Planet Yelnick

Market Still Spiky, Economy Looking Weaker

Mother Market is good at fooling the best of them. Today it drove day traders and technical analysts nuts! Dropped at open, and broke below Dow9630, suggesting the rout was on .. but did not drop below equivalent level in S&P or Naz - a divergence. Then turned and meandered right back to where it started; plateaued, fell hard and came part way back (see Y! Finance chart of Dow). Easy to attribute to quarter-end dressing up. Today is bonus-setting day for many fund managers! 

Whither tomorrow? Dollar Index faded, and may retest 74.50. Gold spiked up! Divergences in major markets suggest some of them have legs. The next two days should help clarify which way the divergences will go. This is a time to wait and see until Mother Market picks a direction. 

Perhaps the market will look a little farther out. Economic news was decidedly mixed to negative. GDP was revised to slightly less negative in Q2 (-0.7% annualized rather than -1%), and hence everyone is anticipating an even better Q3 (+3% annualized instead of +2.5%). But Q3 is now history! Mother Market looks to Q4 and beyond. The Chicago Fed dumped a poor PMI report out that indicates slackening not strengthening. Could it be the gimmicks in Q3 like C4C and $8K for houses pulled demand in from Q4 rather than generated any real incremental demand? If so Q4 will be poorer than expected, and Q1 could run back into negative territory. 

The Market is Getting Spiky

While the S&P looks flat, hovering along the 1065 level, the S&P futures look spiky, making relatively huge moves in the past week. See chart from SlopeofHope. I hope Yasi is doing ok trading the e-mini. 

This is a warning shot of a change of trend. The wave count is right on the cusp. Remarkably it has bounced along the 62% retracement at Sp1065 for two days. Yesterday I discount due to light trading (Jewish holiday) but today the volume came back and the market faded after a morning blip up (presumably from overnight orders being filled). The 1061 pivot was but a momentary obstacle. 

One shouldn't make too much of Fib retracement levels, but typically a wave 2 will go back no more than 62% (with at times a slight slop-over above). Prechter kept finding 78% retracements of wave 2s back in 2001-2 in his favorite formation, a nested 1-2; but in retrospect the period can be better counted without those unusual wave 2s. And so to here. Although a wave 2 could theoretically retrace 99%, they rarely do, and a break above 62% usually indicates the count is wrong. Hence it is fascinating to see how the 62% level provided resistance other than the morning slop-over to 1069. 

Right now we have two counts to watch, and both involve that pesky 62% level slop-over at sp1069/Dow9835. I showed several wave structures on Friday, and the bullish one is still extant (the first chart here). 

• Bullish count has us ending wave iv down off Sp1080 at Sp1041. The rise off that breaks as a five-wave impulse to SP1069, and the long goodbye at Sp1065 is a corrective minor wave ii. Expect a rip-roarin' wave iii tomorrow to break Sp1069 and run past the recent high at 1080. Sp1100 in sight! And Dow10K! Likely timing is Oct8-15 for this to peter out. It would match a pattern of month-end/month-start strength, although one should not rely too much on such patterns; the prior quarter end was a downturn into Jul8. 
• Bearish count has us ending the first wave down off Sp1080 in between the two charts from Friday. The up and down to a lower low at Sp1041 on Friday counts as waves A and B of a flat correction, and the fast charge up Monday/Tuesday-at-the-open to Sp1069 is wave C. A flat breaks as a 3-3-5, and waves B often go beyond the start of wave A, so this fits even though (read Daneric's post today) the waves A and B are relatively tiny. Expect a rip roarin' drop in a wave iii down. 

If we break 1070, the bull is on. If fail to break it tomorrow, the rout should be on. 

Other warning signs are ambiguous. The USD has rallied, and given the inverse Dow/Dollar relationship, is bearish for stocks. But the rally is not yet convincing. If we pop up tomorrow the USD is likely to fade and retest DX74.50. Gold counts as a five-wave down off the recent peak, which indicates a change of trend to down. Volume increased a lot today but breadth was mixed. 

