Stock Market Strategy: All signs point to a continuation of the current rally. We will continue to use the direction of liquidity and the behavior of the credit markets as our fundamental guides to equity investing.

The primary news story making the rounds today involves the European bank stress test results. I have included the official results and accompanying statement below for your perusal. If you would rather the cliff notes I will summarize: Completely worthless nonevent.

CBES releases results of the EU Stress Test — 7 banks fail test

The exercise includes a sample of 91 European banks, representing 65% of the European market in terms of total assets, in coordination with 20 national supervisory authorities. It has been conducted over a 2 years horizon, until the end of 2011, under severe assumptions. In total, aggregate impairment and trading losses under the adverse scenario and additional sovereign shock would amount to 566bn € over the years 2010-2010. The aggregate Tier 1 ratio, used as a common measure of banks’ resilience to shocks, under the adverse scenario would decrease from 10.3% in 2009 to 9.2% by the end of 2011 (compared to the regulatory minimum of 4% and to the threshold of 6% set up for this exercise). The aggregate results depend partly on the continued reliance on government support for currently 38 institutions in the exercise. The aggregate Tier 1 ratio incorporates approximately 197bn € of government capital support provided until 1 July 2010, which represents 1.2 percentage point of the aggregate Tier 1 ratio. As a result of the adverse scenario after a sovereign shock, 7 banks would see their Tier 1 capital ratios fall below 6%… See release here.

Once again traditional financial news outlets fail to focus on issues that actually move the markets and instead waste time and energy on government sponsored propaganda. The typical word on the street from this story is as follows: ‘Street expected 10-11 banks to fail test and only 7 failed so things are better than expected.’

Enough said about the theater of the absurd a.k.a. European banking stability. Please follow me into the realm of reality as I focus on events that are actually having a tangible impact on the equity markets. Committed RCM blog readers will recall this quote from my July 14th post, “The above chart also suggests a change in trend may be in the offing”. At week’s end, it would appear suggestion has turned into sage advice as the rally that began July 7th makes new highs.

Tangible event number one:

Quantitative Easing round #2 is currently underway. How do we know this you ask? The Fed made no comment in the FOMC minutes release and Ben Bernanke said nothing of note to Congress. So how do we know Q.E.2 has begun? The answer lies in the chart below. As you will see, worldwide liquidity is once again on the upswing. This rise and fall of liquidity has been and should continue to be the single biggest factor determining market direction. Close scrutiny of the graph will reveal the selloff of assets in 2008 was led by liquidity contraction, the rally of 2009 occurred on the heels of liquidity expansion and the first 6 months of 2010 suffered from another reduction of liquidity. However, in the last three weeks worldwide liquidity has expanded progressively, hence a rally in asset prices should not surprise. We can expect further asset gains, equity, commodity or otherwise, as long as this liquidity trend continues….

Tangible event number two:

The credit markets are the first to be effected by the liquidity situation. Our credit guru, Mike Johnson, spotted the positive behavior of the credit markets at the end of June. The liquidity expansion began, credit markets immediately stabilized and true to form equities followed. Another review of MJ’s thinking seems appropriate…  

…intraday credit market volatility continues to decline and this indicates that equity volatility is biased to continue to decline. This is clearly a positive for the broader equity indices.  

One of the reasons we became bullish at the end of June was because of the improvement in bank CDS spreads, the normalizing of GS’ CDX credit curve, improvements in consumer credit losses, and improving CDX IG spreads. COMPARING THE PERFORMANCE OF THE CREDIT MARKETS TO THE EQUITY MARKETS (SPX) would indicate that SPX has the potential to rise to the 1150-1175 range QUICKLY. The steepening of CDX IG credit curve further indicates that this 1150-1175 range is even more likely to be reached relatively soon.

Tags: ben bernanke, CDX index, commodities, Credit, credit markets, equity markets, EU Stress Test, FOMC, liquidity, Q.E.2, Quantitative Easing, stock market strategy

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Today, I’d like to address a curious phenomenon developing in the Treasury market.

