Planet Yelnick

The Mother of All Banking Conspiracies

During bear markets conspiracy theories run rampant. (Why? Human Nature: success in a bull is my cleverness; failure in a bear is someone else's fault.) Here is a doozy: that the current market drop is caused by Goldman Sachs. I suppose it should be considered a companion piece to Karl Denninger's argument that Bernanke intentionally crashed the market in Sep2008 to spook Congress into passing TARP, but at least that one has a clear factual basis; intent is the open issue. This one is pure speculation.

The article picks up on Murray Rothbard's view that the monetary history of the early 1900s is largely a fight between the Morgans and the Rockefellers. (Rothbard is a well-know Austrian who wrote a good assessment of the Great Depression, and his banking fight argument has some basis in fact.) When JP Morgan merged with Rockefeller's bank, Chase, it supposedly signaled the two former foes had aligned for some reason. The article argues it was to fend off the growing power of Goldman Sachs, and especially "Goldman Sachs South", formerly know as the US Treasury Dept. Goldman had gone too far by front-running the market and getting away with naked shorts. 

The recent ascendency of Volcker, who came up through Chase Bank, and his proposal to end the proprietary trading desks of places like Goldman, is to curtail these excesses. The particular proposal was a bit of a puzzle, since it seems a bit small time when compared with Volcker's prior calls for a reinstatement of Glass-Steagel, and his editorial in the Sunday NYT. This article suggests it is targeted at Goldman and can be seen as a shot across the bow. 

So far nothing particularly alarming as conspiracies go, but the article drops this bombshell: that Goldman is deliberately driving the market down in a game of chicken to get Obama to back off real banking reform. That slide started when Obama announced the Volcker Plan. Obama's reiteration of banking reform in his SOTU speech shows he is fighting back. The sharp drop since SOTU is the purported reply from Goldman. 

If this theory is substantive, the market should drop hard next week, even crash. 

If you love this stuff, I suggest you follow the links and come to your own conclusion. I discount conspiracy theories. Oswald killed Kennedy. Fluoridation is not a commie plot. Aliens do not abduct people. Area 51 does not contain spacecraft. And I don't buy this one, even if the market crashes. 

Monday Should Break The Pattern

We have had a recurring pattern of a Monday Pump in stocks (up). This Monday is also the first of the new month, and for the whole Hope Rally we have tended to see the first few days up. Yet the wave count looks like a wave 5 down is still incomplete. How to square this?

Patterns like the Monday Pump should be expected to fade. We have been in a Vampire Market for a while, where all the gains happen at night. This is likely due to European investors in pre-market trading hedging against Dollar weakness. They wake up in the wee hours ET, turn on their machines, and trade into the open in NY. Since Dec, however, the Dollar has been on a tear up, and now is in a much more robust wave 3 up, so that hedging has now gone away. The Dollar had been in a wave 2 countertrend for much of Jan, which might have revitalized this pattern, but that has ended. Last week the Monday Pump was pretty weak, and I expect it to be weaker tomorrow. 

We still might get several up days to kick off the month, continuing the other pattern. My scenario is a weak bounce at the open Monday, reflecting a minor degree wave within wave 5, then a drop to end wave 5 down, followed by a robust wave (2) counter-trend rally that could make Monday end up. The wave (2) bounce should go into the range of Sp1115 (say, 1107-1121)

The wave count from the various ewave sites is muddled, which is itself interesting. More on that below. Everyone calls the sharp drop two weeks ago as wave 3 of (1) down. They should call the first three days last week as wave 4, ending in the pop Thurs morning after Obama's SOTU speech, but I see them getting lost in the corrective wave. 

Friday's STU wasn't much help, since they skipped putting a detailed count out. Friday also had a monthly EWFF, which stayed on the big picture. We hit Neely's Sp1075 target, which for him confirms a major downtrend, but he too gave no details of what to expect.

Tony Caldero stayed steady as usual, and has a nice chart with wave 4 in a decent spot. That chart also shows that wave 5 has only done waves 123 so far, with more to go down. Tony places wave 4 as ending with the Thurs am pop after Obama's speech. Wave 5 down has had a big 1-2 down, and is now in wave 3. On this count, Tony would expect a pop Monday, followed by a drop down around Sp1061. A wave (2) rally off that would carry to Sp1105-1115.

 

Let me introduce an interest eave site, EWTrends, by Bud Fox. Bud posts out of China, and his site is blocked there! Bud, you might wikipedia about tunneling proxy severs (or google them if google still works over there). I was in Singapore in 1993 at the dawn of the Internet era, giving a speech on Tech Day, and the night before the government announced their web blocking policies. I was asked to go on AMSingapore the next morning to comment. The host expected some mad US gaijin type criticizing Singapore, but I was much more polite, using an analogy from the movie of that day, Jurassic Park: the Internet will find a way. And it did: within two weeks the Singapore underground (such as it is) had circulated proxy server addresses to bypass the restrictions. 

Bud's charts are detailed and I think very good. Here is his Friday chart of the count. Click to enlarge it. You can see the wave 3 of (1) down, and how he counts the many overlapping waves since. You will see he ends wave 3 down late in the week, and has a series of nested 4's back to the three days leading up to SOTU speech. Under Bud's count, the big waves 1 and 2 of Tony's wave 5 become the final wave v of 3 and wave 4 - one degree higher. Thjis let's him count a wave 5 that has all ready subdivided in 4 waves. Unless his wave 4 (black) of 5 (blue) is over, we might see a very weak pop Monday am followed by the end of wave 5. If wave 5 black = wave 1 black, we will run down to area of Tony's Sp1061 pivot at the bottom, sat Sp1066, then bounce. 

 

Why the muddle of counts? I think it reflects a weakness of ewave, to feel the need to count every move. Zoran's simplification is much more appealing. He would have counted the wave 3 that everyone agrees on as the Thrust out of the prior corrective plateau. It then entered a week-long plateau between Sp1078 and 1104, until it broke down below on Friday. That break should be reversed Monday as we enter wave (2) up, making it a false break. Wave 2 would have its own ABC pattern, where AB should stay within the plateau, and the final C should break above. If that is quickly reversed back into the plateau - as it should be, due to the kickoff of wave (3) down - it would signal that a bifurcation is coming: a decisive & tradeable break below the plateau. One could have gone off an and focused elsewhere until the Friday break, which raises the possibility of a deep fall Monday; and then watch for the (expected) wave (2) bounce and false break above. We shall see Monday! Enjoy. 
 

A Quick Scan of Commentary on the GDP Number

Don't get too excited! GDP came in near the high range of estimates, and Goldman wins the prize for their 5.8% prediction last week. It was primarily driven by inventory. Oddly enough, inventories continue to decline, just at a slower rate - and that change of decline adds to GDP! Today's 5.7% is likely to be reduced later. Without inventory rebalancing it would have come in at 2.3% annualized, about where Q3 ended up after being adjusted down from initially 3.8%. A scan of the blogosphere reveals the following red flags:

Calculated Risk notes how every sustained recovery starts with increases in residential investment (RI) and personal spending (PCE). But:

• PCE (personal consumption) growth DROPPED from 2.8% in Q3 to 2.0%
• RI (residential investment) growth dropped from 18.9% to just 5.7% (and only grew at all due to the gimmicky first-time buyer credit, which is now gone)

Karl Denninger at The Market Ticker points out that even the 2% PCE is suspect, because taxes dropped. This indicates the PCE growth was mostly due to government stimulus (ie. tax free income). 

Ed Harrison at Credit Writedowns says we have to see how retail and DPI rise (DPI = disposable personal income, or after-tax earned income) to project a sustained recovery. Otherwise we get a double dip. 

Barry Ritholtz at The Big Picture notes that an inflation adjustment had a large impact: the GDP deflator rose less than expected, so rather than being a percent above consensus (5.7% vs 4.7% consensus), GDP was really only 1/3 of a percent up (6.3% nominal vs. 6% consensus). 

The ever skeptical analyst David Rosenberg concluded that the "good" GDP was worse than it looks. His key points suggest something is wrong with the report (emphasis added):

[I]t was a tad strange to have had inventories contribute half to the GDP tally, and at the same time see import growth cut in half last quarter. Normally, inventory adds are at least partly fuelled by purchases of foreign-made inputs. Not this time. Strip out inventories and the foreign trade sector, we see that domestic demand growth in the fourth quarter actually slowed to a paltry 1.7% annual rate from 2.3% in the third quarter. Some recovery. Based on some simulations we ran, demand growth with all the massive doses of fiscal and monetary stimulus should already be running in excess of a 10% annual rate. 

[A]ggregate private hours worked contracted at a 0.5% annual rate and what we can tell you is that such a decline in labour input has never before, scanning over 50 years of data, coincided with a GDP headline this good. Normally, GDP growth is 1.7% when hours worked is this weak, and that is exactly the trend that was depicted this week in the release of the Chicago Fed’s National Activity Index, which was widely ignored. On the flip side, when we have in the past seen GDP growth come in at or near a 5.7% annual rate, what is typical is that hours worked grows at a 3.7% rate. No matter how you slice it, the GDP number today represented not just a rare but an unprecedented event, and as such, we are willing to treat the report with an entire saltshaker — a few grains won’t do.

Finally, this chart courtesy The Big Picture shows where the chnages came from. Note how government expenditure growth is scratch - we are passing Peak Stimulus. In PCE, durable growth got adjusted out as well, a bad sign. Inventory balancing overwhelmed the rest of the  categories:

 

The US Might be Better Off with a Global Currency

The Greek Drama got me to thinking about the calls for a new Bretton Woods and the US role as the global reserve currency. It gives the US an advantage of seniorage, which in a fiat currency (as compared with specie) lets it print more Dollars than ever come back home to cause inflation, as a float must remain out of the US to be used for global trade, particularly in oil. Yet this purported advantage ends up creating a persistent trade deficit, where the gap is not really due to loss of trade but due to excess demand for Dollars. (The accounts must balance - a Dollar surplus begats a trade deficit.) 