The most interesting warning sign is the second chart from InvestorsIntelligence which comes courtesy of the STU today. It shows a spiky series of buying climaxes - new 52 week highs followed by a lower weekly close. The STU explains that:

This was the highest total since June 2007 and eclipses the extreme reached at the October 2007 top, revealing once again that Primary-degree second wave rallies will often sport technical extremes that exceed those present at the previous peak. "

The Japan 1989 Analogy

Japan's bubble in 1989 may be the best analogue to today. Japan pursued massive fiscal stimulation ($6T) but let the bank debt rollover and over, leaving zombie banks. In 1930 Hoover let the private sector write-down debt while he pursued massive Federal intervention to prop up wages and prices and doubled Federal spending by bailouts and intervention in the private econony at a scale never before seen (until Obama, Hoover was the answer to this trivia question: which President presided over the largest percentage increase in Federal spending?) 

Today we are avoiding the write-down of debt and massively intervening in the economy. Half a Hoover so to speak. More like Japan. Most pertinent is that we have allowed the big banks to consolidate (removing competition) and made them "too big to fail" (removing discipline). The consequence is the moribund private and consumer lending, and the zombie toxic debt simply being papered over. 

Bernanke gets credit (pun intended) for preventing a bank run after Lehman fell, but has being allowing the financial problems to fester. He intervened in commercial paper markets - they seem to have righted, and LIBOR has dropped. He is buying mortgage-backed securities (over $1T worth) - Fannie/Freddie remain alive. He is a major buyer of Treasuries - they are still being placed at lowish rates. But can he unwind? Can he exit? You can see a lot of worry over this. It does not appear the private financial markets have normalized and it has been a year and counting. 

I have looked at the 1929 (and here in a thoughtful post), 1937 (again and again and again, and more thoughtful here) and even 1987 analogies. And now 1989. The value of these analogies is not great - one is extrapolating from one or two data points. But they may be better than the alternative, of using fractals. 

The market is a multi-fractal structure, meaning shows the same patterns at all time scales, and so one can use fractal patterns to simulate what is happening now. By looking at fractals across much shorter time periods, one can find many more data points to extrapolate from. 

A worthy thing to do but fraught with a different sort of error: the surrounding context may be too different right now for those fractals to be predictive. Specifically, we have had a propensity to consume since the 1960s, and it was a major switch from the propensity to save of the 1930s. This switch pervaded many institutions, including investment and capital structure in the private economy (ie much less debt). And now it has switched back to savings. In addition, a lot of changes have happened to capital markets, such as abandoning the gold standard in 1971, deregulating financial markets, introducing program trading, etc. It may be that fractals before the crisis hit in 2007 are not that predictive, and fractals more than ten or twenty years ago reflect a different economic climate. You can say that human nature has continued the same, but the market structures have evolved and the consumer has switched from consumption to savings - a different context.

So we are back to historical analogies of one-time evnts. The first chart from Ned Bushong shows where we are compared with the Nikkei off 1989, matching the peak in 2007 to the peak in 1989. He suggests we focus on the MACD line (bottom of chart) to show how the technical foundation of the market then is quite similar to ours today. The second chart from dshort.com shows the S&P vs the Nikkei, centered on a 2000 peak not 2007 and adjusted for inflation/deflation. This is another way to look at the 1989 analogy. The third chart is another version of that 2000=1989 analogy, with deflation along the bottom. Doug Short has also shown a series of charts aligned not on 2000 peak but the 2008 bottom, which is a third way to look at this. I have not seen him align the 2008 bottom with Japan's bottom after the initial crash off 1989. 

Back then to Ned's chart. It aligns 2007=1989. It captures a more similar political response (zombie banks and fiscal stimulus, a Full Hoover). It suggest the next wave down will arrive soon, and bottom around 2011. Japan continued fiscal stimulus until 1997 (2015 for us by analogy) and then gave up. The realized they had merely squandered huge resources and done no better than keep the patient on life support. They built the original Bridge To Nowhere. They cautioned the US not to do this, but we haven't listened. 

Of course no analogy is perfect, and we should be cautious about extrapolating from one data point. There are many differences today than Japan 1989 - the most pessimistically being back then it was a problem centered on Japan, and the rest of the world could pull Japan out. Today it is a problem centered on the US and spread throughout the world economy, and it is doubtful anyone else can pull the US out. 

The Economy Is So Bad That ...

