QE-Infinity: Poking Holes in Bernanke's Logic

I'll start off by saying: I was dead wrong about "no QE3" this time.  With the dollar in crash mode and equities trading at multi-year highs, I did not expect the Fed to do anything more than continue their "Virtual QE3" talking-points program. 

With that bit of crow-eating out of the way, it's time to adjust to the new realities and discuss what the program means for the market and the economy; additionally, one simply cannot avoid some discussion on the moral hazard and the politics of it.

Let's start off with what the program entails.  Quantitative Easing is government-speak for "printing more money" (although, in today's world, this is less about the physical printing press and more about digital transfers).  The Fed has been reduced to printing because their usual go-to monetary tool, which is lowering interest rates, has long been maxed-out and ineffective.  Fed fund rates are already effectively negative; thus there's nothing more to be done in that regard.

The Fed has departed somewhat radically even from previous QE programs, as this is the first program with no fixed end-date.  Therefore, instead of calling it "QE3," it seems more appropriate to name the new program "QE-Infinity" (I would simply use a lemniscate after "QE," but my font doesn't allow it).  On Thursday, the Fed committed to buying $40 billion worth of Mortgage Backed Securities (MBS) every month in an ongoing open-ended program, which, for those keeping tabs, equals a total commitment of $85 billion a month when combined with existing programs.  This will cease when the Fed "sees substantial improvement in the labor market."

Of course, this immediately begs the question, "What will the Fed view as 'substantial improvement?'  What are the qualifiers, and where will it end?" 

The answer is a resounding: "Nobody knows."  In Bernanke's own words: "We haven't yet come to a set of numbers, but we're guaranteeing that we won't tighten too soon."  That statement alone should create some discomfort with American taxpayers, as the unaccountable (to voters) Fed is admittedly setting a far-reaching policy with no qualifiers.  But naysayers are glibly refuted, as Bernanke demonstrates in a statement discussed later.

Printing money floods the market with more dollars, which makes dollars worth less (supply and demand: more supply equals lower value), which means that tangible assets priced in dollars -- such as oil and food -- end up costing more. This is euphemistically referred to as "inflation."

One of the arguments against prolonged low interest rates and flooding the money supply is that these actions punish savers in two ways: artificially low interest rates hit savers' accounts directly; and printing money hits them a second time and forces them into high-risk assets as they try to keep up with inflation.

In a weak attempt to address the fact that his policies punish savers, Bernanke responded with this glib straw-man argument: "You can't save without a job." 

Yes, that's a true statement.  But it's not a legitimate argument.  Even in this depressed labor market, there are still far more Americans with jobs than without them; and there are more and more retirees struggling to survive on savings being held in accounts that currently yield virtually no return. 


Bernanke's argument that trying to add a few percentage points to the employment rate justifies punishing everyone else because "you can't save without a job" is akin to the automotive industry announcing that, henceforth, they're only going to produce super-cheap cars that have no seatbelts, no bumpers, and no other safety features -- on the justification that these dirt-cheap cars will allow more people to afford cars.  Ben's simplistic logic is essentially: "You can't die in a car wreck if you don't have a car!"  Can't argue with that statement.  But it doesn't address the real issue at all; it merely reframes it into terms where he can seemingly win the argument.

His statement also assumes the underlying presupposition that an ongoing QE program will actually improve the labor market -- and that assumption is not a given.  There is an ongoing debate over how much influence the Fed actually holds over the labor market, and the question was asked of Bernanke yesterday:  "How does boosting assets really help the real economy?"  Bernanke replied, "There are a number of different channels: Mortgage rates, corporate bond rates, and increase in home prices and stock prices."

This is another non-answer that avoids the real question.  Bernanke responds that there are "different channels," but he does not establish that these channels have any direct causation in creating more jobs (he also argued this earlier, but again in a cursory manner based on unproven presuppositions). 

Nor does Bernanke establish how these "channels" materially differ from what's already been tried.  In fact, Esther George, president of the Federal Reserve bank in Kansas City, recently asked this rhetorical question: “Is there anyone not borrowing today or purchasing a house because interest rates aren’t low enough?  Do we expect that businesses will hire if their long-term rates are lower?”

