by Jeff Friedman
There are three major factors affecting the markets right now. These crosscurrents are the Federal Reserve’s easing measures to stimulate the U.S. economy, China’ tightening measures to dampen theirs, and the escalating debt crisis in the Eurozone. These events represent a little good, a little bad, and a little ugly going on around the world right now.
When I use the phrases “good,” “bad” and “ugly” to characterize the impact of these factors and events on the markets, it’s not meant to represent any sort of moral judgment. “Good” represents potentially bullish forces for the U.S. commodity and/or equity markets, while “bad” or “ugly” would represent potentially bearish forces.
The Good
So what’s going to be supportive of the economy and the U.S. markets? The most notable influence has been the Federal Reserve’s quantitative easing regime. The first easing regime announced by the Fed (“QE1”) was a lifesaver that is thought to have kept the economy out of a depression in the wake of the 2008- 2009 financial crisis.
As the economy still has not significantly recovered, at the November 2010 policy meeting the Fed announced a second round of easing measures, known as “QE2.” QE2 involves Federal Reserve purchases of about $600 billion in Treasuries, flooding the markets with liquidity and forcing long-term yields on interest rate vehicles down.
We saw how this move impacted rates on the long end of the yield curve, represented by the 30-year Treasury bond and 10-year Treasury. The idea is to get banks to lend and entice consumers and businesses to spend. This type of move is not without consequence. It can exacerbate deficits and eventually, lead to inflation. Someone has to pay eventually for the Fed’s accelerated money-printing. Quantitative easing will eventually have to be unwound, but it’s anticipation has created a strong rally in the U.S. equity markets.
We have seen some signs of improvement in the U.S. economy. Most of the recent economic reports have been more upbeat than they had been at the same time last year. Holiday shopping sales are strong this season, auto sales are accelerating, and manufacturing surveys are showing gains.
Employment has not yet staged much of an improvement. The Fed can provide cheap money, but it can’t force banks to lend or businesses to hire. For November, the employment picture is expected to be a bit more sanguine. According to a Bloomberg survey, non-farm payrolls are anticipated to rise 165,000. The report will come out on December 3, so we’ll have to wait and see what it brings, and how the markets react.
The Bad
I would call China the “bad” in this analogy, not because it’s actions are necessarily wrong, but because of their impact on the markets. In October, the People’s Bank of China surprised with a hike in its benchmarks short-term interest rate, to 5.56 percent. The move created a knee-jerk decline in the U.S. stock market.
In late October, the People’s Bank of China Deputy Governor Hu Xiaolian stated that their main task was to use multiple monetary policy tools to improve liquidity management and guide the money and credit growth back to normal. That created speculation more rate increases and/or other tightening measures would follow, and a month after the tightening move, China’s futures exchanges increased margin requirements to dampen commodity speculation and check rising prices.
If we believe lower interest rates are good for providing economic stimulus, then higher rates would be bad for economic stimulus. China is raising rates to counter the threat of inflation, which has been accelerating in developed countries. China’s inflation rate rose to 4.4 percent on a year-over-year basis in October.
China’s tightening measures curb growth not only in China, but in the rest of the world too. China is a major world buyer of raw materials. When prices get too high for its liking, and China cubs its buying, it has a big market impact.
I believe China is afraid of inflation, but I don’t think they want to move so far that it will derail the global economy. They just want to buy what they need at reasonable prices. I think the markets will weather China’s tightening measures, which I don’t think are likely to be severe. But these moves are likely to create some “bad” outcomes for bullish investors in commodities and/or stocks.
The Ugly
I would define the “ugly” right now as the European debt crisis. It started with Greece in the spring of 2010, which threatened to default on its sovereign debt without help from the European Union. Once a 110-billion euro bailout package was unveiled, the crisis seemed to blow over for a few months. Then it spread to Ireland, which was also in need of bailout package. Other countries are in danger as well, including Spain and Portugal.
In response to these spreading problems, the European Central Bank announced it would delay the withdrawal of emergency liquidity measures enacted previously but did not enact a new easing plan.
When we have these types of conflicting good/bad/ugly forces, the result for the markets is likely to be volatility. We won’t likely get a strong trend in the stock market until one of these factors overwhelms the others, or ends.
However, we have seen a “risk-on, risk-off” trade, which is likely to continue as news hits. Commodities such as gold have benefited from the bad and ugly, as well as the U.S. dollar, which investors still flock to as a safe haven.
The chart of the S&P 500 index reflects the overall health of the economy, and you can see how the expectations of quantitative easing factored into the market amid the rally from early September to early November. A mid-November pullback reflects fears over China’s policy moves, and then the uncertainty in the Eurozone. In the past few weeks, we’ve had a lot of up and down action—consolidation.
I’d be happy to address any questions you might have, as well as how you might apply these concepts to a specific trading strategy.
Jeff Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com. You can follow Jeff on Twitter at www.twitter.com/LWJFriedman. Join Jeff for his monthly webinar, Friedman’s Futures Forecast, by visiting Lind-Waldock’s events page.
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