Under Bretton Woods, the US avoided this for years due to returns on overseas investments, repatriating Dollars back home, but the debt-driven hunger of the expanding welfare state eventually overwhelmed that and threw the US into a persistent trade deficit. The expansion of government, particularly the "guns & butter" Great Society in the '60s, resulted in gold flowing out, and the US having to 'cheat' on the gold standard to stem the flows. Eventually Bretton Woods broke down, and Nixon went off gold. Memories my be short, but did you know that the US sent gunboats to South Africa around 1968 to force them to release gold they were hoarding? Such was how low we sunk, and with it the Dollar.

The floating exchange system that replaced it was brilliant - thanks, Milton! Rather than having fixed exchange rates and relying on the flows of gold in and out, leading to gold gamesmanship and cheating on the standard, floating rates punish poor government policies much more quickly by sinking currencies. Within a broad currency like the Euro region, the punishment comes from the bond market, but more slowly. (We can see this drama unfold with Greece.) 

Floating rates can be self-correcting process, as falling currencies enhance exports, which can cause the currency to rise again. Floating rates can act like tariffs to protect developing countries, whose cheap currencies make imports expensive, and drive the internal economy towards import-substitution and later export-expansion. It is probably lost to political memory that the Repubs used to be the party of tariffs to protect nascent industry, and the Demos the party of hard money to protect the value of King Cotton. The parties somewhat have flipped, where the Repubs support free trade, and the Demos support easy credit to pay for the welfare state; but it was Nixon who went off gold, and Clinton who pushed for NAFTA.  

Floating rates, however, have one troubling flaw: having the USD the reserve currency means US domestic policy gets exported to the rest of the world. Off gold in '71, we exported our inflation. Saved by Volcker in '79, we drove too strong a currency. Worried about Japanese imports in '86, we coordinated a devaluation of the Dollar in half (in a year!). What followed was the crash of '87, the Japanese bubble of '89, the S&L crisis, and the seeds of the Greenspan Put, which created the moral hazard that we now call the Greatest Asset Bubble of All Time in the 2000s. 

Compounding this flaw is the capability of mercantilist economies to peg their currencies to the Dollar and preclude the readjustment of floating rates; if they peg low enough, they have erected effective tariffs to protect their internal markets, created incentives for high savings (which are cycled back into business investment), and baked-in a competitive export advantage. In places like China, mercantilist currencies would normally have risen against the Dollar and Euro to compensate for the huge reserves they have accumulated. 

Ed Harrison at Credit Writedowns discussed this today, commenting on the Triffin Dilemma:

The Triffin dilemma, less commonly called Triffin paradox, is the fundamental problem of the United States dollar’s role as reserve currency in the Bretton Woods system, or more generally of a national currency as reserve currency. Briefly, the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: to maintain all desired goals, dollars must both overall flow out of the United States, but must also flow in to the United States, which cannot both happen at once.The dilemma is named after Belgian-American economist Robert Triffin, who first identified the problem in 1960. 

Harrison goes on to explain:

[T]he reason credit has surged dramatically over the last generation has much to do with the monetary system; unless we successfully reflate asset prices, the claims on dollar-based assets cannot be met under this jerry-rigged monetary system with the U.S. dollar at the core. I see this as a Ponzi scheme which is now in its final chapter.

He sees two ways out: follow the easy money path and keep pumping out US-denominated debt (the course we are on) until it blows up; or follow the Volcker path of backing the Dollar and risking a deflationary spiral. Neither are attractive, and neither would fix the Triffin Dilemma.

Let me propose a way out: an independent global currency against which all others would float. This approach can distance the rest of the world from US domestic politics, and get the US off the hook of running persistent trade deficits in order to provide persistent Dollar surpluses. 

I have mentioned that I have a bet that we will be back on some form of gold by the end of this decade, but neither that bet - nor this proposal - necessitates the classic gold standard, nor the bastardized Bretton Woods gold-exchnage standard. Gold can play a role in this new global currency without going back to fixed exchange rates. Gold in effect would circulate with fiat currencies, and help keep the float honest. 

To make the new system work, the US would have to be a major backer, and likely the Fed (or several central banks acting in concert) would have to become the lender of last resort of the world. I have thought that politically the US would oppose such a new system vigorously, down to the last ounce of value in the Dollar; in other words, we would have to be forced by our trading partners into the new system. If the global economy falls into a double-dip after the huge monetary and fiscal stimulus, the political dynamic of shock & awe in the failure of reflation & easy credit should be much more open to a new direction. Paradoxically, our potential failure leads me to have more hope in this change. 

Dubai, then Greece, then perhaps the other PIIGS; this is much broader and worse than prior financial crises like the Asian Flu. The last time we had broad repudiation of debt and sovereign defaults was in 1931, and it resulted in the abandonment of the gold exchange standard. This time it might drive a similarly radical change of the world financial system. 

Beware Greeks Baring Gilts

Ok, one of many bad Greek puns in financial headlines today. I want to get your attention: this news item could hammer markets when it comes to fruition. Greek sovereign bonds are now baring to the financial world an impending financial debacle in Euroland. 

Greek sovereign bonds (Treasuries to the US, Gilts to the Brits) are falling off the cliff, and Greece may default within days. This chart from ZH shows the CDS (credit default swap, or insurance premium if you like) spread has gone to 400 bps, and it kept going after this chart was posted to 420 bips. Just a few days ago it was 320, which is also awfully high, but to change this fast means the end is nigh. At this rate it will close the 55 bp gap with Dubai in hours. (In comparison, Treasuries are at 43 and Gilts at 84.)

 

This is the tip of a huge iceberg. The PIIGS spreads are now higher than BRIC spreads. The ECB has tried to hold value in the Euro as all other major countries (including the US) race to the bottom. One of the many incredulous promises of Obama last night - the AP found 10 other whoppers - is to double US exports. How to live up to that promise? Debase the USD by half? Hard to do, especially if the ECB does not sacrifice Euroland and instead joins that race to bail out the PIIGS, one by one. 

The ECB is Titanic in search of that iceberg, and it may be about to hit it. 

The Greek prime minister did the obligatory "we are in fine shape" and "rumours can cause problems." ZH's take is it sounded a lot like Lehman the night before - or Cramer in 2008 on Bear Stearns! The IMF may need to step in and lead the bailout, or it comes from the ECB, which starts the debasing of the Euro. The prime minister had done the obligatory call to the world's lender of last resort - no, not the US, nor the IMF - China!  China is likely to pass, although Goldman is trying their best to package the deal. (For all of Obama's bashing of bankers last night, Goldman can be really useful at times like this.) The Greeks denied the involvement of Goldman. More fools they. The Chinese put is neatly: the Greek bonds are "more risky than US Treasuries." Ouch!

Where this may end is a breakup of the EU. That seems a ways away. Where this starts is with a continued sharp rise of the USD and the beginnings of the next global financial crisis. Problems in PIIGS-land may quickly spillover to emerging markets. Bet on the Dollar, or even the Yen right now.

First Wave Down Has Ended - Bounce Ahead

The wave count looks pretty clear: five waves down ended this morning. Wave 4 went back only 1/3 of wave 3, not quite the expected 38%, indicating the downward pressure is strong. Waves 1 and 5 are about the same length, of 20-21 pts, a common relationship when wave 3 extends. Tonight's STU notes that it could be over and a counter-trend bounce ahead, but "waning selling pressure does not necessarily equate to waxing buying interest." Neely is looking for a slightly deeper drop to Sp1075 to confirm his trend change; we only got to Sp1083 today. 

Tony Caldera's chart below shows the prime count. He thinks we now have a rally to around Sp1116 at least, but expects it to be tepid as the market is often a bit volatile around an FOMC announcement, which happened today (and little changed).

 

The alt count is that the bottom today was wave 3 ending, and the wave 4 of the prior three days was within wave 3. This alt count suggests the bounce that started today will end fairly quickly. By watching the move tomorrow we will get clarity. The alt wave 3 is 57 pts, and a 38% retrace is 22 pts, or back from the bottom today at Sp1083 to Sp1105. If it approaches Sp1105 and fades, the alt count looks pretty strong. 

We have a State of the Union address tonight, which is being jokingly (and disrespectfully) referred to as "The Audacity of Oops" as Obama is expected to admit to some mistakes and move from Hope to Change by becoming a deficit-fighting populist. News does not normally move markets, and I ask anyone to recall what was said at the last SOTU speech (or any of the last 5 for that matter), but we might get a pop and a drop tomorrow, reflecting the change in direction announced tonight. 

Bullwhip Snap-Back GDP

We are past Peak Stimulus but Q4 GDP should be pretty strong due to the bullwhip effect: a snap-back of inventory rebalancing. The consensus for Q4 has increased quite dramatically, from around 3.5% to 5.5%: 

• Bloomberg says 4.6%
• WSJ says 5% 
• MarketWatch says 5.5%
• Goldman Sachs says 5.8%

That Keynesian cheerleader Paul Krugman (our next Fed Chair?) warns us to beware the blip: the 2Q02 GDP was first reported as 5.8% amidst rising unemployment - unemployment kept growing until the summer of 2003. That report also came after the 1Q02 numbers were revised downward, just as 3Q09 has been, from 3.8% to 2.2%. As then, the inventory rebalancing number is higher than the underlying consumer expenditure number. Inventory rebalancing is not sustained unless spending emerges - hence the risk of a blip.

The blip is clear: inventories rose in both Oct and Nov, and are expected to continue in Dec. Accordingly, industrial production has continued to improve. See chart. But an inventory blip is not lasting. Goldman's report tempered the upgrade in Q4 GDP with a risk of a slow 2H10, even a double dip, as the inventory surge abates.

