Monday, July 30, 2012

Fed and Global bank's Policy Responses in a Crisis

So last week ECB's Draghi claiming the triple play of bond buys, rate cuts and a new LTRO program was the key details that gave markets confidence and a sharp rally.  The first series of 1+% moves seems to have changed the short term undertones of the market.

I was reading Hedge Fund Market Wizards on the weekend and two key points are very clear reminders that whilst underlying economics may be weak, confirmations of market movements and reactions are the key things to be aware of:
1/ What is the second derivative effects - are conditions getting worse at a slower rate?  Thus implicates the market psychology and sentiments which can drive both the volatility and trading opportunities.
2/ Does the climatic nature of the market negativity lead to a very strong policy response and thus forging the path for bullish price action that always goes against the momentum and usually strong enough to turn the tide.

The chapter on Dalio of Bridgewater:
"In 1982, we had worse economic conditions that we do right now.  The unemployment rate was over 11%.  It also seemed clear to me that Latin America was going to default on its debt.   Since I knew that the money center banks had large amounts of their capital in Latin American debt, I assumed that a default would be terrible for the stock market.  Then boom - in August, Mexico defaulted.  The market responded with a big rally.  In fact that was the exact bottom of the stock market and the beginning of an 18 year bull market.  That is certainly not what I would have expected to happen.  That rally occurred because the Fed eased massively.  I learned not to fight the Fed unless I had very good reasons to believe that their moves wouldn't work.  The Fed and other central banks have tremendous power.  In both the abandonment of the gold standard in 1971 and in the Mexico default in 1982, I learned that a crisis development that leads to central banks easing and coming to the rescue can swap the impact of the crisis itself.

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This depiction sounds very familiar with the current fear of what would happen if the market was to see a Greece default and leave the Euro.  Continually we have seen policy makers coming in to put a strong policy response to both shore up the sentiments and keep borrowing costs down.  The Spanish and Italian debt issues are much larger than what we've seen in the past, and that is probably what makes the stakes a lot higher than in the past - but as we see, we've seen worse economic conditions, and the world ended up just fine.

Will we continue this 'secular bear trend' or are we beginning of another bull run for the ages?