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Mikhail Sourikov
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Analyst at Chifbaw. "Mikhail Sourikov" is a pseudonym for publishing purposes.
My company:
Chifbaw LLC
My blog:
Chifbaw M.S.
  • Okto-Bear Fest: When Mr Obananke Meets Mr Romnisher 0 comments
    Sep 28, 2012 3:24 AM | about stocks: VXX, SPY

    After half of year or more of a "catch me if you can" game, the market finally caught Mr Bernanke and found in his "womb" the infinite essence of fiat money, or more vulgarly called QE3. Never has the essence of fiat currency been so exposed to the sun of human consciousness: infinite expansion, until money kills idleness (i.e. unemployment). Although excess of money usually encourages idleness, but that's a philosophical debate.

    But now that the market has discovered the infinity of QE, is there any purpose left in his life, any new mystery to uncover? Why grow any further? Isn't it a time to rest in a state of limbo (post-shot nirvana)?

    The reality is that QE-infinity might end up having a bearish effect in the short term for the markets since it effectively removes the Bernanke put and creates an existential emptiness. By looking at the yield on the 10 year note, one can remain skeptical about a market rally after QE-infinity as shown on figure 1. Yields ought to be much higher if we were in a full risk on environment. Unless we see some weekly closure above 1.9% (break of the descending trend line), we can consider that there is still no lasting risk-on rally ongoing. In addition, the SP500 is so close to a decade old barrier in the 1500-1550 area, with absolutely no sign of a real bullish momentum that would allow us to see the SP500 grow to new highs (like 2000!).

    Figure 1: yield on the US 10-year note. O mighty Bull, what is holding you now?

    Now, this short term bearishness has some temporal key features. October is the month known as the bear-killer since it usually demonstrates strong rallies. October 2011 was one of the best bullish months in the stock market history. And some investors are gearing up for the next leg up in the market to happen in October. This would be so logical: the fed has announced an unprecedented stimulus program, forcing any assets to inflate; the European break-up risks seem tamed by an unusually strong ECB and the Chinese economy is guaranteed to receive soon its own dose of stimulus to facilitate a stable political and economical transition. On top of all this, it's an election year, so how would the crowd dare not to rally?

    Well, there are some parallels with 1987 that could give us a similar big surprise in October this year. Apart from historical parallels, there are also some bearish fundamentals waiting in the background for their turn to enter the stage.

    The monetary nihilism caused by QE-infinity will certainly exacerbate the debates between the Romnisher clan (Mitt Romney + Dallas Fed Richard Fisher which would fit very well the role of fed president if Romney becomes president) and the Obananke clan (Barack Obama + Ben Bernanke) during the election campaign. But this in itself is not enough. In October, the fiscal cliff will change from being a hypothetical end of the year issue to become a visible hurdle that could hurt the market. And the October debates might further highlight the cognitive dissonance that grips the US political system and reduce in the eyes of investors the chances of a favorable outcome to the fiscal cliff. In parallel, the Q3 earnings season will probably confirm that earnings are going downhill and that margins are being eroded by the QE programs.

    On the other side of the Atlantic, Europe remains an orchestra without a conductor and is probably the main source of bearishness. Greece is like a bad Mexican television series that no one dares to end and where the evil Mr Deficit returns every episode to cause new troubles although the hero named Troika thought he had him killed in the previous episode. But today Spain is a more serious potential troublemaker. Mr Market won't be happy until there is a fully-fledged Spanish rescue with ECB intervention in the bond markets. And since Europe advances only when Mr Market "kicks its …", we will probably need to see some renewed pressure coming from bond markets to force Mr Rajoy to consider bowing to the bureaucratic muscles from Brussels. Possibly even more dangerous is the chaos that could be unleashed if Catalonia goes to the polls to vote on its independence (rather in November). Not only would this increase the uncertainty around the fate of Spain and complicate its rescue process, but it also could create a large wave of independence movements all across Europe (there are so many regions that want to break free, the most symbolic one for Europe being Flanders).

    Finally, the fate of China remains the most unpredictable of all. Many signs indicate that we are in a continued slow-down in China such as PMIs consistently below 50. Chinese authorities are now caught between the desire to stimulate again the economy and the risks of re-inflating the property bubble that they were so keen on popping. Overall, China should be fine, but with political succession creating internal shocks, no wonder that the islands conflict with Japan has become so stringent. A military escalation is unlikely; however, a trade war between the second and third economies in the world could cost both China and Japan some GDP points and badly affect all markets.

    In conclusion, we think that October 2012 could offer a big opportunity for the bears. Our recommendation is to closely follow the bond markets. If the Spanish bond yields (2y-5y-10y) start climbing again, and the US yields stay low, that would mean we are entering a new phase of risk-off. The 2012 US elections will be a source of uncertainty for the markets in October and November. A possible way to profit from an Octo-bear fest is to have long term puts on the SP500 (at least till December), or to buy volatility (for instance "VXX(VXX)" ETN ). On the upside, should we see a rally forming on based on the bond market, Gold could be one of the biggest winners ($1800 barrier is a key level before $2000).

    Longer term, If Obama is reelected, then we expect at the beginning a contraction of the stock market until further intensification of the QE programs finally causes hyperinflation: bond yields would explode to the upside and the SP500 would finally grow above 1550 to new records. The dollar would become worthless and gold/silver will reach new peaks.

    If Romney is elected, then we would expect a bull market in the dollar since QE-infinity will be ended and a deflationary environment will finally settle in. Stocks would stay range bound with a downward bias until fundamentals start to improve. The secular commodity bull would take a pause.

    PS. We forgot a little detail. Similarly to October 1987, we could have some real conflict materialize in the Persian Gulf. This region is currently one of the hottest spots for military tourism. FromWikipedia:

    "The crash began in Far Eastern markets the morning of October 19. Later that morning, two U.S. warships shelled an Iranian oil platform in the Persian Gulf in response to Iran's Silkworm missile attack on the U.S. flagged ship MV Sea Isle City."

    Disclaimer: Trade at your own risk. Chifbaw LLC and the author of this article are not responsible or liable for any trades or decisions that you make based on the information contained in this article. The opinions contained herein are for general information only and not tailored to any specific investor's needs or goals.

    Disclosure: I am long VXX.

    Themes: Market outlook Stocks: VXX, SPY
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