March 31st supposedly marked the end of the Fed’s quantitative easing (Q.E.) phase. We were told the Fed would no longer print money and buy mortgage backed securities. There was, of course, no discussion about the Fed printing money and buying other assets. However, ‘ending Q.E.’ carries certain implications and it would not be a stretch to say market participants were led to believe Q.E. in all forms was coming to an end.

Enter ‘curious phenomenon’: Treasury market behavior since March 31st would suggest Q.E. is alive and well. During the month of April, long rates rallied from about 4% to roughly 3.7%.  Treasury prices went up as rates went down after the Fed allegedly stopped Q.E.?! Needless to say this is not the response most market participants would expect.

I’m sure we can come up with more than one reason for this Treasury strength. Perhaps the issues emanating from Europe have driven investors into the relative safety of  US debt. Or maybe Goldman Sachs led financial fears are responsible for the Treasury bid.

However, the following excerpt from ‘The Privateer’ (A favorite publication of ours) offers a compelling argument supporting the theory that the Fed is continuing a Q.E. assault on the credit markets. If this theory is accurate, we would expect any equity market selloff to be contained to a normal uptrend retracement. Moreover, precious metals prices should continue to advance as more Q.E. equals further currency debasement which is a tasty recipe for higher Gold and Silver prices….

The US Treasury auctioned $11 Billion worth of “TIPS” on April 26. They started to sell the regular stuff on April 27 with an auction of $44 Billion in two-year paper. With the Greek debt downgrade to “junk”, hardly anyone noticed. Hardly anyone, that is, except the bidders for US Treasury paper. Indirect bidders (read foreign central banks and governments) bid for only 28 percent of the paper, down substantially from the average demand in 2009.

But much more troubling was the massive 24 percent of the paper on offer taken by the so-called “direct bidders”. The rest was presumably taken by the “primary dealers” in Treasury paper. The “direct bidders” had taken as much as 10 percent of the auction on only 12 of 42 auctions since July last year. They had taken that much only six times in all the auctions held by the US Treasury in the FIVE years from the beginning of 2004 until the end of 2008.

Even more disquieting, the identity of those who are included as “direct bidders” is never disclosed. The fact that the amount of Treasury debt taken by “direct bidders” has blown out since the Fed officially ended its quantitative easing at the end of October 2009 has led to speculation that the Fed has not REALLY ended its policy of monetising Treasury debt after all. More and more analysts (including some mainstream analysts) have come to the conclusion that the “direct bidder” is none other than the Fed. They are almost certainly right, but nobody can know for sure because the “direct bidders” are secret….

Tags: Fed, gold, Goldman Sachs, precious metals, Q.E., Quantitative Easing, silver, treasury market, U.S. Debt

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Euro zone gives Greece 30 days to show good on deficit – Reuters

The tsunami of Greek fear begins to ebb and like proverbial clockwork the US$ drops almost 1%, the equity markets rally over 1% and Gold runs back above the $1100 level up over 1.5%.

By now, as readers of this blog, the financial market behavior described above should come as no surprise.  I exposed the market’s playbook on Feb. 9th and directly addressed the perennial gold bears by saying, “They have not owned Gold during its nearly 300% increase over the last 10 years, but somehow, through a haze of delusional arrogance, they are sure prices have peaked.”

In the five days since that comment Gold has rallied 5%.  Coincidence? Maybe. I’ll concede, sometimes we’re simply lucky, but when understanding is acute luck becomes more pervasive and that, my friends, is called success.

For the last few months, the fear of  reduced stimulus and quantitative easing has gripped the markets. In an apparent effort to support the US$, government officials and Fed members have raised the expectations of economic growth and reduced expectations of Q.E.. I have, time and again, called this type of  jawboning nothing more than propaganda. I explained as much in my Jan. 20th post and highlighted the “need for a new round of stimulus” demand from the conference of mayors on Jan. 22nd as the beginning of a shift in the wind.

