An Addicted Stock Market About to Suffer Withdrawals |
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An Addicted Stock Market About to Suffer Withdrawals.

I have rarely seen a stock market so beautifully poised for disappointment. Pavlov’s dogs are salivating at the thought of more free money spewing out of the Fed tonight. If the Fed disappoints you are going to wake up to a US market down 2–3% tomorrow morning.

The irony of the situation is that the stock market is shooting itself in the foot by rallying so strongly into the announcement. The S+P 500 is only a little over 4% below the highs reached in April. How can Bernanke justify coming to the rescue of a stock market that is only down 4%? What a farce.

There are of course plenty of options open to Bernanke tonight and I am sure he doesn’t want to completely disappoint, so he will throw a bone or two to the salivating rabid dog that is the market. But I can’t help feeling that if he doesn’t embark on an all-out, unsterilized bout of money printing then the stock market will takes its bat and ball and go home.

The technical picture is truly compelling. I am always fascinated by the way the charts can line up with important announcements and tonight is a perfect example.


Emini S+P 500 futures

Emini S+P 500 futures
Click here to enlarge


Have a look at the above chart and notice how the stock market bounced off the 200 day moving average earlier this month. The rally from that area is causing a short squeeze. Stock market traders who have been shorting the stock market (i.e. betting that the stock market will go down) are now seeing their profits disappear as the stock market rallies.

They are forced to cover their positions more and more the higher the stock market goes. The fear of an announcement of more money printing will be adding to the buying pressure.

Now have another look at the chart and notice how similar the current price action is to the price action from last year, which I have circled. The sell off from the high last year found support at the 200-day moving average, before turning around and having a big short squeeze almost all the way back to the high (in fact it retraced to the 73.4% retracement level).

Once that short squeeze had played itself out the market tread water for a few weeks, before turning back down and plummeting 20% in two weeks. Will the stock market rhyme again this year? I think so.

The Stock Market is Close to a Major Sell Zone

The 73.4% retracement from the lows reached earlier this month is at 1379 in the emini S+P 500. The 61.8% retracement is at 1360 and the high from May last year is at 1373.5. I would expect to see some pretty stiff resistance between 1360 and 1379. In fact, I would be so bold as to say that I expect to see a reversal in the stock market either in or very close to that area. Last night the emini S+P 500 futures closed at 1350 after reaching a high of 1357.

Perhaps we will see another surge higher before the FOMC announces the outcome of their meeting at 2:30pm in the afternoon over there, but the fact is this stock market is very close to a major sell zone and any disappointment could lead to a cascade of selling pressure. I wouldn’t be surprised at all to wake up to the emini S+P 500 futures trading at 1340 or below.

A major daily sell signal will be generated if the S+P 500 futures close below the 10 day moving average in the short term. Currently the 10 day moving average sits at 1327. So if the stock market really gets dumped tonight and it closes below 1327 every stock trader and his dog should be shorting with their ears pinned back.

The next retest of the 200 day moving average will fail and you can see quite clearly how far and how fast the stock market can fall after breaking through the 200 day moving average from last year’s price action.

Spanish and Italian bonds continue to deteriorate and there is no doubt that this will be the elephant in the room at tonight’s meeting. Perhaps the Fed is so scared of the situation over there that they will decide to print huge quantities of money tonight.

If that is the case then we may see the stock market head higher in the short term, but there will be a use-by date attached to any money printing rally, just as there has been in the past. I think that this is a very low probability outcome but like so much in the stock market these days it will be the decision of a few men that will create direction for the world’s markets.

If they do print then all I have to say is buy gold. Lots of it. Buy gold stocks. Even buy silver. If Bernanke is happy to embark on QE3 with the stock market 4% from its highs then you can rest assured he is going to keep printing until the whole rotten edifice comes crashing down on his head. Gold will be trading above $5,000–10,000 by then.

History Repeats

I wrote a piece for The Daily Reckoning last year about the course of events leading to hyperinflation following the French revolution. I quoted a section from a book called Fiat Money Inflation in France by Andrew Dickson. I think that we should revisit that quote now that we may be on the edge of QE3:

The first result of this issue [i.e QE1] was apparently all that the most sanguine could desire: the treasury was at once greatly relieved; a portion of the public debt was paid; creditors were encouraged; credit revived; ordinary expenses were met, and, a considerable part of this paper money having thus been passed from the government into the hands of the people, trade increased and all difficulties seemed to vanish.

The anxieties of Necker, the prophecies of Maury and Cazalès seemed proven utterly futile. And, indeed, it is quite possible that, if the national authorities had stopped with this issue, few of the financial evils which afterwards arose would have been severely felt; the four hundred millions of paper money then issued would have simply discharged the function of a similar amount of specie.

But soon there came another result: times grew less easy; by the end of September, within five months after the issue of the four hundred millions in assignats, the government had spent them and was again in distress.

It progressed according to a law in social physics which we may call the “law of accelerating issue and depreciation.” It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible.

It brought, as we have seen, commerce and manufactures, the mercantile interest, the agricultural interest, to ruin. It brought on these the same destruction which would come to a Hollander opening the dykes of the sea to irrigate his garden in a dry summer.

It ended in the complete financial, moral and political prostration of France—a prostration from which only a Napoleon could raise it.

I think these words ring very loud on the eve of this FOMC meeting. ‘To refrain from the third and those following was practically impossible.’ Once the addict has filled his veins with the drug there is no turning back. Abstinence leads to sickness while the drug relieves all pain. Who wouldn’t choose the drug?

Bernanke must know that he only has so many rolls of the dice before his game of smoke and mirrors is shown for what it is. Is the situation really so dire right now that he is willing to give up one of those throws? I don’t think so. And if he doesn’t then the stock market is going to spit the dummy.

Murray Dawes

Editor, Slipstream Trader.

This article is contributed by Money Morning. Click Here to Subscribe to their free newsletter.