WHAT DO BOXERS AND QUANTITATIVE EASING HAVE IN COMMON?

QE II IS DEAD!?
June 30th has come at last and that means an end of additional capital injections by the Fed.  What the discontinuation of quantitative easing measures means is that the Federal Reserve will no longer add additional capital to the liquidity of the global monetary system, although we have been put on notice that the current level of capital will stay there. This means that as treasuries and other assets mature and are repaid, the Federal Reserve will take those proceeds and reinvest them in other bonds, it is important to point out that there won't be new money coming on line under this program. 

IS THE PROPELLANT GONE? 

Bears argue that the economy and markets are simply being fueled by these overt actions by the Federal Reserve to "goose" the system, and without new rocket propellant to move the market higher and higher, we'll see a collapse without the stimulus for higher stock and asset prices.  We don't know if that is truly the case, but we do know that the Federal Reserve is stuck in a box of its own making.  They have created a "liquidity bubble" that has elevated the price of financial assets and hard assets like commodities near two year highs.  The Fed has also forced treasury rates to historic lows.  Time will tell if these levels can hold.

Beyond asset pricing, QEII serves another purpose.  QE II serves as a way for the US government to manage its interest cost.  By selectively purchasing bonds in the open market the Fed manipulates the overall pricing of bonds to keep interest rates low.  Without QE II in place, what will happen to interest rates?  Look at how TLT (20 Yr Treasury) has performed over the last couple of days in anticipation of lower bond prices. 

TLT (100 Day)

WHAT DO BOXERS AND QUANTITATIVE EASING HAVE IN COMMON?
I grew up in the great days of boxing in the mid 70's and early 80's.  Some of my most memorable childhood memories involved watching boxing with my Step-Father.  I recall going to see many local boxing matches which included Olympian superstars.  Remember Sugar Ray Leonard, Marvin Haggler, and Larry Holmes?  These were greats that I grew up watching.  After years of being a boxing fan, one thing is clear, boxers never really retire.  If the paycheck is large enough or economic conditions of the fighter bad enough, they always have one more fight left.  In a similar way, QE has been so successful in achieving its goals that the Fed must see it as one of their greatest instruments to combat deflation.  While QE I and QE II sport amazing records and their heydays are past, they may be called up to fight another match in the near future.

If Treasury bond prices move significantly lower (yields higher) or stock markets fall appreciably we will absolutely see a return of QE.  While the Fed has many remaining tricks up their sleeve, QE is one that has immediate results.  QE is truly one of their favorites.  As a market participant that feels strongly that the invisible hand of government should get out of the stock markets I am not sad to see QE go.  Unfortunately I can say with great confidence that QE will be back for at least one more bout; great fighters never go gracefully.

Photo by Cliff1066 - http://www.flickr.com/photos/nostri-imago/with/2872463375/

GOATMUG

Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments at http://www.goatmug.blogspot.com/

BURSTING WATERMELONS AND ECONOMIES

CHINESE CREATE INTERESTING NEW FRUIT?
I read an article this evening that centered on the strange happenings in China recently where watermelons are exploding as rain fell on the land in the midst of a recent drought.  While the rain is needed, experts suggest that it truly isn't the cause of the projectile flinging watermelon bombs, it is the use of the chemical forchlorfenuron on the melons that is reason for the crazy phenomenon.

EXPLODING WATERMELON
(click on the link above for the Bloomberg article)

While the simple notion that these guys use anything that will destroy entire fields of melons is scary enough, you've got to take the extra step and ask, what else are they using on food that is imported to the USA?  Wow!  So, let me get this straight, some sort of super growth agent causes watermelons to grow so large that they simply blow up?  Why am I not a bit amazed to find this out?

I love the money quote near the bottom, "About 10 percent of watermelons burst normally, with the rate depending on variety and weather, Xinhua said yesterday citing Xu Jinhua, of the Jiangsu Academy of Agricultural Sciences."  Hmmmm, I wonder if that happens in the USA?