The economy is so bad, the mafia is laying off judges .. and more one-liners below. The economy is so bad, time to enjoy it!

Have We Topped?

While the odds favor a top being in, I cannot confirm the top until we break below Dow9630/SP1039. One of the immutable rules of Elliott Wave is that a wave 4 cannot fall into the range of the prior wave 1.

This chart from the STU shows the alt wave count for us having one more wave up to complete the rally (or at least complete the wave action since Jul8). We got very close at SP1041 and approached it with Dow9666. We fell off the peak in five waves, which is consistent with the peak being in (five waves indicate change of trend) - but is also consistent with a flat correction in wave iv (a 3-3-5 pattern). 

The second chart (courtesy TradersAffiates) shows the five wave fall and the action yesterday. It is breaking in a corrective fashion (looks like another flat). If we were still in wave iv, the action should show the impulsive behavior of wave v. It looks instead like a counter-trend move to the sharp break down - a wave 2 to the wave 1 down.Typical retracement levels would be 38%  - 62%. Since the S&P had fallen ~32 pts (1080 to 1048) to that endpoint, the counter-trend should come back 12 - 20 pts, or SP1060-68. 

Given the corrective look, how can this chart support a future wave v? One way would be if the corrective action shown as waves A and B represent an X wave connecting the completed flat with a new corrective pattern to follow; after that we would complete wave iv and have v to go. if this X and follow-on happen pretty fast (less than a week or so), this could fit. While wave 2's tend to be sharp, wave 4's can meander. Yet as the monthly EWFF made clear, the whole rally off Mar6 should NOT be expected to "drag on for months" since the reaction to the sharp drop last year is to be expected to be a fairly fast bounce, as this one has been. Hence such a complex wave iv is unlikely. 

Let me provide what I think is a better count that avoids these problems. The third chart is courtesy Daneric and shows a count that ends the wave down at the low point, not SP1048 but SP1041. The sharp drop listed as a completed five waves in the second chart is merely the third wave down; waves 4 and 5 completed today at SP1041. The rise from that point can be counted as a five-waver, which is consistent with either a zig-zag counter-trend (a 5-3-5 pattern) or the start of the final wave v up. In this count the wave down was 39 pts (1080 to 1041). Targets for the counter-trend are again 38-62%, or SP1056 - 1065. The 50% point is 1061.

SP1061 is also key pivot point according to Tony Caldero. We get past that and he thinks wave v is on! Daneric speculates that on Monday we will blast past the 1053 resistance level and hit against 1060; then we shall see what happens. A fade may turn into the fall below the critical levels of Dow9630/SP1039. So watch for SP1060 Monday. 

Last Chance is Here

Mother Market signaled to day that this is really the last chance to get out. The decisive break down this afternoon retraced the last five days in two hours. Mother Market may have one more twist to go, but then that should be it. This chart from tonight's STU is pretty clear: Dow hit a trendline which has provided resistance throughout this Last Chance Rally and fell hard. 

The bears suddenly came out in force. Tony Caldaro called the move complete. Kenny shows why this was a false break today, with charts. Hank Wernicki at Elliott Fractals had been warning us that this was coming, and pronounced the end of the rally. Jeff Greenblatt at LucasWave laid out his timing model, and compares this to 1974-5 being followed by a retest down to the 1982 bottom, implying a retest is ahead. EvilSpeculator had been noting a growing divergence, and said of the FOMC reaction: "[w]e had our kneejerk blastoff and as usual it was a head fake." You think he isn't a happy bear? He posted a This Is Sparta! video. 

Neely was more circumspect this morning in his newsletter, noting that the market had hit its limit for his count. He had early pegged SP1080 as the likely top, and called it precisely - that is where the S&P peaked today. 

