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How QE Is Impeding the Economic Recovery


The problems that are impeding the economic recovery are not due to the lack of federal agency-backed mortgage loans that wind up in securities, but rather the continued contraction of US bank balance sheets.

You should understand that the massive reduction in the commercial hedgers' positions in 2012 portends a severe correction in US stock prices for 2013 and that it also predicted a top in November. This is one reason why I have been looking to fade the consensus QE asset reflation trade and why I concluded in Precipitous Drop that the various contracting credit market indicators I monitor were pointing to a pending repricing of risk assets:

Was it something cyclical like the fiscal cliff or election that would soon pass, or something secular more akin to a paradigm shift that I had discussed last week? I can't be sure. We have a lot of indicators that, on their own, could be saying something different, but added together could be saying the same thing.

The consensus trade is to get long the QE asset reflation correlation, however what I am seeing is just the opposite. That big sucking sound you hear might be a precipitous drop off in the demand for money. When that happens, the price of risk assets are soon to follow.

Thus far the equity market has followed the playbook I have outlined since the summer. Not only was fading the QE asset reflation trade the correct call, the September 13 FOMC meeting that announced QE III basically top ticked the market.

The other market top ticker is the hedge fund community which, due to a persistent net short position, had been dramatically underperforming the market. Yet when the S&P finally crossed 1400 in September, they predictably threw in the towel and got long. Despite heavy liquidation over the past couple of weeks and a 7.8% move off the top it appears hedge funds remain net long this market. I was looking for a short squeeze option expiration bounce last week and the fact that we did not get one suggests that a short base has not yet been developed. Coming into last week large speculators remained long the ES e-mini S&P futures and had in fact increased exposure.

With large specs still long and all the anecdotes of dip buying -- such as perma bear David Rosenberg of hedge fund Gluskin Sheff apparently looking for an excuse to get long based on "capitulation" -- I think there is a real danger of a flush. The longer we remain below the critical 1370 pivot I had identified last week in Rally Off 2009 Low Flushed the Hedge Fund Shorts, the more pressure will be on the downside.
Regardless of how the week plays out you have to realize how important this area on the S&P 500 is from a technical perspective. There is a reason this was the short/long pivot for hedge funds. The 1370 level on the S&P has been a major pivot going back to 2007. To see where this came into play, simply draw a horizontal line on a weekly and you can see how the market has respected this pivot a number of times. You can allow a little wiggle within 10 points, but I would not fade a move from this area in either direction.

This area is so critical that it's quite possible we vibrate it a bit as to keep the dip buyers in the game. However, despite what may be an attempt to rally this market, investors need to realize that the two primary drivers of bullish price action -- short hedge funds, and the consensus belief that QE is successful in reflating assets -- are no longer on their side. From here the risk/reward of being long and buying dips is very low.
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