The railroads are not confirming growth in shipments, which is a big red flag. For the whole year, RR traffic was at a 20 year low. There is a quarterly pattern to RR traffic where it suffers in Q4 due to stock filling in Q3 for the holiday sales season, but it seems to be slowing in the new year as well. Worse, it is tracking below the disastrous 4Q08 when the economy seemed to be falling off a cliff. No recovery there. (These links have really good charts if you wish to explore this more deeply.)

It is not all doom, however. Exports have been rising. This also adds to GDP, like inventory rebalancing, and is more likely to be sustainable since it indicates demand from outside the US is growingCombined with weak or down RR traffic, however, means the increase in exports is not making up for the decrease in domestic spending. Global shipping overall seems to have bottomed and is on a up trend that should last a while. Copper has also rebounded. Copper is a great leading indicator of industrial activity. 

Spending is a huge concern. Retail sales in Dec ended up disappointing, although they show a slow improvement when unadjusted. Also, the whole quarter shows improvement, and some of the poor Dec may have been due to a more vigorous Nov and bad weather. Still, a good argument can be made that this slowdown represents a continued spending pulback, not a blip. 

Housing seems poised for a double dip. The end of the housing credit has hammered both new and existing home sales. See second chart. In addition, the next wave of defaults is accelerating, with Alt-A delinquencies rising sharply and Moody's putting almost $600B on a downgrade watch.

Outside the US we see ominous signs. The UK seems to already be heading into a double dip. I have earlier reported that Japan fell back to 0% growth, and may be the first to go negative. Overall it appears the massive global fiscal stimulus is not showing up in GDP growth. See final chart. That chart shows fiscal increase in 2008 over 2007, and GDP YoY from 2Q08 to 2Q09 declining, not rising as the stimulus hounds would have predicted. Now, the chart is not up to 4Q09, and perhaps the impact of increased fiscal stimulus is more delayed than a one-year lag. There are signs of life globally, so this analysis is not by itself convincing, but it does put a huge damper on the future impact of fiscal stimulus.

The real question after the Q4 numbers is what it means for the next few quarters. As I have said, a W first starts as a V.

3 Things To Know About Bernanke

He has politicized the Fed more than any other Fed chair. He seems easily manipulated by politicians. His fate is entwined in the new-found populism of Obama. His compatriot in populist ire, Tim Terrific, may already be walking dead at Treasury. Yet he may be reconfirmed! Should he? 

1. He Was Behind the Bubble in the First Place

Greenspan takes blame for keeping rates too low for too long, and removing all sorts of restrictions on banks. It turns out the biggest cheerleader behind Greenspan was Bernanke, who was part of the FOMC before he became chairman; and when he took over, he continued the very policies which created the credit bubble. He gets credit for pushing liquidity out when needed after Lehman fell; but if he hadn't, he should have been fired on the spot. The central bank MUST do what Ben did under a fractional-reserve system. 

Bernanke knows he blew it on credit. He proffered a defense, arguing implausibly that the Fed had not caused the housing bubble, and claiming that under the Taylor Rule, rates weren't too low. Economists didn't buy it. John Taylor, the creator of that Taylor Rule, excoriated Bernanke: Bernanke had NOT followed the Taylor Rule, but had concocted a bastardized version of it. 

This does not sound like an independent Fed, but a highly politicized Fed trying to hide its mistakes. 

2. He May Have Caused the 2008 Crash

This is pretty shocking, and should immediately doom Bernanke: the Fed withdrew 65% of liquidity from the system in the four days after TARP was first announced to a very tepid reception, the same week McCain suspended his campaign and ran to Washington: Sep19-24, 2008. The facts are written in the record:

The market fell 500 pts in the next 10 days - it crashed! Check out this chart. 

 

Was it intentional? Karl Denninger thinks so. The legal doctrine of res ipsa loquiter (let the thing speak for itself) would concur. This draining of liquidity was precisely designed to panic Congress into passing TARP. Bernanke would use the Jack Bauer defense: it was necessary to torture the victim in order to achieve the result. As things turned out, TARP was not needed. In fact, it was a huge bait & switch: Paulsen turned around and used it for different purposes than he said it was for to Congress. It was not used to stabilize mortgage markets, but to use the AIG bailout as cover for funneling the funds to the over-stretched banks. Was Bernanke in on out, or a dupe? 

You decide: is this the type of independent Fed we want?

3. He is Fighting the Wrong War

First Anna Scwhwartz, Milton Friedman's co-author, and then John Taylor, Stanford economist behind the Taylor Rule for interest rates, criticized Ben as trying to fix the problems in the 1930s, not those of today. Now economist Steve Keen wrote a devastating dissection of Bernanke's thinking: 

Bernanke is popularly portrayed as an expert on the Great Depression—the person whose intimate knowledge of what went wrong in the 1930s saved us from a similar fate in 2009.

In fact, his ignorance of the factors that really caused the Great Depression is a major reason why the Global Financial Crisis occurred in the first place.

Steve tells the story of Irving Fisher, the American Keynes, who is oft used as a foil for this unfortunate quote, in October 1929, right before the Great Crash:

Stock prices have reached what looks like a permanently high plateau.

Irving went on to truly understand what drove the 1931-32 banking crisis and deep depression, and came up with his Debt-Deflation Theory of the Great Depression, still the best analysis. As Steve writes, his analysis

 [C]ompletely inverted the economic model on which he had previously relied. 

His pre-Great Depression model treated finance as just like any other market, with supply and demand setting an equilibrium price.  ...

[H]e realized that his equilibrium assumption blinded him to the forces that led to the Great Depression. The real action in the economy occurs in disequilibrium.

His debt-deflation theory is summarized in this chain of logic:

1. Debt liquidation leads to distress selling and to ...
2. Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes ...
3. A fall in the level of prices, in other words, a swelling of the dollar [we would call that deflation]. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be ...
4. A still greater fall in the net worths of business, precipitating bankruptcies and ...
5. A like fall in profits, which in a “capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make ...
6. A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to ...
7. Pessimism and loss of confidence, which in turn lead to ...
8. Hoarding and slowing down still more the velocity of circulation. The above eight changes cause ...
9. Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.

This sounds pretty close to what has been happening, again, 80 years later. 

Steve points out that Bernanke dismissed Fisher's theory because he presumed a form of equilibrium: 

[D]ebt-deflation represented no more than a redistribution from one group (debtors) to another (creditors).

This argument has been disproven by the very events under Bernanke's watch as Fed Chair: after a credit bubble, debt does NOT get repaid, it gets written off. Wanna buy some toxic debt? No one does. How about some subprime? This bad debt is being written off or rolled forward, despite Trillions in TARP & Bernanke's credit facilities. It is not being repaid, except to pick the pockets of the taxpayers and feed it back to Goldman Sachs and their ilk. 

Bernanke's views on the Great Depression are simply wrong, and proven wrong before our eyes. He learned nothing from studying it! His economic prescriptions are colored by his ideology. His economic assumption, of equilibrium, is stuck in 1928. Is this the type of leadership we need right now at the Fed? 

Steve's conclusion:

Bernanke, as the neoclassical economist most responsible for burying Fisher’s accurate explanation of why the Great Depression occurred, is therefore an eminently suitable target for the political sacrifice that America today desperately needs. His extreme actions once the crisis hit have helped reduce the immediate impact of the crisis, but without the ignorance he helped spread about the real cause of the Great Depression, there would not have been a crisis in the first place.

Causa Proxma and the Banking Crisis

The new found populism of Obama, turning against those bankers who thrust him into power, whom he so richly rewarded in 2009, has inspired a guestblog from G8torbear, a frequent commenter. The Democrats are now in a panic ("no seat is safe! no seat is safe!") and looking to get in front of the mob storming their palaces. First to be thrown under the bus looks like Ben "Helicopter" Bernanke. Will Tim Terrific Geithner be next? And will he be indicted for securities fraud? G8torbear wishes to put some perspective around the idea than Bernanke et al. saved the banking system and the crisis is behind us.

Causa Proxima

by G8torbear

First of all, I believe we are already in the banking crisis. How do you "lose" Lehman, Bear Stearns, AIG, Fannie, Freddi, Merrill, Citi and many others and believe that we are not IN crisis. The gash created in the system is wide and deep. Do you really think Bernanke and crew fixed the system? NOT!! They managed to cover up and gloss over years of stupid thinking ie 30-40x leverage on our financial institutions ... for a few weeks or months. What Prechter sees is a chart that suggests we are on the edge of an enormous financial panic!! (Please note I said financial panic, not stock market crash, all asset classes will be involved in the slaughter.) One of the smartest men I have ever known, Stan Salvigsen, said "it is like a game of musical chairs with only one chair. The game will not truly be over until the winner does not get paid."

Causa remota of the crisis is speculation and extended credit. We have been here for a while. 

Causa proxima is some incident which snaps the confidence of the system, makes people think of the dangers of failure, and leads them to move from commodities, stocks, real estate, bills of exchange, promissory notes, foreign exchange - whatever it may be - back into cash.

In itself, causa proxima may be trivial: a bankruptcy, a suicide, a flight, a revelation, a refusal of credit to some borrower, some change of view that leads a significant actor to unload. Prices fall. Expectations are reversed. The movement picks up speed. To the extent that speculators are leveraged with borrowed money, the decline in prices leads to further calls on them for margin or cash and to further liquidation.  As prices fall further, bank loans turn sour, and one or more mercantile houses, banks, discount houses, or brokerages fail. The  credit system itself appears shaky, and the race for liquidity is on!!!! 

I will defer to Charles Kindleberger as to the trigger.

Neely Joins the January Club, Calls the Top

Glenn Neely press release: the S&P 500 is forming an important top and is preparing for a multi-month decline.

Due to the substantial advance following March 2009’s low, many investors and analysts believe the worst of the economic downturn has ended. However, based on NEoWave theory, the opposite appears to be underway. The relentless, almost illogical advance of the past 10 months is coming to an end. This pending top will be followed by a significant 3- to 6-month decline, retracing 60 to 90% of the 2009 rally.

