Watch Out When Spit, Bailing Wire and QE3 Fall Apart

September 11th, 2012
in contributors

by Pebblewriter

It's entirely likely the market will remain comatose for the next two days until the German constitutional court decision on the 12th and/or the FOMC /napSMALLannouncements/press conference on the 13th. IMHO, QE3 is very much baked into current prices; though, we should get at least a nice little pop if the central planners deliver as expected.

If not, expect a sizable sell-off unless Bernanke is able to let us down so easy as keep hopes very high ("we are postponing QE until October 12, at which point we will buy every POS bond in sight.") It's really that simple -- which, of course, renders both fundamental and technical analysis meaningless in the short run and turns any long/short decisions made today into a veritable coin toss.

Follow up:

The German court situation is similar. Draghi's jawboning worked exceptionally well last week, producing a single-day 2.5 cent euro-bump versus the dollar that left it at least short-term overbought. If, after adjusting their hats, the BVerfG reign (sic) on Draghi's parade, look for the overbought euro to become oversold sehr schnell.

I have no special insight into either event. Though, as I wrote last week, Dow Jones put out an interesting statistic last week regarding employment data: over the past 28 years, the August NFP stats have missed expectations 3/4 of the time. For the past 10 years, the average adjustment after the fact is 62K.

Not that I think the Fed harbors any illusions about QE actually addressing the stifling unemployment in this country (yes, I'm cynical), but if they're attempting to at least make it look good...this might play into their decision. Their vastly greater concern is a stock market running on fumes and unbelievably leveraged banks whose solvency hinges on perpetuating the myth that their trillions in derivatives aren't a bad hair day away from implosion [see: The Wipeout Ratio.]

Then, there's the small matter of the election only eight weeks away from tomorrow. The Republicans have stepped up Fed-centric rhetoric of late, practically guaranteeing an Eccles Building house cleaning if elected (though I suspect they're only trying to entice Paulies into the tent.)

At the end of the day, the Fed is at least as concerned with self-preservation as any other body politic. After throwing "We the People" under the bus for their friends on Wall Street, it's hard to imagine them falling on their swords now for the sake of the economy (did I mention I'm a cynical bastard?)

As I perused the financial press over the weekend (anything to avoid doing my taxes), the euro zone's financial melt-down dominated. Criticism abounded, with a common theme being how much better America has handled the crisis. While our friends across the Atlantic face many structural and governance challenges, the real difference between our fates has been the willingness of our politicians to spend $16 trillion more than they've taken in and our central bankers to stymie the natural market response -- i.e., soaring interest rates.

Then, there's the minor fact that the USD is still the world's reserve currency. As a wise friend of mine likes to say, until we go full barter and I start making your kids shoes in exchange for your extra chicken, it'll remain so -- even after we tumble over the fiscal cliff (we can't really expect them to "fix" that in the months leading up to an election, can we?)

This is where things get really interesting. The stock market's ramp to new highs has taken our collective minds off the calamitous impact that a severe spending decrease and/or tax increase will have on our economy. As our predicament comes home to roost, the (continuing) recession will finally be obvious to all. Even if, by some miracle, Bernanke can muster enough spit and bailing wire to keep the markets from crashing, it's not entirely up to him.

George Soros argued earlier today that Germany and the rest of the euro zone are heading for a Depression within the next six months. Draghi and Merkel's solid Eddie Murphy impression notwithstanding (Keep it together! Keep it together! Keep it together!), the weakened and over-leveraged US economy will no doubt follow suit. Maybe the Fed will go down swinging, throwing good money after bad, and maybe not. But, it will make a difference only in when and how -- not whether -- the markets will collapse.

Cycleplane-Frederick-Gerhardt-7-wingsIn 1923, Dr. W. Frederick Gerhardt, head of Aeronautical Engineering at the University of Michigan reasoned that since wings provide lift, more wings would provide more lift. He built a beautiful aircraft known as the Cycleplane that featured a total of seven wings. It even flew a few times. But, it's best known for the time it was being pushed along the ground and the contraption collapsed under its own weight.

Which brings us back to QE... As we've discussed many times in these pages over the past year, the solution for too much debt isn't more debt and higher inflation. There will be a point of recognition, sometime between now and December 31, when capital markets begin to reflect this very simple math. And, the economic shock will be too great for even the Fed to mitigate.

When that happens, the rush to the exits will be swift and severe. But, until then, we'll do our best to navigate the twists and turns -- making the best of markets that are showing few signs of rational behavior.

Stay tuned.

Editor's Note: The author does not intend this to be specific investment advice. Use the information at your own discretion.

About the Author

pebblePebblewriter left Wall Street in August 2001 (95th floor of Two World Trade Center…timing is everything.) He publishes, a source for technical and economic analysis and occasional rants regarding Wall Street. He began his career twenty-two years ago in management with a bulge bracket firm, eventually moving into sales and trading. He spent several years in corporate finance, and the last six years in institutional asset management – working with large corporate, government and non-profit investors. He holds undergraduate degrees in Math and Economics, an MBA from UCLA and is a CFA charterholder.

In addition to trading, he is an angel investor, consultant and partner in a film production company. In his spare time, he coaches basketball and enjoys travel, sailing and aviation. He lives on the central California coast with his wife, two daughters and three cats -- who have inexplicably compiled an enviable investment track record in their random dashes across his computer keyboard.

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