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The Interim Conundrum And Pussy Cats

Although many a people (mostly perma-shorts) were expecting Q2 to herald with a whimper, what we got was a bonanza of a party in yesterday's ramp fest on, you've guessed it, fumes. For a good part of Q1, American equities proved to be the winner, along with several commodities (most notably Gold and Oil). Q1 saw major decoupling amongst risk (and more recently non-risk) assets as broad risk (FX carries, HY credit, cyclical/growth commodities) severely underperformed American equities. European equities also outperformed their credit counterparts but to a more miniscule degree. The haranguing over how the 5th warmest winter in America's history boosted economic expectations and official figures (through the BLS's preposterous seasonal adjustments and old-haughty data collection methods) has been discussed to death. I cannot bring myself to believe that unemployment has fallen when 46.5mn Americans are surviving on paltry government contributions and food stamps. To sway aside for just one bit, if one were to plot a trendline on the America's obesity rate and did some extrapolation, a whopping 75% of Americans would be obese by 2020 (at least according to a study published by the OECD). How does the world like poor, extremely oversized and very angry American protestors (please do not for once think I'm disrespecting Americans as a whole for one bit)?

But back to our alphabet soup of crony capitalism, Q1 seemed to have been extraordinary. After all, the stock everyone owns has risen 48%, disgusting bubble callers and perma-shorts who have seen their equity curve sliding into hades. The ES is a mere 7% off its all time highs while the Dow has advanced a record 900+ points in just one quarter. How much longer can this illusion and hopium last? How much longer can companies with a ruck of cheaply borrowed cash continue their epic share buybacks? How much longer can HFT algorithms that operate on principal of trading faster than what the exchange actually trades continue to last? Call it whatever you wish, because this is in essence, ladies and gents, a big fat ponzi market where the word reality is more alien than a martian. Will Q2 prove to be a period where conditions unlock the gate in Solomon's yard, revealing a giant hydra that attacks from 9 angles? It's hard to say, I've learned not to hold my breath. I've previously posted analyses on what could go wrong in the interim (here and here).

The main things many of the non-mainstream folks have balked about very recently is that US economic data will continue to miss expectations as the seasonal adjustment boost wears off (or at least government officials have no legitimate reason to do so). The placebo of operation twist will also wane in short order. The best hope reality vigilantes have will as mentioned. Although the chairsatan hasn't yet provided a solid stance on where monetary policy will head, it seems QE3 is being partially priced in, as reflected in the Dollar's reluctance to rally despite being 55% Euro weighted. However, if expectations were indeed serious, Gold should not have hovered adamantly under $1700 (and with weak upside momo). Treasuries aren't displaying the traits of previous periods of ebullience. Betting on the presence or absence of QE3 is akin to playing Russian Roulette whist being drunk on Vodka. The markets haven't had enough information to digest, but we will soon get further ques. Watch out for those FOMC announcements by the chairsatan.

The only thing that I'm confident on betting my money on? The Euro. And I expect a fall towards a target of circa 1.2. The fall wouldn't be a watershed cascade but will be a controlled grind which will probably baffle the heck out of most traders. The technical driver? The ECB's vs. the FED's newly created stock (ex. reinvested matured securities). I've borrowed Citi's chart, courtesy of Tyler over at ZH for a salient illustration.

(Click to enlarge)

$600bn of stock was added to the FED's assets under QE2 and that was the last of it (assuming we are being given correct data). ~$1000bn of stock was added to the ECB's assets under its LTRO during early December of 2011. The Euro is almost unchanged from the onset of LTRO. The thesis that I'm betting on a depreciation of the Euro relative to the Dollar and most certainly Gold because of this very fact. The Euro hasn't priced in LTRO and so there's a technical arbitrage to profit from. Timing will be the juggernaut but from what I'm seeing, things look pretty prime for action (note the Euro has been basing for about 4-5 weeks now). Watch Spain, riots have emerged recently. There is absolutely nothing for the Euro to rally on. The oddball is the FED's potential QE present, that's about it.

Happy trading fellas. But one quote from Bruce Lee: "Be water my friend". For those still able to tolerate the market's bullcrap and hubris, flow with the bullcrap and rack in some points. But for most sensible investors, they have already withdrawn what's left in their exchequer, and that's a sad thing.