The January Club

I am in a debating society called The January Group, whose only rule is we can never meet in January. Perhaps the Powers-That-Be would like to join that club, since January has become a cruel month for them. They would rather the market not meet (its end) in January. You see, January has been very cruel to stocks and politicians all decade long. 

Friday's STU has a fascinating chart of how January has ruled the last ten years: we had significant tops in every January, and the first (in 2000) and now this one (in 2010) may bookend two big stock moves of the decade. Neely places the end of the Greenspan Bubble and the start of the Big One down to Jan 2008 as well, and the S&P began its deep dive into the Oct02 bottom on Jan 2002. The Iraqi War Triangle began its final dive in Jan 2003, and the War Rally topped in Jan 2004, as did Bush's popularity.

 

January is the god of beginnings and endings, so we seem to be at not the end, nor the beginning of the end, but the end of the beginning of the Greater Depression that is about to unfold. If you believe in Prechter and his devastating P3 wave down, this is the beginning of the end of equities.

If you are watching the Democrats in panic ("no seats are safe! no seats are safe!") after they lost the Kennedy seat in Massachusetts (did I spell that correctly?), they may be prepared to throw Bernanke under the bus, and Tim Terrific with him. If so, I hope Volcker takes the Fed seat, at least on an interim basis. Truly a great man, finally being listened to again.  But more likely this poor economic teams hangs on. Regardless, watch our erstwhile leaders try to become latter-day Populists to try to get in front of the mob that is storming their ramparts.

Whatever happens in the merry old land of Oz (Washington DC), this January is the end of Hope and the beginning of Change. Will Obama change by triangulating to the center as Clinton did after 1994? Or will Obama be not just a lame duck, but the Albatross around the neck of the Democrats, as the electorate changes out the incumbents in Nov, which happen about when this market may be ending its drop to retest the lows?  

Santa Rally Gone in Three Days UPDATED

The drop this week has completely retraced the Santa Rally, and the Dow is back to levels of mid-November. This is the fastest large drop since before the Hope Rally started. Here is the Dow chart from tonight's STU, where you can see the retrace way back to before the Nov "square waves" put us sideways for a month:

  

The drop has broken below all the trendlines up (see chart courtesy Walter Murphy). If it doesn't rapidly retrace back above the lower trendlines and stay above, it confirms a change of trend of the whole Hope Rally. The top would be in. This is what Chaos Theory says a "Bifurcation Point" looks like. 

This is also what Wave Theory says is a confirmation of a trend change. The drop is in five waves, with the first retrace a sharp one, and the second a sideways one - the rule of alternation in impulses. There was also a "recognition gap" today in the middle of wave 3 down, a typical occurrence: the "Oh Shucks" moment. This is clearest in the March e-mini chart (courtesy Kenny):

 

Normally I would say, since this is a wave 1 down at some degree, expect a wave 2 bounce Monday (which could be from the pattern of a Monday Pump in stocks) of 38-62%, with 38% more likely than the usual 50% due to the speed and severity of the move. That would suggest a 215 pt move Monday up to just under 10400, or 22 pts in the S&P to just under Sp1115. 

Yet, the wave pattern under that count has a relatively short wave 4. This raises the odds that we are still tumbling down. We would be in wave 3 down still (or some form of an extended wave 5 - Daneric shows an extended 5 count in the Wilshire 5000). If so, Monday could gap down. Fun! Or, it might enter wave 4 and go sideways for a couple of days, perhaps with violent swings up and down. Even more fun! Here is a more bearish count, of a nested 1-2 structure in wave 3 down (courtesy EW Trends):

My best guess is a 38% bounce Monday and Tuesday, which could either be minor wave 4 of the impulse down (most likely), or the wave 2 retrace of the whole impulse. Futures are fairly quiet in the after market, which somewhat supports the wave 4 count. The STU thinks we need one more "downward subdivision" to compete the move (which would be waves 4 and 5), or "possibly more" (which would be that scary nested 1-2 pattern). They point out some other factors, which I will leave for subscribers, except to mention that the type of breadth or distribution (churning) at a bottom has not been seen, which also suggests we will go below the intra-day lows today of Dow 10158 and Sp1090. That agina supports the wave 4 view

In a broadening top pattern, we often see an attempt to get back to the final high after the break down, but it fails below the high. Under wave theory, this is easily understood as the wave 2 retrace of the wave 1 impulse down. If we have a final 4 and 5 to go to lower levels, then a bounce, that bounce would be that wave 2, and would likely retrace 50-62% of the whole drop. (Reason for the different prediction than above - of an immediate 38% wave 2 - is the additional waves 4-5 down will slow the rate of descent.) 

As long as the overall drop is faster down than the rise, we confirm a trend break. Since this seems to be the end of the whole Hope Rally, it means the drop should be faster down than the 10 month rise off last March. This puts a "box" around the drop, that it should retest the lows within 10 months, if it is going to do so; a slowing of the descent means it won't in this wave.  Ominously, this places yet another Oct/Nov low on the horizon, and one coming right in the mid-term elections. If instead we slow the rate of decline, perhaps by having a roller-coaster year (down/up/down), this suggests the Mar lows will not be broken during this wave. Not an immediate issue, but something to watch to give guidance towards where this drop ends. 

Tectonic Plates Shifting: Time to Short the Market? UPDATED

An interim bulletin EWT today reiterates the 200% short position. I hadn't commented on it, but that position was pulled in an interim bulletin a few days ago, but today everything is now working out as the January 4 EWT predicted: Dollar up, Gold down, and stocks down. He says go back short. Neely also called the top in a special bulletin today. Suttmeier notes we have broken below the lower trendline of the Hope Rally in the Dow, and if it doesn't recover quickly it would signal a change of trend:

 

For you technical analysts, the drop today is deep enough to end the prior wave and start something new. The S&P got to 1115 and bounced, slightly; that is a key level to watch today. If it breaks, likely we have a "bifurcation" off the top and a much longer and deeper drop ahead.

For you skeptical fundamentalists, note how tectonic plates are shifting globally: 

• ECB likely to have to bail out Greece, and the Euro has dropped below a double-cross of moving averages, pointing to a fall to $1.38
• China's vaunted stimulus (pundits said "China sure knows how to stimulate better than the US!") has caused a huge real estate bubble, with ghost cities, empty buildings, and skyrocketing home prices in major cities - oops! China is the new Japan: Japan 1989
• Dollar is taking off, probably now into wave 3 off the bottom, heading from 78 to over 90 in the Dollar Index
• Earnings reports have been disappointing, and even good ones get faded - and when a market sells off decent reports, the Bear has returned
• Unemployment had a weekly spike, throwing cold water on the recovery
• FHA is tightening lending due to horrifically increasing defaults
• Housing may be in a double-dip down
• Obama is *finally* listening to Volcker and in a huge about-face now wants to reinstate Glass-Steagel
• Democrats in disarray as the "Scott heard around the World" seems to put the stake into Obamunism 

Simply put, the assumptions that drove 2009 up are now up in the air, and the market needs to digest the fallout. Meanwhile outside the US the chickens are beginning to come home to roost. 

In 1930 we had an apparent recovery from the crash, and then slowly developing problems; but in 1931 the crisis came back in the form of banking failures in Europe, and overwhelmed the US economy.  Is history repeating, this time with China as part of the potential brewing crisis?  This chart from today's WSJ shows how the Chinese Stimulus has not gone into real production but into hoarding and speculation, just as in the US:

 

Cramer Has Another Monica Moment

CNBC's Cramer kept telling us in 2008 that Bear Stearns was not in trouble - oops! Last Friday he said if Brown won the Kennedy People's Seat, stocks would soar - oops! Buy on rumor, sell on news? Or maybe news does not move the market beyond Cramer-fed blip? I just wonder when the ever-entertaining and often-wrong Cramer will finally have his Monica Moment, the blunder that dogs him like a cheap cigar for the rest of his career. 

Obama is nearing his Monica Moment. The political tectonic plates are shifting this morning. Warren Buffett threw Obama under the bus by trashing his bank tax proposals. Congress may balk at Obama's morning proposal to nationalize the student loan program, after effectively assuming huge mortgage liability by backing Fannie/Freddie to the hilt last month. It is no longer clear if any of Obama's agenda can be passed, especially those which lead to further socialization of risk. 

While Obama continues to blame deregulation for the current credit mess, a simper explanation is that we privatized the upside and socialized the downside of the shadow banking system, the same mistake we made in the '80s with S&L's, just at much huger scale. Pushing high-risk loans and backing them with Fannie/Freddie implicit government guarantees led to a classic example of Moral Risk in mortgages. 

Finally we begin to see financial leadership pushing back on continuing this foolishness, starting with the former Obama supporter, Warren Buffett. This tectonic sea change will ratchet through investment thinking over the next few months. 

Demographic Destiny and the Long Term Market Picture

My long term view is that after the deflationary depression of the next 5-7 years (to 2014 at least), we will have a rip-roarin' bull market, driven in part by a new family of technologies, including mobile Internet, cloud computing, bio-engineering, and my favorite, nano-manufacturing (a whole new sort of materials assembly). After that innovation wave, however, we will be hitting some huge headwinds against the continuation of the type of increasing wealth we saw from 1870-1914 or 1982-2007. The prime headwind is the demographic demise of many of the current and future economic powerhouses around the world.  

The demographic destiny of the developed countries is already baked in: Japan, Europe and Russia are on a severe downswing in population. The US, Australia and NZ are going to be flattened but not down, due to immigration. China, the purported next great economic leader, will be nothing of the sort: its "one child" policy of its bleak Maoist period combined with its unattractiveness to immigrants dooms it to an aging and shrinking population, particularly after 2020. China is not the next US, but the next Japan. Africa and much of the Middle East are not culturally nor politically oriented to make the great leap forward of China and India, at least in the next 30 years. Latin America has huge potential, but other than Brasil and Chile, seems mired in socialist economies of the sort that have run Argentina through a roller coaster of promise and problems, boom and bankruptcy, for 100 years. This leaves India and possibly Pakistan & Indonesia as the only countries with *potentially* the sort of demographic & economic profile to drive global growth. 

