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A Different Kind Of Exit

ONLY THE FED - I'm not sure where things will be when you are reading this piece, but at the time of writing, markets are making sense to me. US equity futures are off a bit, the Franc and Yen are outperforming, while Kiwi and Aussie are lagging. But overall, nothing has really changed and risk assets continue to be very well supported on Fed policy expectations. Proponents of major equity weakness have all but given up trying to pick a top, and there is a growing consensus that the stock market will never pull back again. After all, there have been plenty of fundamental justifications for a very well deserved reversal in US equities, and yet all of these justifications have been dismissed without hesitation in recent weeks. It doesn't matter that there is now a disturbing divergence between the real economy and financial markets, all that matters is that the Fed will forever be there to incentivize additional upside in stocks. The most amazing development has come from the bullish camp, where you don't even hear any "attractive valuation" or "favorable growth prospect" talk any more. Even bulls have conceded they are in this trade now purely because the Fed is telling them to be there and they will not exit until the message changes. Nothing else matters. Only the Fed.

A PROFIT IS NEVER A PROFIT UNTIL… - But a profit is never a profit until it is realized, and investors that have taken advantage of Fed policy through the stock market, will not appreciate this advantage until they actually book profit. If this is true, it stands to reason that with Fed policy arguably fully extended and stocks at record levels heading into the final weeks of the year, it could be a good time to start to think about actually realizing these profits. Throw in the fact that evidence of the outperformance in stocks translating into stimulus for the real economy has been lacking, and it could be argued that now would probably be a great time to be heading for the exits. The whole idea of zero interest rates and easy policy was to inspire a rally in risk assets that would then trickle down into the real economy. And yet, the only thing that has been realized to this point are the dangers of liquidity traps. Though money is now free, these benefits have only manifest by way of the stock market, and haven't really worked into the real economy. Those that have been able to take advantage have done so and those that need to take advantage have been mostly shut out.

LOOKING IN THE WRONG PLACE - What it all boils down to is that everyone is trying to figure out what that big catalyst will be that ultimately disrupts this goliath rally in equity markets. But maybe we are thinking too hard about this one. Maybe we are looking in the wrong places. It could be this catalyst won't present in the form of a specific fundamental trigger, rather it will come in the form of something as simple as profit taking. After all, there was no fundamental trigger to incentivize the rally to this point (just Fed policy), so why then won't it be something as simple as bulls deciding to close up shop, cash in their lottery tickets and head for the exit. Everybody has been so fixated on the impacts of a Fed exit on the global economy, and yet, perhaps we should be more worried about the impact of a stock market exit on the the global economy. If the Fed's strategy for recovery has been to inflate the stock market, what happens when the stock market is no longer inflated? The money that was supposed to trickle down is trickling down even less, and those that were struggling to get by with free money, will only struggle more as longer-term fears of inflation start to finally become shorter-term realities. Right now, S&P 1740 is the kel level to watch. With the market so sensitive to even the slightest of pullbacks at this point, the short-term level of 1740 becomes critical. I would even go as far as to say that a break and close below this level could very well be that catalyst which opens the profit taking flood gates. Until then, stand aside.