UNNATURAL SUBSTANCES USED BY THE FED
Speaking of unnatural substances and additives, I wonder what the results of QE I and QEII will bring?  Let's think about this analogy a bit more.  In China, the farmers know they probably aren't doing what is really good for the melons or those that consume them, but for the sake of making a harvest and making money (greed) they forgo doing what is honest and right to simply maintain a job and living standard.  In a similar way, we have the Federal Reserve that applies it's own version of forchlorfenuron in the form of super liquidity and abnormal credit support to feed and nourish the "ailing or under growing fruit" of our economy.  Specifically, our economy's bad harvest has been in the banking sector and areas like auto manufacturing and housing.  The Fed too would say that without the unholy stimulus, the fruit might not grow big enough or even may not yield any harvest at all.  And you know what, the Fed and the farmer would be absolutely accurate in their thought process that if they don't act, results could be bad for themselves and those that depend on them to produce. 

THE END JUSTIFIES THE MEANS
The problem behind this justifiable thinking is simply that it is short-sighted and never accounts for the long term material effects of these heroic acts of instant gratification.  Yes, the watermelons grow for the farmer, yet they over do it and explode.  If they don't explode they may have the long term impact of poisoning the unlucky folks that choose to consume their fruit.  Likewise, the Fed makes a choice for today and tomorrow and six months from now, not one that centers on the ultimate outcome of three years or five years down the line.  The Fed doesn't naturally have a hand in developing a manufacturing base or fostering an environment where jobs can be developed for the long haul, no, it props up a broken banking system and through other government agencies sustains a car industry and home building industries that are a disaster, all the while forcing Moms and Pops to take more risk in their assets.

TRANSPARENCY, OVER IMPORTANCE, AND OVER ACTION
The Federal Reserve is becoming the worst kind of public company that manages their "numbers" for the next quarterly earnings release.  The result of using extraordinary measures is that the initial use of them to save the system has plugged the Fed into the role of "saving the system" on a quarterly or even daily basis. 

What happens if the economy slows?  What happens if we have a flash crash?  What happens if we need some extra money to meet our deficit spending needs?  What happens if interest rates tick up?  The clear answer is simply to call on the Fed who is more than willing to step in AND now is even more willing to communicate through media press conferences after meetings now.  Think of the press conferences now as the quarterly earnings conference call.  The Fed will manage their numbers and do all sorts of accounting tricks to always come in above the "whisper".  Heck, if the Fed needs Jeff Skilling, I think he's available to do all sorts of his Enron-esque accounting tricks.  I'm not sure if he's much of a farmer, but I'm darn sure he's good at spinning a yarn and managing fruit until it bursts.

See once you spray on some chemicals on your garden and the fruit grows like mad, are you really likely to not add that same topical additive to your next year's product?  Not a chance.  The Fed, the markets, and the economy are now accustomed to the introduction and infusion of the Fed's exogenous stimulant and they probably won't perform well and yield much without the damaging liquidity substance.  The problem we've always had with the Fed though is that their actions always end up blowing bubbles, just like these bursting watermelons.  Often, too much of anything is a bad thing.  Just like those Chinese farmers, Ben Beranke just won't stop until he's destroyed the whole field.

GOATMUG 

Edit -

As I was proofing this document, I had one other thought related to the Chinese minister that mentioned that they had a loss rate of 10% typically on their watermelons due to explosion.  Clearly, the current results suggest that something is really wrong, but more importantly isn't it striking to note that they know that they will have a 10% loss rate and yet they keep on spraying the chemical on it? 

This is important because I think the Fed is using Mom and Pop as their version of the acceptable 10% loss.  In other words, the regular guy that is getting ravaged by low yielding interest rates and high inflation in hard asset commodities like gas and food is the acceptable version of an exploding watermelon on the crop produced by the Fed.  They have made a decision that by adding QE 1 and QE 2 and perhaps even further stimulus that they will simply have some shrinkage, but those are acceptable to be able to take in the harvest.  Clearly the Fed is not organized to serve the average citizen of the United States, corporate giants are the intended targets of the miracle stimulant provided by the Fed.

BIG WEEK = BIG FLOP?

I want to drop a quick note here.  This is a really, really, really big week. 

ELECTIONS
We have elections in the US for mid term positions where it is widely anticipated that voters will reject the unfettered spending of the current administration, Congress, and Senate.  (Don't forget Bush was also a complete idiot when it came to fiscal controls too and should be held responsible for his completely insane implementation of Medicare Part D which is the worst and costliest entitlement program ever!)

