A Short Covering Rally: Violent and Convincing

A Short Covering Rally: Violent and Convincing

In case you were in any doubt, now you know. Wall Street loves Hillary Clinton.

Following the FBI’s back-down on investigating claims over Clinton’s dodginess, stocks flew out of the blocks overnight.

The Dow Jones index jumped 2%, while the S&P 500 soared nearly 2.2%. Given the S&P 500 had just suffered nine down days in a row — the worst losing sequence since 1980 — a fair amount of buying pressure had built up.

But this rally has all the hallmarks of a short covering rally. That is, over the past few weeks, the increasing prospect of a Trump victory had many traders taking out insurance in the form of betting against stocks and buying assets like gold.

So when news hit that the FBI had dropped its investigation, traders unwound some of these bets. The rally was an impressive one, but that’s the nature of short covering rallies. They are violent and convincing.

But the election isn’t over yet. The US goes to the polls tonight (Australian time). My guess is that Hillary will get up, and that’s what the market reaction was all about overnight. But it’s by no means an assured victory.

There are deep suspicions about Clinton and her ethics and morality. Granted, there are deep suspicions about the ethics and morality of most politicians. But, you have to admit, with Clinton, it is especially so.

When it comes to Trump, his grotesqueness and absurdity are there for all to see. He isn’t really hiding the fact that he is a narcissistic megalomaniac. But Clinton is a bona fide phoney, and the support for Trump is a reaction to that.

Anyway, in 24 hours or less we’ll all be put out of our misery. One of these dangerous people will be in charge of the White House.

Or will they?

Is Obama in charge or is he simply ‘the President’ — the figurehead and representative of US society? Only the most naïve believe that the president of the country drives and controls the US political and economic machine.

There are a whole bunch of Machiavellis pulling strings behind the scenes…or in front of the scenes for that matter. For example, I would argue that the head of the Federal Reserve is more powerful than the president in terms of their impact on economic and, therefore, social trends.

Which is why the market wants Hillary in the White House. She is for the status quo. Trump doesn’t like the Fed, and he threatens to undermine its enormous power.

But enough about US elections. Whoever wins, I don’t think it will make much difference either way. That might sound weird, given the stark differences between the candidates. But, at the end of the day, all politicians are the same. They are puppets, and will deliver similar outcomes.

Within a few days of the decision, the market will turn its attention back to the Fed and, specifically, to the prospects for rate hikes.

The question is: Can the market rise in the face of higher interest rates? Given that the S&P 500 is where it was before the first interest rate rise in December 2015, the evidence isn’t encouraging.

It’s not encouraging in Australia, either. Our stock market has endured a decent correction since August. It coincides with a big increase in government bond yield; that is, rising market interest rates.

Bloomberg reports that the rise in Aussie 10-year government bond yields has been far greater than in other developed economies. As the chart below shows, Australian 10-year bond yields have jumped more than 50 basis points since 7 September — twice as much as other major economies.


Source: Bloomberg
[Click to enlarge]

This reflects an unwinding in expectations of further interest rate cuts. Thanks to the rebound in commodity prices this year, in addition to strong population growth and already-low interest rates powering the Sydney and Melbourne housing markets, economic growth looks to have strengthened in Australia recently.

That means no more rate cuts for the time being. In fact, it would be sensible for the RBA to hike rates back to a more normal level to take the heat out of the housing market, but that is not going to happen.

The last two rate cuts were intended to lower the exchange rate. But they had no effect. The RBA would be terrified of putting upward pressure on the currency with a rate rise now, so we’re on hold for the time being.

And don’t forget, the narrow measure of consumer price inflation the bank uses to set monetary policy says there are no major price pressures in the economy. The RBA conveniently ignores the most rampant and destabilising inflation of all — that of housing.

That’s not inflation, though, is it? It’s simply wealth creation. It’s one person’s debt creating another’s equity. A bank creates credit (debt) for a buyer to purchase a house. The buyer bids up the price, depending on how much credit (debt) they have, and at the point of purchase the debt of the buyer becomes the equity of the seller.

And just like that, wealth is created. It’s the Aussie economic model of the early 21st century.

There’s just one problem. This model relies absolutely on a falling cost of credit. Once interest rates start to rise in Australia, the game is over.

For this reason, interest rates won’t rise for some time. The RBA will do everything to protect the monster it has created.

Cheers,

Greg Canavan,
For Markets and Money

Greg Canavan

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing.

He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’.

Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors.

Greg Canavan

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