Now, there is one more twist, and it may involve a slight divergence between the S&P and the Dow: 

1. The STU still has a continuation of the wave iv correction as the alt count, either a flat or triangle. In this alt count they match the S&P and Dow counts by starting back on Aug17, not Sep3. The flat fits better given the irregular top (higher B wave than start of correction). Hence Mother Market may throw in a 'real' wave v up to end this, and we could still meander to the levels mentioned in prior Last Chance post Monday: just over Dow10K, and just under SP1100. A drop below SP1039 vitiates the alt count. 
2. The count in the S&P is better counted as if this is the end of wave iii, not wave v; you can see some commentary on this in my prior Last Chance post and comments. Hence a 'real' wave iv could be ahead, with a deeper drop than now (fooling everyone), and then the final wave v. Walter Murphy explains that count with a chart.He starts his count back on Aug17 as well, like the alt count of the STU. Since the normal drop of such a wave iv would be back to the level of the fourth wave of the just-finished wave iii, the difference with the STU count is minor: it drops to the range of SP1035-48. 

The difference between the two counts is minor. The STU level of SP1039 is smack dab in the middle of Murphy's range of SP1035-48. A break below SP1040 probably means we head much farther down. If instead we have a good bounce in the next two days, we are probably headed for the SP1100/Dow10K levels.  

A lot of wave analysis looks at a two-dimensional pattern (price/time). I think a multi-dimensional fractal would be more predictive, adding in momentum and other indicators. Let me add a few more vectors here.

• Bifurcation. I have mentioned the Zoran Gayer Chaos Theory method previously. Under it, we have had a sharp break down, but it is not yet a Bifurcation since it hasn't dropped outside the prior trading range on an intraday basis (see chart above). But it is close. Zoran's approach would encompass the wave 4 of the prior 3 as part of the plateau we need to break out of - the trading range that starts as we popped above the red line on the chart above, the Dow9794 line that marks the fourth of the prior third line going back to last Fall. The Bifurcation would come if we break below SP1035, the same as Murphy's target. 
• Momentum. The Contrarian has a good chart with momentum indicators rolling over. If we continue down tomorrow the Daily Directional indicator would confirm a trend change of greater degree than a mere wave iv. (You can see this in the STU's charts.) Thus a solid break down would confirm both momentum rolling over and a Bifurcation.
• Leadership. The Naz has been leading this rally, and many expect it needs to fall first to lead the broader indexes down. Daneric sees a topping in all of the four horsemen of tech (AAPL, GOOG, RIMM, AMZN). And Mike Arrington of TechCrunch had a great column today negative on Yahoo: Can We Please Have Jerry Back? 
• USD. I have oft mentioned how the Dollar is inverse to the Dow, and pointed to a bottom in the Dollar Index as the best indicator of a top in equities. The initial reaction of the DX was to drop below 76 to a new low. ZeroHedge noted that while the DX was expected to drop, Treasuries acted odd: bounce and drop. Then the DX bounced.
• Timing. The break today occurred within a turn window around the Autumn Equinox (+/- one day). It also occurred within a day of the Gann 180 Window. Note that Jeff Greenblatt says we missed the Gann 180 window, and counted with days, which is a common usage of Gann; but Gann 180 also refers to degrees or half a year.  That window ended yesterday and we pivoted today - close enough. Gann says New Year's Day in the market is the Spring Equinox, Mar21, so his 180 would be the Autumnal Equinox, Sep22 this year. 

Not a definitive call, but odds are much higher that a top is in. A rebound would suggest one more run up, probably into the next turn window around Oct9, where the first leg up to Jun11 equals in time the second leg up off Jul8. A drop below SP1040 should pretty well confirm the top is in. What happens next - a serious drop, a retest of March, or a new low - is the subject of a future post. 

Yves on China Stocks Turning Point

Yves sent this chart over to show how the Shanghai SEE is now the first major exchange to rollover after the Bubble Echo rally after last year's crash. China began their stimulus much sooner (and much more effectively) than the US, and the China market took off last November while US stocks rumbled and stumbled until March.

The wave pattern is textbook as I noted yesterday; the pattern suggests a fairly strong drop.

The second chart from the Asian STU concurs:

We are at the point in the wave count where the selling should intensify in the very short-term. ... We think market participants could be surprised by a fast move down to the 2620-2640 area that represents both the late August low and the lower Keltner channel on the daily chart.

After a 3% drop Friday and a flat day Monday, the SSEE was down over 2.3% Tuesday and falling fairly fast past another 2.3% down nearing the close on Wed.

Yves also passes on that Oct 1 is the 60th anniversary of communist rule in China. They may get the wrong sort of fireworks!

