Is that a light at the end of the tunnel or is it a train?

Everyone can relax a little it seems the ECB and BOE are on the job, German Chancellor Angela Merkel is making soothing sounds and the market is simply tired of fear and loathing and wants to rally. So all around the world investors are breathing a sigh of relief which is good news for a change.

Overnight equities were higher across the board reflecting this new optimism – the Dow finished up 1.68%, the S&P 500 1.83% while European bourses rallied very hard again! The DAX was up 3.15%, the CAC was up 3.41% and the FTSE was up 3.7%. But wait there’s more! Crude was up 3.65% in the US and 2.69% in Europe the CRB was up 2% with copper up 5.38% and silver roaring more than 5% as well.

These are not normal moves, neither were the big falls and crashes of the past couple, few, weeks which is a warning that markets are not functioning efficiently at present. But equally it is perhaps the case that markets are simply retracing what was a too pessimistic outlook insofar that everything, all the bad news that is, was priced in and perhaps more.

So the overnight steps by the bank of England to extend its quantitative easing program and inject another £75 billion into the economy over the next 4 months citing persistent spare capacity in the economy were taken positively as was the move by the ECB to extend 1 year loans to European Banks. This liquidity initiative by the ECB comes in the wake of Dexia’s troubles and is aimed are forestalling a cascading impact on other banks by addressing the specific issue at hand, bank liquidity.

But for all this new found positive sentiment and feeling the European debacle rolls on with enduring argument about the if, when and how of a Greek, perhaps other nations,bailout. We all know that this has been buffeting markets since last year and more acutely since the end of April this year. It’s claimed the Franco-Belgian bank Dexia it seems this week. But even against ongoing uncertainty and outright discord amongst the European Union markets seems to keep bouncing back like a good Rocky sequel.

The question I’d ask this morning is what does this tell us about what is going on in the global economy and markets at the moment?

My suggestion, or hypothesis, would be that we have just undergone a mini pessimistic crescendo where market players, traders and investors have de-risked their portfolio. By this I mean that they have retreated to whatever benchmark they use and reduced the risks of underperforming this index.

Now whether you investment benchmark is cash (like me) or the ASX 200, or the MSCI index or whatever returning to an index position when markets have been ebullient and hopeful means that you have to sell. So my hypothesis would be that there has been a large amount of selling to get back to index or benchmark.

Take the CFTC reports on the Australian Dollar for example – last week’s data showed that the net position of the “speculaltive” traders (those who don’t identify as hedgers) was effectively zero. No longs, no shorts just flat traders looking for the next move. This was a big pullback from the very large net long positions of a few weeks ago that had persisted for many months. So even though the AUD traded under 0.9400 earlier this week there wasn’t much position unwinding to continue and thus it was just a short term speculative attack prone, as we have seen, to reversal. The AUD is indicative of other markets as well.

Equally have a look at the Investors Intelligence chart above – you can see just how pessimistic equity market players in the US are. It’s not exactly 2009 but its not too far off. I’d guess this might be a precondition for a further bounce in equities and other risk assets.

Now this doesn’t mean that the crisis is at an end because as the European data is showing they have a weak period ahead of them economically and the US economy equally is weak and the BRICs are weakening. But when all the bad news is priced in then we run out of sellers and markets rally.

Sustainably? Probably not but rally nonetheless.

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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