Thursday, May 31, 2012

More Bad Economic News ... QE3 More Realistic?

Chicago PMI survey result came in at 52.7, significantly below the Street's 57.0, and lowest since Sep. '09.  Production and new order indexes were down, but order backlogs and employment indexes did increase for the month of May.

With all of the recently released bad economic numbers, will the Fed change its mind and begin discussing a QE3?  Just last week, we heard NY Fed's Dudley, who has been very hawkish when it comes to monetary easing, say that he believes QE is no longer needed unless things get worse.  He said: "But if the economy were to slow so that we were no longer making material progress toward full employment, the downside risks to growth were to increase sharply, or if deflation risks were to climb materially, then the benefits of further accommodation would increase in my estimation and this could tilt the balance toward additional easing."  So there is still a chance of a QE3 even in an election year.

Under what circumstances would a QE3 become more likely?  We think given today's bad figures, a big disappointment tomorrow might create more 'optimism' when it comes to monetary easing.  If tomorrow's employment report is in-line or slightly better, which we think it will be, the market will not react very positively, especially after seeing this morning's Challenger job cuts and jobless claims which both indicate a not-so-good employment situation in June.

Again, long strangle positions on VIX and/or SPY could work.  SPY, the S&P 500 ETF, is approaching the 129 level which if it goes below that, the 125 level could be next.  In addition, given that the 20-day moving-average (MA) has already gone below the downward trending 50-day MA, it is also approaching the 100-day MA, which could trend downward after a down day today and tomorrow.  This appears to be a bearish technical indication building on top of an already existing bearish technical indicator.  However, as mentioned earlier, if economic news gets much worse, increasing likelihood of a QE3 could initiate a risk-on strategy in the market, which could turn around S&P 500 and SPY for the short to medium-term.  For all of these reasons, a long strangle on SPY may work.

Regarding VIX, it not only jumped nearly 21% but also dipped nearly 18% after we made a similar recommendation before March 5.  VIX is now nearing the 25.0 level again.  At this point, we think there is still potential for dramatic moves up or down, which is why a long strangle would be a good idea.  Basically, the same reasoning mentioned earlier for SPY can be applied to VIX.

The market continues to take a dump.  S&P 500 is down nearly 0.9%.  FB is down 3.3% at $27.25.  GLD is at $152.2, up 0.2%.  Lastly, VIX and VXX are up 3.2% and 5.4%, respectively.

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