FOMC
Probably more important from a market and economic standpoint we also have a Federal Reserve FOMC meeting on Wednesday.  This is the meeting where Ben Bernanke has purposely timed the unveiling of their plans for additional stimulus spending which has been named "QE2" for Quantitative Easing 2.  The purpose of this program is to continue to spew liquidity in the form of electronic dollars all over the global economy to ensure that asset prices will rise.   As Alan Greenspan has stated, "nothing will help cure the economic conditions as much as a rising stock market!"  The real impact of all of this money sloshing around though is that the value of the dollar drops with each keystroke on the economic printing press.  QE2 is synonymous with dollar debasement.

DOLLAR DOWN MAKES GROCERIES RISE
Is it a wonder why you are going to see grocery costs rise?  Sugar, wheat, corn, rice, and coffee are rocketing higher.  Clothes prices are going to rip higher as cotton is at an all time high.  Oil and gas are vaulting upwards and it is suddenly possible to see my $100 oil price target prediction actually be met this year.  We are seeing all of these hard goods increase in cost, yet personal incomes are dropping.  If you hadn't realized it yet, it is almost like this is a war on the poor as these are the ones that will get squeezed the most in this environment.  Thank you Federal Reserve, US Treasury, and President Obama.  It is odd that the President sits idly by as the Fed rips up and destroys the purchasing power of the poor and the middle class.  I guess this achieves his goals though as more and more marginally middle class will slip into poverty and he can be their benevolent care-taker.  He can continue to promise to take from the wealthy and give the poor their fair share of hope.  The President should be slamming Bernanke and Geithner now and demanding that they quit destroying the value of the dollar.  Instead, he tells us that he inherited this mess and that fixes take time.  Very directly Mr. President, it takes no time to make a phone call and demand that Bernanke quit this now! 

TRADING UPDATE -
Ok, so what do I expect?  I expect that the elections will be exactly what has been predicted.  Congress will go to the Republicans and the Senate will remain in the hands of the Democrats.  The Fed will announce that they will do another $500 Billion of QE 2 and they are going to add more when and as needed with no cap.  This announcement will be less than the markets expect, but the added sentence that they will do more when needed will be somewhat of a life preserver.  The market should sell off some 3% to 5% (individual stocks could go down 10% or more).  At that point, that will be the signal to buy.  The Fed is essentially the market's put (floor) and therefore they will step in and buy and float this thing no matter what.  In a 1930's analog, this is about the time when the market dropped another 30% to 40% because the FED did not provide stimulus and Congress became budget hawkish and tried to reign in spending.  Bernanke will not make this mistake and in fact will go overboard attempting to overwhelm the stagnant real economy.  This annoucement is half the real deal and half a promise that there is no end to the intent to provide as much massive stimulus as needed.  He will signal with overwhelming confidence that there is no lack of desire or willingness to blow as much money as need to reflate the US stock market.

After the temporary drop in the market due to a smaller than expected stated amount, we will be buying anticipating a huge stimulus inflow courtesy of the Fed.  Of course our old favorites will be the targets with a couple of additions.  I still like emerging markets, but I will add SLV and DBA.  I am more positive on silver than gold right now and I like the agriculture commodities.  In addition, although the fertilizer names have run it is possible to see an even bigger move there.

Be careful ------ AND WAIT FOR THE PULLBACK!

GOATMUG

SEPTEMBER CFO SURVEY - DOUR MOOD RETURNS?

The quarterly Duke CFO survey was released and what can we say, CFOs just aren't as excited as they were.  Somehow the kool-aid has not made it to the interior offices of the corporate towers where the bean counters are usually nestled. 

Here are the highlights......  http://www.cfosurvey.org/10q4/PressRelease.pdf

OPTIMISM PLUNGES


Optimism about the overall economy fell at 53 percent of U.S. firms and increased at only 14 percent. The optimism rate of 49 is a level not seen since the first quarter of 2009, when CFOs rated the economy at 40.


“The CFO optimism index has proven to be an accurate predictor of future economic performance,” said Julia Homer, executive vice president for content at CFO Publishing LLC. “Therefore, this dramatic drop in optimism bodes poorly for the economic outlook. Half of CFOs say there is only a six-month window -- and another one-fourth believe it’s a 12-month window -- during which they can maintain current levels of business activity without improvement in the overall economy.”
 
CREDIT - WHERE'S THE PROBLEM?
 
