The pattern is by now so familiar that it
deserves a place beside other technical indicators like
moving averages and Fibonacci retracements.
It begins with part or all of the global
economy appearing to implode under its five-decade accumulation
of debt. The public sector/central bank nexus responds with
a liquidity injection, leading the markets to rally explosively
and the pundits to declare the problem fixed. Then the markets
gradually remember that liquidity and solvency are two different
things, and that the mortgage lenders/money center banks/PIIGS
countries/hedge funds/State and local governments, etc.,
are insolvent, not illiquid. And the cycle begins again.
But what to call it? “Sucker rally”
seems a little too benign and prosaic for a process that
looks more like fraud perpetrated on a learning-disabled,
desperately-credulous victim.
“Death throes of a decadent system”
is accurate but too pretentious and doesn’t convey
the cyclical (and cynical) nature of the process.
“Financial terrorism” is better,
since the regularity of the cycle — and the fact that
central banks have absolute control over the timing —
imply that there’s massive insider trading going on,
possibly as part of a scheme by the (name your favorite
elite conspiracy group) to suck as much wealth out of the
system as possible before finally letting it collapse. Still,
the term doesn’t convey the comic aspect of rich,
supposedly-astute players getting suckered over and over.
Incompetent money managers are funny.
In the end, what it’s called is less
important than the fact that it’s a great trading
indicator. Starting in 2007, if you’d gone long risk
when the markets were falling apart — on the assumption
that panicked governments would quickly intervene —
and then taken profits and gone short a few weeks after
the intervention, you’d have made a fortune from all
the volatility.
The current market looks like another perfect
set-up: A week ago, Europe was collapsing, China was slowing
down and the US budgeting process was paralyzed. Stocks
around the world had fallen hard, and a Euro-zone breakup
was being actively planned for by governments and trading
exchanges. Armageddon, in other words. So the central banks
inject another hit of liquidity and Germany and the ECB
appear to embrace the commingling of the continent’s
balance sheets. And voila, the bulls are back in charge.
Now, trading strategies work until they
don’t, and there’s always the risk that this
latest bailout will actually fix the world’s problems
and usher in a new era of consumer-led growth with soaring
corporate profits, low inflation, and rising share prices.
But…nah, why even give this possibility serious consideration?
Nothing that was promised this week will make much of a
near-term difference. Lower reserve requirements in China
and cheaper dollar-denominated loans in Europe are just
tweaks to already existing programs. More fiscal integration
in Europe is inevitable if the common currency is to function
as promised. But think for a moment about what this implies
— Germany and France getting to micromanage Italy’s
pension and tax system — and it clearly isn’t
happening this month. Getting from here to a German-run
Europe will take maybe five more near-death experiences,
and in any event won’t address the fact that even
Germany’s balance sheet (when you include its unfunded
liabilities) really isn’t AAA.
So, the pattern should hold: “Risk-on”
trades work this week, then things get choppy for a while.
Then the markets grow cautious and finally terrified. The
most likely catalyst for the panic stage is the massive,
front-loaded refinancing schedule that Italy and Spain have
unwisely set up for early 2012. But it could be anything.
The point is to be short risk when it hits but not to marry
the position, because more liquidity is on the way. The
con will keep working as long as the world continues to
see fiat currencies as valuable.