The follow-up question that needed to be asked was, "I understand that, Mr. Bernanke; allow me to rephrase:  How do these 'different channels' actually help the labor market?"

QE1 and QE2 did not appreciably help the labor market, as shown on the employment chart below.  But, hey, this time will be different, right?

While the QE programs haven't helped the labor market, they have pushed up the stock market and commodities through inflation, as shown on the chart below:

Market Awaits the Fed While the World Goes Crazy

There's absolutely nothing to add to yesterday's update -- and believe me, I really looked.  After I studied the charts, I decided to look at some economic stats... and as I meandered my way around the world of online news, somehow I found myself watching the low-budget film trailer which apparently offended some folks in Libya enough that they decided to storm the U.S. Consolute and kill a number of innocent people, including the U.S. Ambassador. 

The trailer is incredibly low-budget, poorly-written, and hastily-produced.  Normally, I wouldn't have watched it beyond the first 30 seconds unless I was being forced to do so at gunpoint -- but I felt a morbid curiosity to discover what could possibly be hidden in a film trailer that could anger a mob so much that they felt its mere existance justified the killing of innocent people. 

Suffice to say, I couldn't find it; nor did I expect to.  All I'll say about it is this... the majority of philosophies leave no equivocation on this issue: offensive words do not justify violence and murder.

Sorry for the tangent, but I found the whole incident disgusting.  I didn't set out to write this; I just ended up here after reading the news -- and I won't say more about it, since I do not wish to have my house burned to the ground by an angry mob.

My heart goes out to those families who were impacted by this tragedy.

I'm sure there'll be more market-related stuff to talk about tomorrow, after the Fed announcement.  Trade safe.

Two Long-Term Charts Every Investor Should See

The first bit of market-moving news is now out, as the German constitutional court ratified the European Central Bank's bond-buying program.  Bulls are hoping this will provide more liquidity to keep equities ramping higher.

The Fed announcement is pending and due out on Thursday, and I feel this ECB news largely rules out a new QE program at this time.  This Fed strikes me as very reactionary, and I think they'll be saving the QE3-bullet for a moment when the market actually needs a lift.  That moment isn't now, since the market is trading at multi-year highs; but it's highly likely that Bernanke will do some more jawboning about how "ready" the Fed is and how they're just itching for any excuse to launch QE3.  They need to keep hope alive in order for their ongoing "Virtual QE3" program to continue working.

The first chart I'd like to share is a monthly chart of the Nasdaq Composite (COMPQ).  This is the type of chart you rarely see published; most traders tend to get focused on the smaller time frames, and then end up blind-sided when the market reaches very long term resistance (or support) levels they didn't even know were there. 

I would be quite surprised if the market can sustain trade above the long-term resistance levels it's now approaching; in a moment I'll discuss some reasons why.  Needless to say: if it can, I would consider that a solid reason to shift to a more bullish footing.

The black channel is called a "base channel" in Elliott Wave terminology, and the price action within is presently viewed as an ongoing correction to the dotcom crash wave.  Most corrective ABC waves will maintain trade roughly within their base channels; a significant breakout through the channel is considered a warning that the assumed correction may instead be something more meaningful.

The top of the base channel crosses roughly 3200, and the market has thus far reached a high of 3139.  This chart suggests that caution is in order for long positions.

Next is a long-term chart of the Volatility Index (VIX).  When VIX goes up, equities generally go down; and vice versa.  I called attention to this chart on August 20, and mentioned that this signal seems to lead turns in equities by a few weeks.  The few weeks have now passed, so we should know reasonably soon if this signal means anything. 

The S&P 500 (SPX) daily chart continues to suggest that a terminal ending diagonal is the best-fit to the current pattern.  Once again, the upper black trendline is my adjustment point from bear to bull; a head-fake breakout would be reasonably normal, but sustained trade above that level would cause me to suspect the pattern is more bullish than anticipated.

The chart discusses a recently-triggered signal in the Bollinger bands, which in the past has led intermediate tops.  This historical market behavior fits the expected terminal nature of the pattern, and it's one more signal that's causing me to continue favoring a bearish intermediate outlook.

