The REAL Reason for the Rally…

So, what caused this massive 1 hour, 500 Dow/100 NASDAQ Comp point rise yesterday? Was it some Belgian bank? Was it the FT rumor of Euro-bank reorganization? No, and no.

When Bernanke spoke yesterday he told of a dire economy, one that is “faltering”. He has officially given up on economic repair or growth with the current status quo. Directly after those comments were made is when markets initially moved away from their new yearly lows, in Bear Market territory.

As you know, I tie much of the recent market weakness not to Europe or banks but rather on no free QE3 money. It was no coincidence that the most correlated assets, stocks and commodities, took a major leg lower once September 21 came and went without more stimulus for Wall Street. And then it hit me. The massive rally is the sole result of someone believing that Bernanke will relent and begin QE3 this quarter.

Think about it. Why else would the reaction be so extreme? Sure, sentiment is Bearish and has been for some time.  And yesterday we made a new range low for the year, just below the intra-day drop on the panicky day just before S&P downgraded the USA. And remember, that day witnessed a 70 minute 70 point rally in the $SPX in the last hour of the day. Coincidence? 

We are still in the bottom of this trading range that we’ve been in since falling from our Distribution peak earlier in the year and there remains significant overhead resistance just ahead. My guess is that there was a significant liquidation going on for the past few weeks culminating with yesterday. The impetus is that the stock and commodities markets are again “reading between the lines” of Bernankes comments and committing to a new round of free money. Watch it happen…

For almost six months the stock and commodities markets have been struggling. First under classic Distribution and then through tremendous internal deterioration under cover of the major indices. Those indices masked and camouflaged the true nature of the market’s day to day activities which was one of the broad breadth of stocks moving succinctly in a clear downtrend. Each drop met with furious  buying that was notable as classic Bear market bounces. And to top it all off, the few favorite stocks gained massive market cap as there was little else working–and this focused buying was the final leg of the whole six month cycle.

As we are now in the Fourth Quarter, the anxiety level is high and confusion with regard to the fundamentals reigns supreme. Headline risk, liquidity risk, earnings risk, government risk and market risk are hiding behind every market hour. The number one question asked by the media, by traders and by investors is the same; what are “They” going to do to help the markets and economy? Everyone is always concerned with “They”. Is that a healthy way for a supposedly free market to operate? And the most recent market downfall? Blame it on no free QE3 money. It is not a coincidence that this leg began on September 21st.  Meanwhile, all the problems, issues & concerns are the same and getting bigger and more pronounced.

Today is the first break of the August 11 low intra-day print in what was a market panic that occurred the day before S&P downgraded U.S Debt. That was certainly a panicky market. There was no panic today on the break to new lows. In fact, most everyone, as far as I can tell, is simply dying to buy the breakdown and to play the hopefully hearty bounce. Listen, we are in a Bear Market and today made it official. Call it cyclical or secular. Call it whatever you want. But the most you should expect at this time is AT BEST a retracement to the latest breakdown area for many individual stocks. Play it if you dare, but make sure your exits are clearly marked.

Many folks feel that today’s breakdown to new yearly lows is THE signal that we’ve been waiting for to identify a bottom. Interestingly, few thought we would break to new lows. In fact, each area of support throughout these past six months has been percieved to be THE bottom and each time it eventually breaks. My advice is to fight the desire to call the bottom. End of year seasonality MAY bring some stabilization. After all, even after the crash in late 2008, markets stabilized until the end of January before the next brusing leg lower towards the eventual low when “They” began doing things to prop up the markets.

My long-standing target was to give back all of QE2’s gains, to the SPX 1050 area. Today we tagged 1075. Is that close enough? Maybe not.

With the markets remaining defensive, the Wealth Effect will be hard pressed to bring us much holiday cheer.

My humble chart kung-fu skills are nothing next to the Great Dr. Le Fly, but here it is, for your review…

Created Monday 9/26/11 and from www.createcapital.com

A study by the New England Complex Systems Institute did a Abstract earlier this year hypothesizing that market correlations, when reaching extremes, precede a crash.

http://www.necsi.edu/research/economics/economicpanic.html

Are markets more correlated now than last year? Last decade? It sure feels that way. Just watch the equity markets; it’s all up or all down. I’m afraid that as the correlation reaches above 90%, combined with HFT, that instability will dominate, then overtake.

