of buying sovereign debt. That program was supposed to be discontinued when the EFSF came into being. It sounded just a little bit too orchestrated to me. To understand the significance of this statement, Brad Delong sounded off on the ECB's refusal to be the lender of last resort to the eurozone:

When the European Central Bank announced its program of government-bond purchases, it let financial markets know that it thoroughly disliked the idea, was not fully committed to it, and would reverse the policy as soon as it could. Indeed, the ECB proclaimed its belief that the stabilization of government-bond prices brought about by such purchases would be only temporary.

It is difficult to think of a more self-defeating way to implement a bond-purchase program. By making it clear from the outset that it did not trust its own policy, the ECB practically guaranteed its failure. If it so evidently lacked confidence in the very bonds that it was buying, why should investors feel any differently?

The ECB continues to believe that financial stability is not part of its core business. As its outgoing president, Jean-Claude Trichet, put it, the ECB has “only one needle on [its] compass, and that is inflation.” The ECB’s refusal to be a lender of last resort forced the creation of a surrogate institution, the European Financial Stability Mechanism.

Did Draghi just signal that a Draghi ECB is ready to embrace its responsibility as lender of last resort and to move off the one needle on its compass? Then take a look at Felix Salmon's account of what happened at MF Global, which was essentially a leveraged credit bet gone wrong. The story of MF Global is a cautionary tale of how quickly a financial institution can go south should it lose its liquidity funding. Is the ECB watching this is this scaring them?

What's more, did anyone catch the odd language in the last G20 communique?

We remain committed to take all necessary actions to preserve the stability of banking systems and financial markets. We will ensure that banks are adequately capitalized and have sufficient access to funding to deal with current risks. Central banks have recently taken decisive actions to defend, and will continue to stand ready to provide liquidity to, banks as required. Monetary policies will maintain price stability and continue to support economic recovery.

When did the ECB's mandate include supporting economic growth and recovery? Or was the G20 referring to other central banks?

The Red Knight to the rescue?

Moreover, there have been hints of Chinese intervention. In the wake of the disappointing Chinese PMI release, Global Macro Monitor asked:

Interesting official PMI was less than the HSBC PMI, which was also released today. Are they paving the way data for an easing of monetary policy or to justify contributing to the Eurozone bailout? Just askin’.

I wrote before that Chinese appear to be signaling a policy of selective stimulus; these "hints" may be part of that campaign.

Don't get bearish too soon

In conclusion, I know that the headlines and recent price action look dire, but I would be cautious about getting bearish too early. The technical backdrop is improving for the bulls and as we face two back-to-back event risk days where central banks may signal imminent intervention.

Even if you are a bear, wait for a rally before putting on short positions. Sell into strength, not weakness.

Even if you are a bear and believe that the Fed, ECB or PBoC can't save the world, they can still rip your face off with a trillion or two of quantitative easing.

Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.