Darshan's Blog

Darshan's Daily Market Ponderings

Friday 30th October, 2009

The Dangerous Truth About The US Q3 GDP Growth!

Morning!

Well I'll get on to the 'surprising GDP' numbers in a minute but before that let me just say what a wonderful day yesterday was! It feels good to be right again! While everyone was selling that hole on Thursday morning, what did I say?

"So let's look at the technicals - sure the Dow and the SPX closed below 9800 and 1050 (most importantly the SPX closed below the 50 DMA)...so technically, we should be selling this market like mad. However, that is how traps are set. So I am not denying that we can't go lower from here and find a floor somewhere in the 9500s and 1020-30s on the SPX but I'm also being careful of a huge short-covering rally taking us right back to the top.

So once again, it's time to keep your powder dry - my advice is the same as yesterday - don't try catching a falling knife but don't short a trap either...Whatever, happens, I refuse to be caught in a trap."

Well what happened? We reversed right from the off - way before the GDP numbers came out and just kept going all day. Now you know how the Fed play the game - get the primary dealers to shake out the equities and attract money to the Treasury auctions. At the same time, the nice low gives the big money a chance to buy up at a lower price. However, I also said that we should be careful about what happens once we get the short covering rally. Well what now?

I will come back to this, as I first want to talk about the US Q3 GDP numbers - as this is important for the investors amongst you. (Traders, sit tight and wait - I'll get to what I think will happen today, in a bit).

So US Q3 GDP increased by 3.5% vs 3.2%

Right, so the headlines are now reading that the USA is now out of a severe recession and we should all hail the saviours in Government for this. Remember the Bloomberg Survey predicted a growth of 3.2% and as late as Wednesday, Goldman Sachs lowered their own forecast to 2.7%. What we actually got was a whopping 3.5% headline figure.

This is great right? NO NO NO

This is a magnificent number on the surface but let's dig deeper shall we? The Consumption input grew by 3.4% but disposable income fell by 3.4%. What does this tell you? Well, it means that the largest component of US GDP, is not supported by income growth. Do you realise how important this is? Essentially Government incentives like Cash-For-Clunkers and the tax relief for home purchases, boosted consumption in Q3 but this meant that consumers actually cut back on savings, as their income did not keep pace with the spending. Over 15.1 million unemployed Americans must be scratching their heads and wondering how an economy can grow at such a pace over a quarter, without them working.

What we do not have is a sustainable recovery. What we have is an artificial number brought about by severe Government stimulus and a devalued US dollar. The USA is technically out of a recession because of the number yesterday BUT what happens when the stimulus stops and the rates have to go up? I keep saying this but for all this stimulus to work, we need the money multipliers to increase above 1 and stay above it. Until that happens, it means we are in a deflationary mess and that means, every single Government that has chosen to throw good money at the wrong solution, will have to keep spending to keep this growth illusion going. Your children's and their future families will have to pick up this bill via higher taxes and suffer chronic underinvestment in the services they use.

So how bad is the problem? Well the broad money supply (M3) has dived by over 1.625% over the last quarter. This sort of contraction is comparable to only the Great Depression. The bank are hoarding money. Excess reserves now measure at $823billion compared to $2.4bn last year and $1.4bn in 2007. Yes read that again! What the heck is the Fed and the Treasury doing? Yesterday, Treasury Muppet Tim Geithner actually had the audacity to talk about how his great work to get the USA out of recession and talked at length about the moral hazard of bailing out the banks. Is this guy for real? They are sitting on $823bn of reserves, while your taxes are used to try and stimulate the economy in a non-sustainable way?

Releasing those funds are the key to unlocking growth and inflating that money multiplier. This is not a stimulus problem, it is a credit problem. Fix the banking system! This whole ramp over the last six months, has been designed to recapitalise the banks. They have been told to raise their capital ratios and therefore, deleverage. In principle I agree, the banks need to stop gambling with leverage but they need to do what banks are supposed to do - lend. They can increase their capital ratio by getting rid of their toxic assets by just writing them off. As painful as that is in the short term- it is necessary. The powers to be, are actually encouraging the deflationary spiral by forcing the banks hands to seek alternative ways of raising the captial ratios. Instead of stopping their gambling, they are simply raising the capital ratios by hoarding the money. It needs to be lent out, otherwise this out-of-recession party will be over with a double-dip recession, sooner rather than later.

This is the the biggest mistake ever. We are all going to suffer with an even bigger crash below March lows because of the policies of our inept officials and our corrupt banking giants. We can't celebrate such GDP numbers - as these one-off stimulus packages may not be renewed - in other words I fully expect a downside revision to this fake upside number, when the Q4 number is reported. Add to the ending of stimulus packages, the reigning in of the liquidity pumps - what will all the hyped up asset classes do? They willl revert to reality and it will do so with a bang. Anyone who thinks the almost 50% move up from the lows in March, captures economic growth - no matter how forward looking, is positively crazy.

What we need to see is how the FED exit from their plans and how the Government deals with the impact. We can't celebrate one number. This is the kind of irrational exuberance that got us to where we are. Remember, the USA is not the only country embarked on a journey to nowhere with their plans - Europe and the U.K. are in the same carriage of insanity. Last Friday, I talked about how the direct stimulus from the German government, would only yield results for a short time...and that once the course of medicine started waning, the economic news would begin to correct the positive anomolies. Well, the other day we find that the confidence figures in Germnay have dropped and today we find that retail sales dropped for the second month. September retail sales decline 0.5% and yet the analysts did not expect this. This is a warning that there is still fear amongst consumers and thay will only spend when the stimulus suits them, and hoard when it doesn't.

I just think we should all bear this in mind and personally, start asking real questions about what our leaders are actually trying to achieve - for I am not sure they have a blinking clue about economics.

So where now on the markets?

Now talking about not having a blinking clue about reality - let's move back to the markets...(Told you I'd come back to help you traders)

I am just looking at USD/CAD again and it could rebound a bit first before the big drop down again. The USDX does not seemed to have bottomed just yet, so don't get too excited. Based on this i have a lot of conflicting signals.

Option 1:

See on the daily Dow chart, we have a bullish engulfing candle - so the obvious play would be to retrace some of yesterday's gains and then onwards and upwards. However, the NDX and the Dow Transports are not really smiling at yesterday's bear trap move up. Also add this to the fact that it is unusual to see a V shaped move up and considering it was on negative money flow with very low volume...we must be cautious. This is where the alternative game play might make more sense...especially since yesterday was a short squeeze without a doubt (I.e Not real buying strength - just buy stops gettig triggered).

Option 2:

The alternative is that the bulls will now have more sell stops to target and might want a better price to buy into. So look at the Weekly candles - not so good looking. So here we have scope for a drop down to the 9600 or just below to meet the long term trendline from March. That might take until next week and then the bulls strike again.

The way I see it - the latter would be a nicer game play - as just about every bear will now be looking to reshort the indices and they will be allowed to have their fun down to that trendline - where they will fall into the bear trap and get chewed up as the short-coverinng begins. At the same time, every bull will now be going long on that daily candle, thinking all is dandy again. So this scenario would kill equal bulls and bears.

All in all, the risk to the downside is always greater than the risk to the upside in this market. It's been a great week for me, so I'm going to stay out of the market today but yes - take both the scenarios above and see if it makes sense according to your own analysis. I'm leaning towards option 2.

Good luck and happy trading!

If you have any questions - then just ask on here or hit me up on Twitter - @chiefchimpanzee.

Darshan

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