As you know, the incredible market run over the past two months has been driven by one factor and one factor alone: the potential for another big round of money printing or “quantitative easing” by the Federal Reserve, to come on top of the $1.7 trillion injected into the money markets last year.
Fed Chairman Ben Bernanke, a true believer in the power of additional monetary stimulus, made a big speech on the subject this morning — and the market’s reaction speaks for itself. The dollar is higher against both the euro and the Japanese yen. Dollar-sensitive commodities are lower. But the biggest reaction happened in the bond market where long-term Treasury bonds are plunging, pushing interest rates higher and ending a seven-month trend of lower rates.
What gives? Isn’t the potential for another round of runaway money printing from the Fed exactly what the bull wanted? The trouble is inflation. In other words, this is an example of too much of a good thing (cheap money) actually being bad. And that’s undermining the raison d’être for the dollar-drop risk rally.
As a result, now is the time to look at profit opportunities on the short side. The focus should be on the assets most vulnerable to a strengthening of the dollar.
Crude oil is a good place to start. As you can see in the chart above, the U.S. Oil Fund (NYSE: USO) is falling out of its multi-week consolidation as its technical measures continue to weaken. The relative strength indicator has formed a bearish negative divergence with price — a pattern that presaged declines in the past. The best way to play this is the ProShares UltraShort Crude Oil (NYSE: SCO), which returns twice the inverse daily return of crude oil.
Long-term Treasury bonds also look to be an attractive short idea with inflation expectations now on the rise. You can see the shift is underway by looking at chart of the Direxion Daily 20+ Year Treasury Bear 3x (NYSE: TMV), which returns three times the inverse return of the NYSE 20+ year Treasury Bond Index. The fund has fallen through its 70-day moving average for the first time since April as the bond market starts pricing in higher inflation.
This is represented in the lower pane of the chart by the relative performance of the iShares TIPS Bond Fund (NYSE: TIP), which are inflation-protected Treasury bonds, versus the iShares 20+ Year Treasury Bond Fund. When it rises, as it is now, that means TIPs are outperforming non-inflation protected bonds as investors buy protection against higher inflation.
As long as this line is rising, the bond yields will be pushed higher and the dream of another round of quantitative easing will remain just that — a dream.
