KRUGER INSIGHTS THURSDAY, FEBRUARY 27, 2014

By: Joel Kruger

Push It So Far That It Just Won't Matter - I have to tip my hat to former Fed Chair Bernanke. Despite all of the turmoil in the markets back in 2008, the man managed to orchestrate the implementation of a super-calming mechanism in the form of never seen before ultra accommodative monetary policy. This resulted in a very attractive incentive to use this free money as a means to invest in risk correlated assets at seriously depressed levels, while at the same time, offering a compelling return on investment. There is nothing more dangerous than fear and uncertainty, and Bernanke understood that the super easy monetary policy would help to inflate one of the greatest gauges of investor confidence in the form of the US equity market. And so, the result has been a US equity market that has flourished in the face of this policy to fresh record highs, despite a still recovering economy. Critics of this strategy (I was one of them) would have argued that inflating the market artificially would only end up backfiring when the Fed was eventually forced to reverse policy, as this would cause a major disruption. But with equities having flown so far so fast, even if we pull back at this point (as the markets start to price in a less accommodative Fed), a sell-off of even 15% would still have the market trading around the record highs that were set just a few months ago in 2013. Bottom line, if we inflate the market to the point where it has gone so high, when we eventually do get a serious pullback, in the grand scheme, the pullback won't be that scary. This seems to be how everything is playing out, and in the end, perhaps this strategy will have proven to be a huge success. The jury is still out. But even if this is the case and the markets won't end in disaster, the fact remains that we still need to see a correction in the market. 

But It Still Has To Happen - No market should be immune to the normalization of a shift in policy, and just as other risk correlated assets have already come back under pressure as the Fed initiates a shift (as slow as this shift may be), so to should the US equity market. It isn't a question of IF but WHEN. The US equity market is just the last man standing at this point, and will not be immune to the domino effect. Currency markets have been warning of more risk off trade ahead, with emerging market FX under pressure and risk correlated, safe haven alternatives like the Yen and Franc very well bid of late. Today's USD/JPY break back below 102.00 and EUR/CHF drop below 1.2165 are significant developments, and should open the door for a broader risk liquidation. I am not sure if stocks finally start to relent to this pressure (I am currently short S&P 1857.6), but I definitely believe the timing is right. Interestingly enough, today's price action anomaly comes from my other position, where the New Zealand Dollar has been outperforming despite these signs of distress. I am a little unsettled with the bid tone in Kiwi, but at the same time, do not expect this relative strength to persist, and actually am projecting this market to start to underperform sooner than later. The New Zealand Dollar may be somewhat attractive on the yield differential side of the equation, but this currency looks quite vulnerable to me at current levels. Just as equities have held up too well in my view, so has the New Zealand Dollar. Other peers in this grouping have seen considerable weakness in recent months, and I believe the fate of this currency should be no different. So while NZD/USD has been bid up into the North American session on Thursday, I would not expect to see these gains sustained. I am holding onto my short position, and will look to add should the opportunity present. Keep an eye on the S&P as well. A close below 1830 would probably open the door for a decent bout of liquidation. Inability to break down today would only delay the inevitable just a little while longer.