Time to Fade the Raging Bull

Although our technically derived target for the Dow is still a very bullish 16800, we wrote here recently that we were keeping one foot out the fire escape.  Given yesterday’s display of bravado on Wall Street, however, we’ve now put the other foot out as well. After being down 116 points, the Industrial Average rallied nearly 200 points to end the day 80 points higher, at 15040.  We had anticipated the initial weakness with a bearish forecast for Thursday of a 15-point drop in the E-Mini S&P futures. This equates to a Dow fall of about 120 points.  At the lows, which occurred midway through the session, both came close to hitting their respective targets. Although the rebound therefore came as no surprise, the relentlessness of it did. After bottoming, the broad averages ratcheted steadily higher for the remainder of the session, strongly suggesting with each new upthrust and shallow pullback that the rally was being driven solely by short covering.

If so, bears will still be on the hook when stocks begin to trade Friday morning. We’ve told subscribers to be ready to short into whatever illusion of strength a bear squeeze might create, so convinced are we that the insanity that has been goosing shares has reached an unsustainable extreme.  There were plenty of reasons for the broad averages to have exceeded our downside targets yesterday and kept going.  For one, the U.S. dollar was in the throes of its worst day in recent memory. This suggests that at a psychological level, at least, all was not right with the world. Couple that with the horrific slide in T-Bond prices over the last month, and the very sharp, upward skew in mortgage rates that has resulted, and one could almost believe the Fed is starting to lose control.

Why QE Is Permanent

Unlike most observers, we view an end to QE as highly unlikely. To keep the U.S. economy nominally afloat, the Fed has been absorbing $85 billion of Treasury and mortgage paper each month. Mere talk of cutting back on this subsidy, let alone ending it, has sent stocks and bonds into a swoon. Under the circumstances, any real change in Fed policy would risk crashing the financial system.  In the meantime, the meager fruits of easing are no longer sufficient to provide cover for the spinmeisters. The rate of job creation has fallen three million positions shy of previous recoveries, and wages remain stagnant. The manufacturing sector has begun to weaken precipitously. And although housing numbers have been strong, there is no reason to think this can continue with mortgage rates sharply on the rise.

With yesterday’s 200-point turnaround in the Dow, the disconnect between Wall Street and the real world only grew more worrisome. Accordingly, we’ll be looking to fade buyers on Friday while acknowledging that the insanity could continue for yet a while longer. We’d rather risk a few bucks going against the herd at these levels than try to get short on a day when stocks are plummeting.