The week of November 1st: privatize your gains, socialize your losses

The events of this week solidified Nouriel Roubini's pet theory that America is out to blame its sorrows on the evils of Big Government as the Democrats faced an inevitable defeat in the Mid-Term elections (albeit they retain the Senate, and Obama's veto); and on the flip side, the markets were more than happy to take flight on the gossamer wings of yet another stimulus.

As predicted in my last few posts, the stimulus plan announced on Wednesday, was to the tune of 600 billion dollars. In its carefully planned statement the FOMC made clear that  it will be flexible and giving:  

"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month." 

I have to give it to the Fed. They have managed market expectations brilliantly over the last few months, and as a result, markets have made their way to year highs in a slow and sustainable manner (helped of course by the amazing earnings season that these last few weeks have been). By the time the FOMC mandate was announced, the S&P 500 had priced in almost all of the stimulus, and were prodded along to grind higher with the extra 100 billion above market consensus (although Goldman's consensus stood at a whopping 2 trillion!). The crucial words in the statement above are "about $75 million per month". This gives the Fed immense flexibility to judge the economic recovery on a monthly basis along with inflation expectations before committing to an amount. 

On Friday, the all important unemployment reading came out, in line at 9.6%. However, the crucial bit was the massive increases in private sector employment. If America is to avoid a double dip, the private sector has to start employing more people, and the numbers this week indicated an increase of 151,000 jobs, way above even the most optimistic expectations. So, it would not be too much of a gamble at this point, to predict that there is no double dip scenario in sight. The tricky bit for the Fed would be to ensure that inflationary expectations don't start getting out of control, even though up until this magical mystery tour of a week for the markets, deflationary scares were pretty serious. 

The reason I am not overly bullish now, is the state of the Euro Zone and sovereign debt issues. This week, Irish and Portuguese bonds had the biggest spreads in the Zone's history relative to the German Bunds, which are looked upon as the epitome of stability. This does not bode well for the state of the Euro Zone, and even Germany failed to produce good data this week, with disappointingly low factory orders.

There might be some correlation reversals to be seen in the coming weeks with regard to the Euro/Dollar and American equity markets. This is not a sure bet, but with the amazingly good data flowing out of the States this week, highlighted by the Non Farms report, and the increasingly difficult state in the Euro Zone,  the dollar might just see some strengthening in the coming weeks even with equities consolidating just a little below year highs. The alternative scenario could be a that the inverse relationship with the Dollar continues and we see a sharp correction in the equity markets, but in this bull market, one has to be a really big polar bear to bet on that. I am undecided. 

Oh, and about my "conspiracy theory", I think things are playing out according to plan. One has to wait and watch for further subtle interest rate hikes by the PBOC in the coming months. I think its a sure thing!