Well, today, I would like to say, the wind is a steady 10-15kts in the direction of stimulus and looks to be increasing over the coming weeks.  Evidence for this forecast below…

IMF tells bankers to rethink inflation – WSJ

WSJ reports the IMF’s top economist, Olivier Blanchard, says central bankers should consider aiming for a higher inflation rate than they do currently to lessen the chances of repeating the recent severe recession. Mr. Blanchard said the global economic downturn revealed flaws in macroeconomic policy, especially the reliance primarily on interest rates to manage economies. Although Japan had fallen into a decade-long funk despite low inflation and low interest rates, “most people convinced themselves that the Japanese didn’t know what they were doing,” Mr. Blanchard said in an interview. In a new paper with two other IMF economists, Giovanni Dell’Ariccia and Paolo Mauro, Mr. Blanchard says policy makers need to consider radically different approaches to deal with major banking crises, pandemics or terrorist attacks. In particular, the IMF paper suggests shooting for a higher-level inflation in “normal time in order to increase the room for monetary policy to react to such shocks.” Central banks may want to target 4% inflation, rather than the 2% target that most central banks now try to achieve, the IMF paper says.

Australian Finance Minister Says More Stimulus Needed

Feb. 7 (Bloomberg) — Australian Finance Minister Lindsay Tanner said the nation’s economy remains fragile and that it will require more stimulus this year.

Australia’s long-term debt, accumulated through the global financial crisis, is also a serious matter, Tanner said on Network Ten’s “Meet the Press” program.

Read More…

G-7 Vows to Keep Economic Stimulus Even as Budget Deficits Grow

Feb. 7 (Bloomberg) — Group of Seven finance ministers pledged to press ahead with economic stimulus measures even as investors intensify their focus on mounting budget deficits.

Read More…

In conclusion, I’d like to accentuate the following analysis of the Japanese experience with private sector de-leveraging. I feel these issues are at the very center of the problems facing our markets…

Richard Koo’s book about the lessons from Japan’s balance sheet recession: The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. ANY attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery and hence the budget deficit ends up bigger than before.

Tags: equity markets, euro, gold, Greece, IMF, Inflation, QE, Quantitative Easing, Stimulus, US$

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Perspective: US$ vs. Gold

Tags: ben bernanke, debt-ceiling, economy, GDP, Geithner, gold, gold prices, obama, Q.E., Quantitative Easing, U. S. economy, US$

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I wrote yesterday: THE FED WILL NOT REDUCE LIQUIDITY AT THIS TIME.

Today, I will reiterate and state: QUANTITATIVE EASING WILL NOT AND CANNOT END AT THIS TIME.

This statement may appear to be rather bold in light of the noise emanating from traditional news outlets and the occasional Fed comment.  However, a review of the facts support the notion an end to Q.E. would be catastrophic for the economy and therefore unlikely to occur under the present administration.  I would also like to add, 2010 is an important mid-term election year. This fact would lay credence to the idea of further stimulus in 2010 not a reduction.

In order to support my thesis I have included three stories from a varying array of sources. The first story, brilliantly styled by Zero Hedge, highlights a voting member of the Fed. The second, reveals the dire situation of the real estate market as told by the Mortgage Bankers Association. And the third story, quotes the respected Bill Gross of Pimco. Bill explains, in plain English, the conundrum of Q.E..

Enjoy…

Bullard Acknowledges Asset Bubble, Yet Fed Policy Will Remain Unchanged As Change Would Destroy Banks. By Zero Hedge

…Ah, the fabled “extended period” clause. Well, thanks to Bullard’s clarification, we now know that this determination defines not an interest rate duration ambiguity, but rather one of the Q.E. program itself. The latter, in turn, is inextricably linked to the $1.1 trillion in excess reserves. So long as that massive overhang exists, and continues growing, any hopes for an end to Q.E., let alone rate increases, are a deluded myth. And all that posturing about extracting excess liquidity and adjusting the liability side of the Fed’s balance sheet, well, we’ll believe it when we see it. Until then, we, and judging by the dollar’s response to this speech, the broader market as well, fully expect another several hundred billion in tack-on MBS and, who knows, maybe even Treasury purchases by the Fed. The dollar carry trade is back, just as it seemed that Japan may regain the dubious distinction of being the supreme annihilator of one’s own currency. Sorry Japan, Ben is the man. READ MORE…

