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Saying Goodbye to the Bernanke Put


If there has been one constant in the Bernanke Put, it has been a reduction in volatility. However, if he loses control, that Put will be worthless.

Last week fin Charting a Course Balancing Open-Ended QE and the QE Asset Reflation Correlation Trade, my goal was to provide a map for the markets into year end. The strategy was predicated on the notion that flow and not discount was driving price action and therefore the technical landscape would provide the best navigational tool for investors. Despite what many assume to be market-moving events such as the FOMC meeting and upcoming month end, mutual fund year end, employment, and the election I cited important technical levels that I thought would get tested regardless of the outcomes.

Regarding stocks:

Friday ES closed at 1424, not far above the level that brought hedge funds to cover. Next week we should at a minimum expect the market to test the area between 1425 and 1400. For the rally to stay in tact hedge funds will have to defend this area. If 1400 gives, the main buyers will then be under water and presumably turn sellers, putting a lot of pressure on the market. If 1400 holds, you should expect an attempt to rally the stock market to new highs possibly into month end and into year end.

Regarding bonds:

In terms of the bond market I do not want to assume that what's bad for stocks is good for bonds and vice versa. As I have repeatedly said the 150-00 level on the US bond contract is real and must be respected regardless. After Friday's rally the US bond contract is entering intermediate resistance at both price and momentum between Friday's closing level up to 148-00. With the Fed on deck Tuesday and with stocks poised to test lower levels, investors should expect the market to challenge this area. Nevertheless bond market price action needs to be interpreted independently of stocks market price action.

The main thing I missed was stating that the FOMC meeting was on Tuesday instead of on Wednesday. Other than that the markets behaved exactly according to plan. This is evidence that my thesis on the market trading off of flow rather than discount is correct.

Out of the gate on Monday the stock market was under pressure and on Tuesday sold off hard with ES trading down 20 handles to the 1405 level. After chopping sideways on Wednesday and Thursday the Apple (NASDAQ:AAPL) earnings miss and lowered guidance saw ES flush the aforementioned 1400 level after hours before recovering to close Friday at 1407.50.

Was that enough to hold 1400? It's too early to tell but I have a feeling that in the next two weeks we will have the answer.

The US bond contract responded to resistance as well, trading right up to the 148-00 on Tuesday before backing off hard on Wednesday down to find 146-08 support early Thursday. The volatility was intense and led by the belly of the curve, the bond contract reversed late Thursday into Friday rallying back to close the week at the 148-00 level on the dot. This was a textbook kiss back of the underside of the previous week's breakdown.

Is 148-00 now resistance like 150-00 before it? Again it's too early, but like stocks, the coming weeks will be crucial.

This idea that flow and not discount is dominating price action is a direct product of Chairman Bernanke's uber-easy and overly manipulative monetary policy. As I wrote back in June in Trading the Wrong Playbook Bubble, the Fed has removed fundamentals from the equation.

With Ben Bernanke having turned all assets into commodities, market price is not driven by valuation and growth based on models and forecasts, it's driven by positioning and sentiment based on speculation and fear.

This commoditization of all asset markets works when prices behave as the Fed intends, but as I warned last week, this apparent benefit comes with increased risks.

The Fed could potentially be a victim of their own success. By being so egregious in their attempt to manipulate the market pricing mechanism and by also boasting about it they have put themselves in a box. If and when the market doesn't behave the way investors think it should, at least when the Fed is inflating, investors will start to lose faith that the Fed is in control.

Last week two prominent investors echoed this heightened risk factor in letters to their respective investors.
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