What has not been widely recognized is the seminal importance of "20-somethings" as the driver of growth. Sure, household spending tends to increase into the 50s before slowing down, but much of that spending is on trading up to bigger houses, better cars, more vacations, and investments in children. A trade-up economy is quite different than a first-time economy. It is those 20-somethings who buy "firsts": first house, first car, first appliances, first furniture, etc.  It is those 20-somethings who drive innovation, and who support the social welfare systems for their elders. When the demographic mixture inverts from a pyramid (more youth, fewer elders) to a column (flat all the way up) or a worse to a V (few youth to support many elders), growth slows and welfare implodes. 

Japan today is the model of Europe and Russia in the 2020s. China should rise then decline in the 2030s. Immigration can keep the US, Australia and NZ afloat into the 2040s, but the coming depression may bring a suppression of immigration, as happened in the US in the last depression. 

What this means is a continued low return environment outside of an innovation blip in the 2020s. I have earlier commented on the demographic demise driving a low-yield environment, and on how the demographic demise will shatter the welfare state. When the Powers That Be recognize this inevitability, we might get a change of policies to promote bigger families and easier immigration. Until such a time, the demographic destiny will overwhelm most projections of future prosperity, which tend to be extrapolations of current policies based on past demographic models. 

In my just prior post I discussed the long wave count, and dismissed the near-term debacle of Prechter as overly pessimistic. In the longer term, however, he may be directionally correct. The demographic demise of the West points to one final wave up during the rise of China and India - the 2020 innovation wave - and then a long plateau if not outright decline, marred by wars and civil unrest amidst failing governments drowning in unfundable commitments to the social welfare of the aging. Like any future, this one is changeable with foresight and leadership, but given the long time frame of generations, it must be changed soon or will suffer a baked-in demographic disaster. Just as nine women cannot make a baby in a month, a plethora of wise leaders cannot fix a baby bust in a generation. 

Prechter and the Long Term Count

 EWT's wave structure was outed today by SlopeofHope. Here is the chart, which Slope published. The target is Dow400, and the time looks around 2014-2015. For a lot of reasons, 2014 is a good target year.

How does he get here? I commented on this at length last summer (updated slightly):

He uses a common relationship, that the low is likely in the area of the prior fourth wave. Since the market is a fractal - looks the same at all time periods (minutes, hours, days , decades) - it matters a lot what degree of wave is being discussed.  To understand Prechter's targets, we must first understand his longer term count. 

It is easy to get lost, so for convenience I will use a convention I first saw Zoran Gayer use.  I will label waves YYwX where YY is the year the wave started and X is the count (waves 1 2 3 4 5 or a b c)

Prechter counts the prior wave 4's as follows:

1784w4 was 1929-1932 and got to a low in the 40s
1932w4 was 1966-1974 and got to a low in the 500s
1974w4 was 1987-1989 and got to a low around 1700

Prechter thinks that 2000 was the top of the whole wave from 1784 - in a nutshell, the end of the Industrial Revolution. The prior third (1784w3) is the wave from 1842-1929, and the fourth wave within it was the low in 1921, below Dow 100. Does this really have any relevance today? Seems hard to believe, since the fourth of a third is an attractor somewhat like a support level - a lot of action occurred around then, and market participants have positions there. Does anyone have a 1921 position? Of course not. Also, the number itself has little relevance given the horrific inflation in between. His viewpoint means he thinks we are in a large wave IV of an equivalent disaster to the period from the South Seas Bubble in 1720 to the start of the Industrial Revolution around 1784. Do we think the Industrial Revolution is over?

Also, his long counts have flopped around in his books. Three big issues:

1. Is 1929 the end of wave III from 1784? Prechter has commented that a good case can be made that either 1929 or 1919 represented the end of the wave I, the rise of European Civilization and the first phase of Globalization. It all came tumbling down in WWI, and the wheels came off Globalization after 1929. I have seen analyses where the unit volume of world trade in the early 1900s was not matched until the 1990s, so far we fell. Imagine the days when you could wander the world without passports, use gold-backed Real Bills from the BoE for commerce with ease anywhere, and keep your shoes on when on-boarding a boat. What happened from 1919 to 1949 was a New World Order emerged (after a depression and a terrible world war) with the US in the center. Without belaboring it, the End of Days is not coming under this count. 
2. Is 1932 the bottom of wave IV? Elliott himself thought not, and had it going past 1942 in a triangle. He died before the end. Neely ends it in 1949, and Zoran in 1950. They all see a triangle, which would peg 1929 as the end of a wave III and the Depression as a wave IV, but the count afterwards changes significantly: whereas 32w3 is 42-66, 49w3 is 74-00 or 82-00. In his books, Prechter continues to insist that 1932-1937 was a five-wave pattern. Funny that Elliott himself did not see it at the time. (Of course, he was influenced by the failure to come out of the Depression.) The 32-37 rally can count as a double-three, something like the current Hope Rally.
3. Is 1974 the start of the final wave 5 of V? In his books, Prechter has flipped back and forth between that view and choosing 1982. In one of his versions of his Elliott Wave Principle, the modern Bible for this stuff, he had an appendix choosing 1982. He thought the purported wave 1 up from 1974 was hard to count as a "5". (Of course, he would have been influenced by the terrible inflation of the time.) In the Constant-Dollar Dow, 1949 and 1982 are the key dates, not 1932 and 1974.

If we step back from the brink, this current wave action is most likely a correction a degree lower than all the way back to 1784. This means it is correcting the wave since 1932 or 1949, whether we count 1929 as the end of I or III. It is not likely to be two degrees lower, correcting just the wave from 1974 or 1982, since it seems much bigger and longer than any correction from 1974-2000. Indeed, it has been noted by many cycle pundits that there is a 16-18 year pattern of major highs/lows since 1949: each wave went about that long ('50, '66, '82, '00 are key dates). This puts the end of this one around 2017 (or 2014 if we note that the 16 yr cycle would make '98 or '99 the turn date). 

This also means the ultimate debacle is likely not to be as bad as the 1930s, but of the order of the 1970s, or the 1870s when a similar global credit bubble burst. This is not necessarily happy news, as that was called the Long Depression. As with the '30s, the worst part was only the first four years (1873-77), but there was a second collapse in 1893-96 when the US Treasury almost went bankrupt! (it had to do with having the wrong ratio of silver:gold in the currency, and Europeans turning in their silver coins for US gold, and taking the gold back home for a nice arbitrage.) The Long Depression was not that bad for the US, however; it marked a transition from the New England mill towns to the Midwest foundry cities, and at the end of the period we were the new global power - the China of the day so to speak. 

The fourth of the prior third in this more benign count is 1987-1994, or a range of 1700-4000. Also, the final wave from 1995-2000 is an extended fifth, typical for a mania. Manias retrace to their start, or Dow4K. Dent has a target of Dow3800, and I recall that way back in 1982 Prechter was thinking the end of the wave up would be around 3600. Hence there is a cluster of relationships that can gets us to 3600-4000.

Now, I am not actually sure how Prechter gets his Dow400 target, and I am very surprised he puts it as early as 2014. The fourth of the prior third in his count for the wave from 1932 is around 1957, and got down to around 500 - the same level touched again in 1974. If he is suggesting we get back to the 1929-32 level, this would be 40-381. Maybe that is where the 400 comes from. If he really means 1784w3w4, that is the 1919-21 level under Dow100. To me, none of these targets are credible, especially given inflation of over 13x. Dow400 then is close to Dow5000 today.

I am also surprised at his timing. If this is a huge wave IV of the order of 1720-1784, it should last 50-100 years. Maybe the low comes right away, as 1932 came early in the 1929-1949 correction, but more likely it grinds out to near the send, say out in 2057. That is far enough away I give it no mind. 

As to the next wave down, let's assume his P3 is part of a five-wave C since 2007. This would make 2000-2014 a huge flat, albeit an odd one - flats are supposed to be SIDEWAYS and at Dow400 this one goes way below the A wave low of Dow7200. This is one of the reasons I do not buy his deep flat scenario - the flat could have been over already at Dow6400 and kept a normal "look" of a flat. His count would make more sense to me if he had 2000 as the end of 82w3 (or 74w3), and then wave 4 went to 2003 and wave 5 went to a new high in 2007. A five wave drop to start a big correction would suggest a zigzag, and his P3 would become PC and go below Dow6400. Interesting is that a normal zigzag has wave C = A or 62% of A. The former gets us down around Dow3200, while the latter would end us just about Dow6400. Neither gets us anywhere close to Dow400. 

But he didn't pick that count, and while it could work in the Dow, it is hard to make work in the S&P, and of course nonsense to try to make it work in the Nasdaq, which is way below its 2000 peak. 

Instead, he is sticking to P3. In a large move it is better to use a log scale, or a percent move. We fell from 14K to 6.4K, or 55%. A 55% drop again from around 11K gets us back to Dow5000. Now, a wave 3 should not be the shortest but it certainly can be shorter than wave 1. This means the final wave 5 will be shorter than 3. If 3 = 1 in percent, and 4 is a typical 38% retrace, 5 would drop to about where 3 ends, or a bit lower. Hence, hard to see how we get much below Dow4K.  

Further, P1 (wave 1 of his C down off 2007) extended. When a wave 1 extends, the waves after 2 (ie. 3-4-5) tend to go 62% of 1, counted fromthe top of 2.  You can see this in this chart from instructional materials from the EWI website. This puts us back to around Dow6K, depending where the Hope Rally (P2) ends. 

Finally, his count would have a "Prechter Point" this summer, a 3 of 3 of 3 etc (actually, I think he gets to 6 "wave 3s" in his EWT) that falls fast and far.  This would be like a crash again. But crashes are not followed by another crash within two years.