“The math is simple. A) Banks are sitting on cash because of their poor health and general uncertainty. B) Small and medium-sized firms have employment-generating projects that they cannot get financed because banks will not extend credit. C) In usual circumstances, small and medium-sized businesses account for the majority of employment growth. A+B+C implies we are stuck at 9 or 10 percent unemployment,” Harvey said.


Harvey added that “recent regulatory reform has not helped. Only 5 percent of CFOs consider the Dodd-Frank legislation as a positive -- and that number excludes all firms in the finance industry. The main concerns about the recent reform are that it will lead to increased compliance costs and make borrowing more difficult. CFOs also expect higher banking fees. Some of these increased costs and fees will be passed on to customers, and others will hurt the bottom line.”
 
The CFO's are telling you that all is not fixed.  What made their outlook change from just a few months ago?
 

Reports like these continue to give me pause on joining in the full blown bullish party.  We've positioned ourselves well since Fed President Bullard's speech in the first week of August, but this type of data continues to reinforce exactly why the FED is continuing its drum beat and repetition of the mantra that they will continue to provide liquidity and will continue to step on the gas.  Clearly they are not going to stop the beating of the dollar either!  The Fed sees this type of stuff way before we do and this is a great data point to remind us that all is not really better.  All stock markets may be heading higher, although it isn't because there is growth or real value, it is because the dollar is being debased. 

One last comment on the dollar.  Remember how I allude to the dollars decline as a well choreographed dance to the bottom?  Well, that is exactly how I see it.  We've tumbled very far very fast and now it seems about like it is time to make a measured move higher just to give all the other central bankers some relief.  That of course means that we may see a pause in the gains in shiny things like gold and silver.  Personally I would not add to my metal and commodity positions here and I would not be short the dollar.  Just a warning.

GOATMUG



XLF UPDATE - RANGE BOUND OPPORTUNITY?

Here is a look at the XLF that I've been watching closely since I posted the Euribor numbers the other day (Sept 16th) which I thought might be a tell as to the direction of the market.  The truth is that banks have been sluggish lately as they have churned around in the upper portion of the range over the last couple of weeks.

Even after this post, we saw a breakout that started to get me excited and then it has turned out to be the ultimate head fake (what is new since all patterns have turned out to be head fakes?). 

The chart posted below is a good one in my opinion because it shows a confluence of many trend lines all centered at the $14.75 area.  As we open up this morning, it wouldn't be too much of a stretch for XLF to drop to the $13.45 lower portion of the range we've seen and then bounce. 

I don't want to overdo things here by getting too bearish and assuming that we are going into the pit.  The recent trend has been to open lower and end the day higher, so I will sell all of my short trading position (long FAZ calls) this morning at the open just to lock in some gains.  There has also been a recent trend to have weakness at the end of each month and especially at the quarter end and then rocket higher after portfolio managers complete their window dressing for regulatory disclosures. 

TRADING STRATEGY -
Overall, I'm harvesting gains (last night was the harvest moon) and not getting too bearish and greedy.  I like nailing a trade like I did yesterday where I bought those FAZ calls at the close, but I don't want to endanger those profits by getting greedy.  The recent strategy to accumulate longs on weakness has been profitable, no reason to change this now.  I will look to add to long positions as we near the bottom of the range (if we get there).

COMMODITIES -
I'm still an uber bull on commodities since Bullard's telegraph of the Fed QE2 strategy in July and August.  Commodities have been on a tear and the dollar has been just clobbered thanks to our great leadership.  We'll probably see more of the same and countries are really getting after trying to crush the values of their currencies.  Competitive devaluations are pretty nasty and it is every man for themselves right now.  Just ask the Japanese and Brazilians.  Look for active devaluations as this is really heating up.  China and Japan tensions are getting hot.  Watch this issue.

TLT -
Here is one last parting shot on TLT.  Remember when the market was rallying and everyone was saying that the long bond (treasuries) were a bubble and they were going to blow up and everyone wanted to buy TBT forever?  Pretty interesting reversal again and still over that important $100.15 level that is marked here as a breakout.  As mentioned several times, we will have 3% 30 year mortgage rates and we will only get there when TLT stays at these levels and higher.  I don't anticipate going back underneath the $100.15 level for a long while.

GOATMUG