The primary market forces remain in play.
The markets are holding up on hopes of additional stimulus from the Central Banks. Some bulls are even calling for QE 4 at the upcoming Fed meeting, despite the fact that QE 3 was launched a mere three months ago and was open-ended (meaning it would not end until the Fed deemed it time).
This is extraordinary and proves point blank my concern that we’d reach the point at which additional monetary stimulus would no longer having a significant impact. This was always the End Game for the Fed’s response to the financial crisis: that by intervening as much as it did, eventually we’d get to the point that even extreme interventions had little if any impact.
Given that the Fed has been the primary driver of stocks for the last four years (even the NY Fed admits the S&P 500 would be at 600 without Fed intervention) this is a major red flag that we could be due for a sharp correction to the downside.
Against this backdrop of hopes for more intervention, the ugly fundamentals continue to worsen. As I indicated in yesterday’s missive, there is little if any political incentive for the Democrats or the GOP to address the fiscal cliff. Consequently we are very likely going over it.
In Europe, the great banking crisis continues to worsen. The EU has definitively lost one of its primary AAA supports when France was downgraded. Moreover, the mega-bailout fund, the ESM, has been downgraded as well.
The implications of this are mainly pertinent to the banks. Sovereign bonds are the primary collateral backstopping hundreds of trillions of Euros worth of trades at the large EU banks. With France no longer AAA and the ESM losing a rating as well, a scramble for AAA collateral is underway. This will be beneficial to Treasuries, bunds, and other high-grade bonds (high grade relative to non-AAA rated collateral). It will be bad for low-grade collateral bonds (Spanish, Greek, Italian, etc.).
Thus, stocks continue to seesaw. The fundamentals want to pull stocks down while the hope of more intervention from Central Banks pushes stocks up.
The one thing that trumps this is the fiscal cliff. Since there is little likelihood of a solution, we are likely to see heavy selling from institutions in the coming weeks (see Apple’s recent action) as they close out positions before the tax increases.
This will put selling pressure on the markets. Combined with the ongoing EU debacle, this makes for a potentially very ugly sell-off into year-end.
After that, we’ll see… but 2013 is shaping up to be an absolutely hellacious year.
Swing by www.gainspainscapital.com for more market commentary, investment ideas, and special reports outlining specific risks and opportunities in the capital markets.