All of this suggests this count is extreme, to say the least. And even within his own theory, not the most likely outcome of the wave structure. More likely 2010 is a sideways year, meaning we stay above the Mar09 lows, and the big drop to come awaits in 2011. 

Do We Feel Lucky?

Yesterday, the EWT announces the top *should * be in, and today was a sharp drop, which is a confirmation of .. something. The STU tonight shows a count which puts the top yesterday. Sure, it works, but so does an alt count where the end yesterday was the end of a wave 3, with a 4 and 5 to go. Tony Caldero shows the main count in green and this alt count in orange in this chart:

 

This count works, in that wave 1 is longer than 3 (orange) as required in an ending diagonal (ED). Note that the STU starts the ED where Tony has wave 2 end (green and orange), so I would ask you to shift the 1-2 in orange forward to where green 3 - 4 are. The count still works, and it makes the prior wave a triangle. It also makes wave 3 in the Dow 62% of wave 1, a really tight Fibonacci relationship.

Lots of interesting relationships:

• if this is the end of the Hope Rally, P2 = 62% of P1 (in trading days)
• in the Dow, wave 3-4-5 (STU) or just 3 (me) = 62% of wave 1
• wave 5 (STU) or 3 (me) ended with a small ED - cute!
• Dollar today bounced off a 50% retrace - bullish for USD, bearish for S&P

Some caveats and guidance for next week:

• Today was options expiration, so it is too easy to read too much into the drop
• Monday is a trading holiday, and maybe there was some lightening up for the long weekend
• Dollar bounce today may suggest no Dollar Dump Monday night - watch for this
• We have the Vampire Pattern where all the fun happens after hours - this suggests a stock pump Tuesday after a Dollar dump overnight, if that happens
• After an ED we expect a sharp drop to the start of the ED, or Dow10264/Sp1095

All this means to wait and see how Tuesday opens. If we don't get the sharp drop, and especially if we got a sharp rise, this is likely a wave 4 that should go sideways for a week or so (since wave 2, on any of the colors above, was a sharp correction). Could be a flat, ending around Sp1130, or a triangle, ending a bit higher. Many of the ewave sites count today's sharp drop as five waves, but to me it counts easier as a "3" with a triangle B wave in the middle. Flats and triangles start with a "3" not a "5".

Walter Murphy had a fun post today: Do You Feel Lucky? He notes that if the Hope Rally is truly over, we should have at least a 38% retrace, which translates to a 16% decline from here. (62% would be a 26% decline.) He says we need to expect a 15% rise to take that 16% risk. Do you feel lucky?

Prechter Recommends 200% Short Again!

If any of you is preparing to short the end of this Hope Rally, you should read tonight's Elliott Wave Theorist (EWT). A great EWT! Concise, clear and very informative. I have waited until his subs could take positions before commenting.

Prechter lays out a stock pattern with a line in the sand a little above Dow10800. (Exact number in the EWT, with stops and recommendations on how to play this.) His count makes it clear that we are in the final wave, and it is close to being done (if not done already). For those of you who are wave-minded, here is his count:

• we are in the final wave of a triple ZZ back to Mar 2009
• the ZZ had a triangle B wave - those funky square waves around Thanksgiving
• the ZZ is finishing with an ending diagonal (ED) - the Santa Rally

This all adds up to the final wave:

• triple zigzags never go to quads
• triangles always appear as the penultimate wave (2d to last)
• an ending diagonal is, well, always the end to a pattern.

All three point to the end of the Hope Rally. The reason for the specific Dow target is the ED: in an ending diagonal, wave 5 is less than 3, and 3 less than 1; since we have reached wave 5 (under his count), we have all the information required to peg an outside end point. 

Now, the pattern may evaporate, or may be plain wrong; this is all about probabilities. The pattern he describes of a triple ZZ with a triangle and an ED is not hard to see; we could quibble over whether this pattern is a triple ZZ or not (see my recent post on this, where like Prechter I count the action since Jul8 as a double ZZ), but that hardly changes his call, since the triangle and ED are clear. I should point out, however, that the whole pattern of a trip ZZ with a triangle B followed by an ED is rare. Prechter himself has only seen one other triangle/ED combo, back in 1986. 

The other reason to read this EWT is he lays out his picture of the rest of this wave down and when/where it might end. Yikes! Given all the zigzags, a triple Yikes!

I have commented on his very-low bottom prediction & timing previously, and plan to put up another Long Term Wave Count post after we truly bifurcate down off the Hope Rally into the Change Market. If his Yikes! Wave emerges, part way down will come the "Prechter Point" where attitudes about the severity of this bear market and the coming deflationary depression will change into a stampede of Yikes! Suffice to say, if his predictions turn out to be correct, all the longs will have at the end of the Change Market is spare change in their pockets (if they can hold onto their shirts). Yikes!

Vampire Market: All the Action is at Night

I have been commenting about how overseas buying of US equities is driving this market, most likely as a hedge against Dollar weakness. It is hard to see this continuing as Greece goes into meltdown today and China tries to rein in its excessive stimulus. The erstwhile buyers have to tend to their home markets. Now here is an interesting confirmation from the UK's Market Oracle, sent in by a reader:

1. Robert McHugh, a famed technical analyst, 80% of the market gains occurring since March 2009 have come on just 30 Mondays. Put another way, you could have bought stocks on Friday afternoon, sold them on Monday at noon, and ignored the rest of the week and roughly mirrored the S&P 500’s blistering performance.
2. Tyler [Durden] of Zero Hedge also points out that the market actually hasn’t produced a gain since September during the 9:30-4PM trading session. Instead ALL and I mean ALL of the gains produced between that time and year-end occurred during the overnight session in the futures markets: 

Dollar Dump But No Stock Pump Signals Pullback

We had last night's Dollar Dump but not the Monday Stock Pump of the prior pattern. A short term pullback may be due. The prior buyers who played this game seem tapped out, or all in. The VIX is low, and a low VIX is usually bullish, except this rapid drop in the VIX has been accompanied by a very modest rise (1%), which seems to indicate that the market's complacency over a presumed risklessness has gone as far as it can. Indeed, the VIX has dropped so much it is causing alarm, even on Tout TV (CNBC). It is down to the levels of Oct07, right before the collapse began. The VIX could go even lower, and stocks head up in a final leg, based on VIX history, but it seems we are nearing an end to the conditions which drove this market up since last March.

Other indicators agree. The tech leaders of the way up in the Naz have been down since the turn of the year. Tonight's STU shows that their ending diagonal hit the upper trendline and threw over a bit, normally a terminal signal (but they caveated that with an alt count where the ED has a wave 4 and 5 to go). Tony Caldero noted that the market is now technically overbought (but it can remain so for a while). Neely's charts today continue to show his rectangle of time & distance for the Hope Rally, which places us at the very end. A reader with the handle Bird has been talking of the Gann box being hit. He provided me with the following chart, to show this. As with Neely's rectangle, it shows that Gann would predict that an end is close, around the Dow10700 level:

Dollar Dump, Stock Pump is Back!!

We saw a pattern in Q4 of a Sunday night dump of the Dollar and a Monday morning pop of equities. This went away during the Santa Rally, but has now come back. This Sunday evening ZH is reporting the Dump is Back! The USD is down from over Dx78 to Dx77 (See chart), and futures are up, although not much. Gold is up. The Dollar correction is not a surprise - I have expected it to get to Dx76 before rebounding. Whether this presages the final run of equities to Sp1160 area, we shall have to see. Often overnight futures moves do not show up the next morning. 

 

Predicting the End of the Hope Rally

It is interesting to me how many pundits have become wrapped around an axle of their own choosing in their failed attempts to predict the end of this rally. I don't think it is that hard to apply wave theory and make a prediction. I have generally avoided adding my own count to the noise since this site is about reporting the waves not defining them. I feel compelled, however, to fill a vacuum left by the wave pundit-sphere: I think this rally ends by early Feb at around Sp1158-1170.

First, the pundits. Neely called the top in Jun. Oops. He seems to have lost his confidence since. Prechter first called the top in Aug and then went double short a couple of months ago. Ouch. Now his wave counts morph from expanding triangles to symmetrical triangles to ending diagonals. The many EWI tout boards follow the big guy in similar morphing counts. The one pundit that has held relatively steady is Tony Caldero, and I will borrow his charts to make my case.

 

Eyeball this chart of the S&P since the March 6 low. There is only one significant correction, from Jun11 to Jul8. Classic ewave would say that the rally should be divided into two up moves with that one correction in between. Neely has it part of a large triangle of a very odd shape. Prechter and EWI divide it into 3 moves (a triple zigzag). They are both getting lost in complexity. Only Tony Caldero has stuck to two moves. 

A typical relationship is wave A=C. A went to Jun11, B is the Jun-Jul correction, and C is what we are in. The distance from Mar9-Jun11 should equal the distance from Jul8 to the end.  That would give Sp1160 as the likely end point: Sp667 to Sp 956 = 290 pts rounded off. Then Sp869+290 = 1160 rounded up.  A range of Sp1158-62 covers all the rounding. 

Where Are We Now?

The second wave can give us guidance as to where and when this will end. The second wave is not hard to count either. The key is to see it as a double zigzag - two corrective waves connected by an X wave. This should not surprise us: 

• The first wave (Mar9-Jun11) was also a double zigzag ("ZZ" for short) 
• The X wave (Jun11-Jul8) was a single ZZ, but since X waves typically are simpler versions of the corrective patterns they connect, it also would suggest two double ZZs
• The whole rally looks like a double ZZ

Thus this structure has a high internal symmetry: a double ZZ first wave, a single ZZ middle X wave, a double ZZ final wave, and a double ZZ overall structure. We might have expected the final wave to be a double ZZ! 

