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When the ECB Says Jump... Sit Down.

Wednesday, July 10, 2013 | Martin Tillier

Contra-indicators are wonderful things. They are signals that the markets, or people in the market, give you, that should be played in the exact opposite direction of what they appear to be saying.

My first experience of them was as a youngster on a busy cable (GBP/USD) desk in London. My mentor at the time was the Director of the desk, a man who had, since I had arrived, shown an incredible knack for anticipating market moves. As a Director, Dave serviced some very large accounts, and threw $20 Million plus deals around all day.

When I first covered his desk, then, I was surprised to find, amongst all of the giant players, a small, provincial Scandinavian bank that rarely dealt in more than $1 Million. When Dave returned, I asked him why he continued to work with an account that would be better suited to me or one of the other rookies.

“Because,” he said “This guy is the most reliable contra ever.”

Later that day, in the pub, he explained what he meant. The trader at that particular bank was a long tenured employee who had been elevated to the trading room in a great example of the Peter Principle in action. Dave had worked out that this guy had an uncanny ability to be wrong with almost every trade he placed in cable. Much of Dave’s success in running positions came from simply taking the opposite side of every trade the Scandinavian placed.

Inevitably, as is the way with human contra-indicators, the guy was let go. The gravy train stopped and Dave was forced to rely on more conventional signals, but I learned a valuable lesson: Trust the contra.

Similar indicators exist in the US stock market. A personal favorite is when the market drops and TV stations bring on the perma-bears. You know the types -- the doom and gloom merchants who predict a market collapse every week. Their reputation was built on the inevitable... they got it right once.

When the hesitation in the recovery came in 2010 and 2011, there was no shortage of talking heads predicting a “double-dip” recession. Those who listened to them and have held only cash and gold since then are still waiting for the big crash. To me, their presence on my TV screen was a buy signal.

When the stock market faltered a few weeks ago, after Bernanke mentioned the dreaded “tapering”, the forex market, which I follow more closely than stocks, was telling me that the move would be a short-lived correction. It would be a buying opportunity rather than the beginning of the end. The prospect of QE ending had caused a rash of Dollar buying, with the greenback appreciating against all of the major currencies.

This “flight to safety” reaction is normal when news appears that may have a damaging impact on global growth, and the potential ending of QE would certainly qualify.

What was different here, however, was what happened next. In a normal “risk-off” environment that money would be used to buy gold or US Treasuries, both seen as safe havens. This time, neither of those options looked attractive; gold seemed to be in free-fall and one of the effects of tapering QE was to reduce the influence of the Treasury market’s biggest buyer.

My feeling was that, in a world long of US Dollars, stocks would be the beneficiary. I gave that analysis during guest appearances with both Costas and Chris that week, but at that point it was only a feeling. It became a conviction when, following two days of double digit losses on the Dow, CNBC dutifully rolled out the aforementioned perma-bears to tell us that this was just the beginning.

One usually reliable contra-indicator is causing me to reverse a call I made a while ago that, in the long term, I favored a short Euro Dollar position. A look at the chart using one week intervals would suggest that we are bouncing off of support at 1.28, but, while that supports my view, it is not the main reason for my change of heart. That comes from recent chatter by the European Central Bank (ECB).

The biggest European Central Bank in pre-Euro days, The Bundesbank, was an institution of few words. They preferred action and intervened aggressively in markets, but when they did talk, traders did what they were asked. There was nothing “contra” about their indications.

The ECB has, however, in its relatively short existence, become a decent source of contra-indications. The difficulty of making multiple nations agree on policy has led to a Central Bank that would rather talk its way to a desired result than act.

Earlier this week, mutterings came out that seemed to suggest that accommodative monetary policies would continue forever. They won’t, of course, but the fact that the ECB feels the need to suggest that they will in order to talk the Euro lower suggests that they fear it drifting higher.

The problem with talk from the ECB is that it is usually just that. I have found over the years that if the talk can be interpreted as trying to influence the market in a particular direction, the opposite is likely to occur. When it does, the ECB will, true to form, do nothing, at least until it is too late.

As far as the public data indicates, sound reasons for distrusting the Euro still exist and the major risk is to the downside. The ECB attempts to talk the currency lower, though, suggest to me that they are seeing the future a little differently.

As I said, I learned a long time ago to trust the contra. The ECB has been so reliable as a contra over the years that I am quite prepared to abandon logic and shift my bias towards long Euro Dollar for the foreseeable future.

Martin Tillier
Contributing Editor
The Tycoon Report
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7/10/2013 4:47 PM

Graham Dunlop

7/11/2013 12:10 AM

Excellent as usual

7/11/2013 8:47 AM

I thought this article was great: really interesting and informative. Wish I had a minor Scandinavian bank on tap!!! The ECB will have to do for now.