These people talk about quantitative easing as if they didn't mean to debase the currency over which they have temporary control. --Jim Grant
The old market saying, "Don't fight the Fed" has been working extremely well for about three years. The liquidity created by the Federal Reserve's quantitative easing programs has had few places to go but into stocks and commodities. It has provided an endless bid under the market and provided some of the most lopsided action we've ever seen.
Yesterday, the Fed indicated in the minutes of a recent meeting that it might not be so generous with quantitative easing in the future. It didn't completely cut off the possibility of more QE, but made it clear that there will need to be some economic weakness to justify more.
As everyone with some economic knowledge knows, the danger of quantitative easing is that it eventually leads to inflation. The Fed continues to state it is unconcerned about that issue, but that can't be ignored forever. Indiscriminant printing of more cash will cause problems sooner or later and the market has no choice but to acknowledge that fact -- although it definitely does not want to.
Quantitative easing has been like crack cocaine to this market, and now we are experiencing withdrawal. The supply might not be totally turned off, but it is causing anxiety and concern and it is going to be the focus of this market.
In addition to the QE issue, we also have pressure caused by the deteriorating economy in Europe. The Spanish bond auction went poorly and bond yields are rising around the continent.
Ironically, the poor economic situation in Europe may give QE addicts a little hope. The danger that the European problems will eventually weaken our economy can't be ignored, and if the Fed doesn't assist the European Central Bank by keeping pressure on interest rates in the U.S., it may accelerate the issues in Europe.
The important thing is that the bears finally have strong justification for selling, and there is some pressure for it. We have been consistently ignoring all negatives for months, but the market is definitely paying attention to this QE issue.
My advice has been to stick with the trend as long as possible but be quick to react when trouble develops. Well, trouble is in the air and now is the time to be more careful. We have to see what the dip-buyers do. Don't expect the market to go straight down, but there have been warning signs in individual stocks and the selling catalysts are building.
If the bounces fail and we start making a series of lower lows, we'll have to start working harder on the short side. I expect a very bumpy ride as we sort through the fundamental issues out there. Keep those defenses tight.
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