The SPX has not quite reached the 1440-1460 target zone, though it came extremely close with Monday's print high of 1438.74. If this is indeed wave 5, the chart below also suggests that it's time to stay cautious and nimble with long positions.  However, so far the bears haven't reclaimed any key support levels, and the weird overlapping structure at the beginning of the move makes it somewhat difficult to predict exactly how many fourth and fifth waves still remain left to unwind.  Inexperienced traders are not encouraged to front-run anticipated turns, as bucking the trend is always a high-risk proposition.

 

 

The three-minute SPX chart suggests a simple bullish trade trigger and probable target.  Trade beneath 1432 would cancel the target and give the short-term market a more bearish bias.

 

 

 



In conclusion, the long-term and intermediate-term trends are still up, so one might ask why on earth I'm favoring an intermediate bearish outlook.  Here's how I parse the evidence:

 

1.  The Nasdaq is near long-term resistance.

2.  The VIX is near long-term support.

3.  There are several recent signals, such as the Bollinger band breakout (discussed on the third chart), which have consistently led intermediate turns in the past. 

4.  The SPX appears to be completing a terminal pattern.

 

These are the types of things I look at when trying to determine the likelihood of one pattern over another; and the combined evidence suggests that a terminal pattern presently makes perfect sense here.  Are there bullish options?  Absolutely, and I'm not closed to those options (see Monday's article); one can never say for sure what the market will do, but the current evidence suggests those options are less likely.  A sustained breakout above the levels discussed would shift the odds into the bulls' favor; barring that, the evidence suggests that an intermediate turn is fairly probable. 

 

Once again, this does not preclude higher prices over the short-term, and indeed the short-term pattern suggests the move may have a bit farther to run.  But for longer-term traders, now is definitely an excellent time to exercise caution.  Trade safe.

 

Reprinted by permission; copyright 2012 Minyanville Media, Inc.



This Week Should Be a Game Changer -- and Two Charts for Bulls

This week has the potential to be a game-changer for the markets.  On Wednesday, Germany's courts will decide if they're going to support the ECB bond-buying program, and Morgan Stanley has put the odds of the program being killed at 40%. 

On Thursday, the Federal Reserve will announce the verdict on a new QE program.  Most of the pundits I've read seem to think QE3 is all but guaranteed -- but I still think it's a long-shot.  As long as the Fed can keep bullish sentiment reasonably high with their Virtual QE3 (i.e.- talking about it and dangling the carrot), then there's no reason for them to actually launch QE3.

Both of these pending announcements are all but guaranteed to be market movers.  I've been arguing the intermediate bear case for several weeks, but a bullish announcement from the central banks does have the potential to blow that case up.  Of course, conversely, a failure of action from the CB's has the potential to validate it.

It's becoming quite unpopular to be bearish, and there's a feeling that the central banks won't ever let equities head south again.  Maybe so; I can't control or predict Dr. Bernankenstein.  But when there are signals present which have consistently led intermediate tops in the past, what's an analyst to do but assume the odds favor these signals will work again?  Past performance is never a guarantee of future results, but we really have nothing else to draw from besides historical market performance.  Imagine you asked me if I thought it was likely that Congress would enact a law raising the interstate speed limit to 120 miles per hour.  I would say no -- but if they raised it next week, I would still have been dead wrong.

So far the market has performed in line with expectations for the intermediate bearish counts.  It's important to understand that there are different time frames at work, and the margin of error is different for each time frame.  I predicted the top at 1426 and hit that turn to the day using short-term wave counts.  At the time, I thought it would be an intermediate turn, which was proved incorrect; and it turned out to be only a short-term top (I still consider that a pretty decent call, considering that there was no sign of weakness at all heading in).  Everything that's happened since falls within the margin of error for the intermediate bear outlook, and I repeatedly stated that no bearish confirmation levels had been crossed to the downside, and therefore a new high to 1440-1460 remained possible. 

