Last Friday I warned that a second consecutive week of gains following the strong rally last week was a big hill for the bulls to climb. Well, with Bernanke’s willingness to throw another trillion dollars around, the bulls were able to hold on to record a second week of gains – but barely.
I really didn’t think they would do it. And, truth be know, they shouldn’t have.
The shell game of monetizing debt by the Fed where they are buying and selling treasuries reaches the public through the press as though all stops have been pulled out to get this economy on track.
The real truth is that things are so bad there is literally no one in the world willing to buy up any more US debt. So the Fed acts like a hero on a white horse and pretends that they can actually buy up US debt. The problem is that the Fed doesn’t have any money to do this - - - - - unless they print it up! … which they have just done.
And that is where the risk just became even higher. The real truth about the implications of the Fed monetizing US debt is starting to sink in. While there is definitely a stimulating effect by pumping fiat money into the system, the real effect is that the dollars in your wallet aren’t going to be able to buy as much stuff in the future.
If the Fed can put the brakes on fast enough, then perhaps a hyperinflationary period can be avoided, but the actions of the Fed this week are like playing with matches in a garage of gasoline soaked rags. Sure, they can light a fire under a rag or two and everyone in the garage can enjoy the light and heat, but what happens if all the rags catch on fire - - - down comes the garage with the occupants inside.
This is a time to think short term. Long term success of the Fed action is fraught with question marks. It is almost like somebody behind the curtain really wants the US dollar to collapse, the implications of which could be horrendous for the average US citizen.
You have to keep asking the question, “Can we really bail out anything and everything?” Or should we just let some things fail so there will at least be some pieces to pick up. There simply isn’t enough money to fix all these financial problems. Someone needs to fail or everything will fail.
Sorry to sound like a doomsayer this week, but the steps being taken by the administration and the Fed so far in 2009 are at levels never seen in my lifetime and it makes me concerned about the long-term prospects for the economy.
Don’t get me wrong – I am comfortable guiding you and my clients through these rough waters. Heck, I think we might even make some good money with the short term long/short opportunities that are likely to exist for a very long time now.
But the slow and steady recovery that the US economy needs after the bloodbath we have gone through is clearly no where to be found. All this government manipulation to keep the ship upright and heading forward may end up being just the thing that tips it over.
Perhaps they should let the ship take on a little water, let it slow down a lot, and then go to work fixing the ship rather than trying to gun the engines and put fingers in all the holes to keep the water out.
From a technical perspective, prices for the broader market have quickly reached resistance at the 50-day moving average. Check the S&P 500 out on the following chart:
If the market overcomes this resistance level and puts in a third week of gains, it will be remarkable, given the current environment. But if the reality of the Fed intervention by monetizing debt becomes clearly understood and appreciated, then I expect to see a retest of the March lows.
If the spin that the Fed and administration put on this monetization is successful in convincing the public that they are closely at the controls and it is not going to get out of hand, then perhaps a 50% retracement of the recent rally is what we will see.
If the truth about monetizing debt can be well hidden from the public and the short term traders dominate the market, then a very slight retracement could result – even so much that the markets could retrace early next week and still rally to a positive conclusion by the week’s end. This would be a very bullish, but risky proposition – one that could see the markets climb rapidly, but likely set up to fall even harder.
For a longer term picture of how significant the 50-day moving average is take a look at the following one year chart of the S&P 500:
You can see clearly that the May 19, 2008 high (at 1440) began a treacherous path downward, even though October is where the real pain was administered. And the low point was set only a few short trading days ago, on March 6 (at 666). The precipitous drop over ten lousy months was – 54%.
Notice that over the last year, once the S&P 500 prices fell significantly below the 50-day exponential moving average (in early June of 2008), that they have never ventured above this resistance line for more than two or three days. That is why betting on the bulls is a formidable choice to make.
On the other hand, an intermediate advance is long overdue. With the recent disappearance of the November lows as the Bear Market Low and a new Bear Market Low set in March I am forced to declare that the initial bear leg is still in play and was NOT set in November. Hopefully it was set in March.
When you see prices on this chart trend above the 50-day moving average for a couple of months then you can feel assured than the initial down leg of this bear market is “IN”.
But you can be just as sure that after a retracement of 40-60% (maybe less) that another hard leg down will likely be attempted – one that could easily be even lower than this first leg down. This is going to be a long and drawn out bear market, I am afraid.
Remain defensive unless you have clear and focused guidance on long/short opportunities. Once in a lifetime events are unfolding.
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