Traders Love Liquidity
The market absolutely ripped higher last week. Volume was mixed, but it rose to above average levels on a few days. The 7% move higher followed news that six central banks would collude in the swap market in order to increase liquidity.
Traders love liquidity. And as a trader you don't need to worry about the long-term ramifications or degrees of success associated with such plans, the only concern is the very near term.
In the near term, a liquidity increasing strategy was introduced into the system. Liquidity boosts into financial systems have the side effect of a higher risk tolerance.
And boy did investors embrace risk. Most indices were up 7% and finished near the highs of the week. But perceived high-risk groups like banks and home builders were up 9% and 11% during the week.
Since the October bottomed I stayed bullish in my trade. Although the portfolio went through some incredible ups and lazy downs during that time I remained biased to the bullish side of the trade.
While neither group (bull or bear) can claim a victory over the past month, since the market is exactly where it was two months ago, the edge should go to the bulls. Market valuations are depressed historically and short interest in the market is over 20% for many securities.
Short interest is a delayed statistic, but even if the true number is half that, a 10% short interest is a lot. The high short interest, which is on a week or two delay (depending on the specific security), indicates that the recent rise was not exclusively short covering. And should the shorts decide they have had enough, the market could easily race another 7% higher, probably more.
Aside from the cooperation between six central banks, the market has also traded higher due to increased optimism in Europe. And this week will be a huge week in Europe.
December 9 begins the EU Summit. Many investors hope that leaders from the EU, especially the Germans, will form a tangible plan to address the issues in the region. I also think that if such a fiscal pact were in place this week, the ECB would be willing to provide a backstop to the whole thing.
The market in Europe is already moving higher this morning in advance of (and in the hope that) a deal will be reached. And with Merkel and Sarkozy expected to give a news conference, the indices have moved higher as traders believe the two may gives clues ahead of the summit.
The indices are clearly stretched in the short term. And today's initial increase is built purely on political speculation.
I think it's all fluff. At some point, Europe will formulate a fix, but not this week. Politicians just don't act fast.
The meeting this week is the fourth of its kind this year. Not much else has come from the other three. Additionally, the euro has not risen in conjunction with the equity market. The distinction between forex expectations and equity expectations is noteworthy and not a good sign for the bulls in the very near term. Get ready for another wild week.
Do you think the euro can survive 2012? We love to hear from you, email us at marketforecast@wyattresearch.com.
