"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Thursday, February 21, 2013

A Little bit of Fear?

Yesterday's downside reversal in the S&P 500, coming on the heels of the FOMC minutes, combined with a cornucopia of Central Bankers taking to the microphones today, seems to have FINALLY jolted the complacency of the Equity Perma Bulls. The Complacency Index, my name for the Volatility Index or VIX, has jumped quite sharply as signs are beginning to emerge that yesterday's FOMC minutes have rattled those who have somehow been hypnotized into believing that Central Banks have a magic can filled with magic beans that magically make all problems go away into never, never land, never to be seen again except in the dark recesses of our imaginations.

Here is a look at the chart that has gotten the technicians extremely concerned....

The extent of the stock market rally that we have witnessed since the beginning of this year alone is proof in my mind that investors can be herded into unthinking behavior faster than the word, "oligoply" can roll off the tongue.

Let's be honest here, the entirety of the stock market rally has been fueled by hot money courtesy of the Federal Reserve's Electronic Printing Press. It began with it back in 2008 with QE1 and has continued ever since then. Yes I know some point to corporate profits and signs of improving growth but does anyone out there genuinely believe that this economy can withstand higher interest rates? If the growth is so solid and the path to recovery is so entrenched then why is the Fed still continuing to conjure $85 BILLION each month that it might have it injected into the economy. Come on already....

The current fiasco involving the so-called "sequestration" in Washington DC has served to remind the saner among us that the US government is on a path that can only be termed "madness". The projected deficit for this fiscal year is over $ONE TRILLION. In a deficit of this magnitude, talk of even slowing the rate of spending increases (Washington DC speak for a cut) has brought out all manner of apocalyptic doom scenarios. What idiocy is it that grips the mind of these people? They are intent on bankrupting the nation. Historians paint a picture of the Roman emperor Nero supposedly fiddling while ROME BURNED. The current crop of leaders has certainly nothing on him. Matter of fact, they make Nero look downright statesman-like by comparison.

Here is the VIX CHART. Notice the sharp spike higher. Keep in mind that the only reason it had spiked higer in late DEcember of last year was over fears involving the now infamous "fiscal cliff".

Gold finally had some upside movement off its worst levels as it is seeing a bit of a reprieve from the nearly nonstop selling that has hit it since it took out support at $1640 last week. My buddy John Brimelow's excellent "Gold Jottings" reports very good premiums being paid for Gold by Indian buyers overnight. Demand was strong in Asia for the physical metal.

While the bounce is welcome, it does not look particularly impressive at this point. I suspect that there are more guys looking to sell rallies right now as they were caught long in gold and did not get out during the initial break towards psychological support near $1550. As I stated in yesterday's missive, gold needs to get back above $1640 to spook any of the shorts except for the most weak of hands. A move through $1620 will get some of them nervous enough to be ready to exit but the sentiment seems to be to wait around to see if the rallies have any staying power before exiting.

Something worth noting here, the Yen had a sharp rally, lots of short covering, as it and the US Dollar still remain safe haven currencies for some unfathomable reason. That implies a sharply weaker Euro and that is exactly what we saw today so far. The Euro got kicked in the groin by risk aversion trade tied to losses in the stock markets. Heck, the long bond finally showed some signs of buying although considering the extent of the jump in the VIX, for it to have trouble holding onto gains above a full point, tells me that there are still an awful lot of guys who want no part of bonds. Perhaps the thinking is if the Fed is going to throttle back on the bond buying program, there is no particularly compelling reason to lock in yields at such ridiculously low levels.

Let's just close today's thoughts with this... for the better part of nearly two months we have seen a near consensus among traders/investors that the Fed policy, in combination with the ECB, the BOE and the BOJ, had guaranteed smooth sailing in stocks. That led to one way trading in equities and in some of the currencies with the return of TRENDING MARKETS. That is the environment that traders, especially hedge funds LOVE. They find it extremely difficult to trade herky, jerky markets that whipsaw them up and down. The hedge funds were happy; the Central Banks were even happier as they had successfully herded the speculators into the markets they wishes them to ply their leveraged one way bets. All was well with the world, until....

 Yesterday's FOMC minutes have now injected uncertainty back into the minds of enough traders to return us to the wild up and down, nearly unpredictable movements of yesteryear. We'll have to watch these things very closely to see if this is the start of another new norm of more wild price swings or if we can return to the one way trades that marked the beginning of this year. Keep an eye on the Euro as it will give us some clues.... other than that, we are all trying to watch to discern what comes next. No one ever said this business was easy.


  1. Well that last comment was wiped away. Thank you Dan for your time efforts expertise and commentary.
    Hedgies looking for the big waves this year. Buy Sell Buy Sell. The Fed is looking at any way to exit their madness without hope that rates will skyrocket and business will suddenly crater. If they do not buy the debt what kind of interest rates do you think the public/Chinese/heck anyone will buy the debt for? Awfully pricey. Me sees VIX and Gold going north. How about Semafo, AUY, down 8% up 6, down 5 up 9, poor poor hedgies..

  2. "The projected deficit for this fiscal year is over $ONE TRILLION. In a deficit of this magnitude..."

    Not anymore. It might not seem like a big deal yet, but at least it's a step in the right direction.
    - 2013 deficit pegged at $845 billion -

    I suspect the markets simply used the FOMC minutes as an excuse for the much-needed correction.

  3. Hi Dan,

    I'd like to quote Clyve Maund here, as it might mean that FED decided to sacrifice SP500 uptrend (and PMs) in order to herd hedge funds and other investors towards the most important asset of all, the Treasury Bond, in order to avoid a dollar collapse and a brutal increse of interest rates.
    Do you agree with this vision?

    "The US Treasury market is the grand aorta of the US economy, which enables the goods and services of the rest of the world to be exchanged for piles of intrinsically worthless paper, thus allowing the US to live way beyond its means. As such, the Fed and US government can be expected to defend it with every means at their disposal. Right now it is under stress after its recent decline and in danger of crashing key support which could trigger a tidal wave of selling, as we can see on the chart below for the proxy iShares Barclays 20+year T-bond Fund. With both the dollar and Treasuries on the verge of tanking, it is clearly time for some really big levers to be pulled, and the most effective way to sluice funds into the dollar and Treasuries is to engineer another deflationary scare involving pulling the plug on the commodity and stockmarkets, and given the vastly greater importance of the Treasury market, the Fed would have no qualms about doing this. Such a scare would also provide a politically favorable environment for cranking up QE to even greater levels. While this is only a theory at this point, the logic behind it is plain – and it explains the current positions held by the powerful Commercials, who are at the top of the market food chain. "

    1. Compare a chart of QE instances with the 10-year yield. Yields have tended to go *up* during periods of QE.

      The yield on the 10-year went up from about 2.5% to nearly 4% when QE1 was in effect from early 2009 to mid-2010.

      As QE1 was winding down, it went back down to around 2.3%.

      Then when QE2 began, the 10-year yield went from that 2.5% in the fall of 2010 to about 3.4% in the spring of 2011.

      When QE2 ended, replaced only by Operation Twist, yields collapsed. They've only begun to recover again ... perhaps not coincidentally as QE3/4 has begun.

      If you don't believe me check the chart.

      One can argue that yields would be higher without any QE, but that begs the question as to why they went *up* as each round of QE went into effect? The only time yields went or stayed low was when there was no Fed balance sheet expansion (such as the summer of 2010 and during Operation Twist).

      So basically, I'm saying the evidence shows that the Fed is *raising* the government's cost of borrowing by doing QE.


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