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A Rally and a Reality Check (or Two)

2 | By Shah Gilani

“Rudolph with your nose so bright, won’t you guide my sleigh tonight…”

Thank goodness there’s a light out there somewhere, so we can see what’s coming.

And judging by last week’s market action, guess what?

Santa Claus is coming to town!

Ho, ho, ho, what a rally. The Dow Jones Industrials rose 787.64 points, a 7.01% jump, making it the venerable benchmark’s second-best weekly up-move ever! The S&P 500 rocketed up 7.39%. The Nasdaq Composite shot up 7.59%.

But the real winner was the broader market, encompassing the less muscular household names ensconced in the Russell 2000; it rose a whopping 10.34%.

Speaking of the 10% gainers club, guess who else got their tickets punched on this sleigh ride? Not surprisingly (considering a little thing called “short-covering”), Italy was up 10.4%, Spain was up 10.24%. France was up 10.78%, and Germany was up 10.7%.

The week before last, not one single stock market in the world advanced by even a hair. Last week, every single key stock market in the world rose – and very impressively.

Oh, wait a minute. There was one little country that actually fell almost 1%. Good thing they’re not on anybody’s radar and don’t matter much. Who was it, you ask?

China.

Ho, ho… uh-oh!
In fact, China was the only real “reality check” on the bullish stampede last week.

The Chinese government lowered the reserve ratio it makes banks hold against loans outstanding and the new ones they make. They did that, not because they’re little elves cobbling together market gifts, but because the Chinese credit markets are getting uncomfortably tight. They did it to ease into further easing. They did it gently – as opposed to lowering interest rates – to add liquidity to their banking system.

The same banking system that’s afraid of (and very exposed to) Europe.

Oh yeah! Europe, we almost forgot didn’t we? There’s something going on over there, right?

No, no, no… it’s over, didn’t you just read about how all the world’s markets rose last week? Didn’t you hear the good news? Don’t you know that the U.S. Federal Reserve huddled with central bankers from the ECB, the U.K., Canada, Japan, and Switzerland to lower the interest rate they charge on dollar swaps?

You know… dollar swaps… those little arrangements that allow foreign banks to swap their unloved currencies for dollars. They really come in handy when there’s a panic and a flight to the safety into U.S. Treasuries (whose purchases must be made with dollars, thank you), or some unlikely black swan event that never happens… kind of like what happened in 2008. But, like I said, that never happens.

Thank you China, for one reality check.

Here’s another: Adding liquidity on an essentially massive scale, in a globally coordinated fashion – kind of exactly like what the Fed just orchestrated (at the behest of America’s biggest banks, by the way, and the quivering Europeans) – isn’t a sign that Santa Claus is coming to town.

It’s about getting ahead of a potential meteor hitting us and causing a nuclear winter… this winter, as in any day now.

Oh, don’t worry; I’m just saying that for dramatic effect. Silly me, as if…

Sorry, lost my holiday spirit for a second there. About that rally!

Will there be continued momentum? That depends on… Europe.

Remarkably, if you look almost any or almost all the world’s key markets in terms of their three-month, six-month, one-year and two-year charts, they are eerily similar. Talk about correlation, wow!

We’re all near the same place at the same time – a place from which we can either rally or tank.

My bullish scenario stems from the fact that we can’t take a black swan event. It would be catastrophic for global markets.

Of course, Europe is the ugly duckling that could be that black swan.

For the life of me, I have to be bullish at this very, very critical juncture for global markets. Why? Because I’m not the only one looking at all this correlation. The Fed sees it, the Europeans see it, and the whole world sees it.

Europe has to come up with a plan this week. They have to.

It doesn’t have to be an immediate fix – there isn’t one. But it has to make sense to the markets and essentially be bigger than the markets.

Is that possible? Is there any fix for anything that’s bigger than the markets? Only if the fix is a massive coordination, on an unlimited, global scale, backed by credible measures and the firepower of the world’s central banks.

We got the first whiff of that on Wednesday. That was the market’s shot across the bow.

It was a silver bullet aimed at the shorts. And it worked beautifully. It was so effective that I can almost see the Bernanke and Draghi snickering together and looking out from their bunker, as if to say, if you liked that silver bullet, you’re gonna love this silver bazooka we have, and watch out, we will use it.

I can’t stand in the way of firepower like that. Well, maybe you shouldn’t. But I will.

I will, because there’s a chance that I’m wrong (yeah, it happens, I know, you can’t believe that, can you?).

Maybe, just maybe, and this is going to get me in trouble, I know it, maybe Europe will drop-kick Greece, and maybe Portugal, at the end of this week, or over next week-end?

Maybe they don’t have any hope of working out all their problems…

Maybe the French say, screw it, we won’t risk our AAA status, which will immediately get cut if they agree to backstopping a deeper bailout pool for the PIIGS, because they can’t afford it.

Maybe the Germans will say achtung baby, fold their arms and let the chips fall where they might. It could happen.

So, I’m going to add to my shorts here. I’m going to add up to the Dow reaching 12,200.

If I’m wrong, I’ll get out very quickly. If I’m right, then things will be really wrong.

But I’m a trader; this is what I do to make money. I take risks.

On the other hand, we could be setting up for a short rocket ride higher, which is okay with me, because I have my share of long positions too. However, they are all locked-down with stop-loss orders in the event that the correlation that’s here ends up being the Grinch that steals Christmas.

Stay tuned… This could be one heck of a week, one way or another.

Shah

2 Responses to A Rally and a Reality Check (or Two)

  1. Marat Khamzin says:

    Dear Mr. Gilani,
    Thank you for the incredible posts!
    It is a pure joy to read them and think about you has written. And make some important decisions in trading.
    Thank you

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