So when and where does that count exceed the margin of error?  Again, from a technical perspective, the upper trendline of the proposed ending diagonal is my adjustment point (upper black trendline on the chart below).  A "normal" ending diagonal may or may not overthrow that line to the upside, but if this is a terminal pattern, then any breakout will whipsaw.  If the market can instead break out there and sustain that breakout, then I will throw in the towel on the bear case until further notice.

When I study the charts, I simply can't ignore signals such as the one discussed on the S&P 500 (SPX) chart below -- and these signals lead me to persist in favoring the bear outlook.  If respecting historical significance ultimately leads me wrong in the end, then that's exactly the way I want to be wrong. 

 

The next chart is one of my proprietary intermediate-term buy/sell indicators.  This indicator has served me well enough over the years that I'm not willing to share the signal components with the general public -- but I have marked each prior signal on the chart, going back to 2002.  This indicator gave a confirmed sell signal at 1426 -- and this is the first time in its history that the market has broken back above a confirmed sell signal this rapidly.  I honestly don't know what to make of that behavior, but either this indicator will prove itself right in the end, or I'll have to add this to my list of "weird" market behavior from the recent past.  This indicator is suggesting that the market is massively over-bought right now.

Next is the SPX 30-minute chart, which still suggests that higher prices are reasonably likely over the short-term.  If the intermediate bear outlook is correct, this should be the final wave up. 

On Friday, I promised to expand a bit on the bull case, so the next couple charts discuss that, and as I've stated, the central banks remain something of an x-factor.

The first chart is unarguably bullish from a classic technical analysis standpoint.  The NYSE Composite (NYA) has broken out above a three-point validated trendline that goes back to spring of 2011.  As long as it sustains that breakout, my bearish intermediate outlook is pure and unadulterated front-running.

Next is an examination of a potential bullish wave count.  I discussed this count months ago, but largely discarded it as unlikely -- again, based on the historical significance of several indicators.  Time will tell if that was a mistake; but if so, that's the type of mistake I'm not ashamed to have made.

While Elliott Wave suggests this count is unlikely, classic technical analysis says the pattern is bullish -- but for now, this remains an alternate count.  Again, depending on what happens next, I will let the market dictate if this count is to be followed or ignored going forward.

Finally, a simple long-term trendline chart of SPX. 

In conclusion, it appears reasonable to assume there will still be higher prices over the near-term.  I remain in favor of the bearish resolution to the intermediate-term... but if you don't like front-running turns (and I've never recommended it for anyone but veteran traders), then remember that the short-term trend is up, the intermediate trend is up, and the long-term trend is up.  Meanwhile, the central bank actions later in the week have the potential to alter either my bearish outlook or the bullish trend.  Trade safe.

Reprinted by permission; copyright 2012 Minyanville Media, Inc.

Europe Buys Higher Equities Prices

Yesterday's outlook expected upwards movement in the S&P 500 (SPX) toward two different target zones, 1412-1416 and then 1420-1426 beyond that.  The rally substantially outperformed and continued up past 1426, which invalidated my short-term preferred count and now opens up the next target zone of 1440-1460. 

The European Central Bank announced yesterday that they would provide additional bond-buying, which effectively offers more liquidity steroids to an already-pumped-up market which could put Ahh-nold (Schwarzenegger) to shame.  This inspired me to draw up a chart illustrating how the Central Banks have "printed our way to prosperity." 

This chart isn't a full accounting, and completely ignores the actions of the Bank of England, Bank of Japan, and even some of the ECB's past programs.

The Central Banks remain the x-factor in any and all long-term analysis, and it seems that every time the markets try to return to any sense of normalcy, the CB's step in and goose the market with another round of printing/lending/throwing money out of helicopters. 

Yesterday's price action was still well-within the parameters of the preferred long-term outlook, and if this is indeed an ending diagonal for intermediate wave (c), then the long-term pattern still appears on track, and actually looks better with higher prices over the near term. 

The chart below outlines my adjustment point from bear to bull, which is represented by the rising red trendline.  If the market can somehow sustain trade above that level going forward, then I will capitulate the bear case until further notice and simply join the masses in singing the endless praises of the printing press.  Presently, my preferred long-term outlook remains in expectation that a top is forming, though this could be several more weeks in the making. 

