Bazooka-Light

This note was originally published at 8am on October 27, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The emotions aren't always immediately subject to reason, but they are always immediately subject to action."

-William James

If you gave me the written press release with what imprecisely this European band-aid actually says, I would have stayed short the SP500 (SPY) yesterday. That would have made me really wrong.

Rather than talking about what I would have, could have, and should have done, here’s what I did yesterday – and therefore where I stand for this morning’s emotional market open (Time Stamped):

------ 

10/26/11 11:33AM EDT

Booking It: SP500 Levels, Refreshed

POSITION: Long Consumer Discretionary (XLY), Short Consumer Staples (XLP)

After a 30 handle drop in the SP500, I’m booking it.

That doesn’t mean I’m bullish. It doesn’t mean I’m bearish. It doesn’t mean I can’t re-short it either. It just means that we’re holding my most immediate-term TRADE line of support at 1217.

Across our 3 risk management durations, here are the lines that matter most: 

1. TAIL = 1266
2. TREND = 1254
3. TRADE = 1217 

So the intermediate-to-long-term picture still supports selling all rallies that extend themselves toward 1254-1266. And, until the immediate-term TRADE is no longer bullish (1217 support), I’ll respect whatever it is that the market sees coming next. As the Keynesian central planners have proven in the last 3 weeks, anything can happen.

------

And then… here’s what the Europeans did:

“The world’s attention was on these talks… We Europeans showed tonight that we reached the right conclusions.”

-German Chancellor Angela Merkel

And then… here’s what Global Macro markets started doing (which is what led Merkel to stating she has this right, for another day?):

1. China was up small (+0.34%) and up for the 4thconsecutive day but, like the Hang Seng, remains bearish TREND and TAIL
2. Japan was up +2% and the Nikkei remains below its intermediate-term TREND line of 9219 resistance
3. Indonesia, Singapore, and Thailand were all up +2-3% on the squeeze, but all 3 failed to traverse their respective TREND lines
4. Germany’s DAX is having the most impressive move, scaling slightly above its 6221 TREND line resistance (bullish if it holds)
5. France’s CAC is up big but failing to eclipse its TREND line of resistance = 3411 (TAIL resistance for the CAC = 3889)
6. Greece’s ATG Index is up over +3% and actually moved above its immediate-term TRADE line (784) for the 1sttime in 6 months
7. CRB Commodities Index remains bearish TREND (327) resistance and bearish TAIL
8. WTIC Oil has recovered its TREND line of $88.57 support, but remains a bearish TAIL (resistance = $93.87) after failing there
9. Copper has recovered TRADE line support of $3.36/lb but remains bearish TREND ($3.90/lb) and TAIL
10. Gold is back to bullish TRADE ($1671) and TREND ($1701), which makes sense post the biggest fiat bailout in world history
11. 10-year US Treasury Yields have rallied from TRADE line support (2.04%) but failed to recover TREND line resistance (2.40%)
12. Yield Spread (10s minus 2s) is +8 basis points wider day-over-day to 197 bps wide, well off the all-time high of 293bps wide in FEB
13. US Dollar Index is holding TREND and TAIL lines of support of $75.37 and $75.77, respectively
14. Euro is ripping the shorts right back up to the TAIL and TREND lines of resistance at $1.40 and $1.42, respectively
15. My inbox and twitter streams are jammed with, “shouldn’t I cover… we could go a lot higher”

So, what do you do with all of this? If you are me, today you probably do a lot of nothing. When I worked for other people, that would not be a tolerable answer – we “smart” hedge fund people always have to do something…

Or do we?

In the land of chasing short-term returns, emotion is not often subject to reason. But very often it is “subject to action.” That’s mostly what I see going on here this morning and, effectively, why I have turned down offers to run Global Macro books for other people for the last couple of years. Been there, done that – and I don’t need to do things in life that I don’t think make sense.

In the end (and, in the end, this will not end well), I don’t think this concept of Bazooka Light will make a lot of sense to anyone who takes a deep breath and actually reads what it implies.

The timing and size obviously matter – but the timing (end of November? is subject to a hefty political debate) and the size is basically whatever the Europeans want the media to buy into the headline being.

It’s all theoretical multiples of leverage on the agreed upon EFSF baseline number. Obviously that’s the best way to threaten the shorts – remind them that you may not have any money, but that you can have lots of money if you print other people’s money and lever it up!

Mechanically, since the ECB and IMF have not formally engaged in backstopping any of these concepts of theoretical leverage, this is what happens next (in this order):

1. Insolvent European banks have to try to raise capital in the public markets (good luck)
2. If that doesn’t work, then they have to tap their national government (most of whom are tapped out)
3. If that doesn’t work, tapping the EFSF is considered “last resort”

In other words, this keg of Bazooka Light will be tapped, then kicked… then the 2008 post TARP (October-November 2008) price volatilities begin.

My support and resistance ranges for Gold, Oil, German DAX, and SP500 are now $1701-1729, $88.57-93.87, 5829-6221, and 1226-1266, respectively. Emotional decision making today will be epic.

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer