Will Bernie come to the rescue?

We believe that after yesterday's big bounce in the equity market, a potential QE3 may be partially priced in. If that is the case, then the question is - would the equity market go down on the news (on which Bernanke may provide a hint later this week)?

The answer is yes and no; a usual Street response! Yes, if upcoming economic figures are in-line and do not disappoint too much. However, what many may consider as unusual (but we have seen it before) is that very bad economic news (below expectations) would actually help the equity market as it could increase the chances the Fed will go into fifth gear and initiate QE3. If this occurs, then there could be further upside in the short to medium term.


Today's July durable goods orders came in better than expected. While this may provide a more positive perspective on the economy (with which we disagree), it could increase chances of the Fed staying put and not creating QE3, which we believe may mean that QE3 could be priced in. However, this is not yet clear as Q2 GDP, consumer confidence, and weekly initial jobless claims will be released later this week. In addition, various market moving employment indicators are scheduled to be released next week. We also note that the MBA Mortgage Index released today disappointed, but then again we assume everyone has accepted the double-dip in the housing market.

Basically, this year is somewhat similar to last year - the equity markets benefit if the economy is in much worse shape than expected as it will 'force' the Fed to meddle again; and the equity markets will benefit if the state of the economy is not as bad as the market currently indicates. We note that these benefits will be good only for the short to medium term, similar to last year.

Technically, gradual run up towards and past 1,200 would likely lead to 1,250 - 1,275.  But if the upcoming economic indicators disappoint before we get more color from Bernanke, then breaking below 1,120 could be next which could drive it down as much as another 100+ to 1,000.  Right now, with the uncertainty surrounding Bernanke's decision, the economic status of Europe, some slowdown in the emerging markets and the political upheaval right here at home markets are basically ignoring fundamentals.

Lastly, gold is taking a breather (and may be breathing pretty heavily) as we suggested before. Technically, it is close to breaking through its support level, which we believe is $1,760. If that takes place, then its next support level would be around $1,600. If Bernanke installs another QE, then we could again see gold rise along with the equity market possibly driven by risk of higher inflation. We note that gold did move along with S&P 500 after QE2 was announced. The movements in the two were correlated until pretty much the official end of QE2, end of Jun. ‘11. We wouldn’t recommend getting in until another support level is maintained or more certainty regarding Bernanke’s QE3, if any. By the way, VIX is down nearly 25% since it hit its YTD closing high of 48.00 on August 8th.  Volatility would likely return after Bernanke's speech and leading up to next Friday's (9/2) key employment numbers.