All these ZZ's might put you to sleep, so bear with me. Within this second wave, let's call the first zigzag wave W, and the second wave Y. Here is the count:

• W goes to the Sp1080 peak in Sept, with its B wave a three wave irregular flat (meaning b of B went to a new high). This is a different count than Tony has in his chart (his red ab are my bc of the flat). 
• X fooled the pundits since it broke as an irregular flat with a higher internal wave than it started or ended: its A wave dropped to Sp1019, the B wave rose to a new high at Sp1101, and the C wave dropped to Sp1029 on Nov2. Again, this is a different count than Tony's chart shows. 
• Y began on Nov 2 and we are still in it.  

What I like about count this is it also captures the psychology: Prechter called the top near the end of wave A up in Aug, and got fooled by the irregular flat that followed; then he went double short in the middle of the X wave in October (Sp1101 in Tony's chart), and again got fooled by an irregular flat. Remember that casinos are places to separate money from people, markets are mechanisms to take money from traders, and irregular flats are waves to take track record from pundits.

Check out this second chart to focus on the final zigzag, wave Y, noting that Tony's labels are different from mine but his final count is similar:

Wave Y should break as a 5-3-5 ABC, with A and C five wave patterns. The sharp rise from Nov2 to Nov16 is A of Y, and easily counts as a 5 waver, as it should. The long plateau with the funky square waves is a triangle B wave, a "3". We started the final wave C of Y with the Santa Rally on Dec9 at Sp1086, and so far it has broken into five waves. We are in the final fifth wave. The end is near. 

How Far Might it Go?

We can use the internal waves of this Y wave to estimate the end of the whole rally: the usual pattern has wave C=A of a zigzag. This gives a target of around Sp1170: A went 1029 to 1114 = 85 pts, so C should go 1085 + 85 pts =1170. Pretty close to our other target of 1160 for the whole Hope Rally. 

Tony notes in the box in his chart two relationships which target Sp1158 to 1162. His "Major A" is the first wave from Mar-Jun, and like I did above he reaches Sp1158 as a target. His "Int. A" is what I termed wave W, the wave from Jul8 to mid Sept. Tony has that wave end in Oct at Sp1101, and gets his target of Sp1162. I end that wave earlier, at Sp1080, and count the Sp1101 level as the peak of the irregular flat. I would come up with a lower target using W=Y, except given it is an irregular X wave connecting W and Y, I instead count the equality of W=Y from the middle of the X wave. If you do that you get a target of Sp1164. 

Thus, in terms of distance, we have a range of Sp1158-1170. Tony also has Sp1168 as a major pivot derived from other relationships. A cluster of relationships points to an end in our target range. 

When Might it End?

In terms of time, we can use wave structure for guidance. Note that time is not as well incorporated into ewave as distance, so while we come up with tight time ranges, the confidence in them is less than with the target distance range.

In flats wave C tends to be faster than A. The period from 2000-2009 fits the pattern of a large irregular flat (irregular since the B wave exceeded the start in 2000). The A wave was choppy and sloppy, while the C wave was dramatic and sharp in 2008! 

Note: if the 2000-2009 period was a completed flat, does that mean we are now in a new bull market? One count floating around a lot of sites is that the C wave is not done yet; we have only done two of the five waves of a C (flats break as 3-3-5, so C is a five wave impulse). This is the Prechter count, that the Big One down in 2008 was Primary 1, pr P1, and the Hope Rally is P2, with a devastating collapse in P3 to follow. The other count, which I favor, is that the Hope Rally is a large X wave connecting the flat to a second corrective structure to follow. The whole pattern might become a large triangle, or a double flat. 

In zigzags C tends to be slower than A. This seems to be the case right now, as the rally has slowed its ascent since Jul8, and seems to be in a sloppy, overlapping topping motion since mid Nov. While in ZZs we see C=A in distance, since the C wave slows down, we instead see C = A+B or 1.6x A+B in time: 

• For the whole Hope Rally, A took 3 months, A+B took 4 months (18 weeks actually), C has taken now almost 6 months (Jul8 is six months to today!). The 1.6x ratio gives an estimate of 6 1/2 months, or more precisely 29 weeks, the week of Jan 25. 
• For the second wave of the Hope Rally, A+B (or in this case W+X) went from Jul8 to Nov2 or 17 weeks; 17 weeks after that gives a target of the end of Feb. 
• Since this is a double zigzag, the X wave could split it in two in time. To the middle of X took 14 weeks. 14 weeks after that take us to the week of Jan 25.
• For the current Y wave, A+B went from Nov2 to Dec9 or 5 weeks, and C should go either the same 5 weeks and top next week; or go 1.6x that or 8 weeks, and top the first week of Feb.

Add these together and we have a topping window from next week to the end of Feb, with a most likely range from the last week of Jan thru the 1st week of Feb in a target range of Sp1158-1170.

The Very Bearish Very High Bullish Sentiment Drops From Record Levels

Bullish sentiment has been at or near record levels, levels seen at tops, not kickoffs to higher highs. This is of course a very bearish signal. Since the pop up Monday, bullish sentiment has fallen fairly significantly. Take a look at these two charts, the first showing sentiment levels at recent highs/lows (courtesy Michael Panzer), and the second showing the change this week (courtesy TPC):

Similar signals come from breadth (where advance/decline and up/down volume is falling, a bearish sign), complacency (where the VIX is at a level not seen since May 2008, just as the Big One began down), and optimism (where the put/call ratio is at its lowest level in four years). Tonight's STU has a take on this: 

Unless there is a dramatic shift in breadth, volume and sentiment, the market appears on course to reverse this week's rally, which appears extremely stretched. ...

It appears clear that few investors expect a significant market decline from near current levels. These measures do not necessarily guarantee a selloff, but when viewed within the context of a fully developed wave structure for Primary 2 (circle), they certainly increase the odds for just such an outcome.

The STU wave structure is looking more like an ending diagonal - see their chart from my Monday post. Since then we had a sharp wave 4 down (intraday this week), and it looks It looks like we are in the final wave 5 up. It needs to get back to the upper trendline, and maybe have a bit of a throw-over, getting us to the Dow10700 level. As to timing, Tony Caldero has a good take on next week:

Next friday is Options expiration. Typically, a rising market makes a high early in the week, pulls back some, and then Options expiration takes over into the friday close. Monday/tuesday could be quite interesting.

What are the implications of this week's downtick in bullish sentiment? It could reverse in a hurry Monday if we have another gap up at the open. More likely it indicates a short-term reversal ahead but not yet the end of the Hope Rally. I still hold to Feb for the peak as most likely, within a view of a peak in Q1. We might get the reversal next week, but still within the ending diagonal (ED) trendlines (ie above Dow 10420). If so, we would have rolled into the alt count of the STU: that Monday's pop and the intraday low this week were not legs 3 and 4 but merely subdivisions of leg 2 of the ED, meaning legs 3 and 4 haven't come yet. 

Unemployment Disappoints, Dollar Drops

Unemployment came in a 10% where the market expected a drop from Nov's 10%. The major immediate impact is to adjust assumptions about the Fed easing out of QE and raising rates - history shows this happens about a year after unemployment peaks, or at the end of 3Q10 if we had kept dropping. But the flat month may spook investors out of the USD and back into commodities. Gold jumped on the news, and Oil spiked up today, but has since eased; and the Dollar Index dropped.

This flip of assumptions may flip back, but not until April or so. As I have written, the 10.2% jump in Oct was a bit spurious, driven by seasonal adjustments which are based on assuming more retail outlets than we have anymore, and the Nov and Dec reports have this problem baked in. The next report (Jan numbers, reported early Feb) is beyond the seasonal (holiday shopping) adjustments, and may pop back up. After that we get the offsetting flood of census workers, which could drive the rate down even though those are once-a-decade temp jobs. A bit of an election-year scam, according to Mish, since we are hiring 3x the number of workers from last time. The excess hiring starts now and accelerates in April, pointing to a drop in unemployment rate in March or April, reported in May or June. This would start the Fed Rate Raise clock ticking again. Note that by around August those temp jobs will be gone, so any positive impact in Q2 is washed away by Q3. Did I hear double dip? Or in this case, roller-coaster?

Here is the latest chart:

Innocent Bystanders has an interesting take on this, comparing the predictions of an independent analyst (Zandi) with the government projection to give a different with- and without- stimulus chart. As you can see, hitting Zandi's "without-" projections suggest the Stimulus is having no impact over what would have happened without it:

 

Calculated Risk points out that despite the Unemployment RATE flattening, the Jobs-Lost PERCENT continues to get worse. The rate is the percent of reported unemployed over predicted workforce; the percent is of jobs lost from peak employment (it is more accurate, since it avoids the adjustments to the purported workforce):

There are a number of ways to square the two percents in the real world, not the surreal world of govt statistics. One way is to look at unemployment exhaustion: unemployed dropping off benefits is at record highs and increasing. The easiest way is to look at the number of former workers who have dropped out of the labor force:

 

As the purported workforce is shrinking, the rate can drop even as unemployment gets worse since it is based on employed/workforce, with the remainder the unemployment rate. Fewer employed, but even fewer in workforce, and unemployment RATE goes down even as unemployment goes up. The adjustments to workforce size have a large impact, as explained by Reuters today:

Then will come the second-take stories that will notice the shrinking labor force, which dropped by nearly 700,000 from November. Had it stayed stable for last month, the jobless rate would have been 10.4 percent. Had it stayed stable since August, the jobless rate would be 11 percent!

The adjustments also work distortions the other way: as the economy improves and those dropouts come back into the workforce, it will keep the RATE highish despite improving employment. Here is how Peter Boockvar put it in The Big Picture:

Household employment fell by 589k but because the labor force fell by 661k, the unemployment rate remained unchanged at 10% and this continued drop in the labor force is why the unemployment rate will remain high even when jobs are being added b/c these people will eventually come back into the labor force

This means things will be "lumpy" over the next year, and "sticky" after we really see private sector improvement. Investors will be whip-sawed a bit - another reason for 2010 to be a choppy year, not the dreaded debacle of a devastating P3 wave down to lower lows. 

