Pre-elections QE3 Boost – How Sustainable?

 

For the past few weeks, I have been rather bearish on the US indices, expecting them to stop the ascend at their respective key resistance levels. However, a major news catalyst (QE3) has changed all that. With the new tweak in money supply, and the added confidence (real or perceived is debatable), we could continue to see the market drift upwards till the elections in November. There is also likely to be “words of encouragement” by the leaders to prod the market in the right direction.

Hence, the reversal could instead occur at the next resistance levels, which would more likely coincide with the end of the elections. This is not a forecast, merely a guess. At this point, I would look to buy on a weak pullback, or be ready to short if I see a sudden strong breakdown of the bulls.

S&P 500 – Bernanke’s Comments Provide Fuel for Stocks

 

Although there was weakness in the STI today at closing, the European and US markets have rallied strongly after comments from Bernanke. 

“U.S. stocks advanced, sending the Standard & Poor’s 500 Index to the highest level since May 2008, after Federal Reserve Chairman Ben S. Bernanke said accommodative monetary policy is still needed to spur jobs.” – Bloomberg

Looking at the chart, the S&P 500 has rallied strongly since the beginning of the year, and during the time employment has marginally improved, while the Fed has continued to keep interest rates low. Clearly, it seems the liquidity that is fueling the stock market is not translating into improvements in the real economy. This could prove problematic if the divergence continues to unhealthy levels.

For traders, it means that we should join the party and ride the trend however high it goes, but be ready to pull out when the music stops. For the STI, the last 2 weeks of ranging action makes the market hard to trade, and I am seeing more signs of weakness. Let’s see if today’s boost from the US markets can translate into gains for the STI.

Historically, April is one of the most bullish months of the year, but we will have to keep an eye on earnings, which may be lackluster since there has been no clear signs of economic bullishness.

Long-term refinancing operations (LTROs) – Long-term time bombs?

Long-term refinancing operations (LTROs) involve the central bank lending money at a very low interest rates to eurozone banks, which has led to the term “free money.”

The injection of this cheap money means that banks can use it to buy higher-yielding assets and make profits, or to lend more money to businesses and consumers – which could help the real economy return to growth as well as potentially yielding returns.

Banks can use assets such as sovereign bonds as collateral for the loans – although they can no longer use Greece’s bonds as collateral after the country was downgraded to a default rating by Standard & Poor’s. This has helped to boost some of the more troubled sovereign bonds, in peripheral countries such as Spain and Italy, as their yields have fallen because they are being used as collateral for the operations.

This can help out the entire country. Spanish and Italian banks, the biggest buyers in the last operation, used their holdings of their own sovereign bonds as collateral for the LTROs. This helped reduce sovereign bond yields, which were threatening to stay at unsustainable levels that would make debt repayments impossible.

In previous auctions, the money usually had to be paid back within three months, six months or 1 year. The ECB’s launch of three-year LTROs in December meant that this time scale was extended, which helped cause a much greater takeup than usual.

– references: CNBC


The question is, what happens after 3 years?

Unless the Euro zone countries can miraculously turn their economies around in 3 years, the problem has just been delayed by 3 years. If the banks choose not to loan out the cash, they can simply use the money to increase their returns via investments, which does not benefit the economy at all. Also, where does the ECB get this cash from? It will need to pay back the cash one day, or risk the devaluation of the Euro, similar to what the US is facing now. The collateral used are the sovereign bonds (which no one wants to buy in the first place), and should the countries decide to default, the ECB will be left with a lot of useless junk on their hands.