Thursday, October 30, 2014

SPY on Life Support

After a sharp, persistent bounce from the lows at the 182 level, SPY appears to be running out of steam at the 198.50 level.

This three-bar test of the high, albeit in premarket trading, may signal the end of the move, at least for now.

There has been much debate whether this move up is just a correction in an ultimately much larger move down, or the start of a new move up.

While there continue to be some bullish factors present, such as the end of the month "window dressing", my expectation is that next week, we will head lower in an attempt to test the three-week low closing price.

Support at this level would be the perfect setup for the three-month test of the high, which I had expected to occur at the end of November.

A failure to close out the month with new highs would present us with a major sell signal.  Keep in mind that such a signal has become quite rare in the age of QE as every dip has been aggressively bought.

This last dip has been no different. 

Without the QE sugar though, can the new highs continue? 

The Fed has put itself in a difficult position now, having said that the economy is looking good and thus, there is no reason to continue with the QE program.  The reality could be that the Fed now holds a considerable portion of available bonds, especially in the 10-year tranche, causing a liquidity problem in the bond market.  Many believe that the Fed's QE actions have done little more than boost asset prices, as was their intention.  However, this wealth effect has not stimulated the economy as it had when house prices were skyrocketing some 7-8 years ago.  At that time, the average guy, who owned a home, was able to benefit from the rising equity values.  That no longer is the case as many homes remain under water with mortgages and the job market, while "improving" has not resulting in rising average wages.  Additionally, inflation in areas not counted by the government has soaked up excess consumer liquidity really putting a damper on even the little luxuries such as dining out and retail shopping.

While many corporations have been buying back stock and engaging in financial engineering to boost earnings per share, the gains are illusory and one day, when interest rates rise, balance sheets will be damaged and then we will face the true process of deleveraging, this time in the corporate sector.

So all in all, I remain negative on the market over the long term and look for an eventual cleansing of the system.  Not that I want to be negative, on the contrary, the business cycle must be allowed to go through the motions to clean out bad banks, bad loans and other weak and inefficient players.  While the Federal Reserve has tried and tried for many years now to control this cycle, eventually it must occur.  It should not be looked upon as a bad thing.  It will eventually make the economies stronger.

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