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12/09/12 News Letter


Chart courtesy of Stone McCarthy.


The chart shows, without a doubt, that the Fed is now the sole monopolist of Treasury demand expressed in mid-modified duration- i.e., the risk parameter most relevant to the Fed as it attempts to push everyone into higher risk assets (when instead all it is doing is merely allowing everyone to front run it). It also shows that in the past 3 years, the Private Sector has had its exposure to US Treasury’s grow by virtually a non-existent amount, a simple fact that would make the head of steeped in theory and clueless of actual practice hollow pundits, such as Paul Krugman, explode.

To put it simply, the Fed’s QE can not stop as there is no real market, or demand for Treasury’s expressed in duration terms, a fact the Fed’s 4 year meddling in the market has been able to conceal quite effectively. Alas, the Fed knows this. The Fed also knows that in a country which will continue piling up $1 trillion + deficits forever, there will always have to be a backstop funder of the US deficit. Since China is long gone as a buyer of US paper, this only leaves the Fed.

In other words, the simplest reason why the Fed will never exit is because the US will never again run a surplus, meaningless discussions over what a token $80 billion a year tax increase (which will fund the US deficit for 2-3 weeks) will do notwithstanding, and the Fed will need to monetize ever more US-sourced paper until Bernanke and his successor after 2014 are the only “market” for bonds left standing.

The market now demands roughly $85 billion in ten year equivalent “Flow” per month injected by the Fed: this was what QEternity allowed the market to price in as the basis level for the future and is why we knew with certainty that operation twist would be extended the day it was announced on Sept 13, only without the offsetting sale of ZIRP-umbrella securities (which are irrelevant from a 10-year duration standpoint), a forecast that has now been adopted by everyone. In plain English: the market needs the Fed to inject $85 billion each month just to stay level, never mind grow (sure enough, the market highs for 2012 were hit the day after QEternity was announced, confirming the market will need to see even more monthly flow to continue rising).

Manufacturing ISM came in just as expected, at least by those skeptical of all the sugar high economic data the US population was spoon fed in the past few weeks. At 49.5, the headline PMI print was the lowest since July 2009, the biggest miss to expectations of 51.4 in 5 months, and down from 51.7. Also, as most know, as sub-50 print indicates a contraction in the manufacturing space, usually a precursor to overall recession. Particular data points of note: Employment down from 52.1 to 48.4; New Orders slide from 54.2 to 50.3, and in the worst news for GDP Exports declined, Imports rose and Inventories plunged – which was to be expected after a huge inventory build up in Q3 pushed GDP much higher in the period. Expect even more downward GDP recessions on today’s ugly data. Finally, while the bulls would love to blame the collapse on Sandy, it was not mentioned anywhere in the release and the ISM’s Holcome said just one respondent even mentioned Sandy in the release, which means the manufacturing reality will only get worse as the full impact of Sandy is internalized.

Lowest print since July 2009…

Manufacturing ISM Index has been a good leading indicator for future S&P 500 performance. This does not bode well for early 2013.


S&P 500

The S&P 500 finished the week at the Pivot and above both the exponential and simple 200 day moving averages. Technically we need to consider closing short positions on a close above the Pivot on Tuesday. The market has held up surprisingly well considering the re-election of a socialist president, the looming fiscal cliff and the slow motion implosion of Europe. Emotionally we want to remain short. However, we will follow our discipline as stated prior.




We missed our targeted profit taking trigger of the 200 day MA buy a few points and now our short established at 7200 is under water. Any pull back to the Pivot will be used to exit that short position. The DAX has traced out a megaphone pattern. I our experience these end badly.



Our short Treasuries represents our worse trade to date. We remain short. Still hoping reality will take hold of this market before we are stopped out. However, the information at the start of this news letter leaves us with little hope.


Currency: Euro

Euro remains surprisingly resilient. Expect test of Pivot near term. While we anticipate that Eurozone debt troubles will lead to a strong move lower we will monitor price action looking for a break of Pivot or a move to Pivot Top1 before we take any action.


Energy: Crude

Crude has been weak and we expect it to remain so. We are looking for a move to Pivot Bottom 1 before we establish longs.


Metals: Silver

Silver remains well bid and we are looking for a move to Pivot Top 1 where we will take long profits.



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