Yves adds that he had called the original bounce and top and the possibility of this pattern down. He writes that the first time China turned (July) he thought it bore watching but was a fringe element which would not drag down the Dow right away. This time he expects it to drag down the Dow and beyond.  He will be on Bloomberg Radio Wednesday (Sep23) at 4p ET.

LEI Say Recovery, Bond Yield Curve Says Maybe Not UPDATED

Today's leading economic indicators (LEI) point to a recovery. The bond market, however, shows a flattening yield curve (see chart). Usually it steepens as a recovery gets underway. Maybe the curve is anticipating a W-Shaped recovery? Since the LEI looks out around one quarter, and the bond market much farther, this could explain the discrepancy. The LEI started up five months ago, indicating a recovery began two months ago and will continue at least a quarter; but the bond market is looking out several quarters, and is skeptical.

I would urge caution with the flattening yield curve. The learning from the Yield Curve really comes post WWII, in a period after the Great Depression when the propensity to save was giving way to an avarice for consuming. This has wholly flipped. Consumers are saving, not spending, and private business is still not borrowing to invest. The propensity to save lowers yields and flattens the curve.

UPDATE 9/22: Good discussion in The Big Picture over the usefulness of the LEI.  As the chart shows, it has not predicted well during recent bubbles.  It went down during the 1997-2000 tech bubble, and went down again during the 2004-2007 Greenspan bubble. This may reflect a theme I have posted on, that debt-fueled growth is losing effectiveness. See chart here. During the Greenspan Bubble, as an example, we borrowed (private and public) $24T and only got $10T of cumulative GDP growth. In general a lot of metrics developed in the post-war period (after the Depression) may no longer work.

Make It or Break It Point in the Last Chance Rally

Tomorrow at the opening may signal which way this market is going. Neely calls it the "make it or break it" point of the rally, since it has hit the end of his fractal box in both time and level. The STU has two counts, and tomorrow should determine which: 

• if it opens up, we would be in the final wave v up towards Dow10K/SP1100
• if it opens down, we likely have already topped and should fall to retest SP992

This chart from the STU captures their bullish count, and it has been the one I have been watching in my Last Chance posts here and here. This count has us in a minor wave iv. In my Thursday post I was wondering if it would break as a flat or triangle. It appears to have done a flat, with today's gap down at the open the final C wave. If so, it should take off at the open tomorrow in wave v.

This minor wave iv and v will complete the wave structure from early Sept. As seen in this chart, wave i was longer than wave iii.  Normally third waves are the longest and strongest; but the hard rule is that they cannot be the shortest, or the count is wrong. This rule puts an upwards cap on the final wave v: it cannot break SP1097 nor Dow10450. So the Dow can crest 10K but the S&P needs to fall short of 1100. 

Also, in an impulse wave which runs in the direction of trend, either the third or fifth waves normally extend. The extension can be seen as the herd piling on in increasing enthusiasm (or panicking in an impulsive fall). In this case the first wave may turn out to be the longest, which is another indicator that this is a rally running out of steam, not extending with enthusiasm and increasing volume. 

Now, the bearish STU count has a really small i and ii waves, which makes it suspect. An alternative count from Daneric makes wave iii the longest and would permit the wave v to run. Keep this in mind since if we break Dow10K the market may run to the 50% retrace of Dow10.33 and SP1121. 

Cu-nary in the Coal Mine

Copper (Cu) is a great lead indicator of economic conditions. RIght now the China futures contract for Cu is ending a triangle formation (chart courtesy the Asian STU, which is still on free week). Triangles are always the penultimate indicator, so the Chinese futures markets are signaling one final run up in copper, then C U later. This could also signal the ending of the China Boom. Worth watching.

The Shanghai SEE dropped 3% last Friday and was flat today amidst a general Asian selloff. Its wave pattern is a fairly clear and would support a much more vigorous wave iii drop to come. (This is also laid out in the Asian STU.) 

The USD continued its bounce as the Dollar Index may have found its bottom at DX76 last Thurs. 

