For Wednesday, December 21, the market forecast is for growth

If you choose to invest now we recommend any leveraged ETF that grows with the US market.

Here are some options:

2x Leveraged ETFs


Russell 2000

S&P 500




3x Leveraged ETFs


Russell 2000

S&P 500




Technical Comment:

Tuesday the S&P 500 shot up a large 3% on volume above Monday and slightly above the 30-day moving average volume.  The up-day has caused our forecast to return to growth.  On Wednesday the S&P 500 would have to drop about 21 points (1.7%) to switch our forecast back to uncertain.

Subjective Comment:

Our comments today are a little longer than usual.

While the market index was up 3%, the higher volume was not terribly strong.  In fact, it was barely above the 30-day moving average.  Friday’s volume last week was larger than Tuesday’s, and Friday volume is typically light.  The market index can move more on light volume.  The large up-day was more than enough to turn our forecast back to growth, and it further disrupts the formation of patterns that precede declines.

The backdoor bailout from the European Central Bank continues to get more and more discussion in the financial press and blog-o-sphere.  The official name of the ECB program is the Long Term Refinancing Operation, or LTRO, and it formally starts tomorrow.  If you search the internet for “ECB LTRO” you will find the discussion is mostly differing opinions regarding if it will work as a bailout for the Eurozone.  Here is the ECB’s announcement of the LTRO, or what we will continue to call the backdoor bailout.  The opinions regarding if it will “work” are varied.  To engage in any speculation about the effectiveness of the LTRO backdoor bailout, success criteria are needed.  If you need a review of how the LTRO bailout works, see our post from late last week.  Here are some success criteria for LTRO:

  • Provide sufficient funding for sovereign bond auctions through the next several months, ensuring high enough demand that yields remain low – this is how the governments of Spain, Italy and others would judge success
  • Prevent defaults in the payments of sovereign bonds by Eurozone countries – such defaults would bankrupt many European banks, cause huge losses for others, and cause losses for US banks and institutions that have sold insurance Credit Default Swaps against such defaults
  • Provide sufficient profits for European banks to prevent them from defaulting, and enabling them to expand loans not only by buying bonds but to the private sector to stimulate the Eurozone economy
  • Ease the fears of US banks sufficiently so they resume more aggressive lending so as to stimulate the US economy
  • The stock markets of the Eurozone and the US rally

This list could likely be expanded, but it seems sufficient for the purposes of brief discussion.  Note we did not include a permanent solution to the Eurozone debt crisis.  No bailout, no matter how the mechanics of it work, will solve the debt problem.  More debt does not solve a debt problem.  The debts are too large to ever be paid, so the only solution is bankruptcy.  Until that happens, bailouts can at best delay the bankruptcies the must occur.  If the ECB prints money to avoid bankruptcy, which is technically possible, the resulting inflation would be incredibly high.  So, either bankruptcy is declared and the bond holders take the losses, or hyperinflation destroys most of the purchasing power of the Euro, causing the citizens of the Eurozone to take the losses.

We will now return to the bailout’s ability to achieve success in the above bullet points.  The LTRO backdoor bailout should achieve success in avoiding sovereign bond defaults for the next several months at least, and it should cause bond auctions to be successful enough that refinancing of national debts will be at reasonable rates.  As we posted last week, in the first 4 months of 2012 Spain has €55.2 Billion Euros maturing, France has €140.6 Billion, and Italy has €157.4 Billion.  LTRO should provide enough funding to cover these maturations and some others.  So, for the next 5 to 6 months, LTRO will succeed at the first two bullets.

The third and fourth bullets are less certain to be successful.  Some European and US banks could still go bankrupt even with the LTRO bailout in place.  Banks that are in worse financial shape will likely participate in bond buying and using such bonds as collateral for cheap loans from the LTRO program.  Stronger banks might participate as well.  However, the LTRO by itself will not be enough to convince European banks to expand lending in the private sector.  As long as the ECB funds LTRO loans by selling other assets, called sterilization, the money supply will not expand.  This means the banks will not have sufficient reserves to expand loans to the private sector.  As long as the ECB sterilizes, European bank lending will be mostly to buy sovereign bonds, thus crowding out the private sector and permitting continued stagnation in the Eurozone economy.  If the ECB prints new money to fund LTRO loans, then the money supply will expand.  European banks will see their reserves growing, thus improving their capitalization and allowing them to make loans to the private sector, in turn causing a bubble-boom as described by Austrian Business Cycle Theory.  Only if this occurs will US banks then begin lending in the US, reigniting the bubble-boom that started this past summer in the US.

The last success bullet we listed was a rally in US and European stock markets.  Market participants will cause short term rallies as they take speculative positions regarding their expectations of what will happen in the future.  As we discussed above and in our last several blogs, it all comes down to this backdoor bailout and if the ECB funds the LTRO loans via massive money printing.  Some market participants are concluding this will be the case, but many others are posting contrary opinions.  Today participants with the bullish opinion of this situation drove the markets up by buying equities in anticipation the LTRO will “work”, meaning it will cause a market rally.  If most participants shared this opinion, the up-day Tuesday would have been stronger and on much higher volume.  The mild volume suggests a lot of participants are still waiting to see if the LTRO will cause a sustained rally.  Those with bearish opinions are shrugging off Tuesday as a blip up in an otherwise down-trend.

Spanish Bond Auctions

The bullish scenario regarding the LTRO backdoor bailout includes European banks purchasing Eurozone sovereign debt.  Last Thursday Spain had an auction that was successful by some standards and mixed depending on your point of view.  Tuesday Spain had another auction, and it was also strong or mixed depending on how you want to look at it.  The bearish opinion is the bid-to-cover ratio of 2.9 was barely above the previous 2.8 ratio.  The bullish opinion will note 3-month paper sold for a yield of 1.735%, which is much cheaper than the average of 5.11% last month.  The 6-month bill sold for 2.435%, down from 5.227%.  Demand for last Thursday and Tuesday’s Spanish bonds was clearly strong, most likely because the banks will immediately use these instruments as collateral for the first LTRO loans from the ECB on December 21st (tomorrow).  Strong auctions are happening, now we have to see if the ECB prints or sterilizes.  It will be a few weeks before the ECB balance sheet and money supply data shows clearly which is happening.

We think it is likely US stock markets will bounce up and down until there is clarity regarding the effectiveness of the LTRO backdoor bailout and ECB money printing.  Most market participants do not fully understand the Austrian Business Cycle Theory and how an expanding money supply impacts an economy, its capital structure and stock markets.  Many participants will take longer as they wait to see if the rally appears sustainable.  Some participants have learned through experience not to fight the central bank, so they will react once they see if Euro printing is happening by looking at the ECB balance sheet and money supply.  Those entering the market now are betting the ECB will print money to fund LTRO loans, even if they don’t know this is what will cause a bubble-boom.  The light volume tells us that despite the large up-day in US markets on Tuesday, there is still not a clear technical indication of the market direction.  Finally, remember that external shocks such as a Chinese economic crash (which will happen eventually, and probably sooner than later) or a geopolitical shock to oil supplies could cause large down-days.  If you’re aggressive, consider putting some of your money into US equities via leveraged index funds.  If you’re cautious, continue to hold a cash (or risk-off) position and avoid money market funds due to exposure to European debt.

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