Incidentally, while I have been long-term bearish for some time, I do not want to develop a reputation as a "perma-bear."  Newer readers probably don't realize that I was bullish at the October 2011 low of 1074 (and called that turn to the day), as well as very bullish at the March 2009 low of 666 (and also called that bottom to the day, in real-time).  I am not a perma-anything; I'm simply long-term bearish at this time. 

I continue to work both sides of the trade on the shorter time frames -- in fact, my key levels yesterday led right up the market ladder, and the market reached all but the final target: I suggested a breakout above the triangle (which crossed 1408) would lead to 1416; that a break of 1416 would lead to 1426, and that a break of 1426 would lead to 1440. 

I'm also not perfect, and it's always possible that my long-term bear outlook is entirely off-base.  I simply call what I see.  During the weekend, I'll delve further into the bull potentials and expand next week on whatever data I find in support of the bull case.

The next chart is the 30-minute SPX chart, and the price action strongly argues for higher prices over the near term.  Somewhere in here, we should get a sideways/down consolidation in wave (4) of 5, which should ultimately resolve higher in wave (5) of 5.  If my intermediate outlook is correct, then 1440-1460 is the next price target.

(NOTE: small typo on the chart -- blue 4 should be farther to the right.)

Next, a quick update to the Nasdaq 100 (NDX), which has so far performed as expected and is on track for the 2900-3000 target.  I was unsure if SPX would break back above 1426, but I felt reasonably confident that NDX would make new highs, as last discussed in this article from August 22.

Finally, a quick update on gold, which yesterday captured my 100 point target from July (from 1610 to 1710).  Gold could encounter resistance from the broken blue trendline.

In conclusion, yesterday suggested strong momentum, and that type of move usually carries over with residual upwards momentum.  The next target for SPX is 1440-1460; and I'll try to narrow the target down further as the structure takes shape.  Trade safe.

Reprinted by permission; copyright 2012 Minyanville Media, Inc.

Europe vs. U.S. Economic Fundamentals and the Charts

In this article, I'm going to discuss three important factors the stock market is currently facing, starting with:

Europe

The market has been anxiously awaiting the European Central Bank policy decision, and at 12:30 GMT today, ECB chief Mario Draghi is expected to announce the framework for a new bond-buying program to help bring down the borrowing costs of Spain and Italy.  Investors are looking for Draghi to back up his promise of July 26 to do "whatever it takes" to preserve the euro.

European markets and U.S. futures were rallying on Wednesday night in anticipation, and this could be a make-or-break moment for the markets.  Gilles Moec, senior European economist at Deutsche Bank stated, "Expectations are extremely high. If the ECB does not deliver, we will get into another bad patch."

ECB debt purchases would succeed the bank's Securities Markets Programme that has been dormant since March -- which, not coincidentally, is when the S&P 500 (SPX) began struggling.  I believe it was the liquidity overflow of the ECB's LTRO, not the Fed's Operation Twist, which was the driving force behind the rally that lasted from December 2011 to early April 2012.  The time-lines match perfectly.

Central bank liquidity operations have a huge impact on equities, since equities prices are driven solely by liquidity ("excess" liquidity drives up asset prices through inflation).  Thus, until the details are revealed, the pending ECB policy decisions are currently an x-factor in my projections and analysis.

The U.S. Economy

The next two charts are courtesy of my friend Lee Adler at the Wall Street Examiner, and portray the ISM Manufacturing Index (which represents goods) and the ISM Non-Manufacturing New Orders Index (which represents services).  Non-Manufacturing numbers are due to be released today.  Levels below 50 on either index tend to indicate economic recession, and the Manufacturing Index is already there.

The first chart is ISM Manufacturing:

Lee's comments below:

In June the current slide reached 45.2, the same level the index had reached in March 2007, 7 months before that bull market ended. With the number still below 50, the rally's days are probably numbered, although it's impossible to tell from this data just how long the lead time might be this time. Federal withholding taxes were weak in August through last week, so there's some reason to believe that business has continued to weaken. High gas and food prices and weakening exports are apparently having an impact.

