END OF AN ERA - Monday should go down as a memorable day for markets. I say "should" because you never know what the Fed will do next and how reliable the central bank's guidance really is. But yesterday, the Fed officially ended Permanent Open Market Operations or POMO, a program designed to inject liquidity into the market to help stimulate recovery. This concludes QE3 as we know it and should have consequences that are anything but equity bullish. The completion of QE1 and QE2 both brought about significant market corrections, and there is no reason to think any different this time round. Simply put, the Fed is no longer actively supporting the equity market and is now inching closer to higher interest rates, which will completely take away the free money incentive to be long stocks.
YET TO PLAY OUT - I have argued for some time that the move away from QE and towards higher rates would be a major liquidation event, and though we saw a sharp pullback in the previous week, the fact that the market recovered so quickly is a sign that the correction has yet to play out. We need to see a legitimate correction here. It can't be a 10% correction that happens in a couple of days that is then completely erased only days later. That is not healthy. For this to play out the way I expect, stocks should come under pressure and remain under pressure for a matter of months, not hours. I have established a fresh SPX500 short around 1960 as per my recommendation last week, and look forward to seeing how this plays out. A close above 2000 would be concerning, while a break back below 1900 should get things going.
FX APPLIED - Interestingly enough, there are implications on the currency front that extend to that other trade I have been looking to put on. With the Swiss Franc correlated to safe haven flows, any intensified pullback in equity markets is likely to have a weighing influence on EURCHF. I have talked and talked about the SNB and their well publicized commitment to defend the 1.2000 floor, and so, should equities start to come off again, this could open a move in EURCHF towards 1.2000 and force the SNB into action. I like the idea of taking a shot at buying EURCHF in such a situation, as I believe the SNB has the ability to step in and make some noise. I will be looking to buy EURCHF somewhere between 1.2000 and 1.2050 over the coming sessions. If you get into this position, be prepared to sit on it for a while and consider the possibility that 1.2000 could even get taken out before the SNB intervenes. So don't get long with a stop-loss just under 1.2000. If you get long, have a stop-loss well below 1.1900 in mind. I would say only consider an exit on a two-day close below 1.1900. But for now, let's see what happens.