Cash4Clunker Hangover

Edmunds estimates that car sales will hit a 28 year low this month. C4C drove the only year-over-year monthly increase in auto sales since 2007, and appears to simply have drawn demand forward. Now sales fall faster. The WSJ also reports that Cadillac sales are slow due to a lack of a leasing program. The SeekingAlpha report speculates that a similar fate is about to befall housing as the $8K tax credit has expired along with other mortgage-backed securities subsidies. 

We are coming out of Peak Stimulus, and the downslope puts the real economy at risk of backsliding absent more gimmicks like C4C. Can the economy revitalize with government gimmicks? You think a free market would act this way? No, only the 'sophisticated' imagination of central planners can come up with policy clunkers like this. No, only the 'sophisticated' imagination of central planners can come up with policy clunkers like this. 

Is The Stimulus Working?

I expect the Stimulus to have some impact, and hence believe in a double-dip W-shaped recession: it works but we fall back down when government life support is removed. 

An op-ed this week has thrown the issue front and center: John Taylor and others wrote The Stimulus Didn't Work. Core point is in this chart: consumer consumption has continued to decrease. Taylor shows more evidence that temporary tax rebates simply do not change behavior. Ford did one; Bush did two; and now Obama is doing one (the largest part of his stimulus was tax rebates to people). It takes a permanent tax or income change to change behavior. Oh why haven't we learned that lesson? 

Taylor looked at the Q2 GDP and noted how the largest change came from private investment, not consumption; and yet it is hard to see where any government spending affected that. Instead he attributes it to a snapback from a freefall several quarters earlier. So where the government asserts that stimulus added 2-3% of the improvement, Taylor's model has it less than 1% (which is more in line with my Peak Stimulus analysis). He notes that 1.8% of the 5.4% GDP improvement according to govt stats came from govt spending, of which more than half was defense not stimulus.  Hence the less than 1% estimate. 

The reply from the neo-Keynesians such as Brad De Long was swift. He first oddly enough cited Goldman Sachs for this viewpoint:  

Our second problem with the Cogan-Taylor-Wieland analysis is the absence of a serious attempt to construct a counterfactual baseline – the path the economy or some part of it would have followed in the absence of fiscal stimulus. Analytically, this is a much more serious issue than the lack of sufficient data availability, which will take care of itself. Nobody can know for sure what the baseline is, but it is incumbent on economists claiming either an effect from stimulus or the absence of one to provide some defense of the implied alternative path...

I say oddly since when have econ professors become shills for Wall Street? Not for a while, and not from Berkeley! The Keynesian side has not done this either, and yet made claims of the Stimulus working. The government did do this, and got caught out - see for example this chart on actual unemployment vs. government predictions with and without stimulus, courtesy Innocent Bystanders. Taylor is using the government's own assertions of where the GDP change came from. 

Sigh. Oh for a better economic discourse! 

Brad is unfortunately fiercely partisan, and it makes his commentary highly suspect, especially when it is filled with snarky ad hominem attacks. As an example he states in this post: "right-wing pieces that serve Republican political interests that are published on the Wall Street Journal op-ed page should always be regarded with grave suspicion."

He does state his economic view near the end:

[V]irtually every builder of structural macro models besides Taylor and company (see, for example, the survey Douglas Laxtonhttp://tinyurl.com/dl20090918a) finds that the test of whether expansionary fiscal policy is successful lies in what happens to interest rates: if interest rates rise far and fast in response to an expansionary fiscal policy it is probably ineffective; otherwise it is effective. Interest rates have not risen far and fast in response to Obama policy.

This is heavily ironic since Taylor is the originator of the Taylor Rule of how to figure out the correct Fed interest rate! Or maybe like Muhammed Ali in the Rumble in the Jungle, De Long was right jabbing the champ (right jabs should never work in championship boxing since the distance of the punch is much farther than a left jab, but Ali did it over and over, infuriated Foreman; Ali was treating him like a chump, not a champ. This led to the famous Rope-A-Dope strategy). 

Most of us would see the test as whether the private sector revitalized. Interest rates themselves are enablers; a high rate can stop private investment, but low rates may not restart it. Clearly the consumer is not back, and there is lots of speculation that a sea change of consumer behavior has occurred, making all those vaunted models worthless. Despite the snapback in private investment, private debt continues to drop (see chart, courtesy Thought Offerings. 

