Mr. Bernanke has to know!

Important Snippets From Today’s Commentaries Snippet #1: There are two sides to every market transaction – a winner and loser. It seems to me that a critically important question is this: if the investment banks and hedge funds always win, who always loses?

Snippet context: I have done some limited research to find good answers to this question, and so far have ‘come up empty’. Snippet #2: If this week Mr. Bernanke makes an announcement of QE3, or fails to make an announcement of QE3, watch the reaction of the financial markets carefully. It is highly likely they will respond positively if he does, and negatively if he doesn’t. This means the financial markets are, in the short term, detached from value fundamentals – or so I think – and that the game of musical chairs continues. Snippet context: If one assumes ongoing quantitative easing will not result in meaningful long-term economic recovery, long-term ‘investment markets’ ought not to respond positively to it.

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Today’s Detailed Commentaries Financial Markets: Can the equity markets be making sense? Why Read: Because for anyone directly or indirectly trading or investing in the current equity markets the ‘big question of the day’ has to be found in the title of this commentary. Commentary: On Friday, July 27, the Dow Jones Industrial Average closed at 13,076, up 188 points on the day. At the same time the S&P 500 closed at 1386, up 26 points, and the S&P/TSX Composite Index closed at 11,766, up 127 points. While this was going on, Spain said it might need a 300 billion (U.S.$366) bailout, U.S. GDP growth seems to be further slowing as U.S. consumers are reported to be spending less, and concerns with China’s growth continue unabated. So what gives? The explanation that seems to make the ‘most noise’ is that the equity markets are expecting more U.S. and other developed country stimulus, and that will buoy them up when – not if – it occurs. I say that for equity market participants to be bullish in this world economic climate their reasons can have little to do with ‘investment values’, and everything to do with ‘trading prices’. I further suspect that a good deal of that likely is promoted by and the result of high frequency algorithmic trading. There are two sides to every market transaction – a winner and loser. It seems to me that two critically important questions are:

• if the investment banks and hedge funds always wins, who always loses; and,
• when does that merry-go-round stop?

I have done some limited research to find a good answer to the first question, and so far have ‘come up empty’. Context: If I am right that the current financial markets are driven by trading transactions and not investment transactions the disconnect I see arguably can be explained by the financial markets simply functioning on a virtual ‘minute by minute’ basis without regard to meaningful underlying long-term ‘value analysis’. Topical Reference: Dow surges past 13,000 on hopes for stimulus, from Market Day, NBCNews, July 27, 2012 – reading time 2 minutes; As economy falters, Washington fails to act, from Economy Watch, NBCNews, July 27, 2012 – reading time 3 minutes; and Central Banks Chomping At the Bit: Perpetual ‘QE’, from Financial Sense, Pater Tenebrarum, July 26, 2012 – reading time 4 minutes. North America >> United States: Mr. Bernanke has to know! Mr. Bernanke has to know in the face of (among many other things):

• Washington’s political gridlock, lack of political will to change that, and a system that promotes ‘advantage to political donors’;
• loss of American manufacturing jobs;
• American structural unemployment – being an environment where workers either are not trained for available jobs, or are geographically dislocated from them;
• what appears to be a current downturn in the U.S. economy, in the face of all prior and ‘ongoing soft’ quantitative easing to date;
• that the oft-spoken and reported idea that ‘Americans are the best innovators’ and ‘that will in the end ensure America will be the continuing reigning world economic power for decades to come’ is a myth;
• that technological innovation broadly speaking results in replacement of jobs with mechanized solutions to productivity, and hence is ‘worker unfriendly’ – meaning Main Street America unfriendly; and,
• the Eurozone is a deep and escalating world economic problem

that a continued strategy of ‘more quantitative easing’ can’t restore America’s economy to what it was (or latterly ‘appeared to be’) prior to 2008. Notwithstanding, for some months now I have said in these Newsletters that QE3 (which is really a misnomer because QE has never really stopped in its various forms since 2008) can be expected in 2012. It looks like the ‘time may be coming nigh’. If this week Mr. Bernanke makes an announcement of QE3, or fails to make an announcement of QE3, watch the reaction of the financial markets carefully. It is highly likely they will respond positively if he does, and negatively if he doesn’t. This means the financial markets are, in the short term, detached from value fundamentals – or so I think – and that the game of musical chairs continues. Context: If one assumes ongoing quantitative easing will not result in meaningful long-term economic recovery, long-term ‘investment markets’ ought not to respond positively to it. Topical Reference: Jobless rate pressures Fed toward providing more stimulus, from The Globe and Mail, July 29, 2012 – reading time 3 minutes. Brief Commentaries prompted by world headlines Eurozone >> Spain: Spain’s unemployment even higher Spain’s unemployment and youth unemployment have now been reported as having increased further to 24.6% and 53.2% respectively, with “no end in sight”. Consider that small landslides are hard to stop, and large landslides are virtually impossible to stop. Then consider the consequences of what might happen if Spain proves to be ‘too big to save’. Context: Spain’s unemployment is a big deal in Spain, Spain’s bailout needs are a big deal to the Eurozone, and the Eurozone is a big, big deal to the world economy. Topical Reference: Spain’s problems mount as unemployment hits new record, from Deutsche Welle, July 27, 2012 – reading time 1 minute. Financial Markets: SEC vote on algorithmic trading In what has been described as a ‘narrow’ 3 to 2 vote, the U.S. Securities and Exchange Commission two weeks ago voted in favour of a rule intended to enable better tracking of information related to high frequency algorithmic trading (HFAT). Without knowing the detail of any debate around this, one has to wonder what would possess anyone to vote against such a thing in circumstances where HFAT now dominates equity markets trading volumes. Context: Unregulated banking and investment banking has proven, and continues to prove, to be highly Darwinian and counter-productive to the well-being of developed country economies. The question now: is any new regulation ‘too little, too late’? Topical Reference: SEC votes in favour of high frequency trading audits, from High Frequency Traders, July 13, 2012 – reading time 1 minute.