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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.
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