Government debt to fund the stimulus is filling the gap, and in a second delicious irony may be crowding out private borrowing. This deleveraging is of course deflationary, and should keep interest rates low. De Long gets his low rates while things fall apart! Three cheers for Keynesianism and snarky tenured professors!

S&P Grossly Overvalued

This bounce off the March low has gone faster and farther than other such bounces, and has run the S&P back into bubblicious territory.  Today's Breakfast With Dave lays out how bad it is: 

• 60% rally where 2.5M jobs were lost; the Mar03 rally came with 1M jobs created
• 26.5 trailing P/E based on operating earnings.  It was 18.8 at the Oct07 high
• 184.2 (!!) trailing P/E based on reported earnings.  It was *only* 23.4 in Oct07, and a meager 20.3 in Oct87 before the crash
• 53 P/D (price to dividend), same as Oct07. In Oct87 it was only 12

Now, historically a 26 P/E is followed by a 60% decline in the following year. And a 180 P/E is ludicrously high - so high that many bullish pundits dismiss it as an artifact of a FASB rule change. Instead they look at forward earnings estimates.  But they tell an equally dim story:

• 15.7 P/E on forward operating earnings. It was 14.3 in Oct07, and 14 in Oct87

In order to believe in this market, one needs to believe in a robust V shaped recovery of over 4% annualized growth. Dave goes on to look inside the recent Philly Fed industrial indicators:

• prices paid rose 5 pts, but prices received tanked 9 pts
• new orders edged down
• inventories fell a lot (so much for a need to restock after C4C)
• employment declined
• the six-month outlook declined to below 50, the lowest since last April

Now, the Philly report showed a good increase in manufacturing, rising to 14.2 from 4.2 in August, and this has been read as bullish today. Dave however hints that the upcoming ISM survey will actually show a drop from 48.9 to 47.5. We shall have to wait and see, but that in itself could spook the bulls since it makes their greenshoots begin to look brown. 

Technically, the market is over-valued. The blogosphere has lots of bulls dismissing this and finding other measures of under-valuation. To their credit, volume "exploded" today (the words of the STU tonight) on options-expiration Friday. To support a bullish case, breadth (which was neutral today) and volume need to strengthen. What the bulls have a hard time overcoming are indicators like the Daily Sentiment Index, which is at the bullish extremes found at tops. Also, today was a reversal day of a number of trends: gold down, Dollar up, Shanghai SEE down over 3%.  

Hence the risk is high that some form of a pullback is ahead. Seasonally the time around the Autumnal Equinox (Sep22 this year) is often a turning point. With the SSEE down big today, a continuation Monday (Sunday in the US) could presage a downturn in equities and an upturn in the Dollar. 

Fed Repairing Its Balance Sheet: Not Inflationary

A lot of pundits expect inflation due to the Fed's moves to provide liquidity. Since banks aren't lending, this potential high-power money does not come into the money supply. In addition, velocity of money has been slowing. No surprise that we have been in a deflationary environment for a year. 

Yesterday the Fed released data on what reserves they hold. As you can see, the overall level of reserves has been flat for a year. Bernanke applied the Bagehot Remedy a year ago to stem the crisis, and in the process swapped solid reserves (Treasuries mostly) for all sorts of questionable paper held in the Maiden Lane structure. Since QE was announced, the Fed has been swapping out of those poor reserves and back into solid reserves (Treasuries again and govt-backed mortgages and agency paper). This chart shows how substantial the reduction has been in the Maiden Lane stuff. But the Monetary Base has remained flat for a year, and you can check out M1 and other money indexes as well. Not inflationary. 

Rather than being inflationary, this should have the impact of solidifying the quality of the reserves and therefore (eventually) the USD. The DX has bounced for the past two days on increasing volume, which might mark the Dollar Bottom, but it is too soon to confirm that. 

Providing liquidity after the secondary crisis after a credit bubble ("secondary" means not the stock market crash, but the inevitable banking crisis which comes after, which came in 2008 after the 2007 peak, and in 1931 after the late 1929 peak) is not inflationary; it is necessary to ameliorate the damage of the credit collapse.  

Yves on a 1987 Setup

We have run a series of historical comparisons, primarily to 1929 and 1937. Now I am seeing comparisons to 1987. Yves published an interesting piece over at Zerohedge and I asked him to focus it for this site, particularly on the 1987 comparison. 