Adding to the choppiness will be Q1 residential numbers, which the Fed in the recent FOMC minutes now expects to be poor to down:

It appears residential investment will disappoint in Q1, and prices might already be falling again - and that is before the massive government support programs will be wound down over the next 6 months. Of course CRE is getting crushed, but residential investment is usually a key to a recovery - and residential investment will remain sluggish.

The Decenniel Pattern: Zero Years are Downers

The Big Picture has two charts that should chill investors who rely on tendencies to inform their investments. I wouldn't read too much into these statistics - indeed all the seasonal tendencies have been blown up by the last two years except my beloved Santa Rally - but they are interesting:

The Decenniel Pattern

The Zero Year Pattern

A Market Epiphany

Today is the 12th Day of Christmas, better known as Epiphany, and the day when gifts *should* be exchanged, at least your frankincense and myrrh. (Hold the gold!) We had a bit of an epiphany in the wave count today. Neely says we are at the end of his wave pattern, and if it is what he has thought it is, we have a sharp drop within days. The STU had expected the kickoff of a strong wave (iii),  but instead got a couple of flat days.  This raises the odds that we are in their alt count, and ending diagonal, and it is about done, but not that quickly; they would have us in a wave 4 with a 5 to come. Tony C thinks this makes the final wave 5 of his final C wave like waves 1 and 2, which does not mean and end is nigh, but it does mean a slow rise over a longer period than the prior two pundits, to his target of Sp1168 (which gets the Dow up around its target of 10700).

The market has returned to a pattern seen since mid-Nov and broken only during the Santa Rally for a couple of Mondays, of a sharp Monday rise and a plateau or fade during the rest of the week. Then we party again the next Monday!   Some interesting news coming the next couple of days, including unemployment, which might surprise to the upside. And of course the interest in the GDP report is growing, since Q4 might also surprise to the upside, above the 4-4.5% consensus. Possibly the market is stalling in a wait for more information.

In the meantime, AAPL and GOOG faded after their competing announcements yesterday, and the Naz was down. We might now see the Naz lead down first, while the broader indicies continue their slow climb, marked by Monday Moves and Rest-of-Week Blues.

Consensus 10 for '10 Predictions

For comparison to my predictions, here is a compendium of almost all major forecasts. The consensus forecasts and advice seem to be:

• S&P 500 rallies to 1250
• Emerging markets outperform developed
• U.S. outperforms other developed markets
• Earnings growth of 20% Plus
• U.S. economy grows at 3%
• Job growth turns positive early in the year but unemployment remains high
• Inflation remains low
• Rates to rise across the curve
• Stocks outperform cash and bonds
• Overweight health care, tech and telecom — Underweight financials, utilities and materials
• M&A picks up because of strong cash flow and slow growth
• GOP makes gains in House and Senate but Dems continue to control Congress

Santa Rally Has Legs

Normally the Santa Rally continues for the first week of the new year, then pauses. This one looks stronger than that. I stand by my prediction from last night, that we are likely to have the Hope Rally continue into mid-Feb before peaking. After that comes the Change market. The major ewave pundits have had to scramble a bit, so lets look at their modified wave counts.

Tony Caldero was on edge Friday with his count, as the S&P crossed into the top of his wave 1, something a wave 4 shouldn't do. Tonight he shrugged it off, saying:

Today's rally confirmed the SPX wave 4 low on friday at 1115. We updated the hourly chart accordingly. Yes, there was a slight overlap between Wave 1 at SPX 1116 and Wave 4 at SPX 1115. Yet, OEW did not confirm the overlap in the SPX, only the overlap in the DOW. The hourly charts can get just a bit sloppy at times. Once the OEW 1133 pivot is cleared the market should rally near the long term pivot at 1168. If this new year enthusiasm continues, it could happen this week.

Neely has been squirrely of late, and today he had two counts: the end is very close, or we run hard up to Sp1200. Not much to do with that.

The STU has morphed their expanding triangle into a symmetrical triangle. This does not surprise me, nor should it my readers, since I have twice commented (most recently in First Look at 2010 Stocks) how their expanding triangle could be modified into a more normal form. They get there by making the end of leg A where they had leg C, as I suggested (although they get there in a slightly different way), and then they end the triangle at the Dec18 start of a strong move up. The implication is that the strong move through Christmas was a wave [i] of the final C wave, and the correction last week a wave [ii]. That makes this week the kickoff to wave [iii]. If so, it should be a pretty strong move and go for several weeks at least.

In contrast, Tony C would have us instead in wave [v] of the final C wave (the difference is Tony started his wave where the STU chart below has a leg C of the symmetrical triangle). The STU has an alt count which fixes Tony C's overlap issue and fits as well: an ending diagonal that started at that leg C below. The corrective wave B would be recounted as a flat, not a triangle, itself with a small ending diagonal to make the overlapping wave structure of leg C work as a "5" not a "3" wave. Since ending diagonals are relatively rare, they put this as lower odds. 

My take: when ewave counts break and need to be recast, even in a minor way (Tony C's count being redone as an ending diagonal), it usually signals that something else is going on. Breadth today was pretty strong. Sure, it can be attributed to year-end tax planning last year, and jumping in this year. If so, the upside momentum should fade by the end of this week, in classic Santa Rally fashion. More likely it means the Hope Rally has a ways to go before the Change Market takes over. 

Several things to watch:

• A quick fade of this rally means it is not in a wave [iii] and increase the chance of a top this week
• The leaders on the way up usually signal the way down. Watch AAPL and GOOG tomorrow
• Naz had a gap up today. If it gets filled relatively quickly, it would be considered an exhaustion gap, and the Naz may peak first and lead the Change Market down
• The USD is hovering rather than correcting, which suggests it may rise again over the next few weeks, pressuring stocks. If it turns down towards Dx76, watch for sticks to soar
• The Treasury has key auctions this week which might drive bond rates higher, pressuring stocks. If they go well, watch for stocks to soar
• Hope has returned in optimism over the strength of the recovery, and we might see flash estimates of a much stronger Q4 (consensus was 4% +/- 0.5%), which will bolster the rally

Financials and Tech led the rally up, and Financials have been lagging since November while Tech has soared. Today Amazon was down. I think it a short, so am not surprised; but now watch AAPL and GOOG, who both have big announcements tomorrow: GOOG their NexusOne phone, AAPL their Tablet, leaked to the WSJ in a counter-PR move to GOOG. Will their stocks rise into the announcements and fade after? If so, it should drive the Naz back through their gap up today. Hope gets exhausted, and Change is on its way. 

Predictions 2010

That time of year again: predictions! Last year I laid out 9, and would grade this as 6 correct, 2 half correct, and one missed. I suppose 7/9 is pretty good. Some highlights:

• The Dow would rally to 10500, which it has; but I thought it would get there sooner, by the end of summer. Only half a point
• The lows of Nov08 would be retested by Feb, which they were. Point
• Oil would break $28, but it bounced of $31. Close, but no cigar
• 2009 would not be as bad as expected (that turned out correct) but the recovery in Q3 would be delayed. Nope, it came, albeit has been reduced down twice in size. Half a point
• That the Meltdown would be delayed into 2010, with next summer Obama's Summer of Disillusionment. Still right, and I will roll this over to 2010

My predictions last year were informed by historical patterns: after a steep fall, a 50% rebound is typical. My predictions this year are informed by a belief in a W shaped recovery, which will start like a V, so most of 2010 should be up; see the recent post The Stimulus Has Stalled. 

Now, 10 for '10:

1. 2009 was the Year of Hope. 2010 will be the Year of Change: the assumptions that drove markets up in 2009 will roll over in 2010. 2011 will be the Year of Chickens (coming home to roost)
2. Stocks peak in Q1, probably by early Feb, and retest the Nov08 (not Mar09) lows, and bounce
3. Bonds fall in 1H10 as rates keep rising, to above 6% in the long-bond. It could get to 6.9%. This could reverse in 2H10, with rates falling again, but that depends on how the powers-that-be fund the $2T in new Treasury issues and $3T in roll-over of short-term Treasuries. A panic stock crash would drive rates back down. Watch the Treasury auctions in the first few weeks of Jan for a tell of how the year will go
4. The USD goes above DX90. Its rise is being driven by weak Treasury auctions, which drive the long end of the yield curve up
5. Commodities should drop as the Dollar rises, including oil going below $50/bbl, but so many nations are engaged in a race to cheapen their currency that commodity inflation will continue in 1H10 and drop in the second half
6. The Summer of Disillusionment is next summer, when the economy begins to fade, but we might not see a negative GDP quarter until 2011
7. Real estate will fall another 20%, despite its blip up recently, which was driven by Cash4GDP gimmickry. Look for that blip to reverse down by the Summer of Disillusionment, if not earlier. The second wave of defaults is coming as optionARMs reset
8. Euroland will be the canary in the coal mine of the next financial crisis, with increasing problems in 2010 beyond the PIIGS, including problems with investments in Eastern Europe. Nations over-extended on sovereign debt will have to start getting their house in order, which will cause a reduction in global fiscal and monetary stimulus, leading to deflation
9. China's bubble begins to unravel by the Summer of Disillusionment. It will start as a real estate bubble bursting, probably right after the Chinese raise rates to stem a raging inflation
10. Unemployment will keep rising to go over 11%. The apparent peak in Oct and drop in Nov was driven by seasonal adjustments

Key advice to investors: there is no "long-term" in 2010. The bottom last March was artificial, based on extraordinary monetary policy, massive fiscal stimulus and ad hoc gimmicks (cash4clunkers, first-time homebuyers credit, etc.), and therefore is not lasting. The underlying economic fundamentals are highly uncertain, but it is clear the high-bailout, low-rate policy cannot last much longer. Question is how long? My bet is the crisis builds slowly, as the problems accumulate through the year, and then hit hard in 2011.