US mortgage originations seen plummeting – MBA

WASHINGTON, Jan 12 (Reuters) – U.S. residential mortgage originations will plunge 40 percent this year to the lowest level in a decade as home refinancing demand sinks with rising mortgage rates, the industry’s main trade group said. Lenders will underwrite $1.28 trillion in home loans this year, down from $2.11 trillion in 2009, the Mortgage Bankers Association said in its annual forecast on Tuesday. That would be the lowest since $1.14 trillion in 2000. The forecast was downgraded from December, when the MBA predicted originations would fall about 24 percent.  READ MORE…

Pimco’s Bill Gross on Fed Q.E. Conundrum:

Here’s the problem that the U.S. Fed’s “exit” poses in simple English: Our fiscal 2009 deficit totaled nearly 12% of GDP and required over $1.5 trillion of new debt to finance it. The Chinese bought a little ($100 billion) of that, other sovereign wealth funds bought some more, but as shown in Chart 2, foreign investors as a group bought only 20% of the total – perhaps $300 billion or so. The balance over the past 12 months was substantially purchased by the Federal Reserve. Of course they purchased more 30-year Agency mortgages than Treasuries, but PIMCO and others sold them those mortgages and bought – you guessed it – Treasuries with the proceeds.

Rosenthal Capital Management runs the Fortune’s Favorite Family of Funds, including Fortune’s Favor I, Fortune’s Favor Precious Metals and Fortune’s Favor Offshore. For more information visit www.rosenthalcapital.com

Tags: Fed, mortgage, mortgage bankers association, Q.E., Quantitative Easing

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Investment strategy: Many factors will affect our investment strategy in 2010 not the least of which will be the continued development of the Chinese dragon. The transformation of China into an economic powerhouse will lead to many dynamic investment opportunities for those who can separate the proverbial wheat from the shaft.

I can think of no better international combine driver than our own research guru, Gary Rosenthal. When he simply touches a shaft of wheat a loaf of bread materializes. Am I bias because he is my father as well as a partner at RCM? Maybe, but proof of his personal success can be found under the ‘Charts & Graphs’ page of our website www.rosenthalcapital.com. Review ‘Gary’s Rosenthal’s rollover IRA’ section and judge for yourself whether my sentiments are justified or exaggerated.

Welcome to Our Research Room:

Bret: Gary, China has offered fertile soil from which to reap investment returns for some years now. Why do you feel 2010 may offer continued opportunity?

Gary: On Friday Jan. 1st 2010 a China and Asean free trade deal began. This is a major event on par with China being allowed into the World Trade Organization in Dec. 2001. I believe this Asean free trade deal among nearly 1.9bn people will further accelerate the growth in Asia. Furthermore, China has established initial agreements to settle trade in local Asian currencies, not the US$. The stage is set for Asia to roar away from the U.S. and to establish the Yuan (Rinmembi) as a hard currency.

Bret: Forgive this question for being the softball it is and riddle me this: What do you believe is in store for the US$ this year and how would you structure a portfolio to benefit.

Gary: Softball? More like a pumpkin or watermelon! Take my previous comments, add Quantitative Easing (unlimited Dollar printing) to declining Dollar demand in Asia and you have the blueprint for a dramatically lower Dollar over time. An appropriate long term investment strategy: Precious metals, industrial metals, energy, agriculture and well researched high growth Chinese equity ideas.

Stories reported since Jan. 1 2010 supporting the Chinese theme:

Asian consumers most upbeat, American sentiment dips – Reuters.com

Reuters.com reports consumer confidence is strongest in emerging Asia, Brazil and Australia, but weakened slightly in the United States in the fourth quarter as Americans worried about job security, a survey showed. Consumer sentiment was highest in Indonesia, followed by India and Brazil, and was weakest in Japan and South Korea, according to the survey conducted by Nielsen Company a month ago. Globally, the Nielsen Global Consumer Confidence Index averaged a reading of 87 points in the fourth quarter, little changed from the third quarter but 5 points higher than the second quarter. The U.S. reading dipped to 82 in the fourth quarter from 84 three months earlier, reflecting concern about rising unemployment and ranking U.S. confidence at 18th among the 29 markets surveyed worldwide. 