And how about today’s action?! End of quarter markup interrupted by a bit of headline risk…And precious metals are up on the thought that the Euro Bailout must come from somewhere. What if it doesn’t come? Care to think about that?

Equity and commodity markets are exhibiting some of the most intense and compressed volatility in history. The DOW has been up and down 700 points in just two days six times in the past six weeks. Gold has fallen $100 in a day and rallied just as much the next day. Silver swings 15% daily. If  I’m starting to get dizzy, then I can imagine that the individual investor has closed their eyes and completely turned away.  

The news flow is being held responsible for the massive swings. First it was the domestic economy. Then it was Bernanke and the FED. Then and again it was/is Europe. Allow me to outline the true causes of the past two moves over the past two weeks.

Last week was a record setting drop, as the speculative money betting on a “traditional” QE3 were disappointed. That unhappiness was primarily manifest through the outright dumping of the metals complex. After all, metals–precious and otherwise–were elevated based on the uncertainty of money printing by the FED. When that didn’t happen, the hot money exited and the equity markets dropped quickly to test the August lows. Needless to say, bearish sentiment zoomed amongst the professionals that have been banking on more Free Money from Uncle Ben.

There was plenty of fear and trepidation over the weekend about what would happen to markets on Monday, especially since there was no real agreement to create the multi-trillion dollar bailout that would be needed to save Euro-banks and Countries. Futures were down again and traded at the August lows near SPX 1100. But mysteriously, by the time most of us came to work in the morning, futures had reversed. Metals had reversed. And the heavy-duty sellers that were all over every market last week were gone. Poof.

The bid was initially for industrials, then banks, then multinationals, then materials, then technology. And it spread from there. Never mind that there was no real agreement to fund Europe. We were faced with the end of the third quarter this week, with a Jewish holiday during the last two days. So there we were, again subject to another “Magical Mystery Rally”, almost exactly like the one that occurred during the last week of last quarter. Do you remember? 80 SPX points in four days. Magical! And then markets fell off a cliff.

I cannot help but think that this kind of gigantic mystery rally is nothing more than Bear Market Action. But then I see how the major indices are trading in a almost perfect 100 point SPX trading range and this range is sandwiched between two almost perfect 100 point SPX trading ranges. The lower range is bordered by SPX 1040 to 1140 outlined during last summer’s wait for QE2. The upper range trades between 1250 to 1350 and is labeled “Distribution” on my CreateCapital chartwork published yesterday. Our current range is the meat in a multi-year trading range sandwich and we remain trapped for now, even with the abnormally volatile movements in equities and indices.

Do you want to use technical analysis to pick your spots? You will have to buy when things are overwhelmingly negative and at the bottom of the range and you’ll have to sell just when your getting comfortable with a mending market. I don’t know if Europe can be fixed and neither does the stock market. But they do know that the end of the quarter is the time to make hey, because if they don’t, they won’t get paid. Plain and simple.

Most stock traders and investors have come to take our former Savior, Dr. Bernanke, completely for granted. There have been so many high expectations put on just one man through the “Bernanke Put”. You may think he is Greenspan2 but I assure you that Dr. Bernanke is no Dr. Greenspan! Greeny never went from hero to goat this quickly…

So, if you believed the equity and commodity markets were trading where they were because the market was “cheap” based on earnings estimates or the prospects for growth, you would be wrong. If you believed equities were “telling you something” or you “just followed the market” because it “tells the ultimate truth”, you would be in for a shock today.

We’ve all prided ourselves at being Capitalist but we expect that Central Banks will ply us with free money. But it cannot go on forever. Perhaps its monetary, perhaps its political, but the free money will not be forthcoming today. And because of that fact, the money pouring into “risk assets” will now go to “money heaven”. Poof.

The bad news is that prices are going down. But the good news is that prices are going down. Now is not the time to hurry but to gather your assets and get your shopping list together for there will be a buying opportunity of a tremendous magnitude. But not yet. Let a bank or two in Europe fail. Let’s feel some real panic, which we do not yet have. This “adjustment” is overdue and necessary.

When all of QE2 has been given back, we will be MUCH closer.