This liquidity-addicted, overcooked market maintains the twisted logic of any other kind of junkie. So, good news like a recently announced budget deal is bad news since it jeopardizes the one factor that’s been driving stocks higher: the Federal Reserve’s $85 billion-a-month QE3 bond-buying stimulus.
Right now, risky assets are under pressure despite the announcement of a small but meaningful bipartisan budget deal Tuesday night that will keep the government going through 2015 and removes the risk of another shutdown showdown in January. That’s good news for regular Americans, not just federal employees.
Yet the bankers and hedge funds types are disappointed. That’s because the budget deal gives the Fed one less excuse — as the job market firms — to keep the cheap money flowing at its upcoming policy announcement on Dec. 18.
Make no mistake: It’s all about the Fed right now.
The size of the Fed’s balance sheet has a growing statistical relationship to the level of stock prices — a sign that fundamentals like the real economy and corporate revenue growth matter less and less.
Moreover, on a day-to-day basis, days in which the Fed is buying large quantities of bonds are associated with the majority of the gains we’ve seen during the past few months; whereas days in which the Fed is inactive, the market tends to drift aimlessly.
If you care about free markets and worry about destabilizing asset price bubbles, this behavior should worry you. It’s not healthy. And it’s not sustainable.
But it also presents opportunities for nimble traders. As the taper becomes more and more likely — an event Wall Street has been worrying about since May — you’re seeing relationships that have pushed the market higher start to reverse. And that’s creating new opportunities for short-side profits.
The biggest shift, when the taper announcement finally comes, will be in the currency market where the U.S. Dollar should stabilize and move higher. That will put new pressure on emerging market stocks which, as represented by the iShares MSCI Emerging Markets ETF (EEM), have been underperforming since mid-October.
Digging down, EM focused areas like the solar industry are also being hit very hard. Just look at the way the Guggenheim Solar ETF (TAN) is melting down.
In response, I’m recommending positions such as the ProShares UltraShort MSCI Emerging Markets ETF (EEV) and a short against Trina Solar (TSL) to my clients.
Since I added the TSL short to my Edge Letter Sample Portfolio on Nov. 19, the position has gained more than 33%.
I’ve also recently covered a short against Tesla Motors (TSLA) for a 15% gain and a quick trade in the ProShares Ultra Crude Oil (UCO) for a 3% gain.
As of this writing, Anthony Mirhaydari had recommended EEV and TSL short to his clients.