The manufacturing sector represents about 11% of the economy. The services sector data representing the bulk of the US economy, normally released a few days after the manufacturing data, typically lags the manufacturing index by a month or two. The ISM manufacturing new orders index therefore appears to be a good leading economic indicator but in terms of its bigger year to year trends, it is not very useful as a stock market indicator.

Below is the ISM Non Manufacturing (Services) New Orders Index, not seasonally adjusted through July.  The August index will be released on Thursday, September 6. If it does not follow the manufacturing index, and stays above 50, then the stock market uptrend can probably hang on for a while longer. If it drops below 50, then there's reason to believe that the rally will soon end.

So, the U.S. economy isn't particularly rosy (as if I needed to tell you this), but today's number will be important for fleshing out the picture.


The Market Charts

The first chart I'd like to share is my interpretation of the long-term SPX pattern.  The main question in my mind is whether the top is in, or whether there's a run slightly higher still in the cards.  My preferred view since the anticipated swing high at 1426 has been "the top is in," however, since 1391 has not yet been crossed heading downwards, I'm still unable to add confidence to that view.  In either case, this is expected to be a major top under formation and, in my mind, only a material breakout through the upper red trendline would challenge that view.

The next chart depicts an interesting relationship and historical pattern I've observed between the SPX price movement and its 81-week moving average.  The chart explains the details.

The charts above represent the long-term outlook.  Changing time frames rather dramatically, the chart below discusses some short-term levels to watch, and the higher-probability short-term outcomes if each key level is broken.

The next chart represents a best-guess at the short-term wave count (as discussed yesterday), but this pattern is very difficult to interpret, and I wouldn't be surprised to see the market do something unexpected here -- especially given the anticipation and pressure surrounding the ECB announcement.  Until the bulls reclaim 1413.95, there is the potential of an extremely bearish short-term outcome, and trade beneath 1391 is likely to precipitate an acceleration lower. 

Conclusion

There's a lot going on today, and the ECB has the potential to disappoint the market.  I think the best possible outcome for bulls really isn't that wonderful: the ECB might be able to kick the can further down the road and delay the inevitable for a few more months.  I seriously doubt they're actually going to solve any of Europe's long-term problems, however the new policy does have the potential to generate a temporary result in equities and will thus need to be watched closely.

The U.S. economy appears to be on the brink again, and today's ISM numbers should be revealing.  It does not seem coincidental that the fundamentals are suggesting a major market top is forming, while the price charts (in my view) are also suggesting the same thing.  The x-factor seems to be the question of how much longer the central banks can keep pulling rabbits out of their hats... as of right now, many indicators are suggesting that they're running out of rabbits.  Trade safe.

Reprinted by permission; copyright 2012 Minyanville Media, Inc.

SPX Update: Key Levels for the Short-Term

Yesterday's outlook discussed the fact that the rally from Aug. 30 appeared corrective, and was thus likely to be fully retraced -- and that happened pretty much straight off the open yesterday.  The short-term pattern is finally starting to shape up into something vaguely recognizable, and while there are still different interpretations, there are now some additional clear short-term levels to watch going forward.

My intermediate and long-term outlooks remain bearish.  The short-term is less clear, but leaning bearish.

Accordingly, I'm going to lead off with the S&P 500 (SPX) 15-minute chart, which is loaded with annotations and outlines the key short-term levels.  There are two bearish options for this pattern: a leading diagonal, or a bearish nest of first and second waves.  There's nothing yet to differentiate the two patterns, but I'm ever so slightly leaning toward the more bearish interpretation, which would see the market gearing up for a solid drop in the more immediate future.  The chart explains the rest.

Next is the 30-minute SPX chart, which hasn't changed much over the past month.

Finally, a quick update to the SPX monthly chart and the position of the potential cross of the 50-month and 200-month moving averages.  I covered the historical significance of this in detail in this article.  The two averages have edged ever so slightly closer to crossing, and are now only 4 points apart.

In conclusion, while the intermediate outlook is still bearish, the short-term continues to leave its options open -- but I'm favoring the view that the pattern is finally wrapping up and the four-week-long trading range will soon be in the rear view mirror.  Trade safe.

 

Reprinted by permission, copyright 2012 Minyanville Media Inc.