I have been quiet on this site for the past half year, focusing on venture capital not the stock market, but have received a number of requests for a quick market update. We should be entering the seasonal strong period (Nov to May), but instead have suffered the worst Thanksgiving week since the bottom of the Great Depression in 1932. We should be expecting a Santa Rally, which typically begins in earnest around the second week of December, but instead the doom & gloom crowd has suggested that money managers will stay home this holiday season, Grinches all.
The comparisons to 1932 seem particularly telling. The market since 2008 has seemed to replicate other great crashes pretty closely - the best fit being 1907 - and has some parallels to the 1930s, especially if this time it is seen as unfolding at about 1/3 the speed. Specifically, what started as a pretty bad recession seemed to have turned around in 1930, but a sovereign debt crisis out of Europe in 1931 spread like a contagion to the rest of the world, and pulled the US down. In our case, the equivalent to the bounce of 1930 unfolded over three years, 2009-11, and now seems to have run head-on into another sovereign debt crisis out of Europe. If history repeats at 1/3 the speed, we head down, this time in a sickening slide over the next 4 - 5 years, not a dramatic fall in just the 18 months of 1931 to summer 1932.
The pattern that unfolded in 1931 was the sovereign contagion led to capital flight from country to country. Hoover in his memoirs likened it to cannons moving back & forth across a ship on a tossing sea in a tempest (a quote you all have probably seen). Right now a run on the European banks is in process, the commodity currencies like the AUD have fallen hard, and Chinese currency outside of China seems to have dried up as stories emerge of Chinese oligarchs cashing out and disappearing. Back in the 1930s, capital flight led the wealthy to go into tangible assets like gold - transportable across borders as it were to escape currency controls. We may be seeing that in China, although the data is sparse, anecdotal and likely exaggerated. As capital sloshed like loose cannons in the 1930s, safe harbors skyrocketed then fell; recently we saw the Swiss Franc skyrocket until the government curbed its enthusiasm. Eventually money went into cash or mattresses.
This was all very dramatic, and given a slow-motion rotation this time, should unfold more as a surreal process of "this cannot be happening." The slowness gives time for the powers-that-be to find solutions, such as Eurobonds done right, but so far they have failed to rise to the historic challenge.
The markers of the capital-flight stage will be clear:
- The TNX (the US ten-year Treasury) yield should fall to remarkably low rates, at least below 1.4%. (Near the ed of the Great Depression, it got below 1%.)
- The interbank lending rates should skyrocket; watch the LIBOR
Looking at the near term, the big issue is whether this will simply spiral out of control or will we muddle through and kick the can farther down the road.
From a Fractal Finance point of view, this chart should give us pause.
Wave practitioners have been trying to count the waves since the big drop last summer. In Fractal Finance, the process is simpler. The Fractal view is that markets normally are in trading ranges - corrective patterns with overlapping waves - as they try to seek order, meaning a direction. When the direction is found, markets thrust rapidly to a new plateau, where they pause to find direction again. Like all non-linear chaotic systems, markets tend to be on the edge of chaos most times and in rapid thrusts occasionally.
The blue lines in the chart aptly convey the trading range, and the momentary breakout above. Often a trading range of a chaotic plateau shows a false break below (as we see at the end of September) followed by a false break above - which is what the whole month of October now appears to be. When a thrust fails to sustain above the prior plateau, a reversal is in order. We saw in 2009 a thrust out of a multi-month trading range, and the market never looked back. This time we have fallen back.
It is now crucial to head north again in that proverbial Santa Rally. If we do, the break above is still on. We should then run up into January, and we might confirm a prediction of several years ago by Bob Prechter, that the top would be in January 2012. But we really only have a week or so for this to occur.
One of my readers predicted I would blog again when the perma bears like Prechter went bullish. Alas, they remain super-bearish. Let me finish below the fold with a recent Interim Report from EWI so you can see for yourself their latest view. It may be that even their January 2012 prediction for a top was too bullish for the currenct circumstances.
November 9, 2011
There is a good chance that the upside lunges that have peppered the stock market since August 9--exactly three months ago--are over. According to reports, the consensus among fund managers is that the market is primed to rally until year-end. The big gains of October convinced them that the worst had passed. But in my judgment the setup is very much like that of 1973.
In late December 2010, I said on television that the situation looked much as it did just before the start of 1973. The market had been in a two-year bear market rally, per our interpretation of the Elliott wave model; and a broad bullish consensus had developed on the outlook for stocks, recalling January 1973's "Not a Bear Among Them" headline from Barron's. (See the March 2011 issue of EWT for a list of indicators of extreme optimism among every class of market participants.)
In 1973, the stock market topped in January and was weak into August; then it rallied hard right through September and October, statistically the two most bearish months of the year. It was a convincing rally, and optimism returned. That rally ended on October 31, leaving the "bear months" in the dust. But instead of continuing higher, the market turned down from there and in just a month plunged below the August low. November is usually a benign month, but that year it wasn't.
Here in 2011, several key market sectors topped in February, the broad market topped in April, and it was weak into early August, when the NASDAQ made its low. The market spent September basing and then had a huge rally in October, just as in 1973. It made a closing high on October 28, one trading day before month's end. It fell so hard over the next two trading days that on November 1 the Trading Index (TRIN) reached 11.30 intraday, enough to indicate a short term low. The ensuing rally, which took place over the past week, brought the market nearly back to its October high. In doing so, it got through the seasonally strong days, which ended at yesterday's close, filled the gap from October 31 in the NASDAQ, ended a diagonal triangle (see text, p.37) in the Dow Jones Transports, and reached the upper end of the upside resistance zone of 1270-1277 basis the S&P cash index that Steve Hochberg cited in Monday's Short Term Update. Today it is falling hard from that point.
None of this proves anything. All market analysis is probabilistic. Today's huge intraday TICK and TRIN numbers so far (-1600 and 7.45, respectively), in fact, would normally be associated with a near term bottom, so there is plenty of room for uncertainty. But the main exception to that tendency occurs at kickoffs of major declines, and that's how the waves seem to be positioned. We will soon know which event is occurring. Overall, recent market behavior has been conforming to our analysis and seems to be in line with our bearish position.