China raises key interbank rate – WSJ

The Wall Street Journal reports China’s central bank unexpectedly raised a key interbank market interest rate Thursday for the first time in nearly five months, signaling a change in its policy focus toward pre-empting inflation risks in the new year. The tightening move, in the form of a higher yield in its weekly bill sale, came less than a day after the People’s Bank of China hinted its priorities had shifted toward managing inflation expectations and away from single-mindedly supporting economic growth. It also shows the PBOC still prefers using liquidity management tools, rather than policy interest rates, to guide market funding costs gradually higher before inflation becomes a real threat, analysts said. In its weekly open-market operation, the central bank sold 60 bln yuan ($8.8 bln) worth of three-month bills at 1.3684% Thursday, after keeping the yield unchanged at 1.3280% since Aug. 13. The PBOC drained a net 137 bln yuan from the money market this week, its biggest weekly fund withdrawal in nearly three months. The central bank has been draining liquidity for 13 consecutive weeks.

 Jan. 6 (Bloomberg) — China overtook Germany as the world’s top exporter last year, data compiled by Global Trade Information Services Inc. show. 

China shipped products worth $957.7 billion in the first 10 months of 2009, while Germany sold goods worth $917.7 billion to customers abroad, according to an Internet database operated by Columbia, South Carolina-based GTI. Exports from China exceeded German shipments every month since April last year, data show.

China has already slipped past Germany to become the world’s third-largest economy and is forecast to overtake Japan this year, assuming the No. 2 spot behind the U.S. Exports have driven a 15-fold increase in China’s economy to more than $3.8 trillion since the nation opened its doors to foreign trade and investment in 1978. READ MORE…

China approves stock futures, margin trading – AP  

AP reports Chinese regulators have approved the launch of stock futures and a trial run of margin trading, a state news agency said, in a move that could help boost stock prices and increase the role of China’s securities markets in financing economic development. It will take about three months to complete preparations for stock futures, the China News Service said Friday. It said the trial of margin trading – buying stocks with cash borrowed from a broker – might be followed by full-scale use but gave no indication when that might happen. The decision was long-awaited by investors. Rumors that the innovations might be introduced this week helped to push up stock prices. They fell back when the changes failed to materialize.

Tags: China, investment strategy, precious metals, Quantitative Easing, US$, yuan

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NEW YORK (CNNMoney.com) — The news that the sovereign wealth fund of Dubai requested a postponement of billions of dollars of debt this week could pose a big problem for U.S. banks…

…Bove said the underlying problem is that there is a lot of uncertainty floating around. For example, there’s little information available about counterparty derivatives, guarantees that transfer default risk from lenders to other financial institutions. And it’s unknown how much of Dubai World’s debt guarantee is held by U.S. banks. Read More…

Stock Market Investing: The above story along with many others have filled the airwaves and blogosphere over the last 4 days. I will refrain from adding my voice to the din. Moreover, endeavoring to postulate on the repercussions seems to me a fool’s errand. The sheer plethora of moving parts and back room deals makes a supposition worthless.

I will, however, offer some insight to a more pressing question: How will this event effect the US$, the equity markets and the price of Gold?

An avid reader of this blog will find the answer both simple and familiar. Bad news on the global economic front equates to good news for the U.S. equity markets and the price of precious metals, Gold and Silver.

Investment Strategy: The legend for deciphering this market environment:

Neg.Eco.News = Con’t.Q.E.; (Q.E. = Quantitative Easing; catchall for liquidity creation)

Con’t.Q.E. = Con’t.US$.Dval.; (US$. Dval = US$ devaluation)

Con’t. US$.Dval = Exponential Gold and Silver price increases + higher US equity prices

This legend, in all likelihood, will remain in force until major policy changes occur within the White House, U.S. Treasury and Fed. Never in history has the systematic devaluation of a currency led to sustained economic recovery and long-term growth. However, without fail, said devaluation leads to inflation, often hyperinflation, and a flight out of the currency into hard assets. The move unfolding in the price of Gold and Silver will be for most unimaginable, but for the few, the proud, the aware, it will be a move of a lifetime.

Tags: Dubai, Fed, gold, hyperinflation, Inflation, investment strategy, precious metals, Quantitative Easing, silver, stock market investing, U.S. treasury, US$, white house

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