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A Binary Event

(November 17, 2011)

Dear Subscribers and Readers,

Make no mistake: the world is back on an easing bias, with the Bank of England now rumored to increase its QE limit, the ECB cutting rates (and supplying Euro Zone banks with unlimited borrowing), China encouraging official bank lending, Japan increasing its monetary base, and various emerging market countries (Brazil, Indonesia, etc.) cutting rates.  For example, starting mid-October, the Bank of England expanded its debt monetization program to a limit of 275 billion pounds.  The Bank of England is now committed to about 5 billion pounds of asset purchases on a weekly basis, or almost as much as its initial pace from March to early July 2009 (see below chart).  Should the UK banking system remain lending constrained, and should UK inflation remain below its targeted rate of 2%, I expect the Bank of England to expand its QE program again early next year.  In the meantime, this new limit (the size of its balance sheet is currently 224 billion pounds and thus 51 billion pounds below its limit) allows the Bank of England additional flexibility in combating a slowing economy and the risk of another liquidity shock:

In addition, while liquidity in Japan isn't as loose as it was in the aftermath of the March 11th earthquake, its monetary base has recently crept up.  From month-end September to month-end October 2011, the year-over-year change in the Japanese monetary base increased from 16.7% to 17.0%--although it's still down from 23.9% at the end of April—as shown in the following chart:

That said—despite the ECB cutting rates and purchasing Italian and Spanish sovereign debt in the secondary market—investors should continue to be cautious given the Euro era high yields being paid across the Euro Zone, including those of France, the Netherlands, Austria, and Belgium.  Short of a more significant monetization by the ECB (accompanied by a devaluation in the Euro), I do not see a way out for Italy, given its lack of productivity growth over the last decade and horrible demographics.

For those who want to bet on a benign outcome, however, now is still not the time, as technicals are not that oversold.  For example, the percentage of NYSE stocks above their 20-EMA is still sitting at 47.47%, despite yesterday's 190.57-point decline in the Dow Industrials (see below chart courtesy of  We will be cautious on the stock market (even from a trading standpoint) until this reading declines to 20% or below, or if the Dow Industrials declines to 11,250 or below.

Signing off,

Henry To, CFA, CAIA

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