Tuesday, August 30, 2011

Did Bernanke Give the Market a Needed Bailout ?

Overview

It appeared that Bernanke showed his magic once again after he hinted more "stimulus", which is really the "bailout" market participants have been looking for, at the next FOMC meeting in late September. The S&P 500 index rallied more than 4% in two days since the speech on Friday, or 7% since August 22 when the Jackson Hole event was highly anticipated. The VIX index (approximated by ETF VXX), which measures the short term implied volatility on the S&P 500 index (SPY) or is really a gauge of market protection insurance premium, declined roughly 10 points from low 40s to low 30s. More than a third of the rally occurred on 8/29/11, the day after the Bernanke speech. The rally was very impressive with all sectors such as tech, commodities, and more importantly banks participating. Bank of America (BAC) and Deutsche Bank (DB), which have been under severe pressure lately, shot up over 8% and 6% respectively. The advancing stocks overwhelmed the decliners by a ratio of greater than 10 to 1. Using a military analogy, the bears experienced a "Waterloo" type of defeat against the bulls! Historically, days like this usually mark the beginning of a new bull run. However, a good day does not a trend make. In the next a few days before the long weekend, the bulls need to hold off the bears in order to sustain their gained territory.

What is Next

Uncle Ben's challenge now is that he has to deliver the "goods" at the next meeting on Sept. 20th and 21st. A simple QE3, or printing more dollars, may not satisfy the bulls because QE2 did not do much other than causing commodity inflation around the world. Also, there are some indications that Obama is planning more stimulus in September.

In Summary, how these measures are perceived will determine if the bull run has legs or not.

Short Term and Long Term Challenges Remain

In the short term, the austerity measures are getting widely adopted in most of the developed world. Even China is cutting back to counter inflation. Without the expansionary policies and the subdued consumers, it is hard to achieve economic growth, without which the stock market will suffer (it already did). The sharp downturn in the stock market worldwide can cause the next recession. 

There is another structural issue in the long run. The success of capitalism globally has some side effects. One is the widening wealth gap between the rich and the poor. The rich lobbied policies in their favor and made the real reform difficult. As a result, the financial system/economy is still extremely risky. At the same time, the poorer poor make poor consumers, dampening the economic growth. In other words, the very success of capitalism undermines its own success.