Back on Jun19 Yves posted a guestblog on how the greenshoot-fed bull market was dying, and recommended a move into bonds. Rates have dropped and bonds have done quite well over the past three months.  His count for the long bond is attached.  He asks rhetorically: if bonds are in their strong wave 3 move up, what does that imply for stocks? Will the hot money roll out of equities into bonds? 

Here is his take on the Dollar and how it drives stocks and bonds right now.  Where this leads is to another rhetorical question: are we about to repeat 1987?

The Problem With Competing Views

US dollar bears should take notice of the great correlation between global liquidity annual change rate and the dollar index. We view this big drop as a positive development for the dollar. It is tempting to get on board with  talk of the greenback going into freefall. However, if taking a look at the graph one can reflect as to the big picture in the making perhaps then you can arrive at a different set of conclusions. We stand in the deflation camp and have been accumulating long term Treasuries since June. Our behavior is very similar to primary dealers, as discussed in my Zerohedge piece.  

The problem with competing views is that the bond market looks out to the medium and long-term horizon while stocks today are mostly concerned with the day-to-day fluctuations. If you were confused, you were not alone. Investors needing to be protected are pushing managers and advisers to invest at all costs if not beware. The fast move up in equities makes you react the same way as when a drop occurs. You behave out of fear.

There is no doubt that a bull market of regrets will ensue. 

This market looks like the setup in 1987, where the Dollar had just dropped in half in 1986 as part of a coordinated worldwide effort. Just compare our current market (first graph) with 1987 (second graph) and what might be next (third graph).

Yves Lamoureux, Investment Advisor, Blackmont Capital inc

The opinions contained in this report are those of the author and are not necessarily those of Blackmont Capital Inc., nor Yelnick. Every effort has been made to ensure that the contents of this document have been compiled or derived from sources believed to be reliable and contains information and opinions which are accurate and complete. However, neither the author nor BCI makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use of or reliance on this report or its contents. BCI is an independently owned subsidiary of CI Financial. CI Financial is a Canadian owned diversified wealth management firm, publicly traded on the TSX under the symbol CIX. Blackmont Capital Inc. is a member of CIPF and IIROC.

Last Chance Trading Update

For those of you who are shorter-term traders, there is a growing chance the market is about to top, at least for a deeper pullback then we have seen for a month. I mentioned in the Last Chance To Get Out post that we appeared to be in a final wave pattern up, which was breaking into five smaller waves: 

This morning the little wave ii had a continuation, then the wave iii was the strong rise during the afternoon. Perhaps a wave iv pause tomorrow or Thurs, then a final pop up. If this wave structure is correct, the market could meander up to the autumnal equinox of Sep20, this Sunday; meaning topping Friday or Monday.

On schedule we had the wave iv pause today. It looks like it is not over, since only a down-up so far, and needs either a final drop (if it breaks in a flat) or a down-up-down sequence (if it breaks as a triangle).

Treasury Yield Dive Signals "Barbell" Market

Treasuries are rising as yields plummet. This is leading to a barbell market: gold-and-Treasuries, and is bad news for investment in venture capital and private business. It may presage the next phase of the crisis, just as Bernanke is declaring victory.

This chart is from tonight's STU, which commented: "Short term yields were plunging last fall, even briefly turning negative last December, as investors clamored for “safety” in the wake of the vortex of selling pressure throughout the stock market. But that’s not what is occurring now in stocks, as prices persistently rise in Primary wave 2 (circle), the big bear-market bounce. We are not exactly sure why short-term government paper is plunging (yields), but it does bear watching since a slew of investors (or an investor with “big money”), for whatever reason, want to be safe and liquid."

One possible explanation is the big Treasury buyers (China, Japan) swapping out of long-term to short-term notes, driving down yields. This reflects a heightened fear of a US Peso meltdown, which is still underway. The Dollar Index keeps breaking below supposed support levels, with DX74.50 the next stop before testing the all-time lows around DX71 from last year. The STU notes that we need a bounce back above DX78.70 to confirm a rally.  

David Malpass thinks he knows the odd market dynamic that is developing: a barbell market where investors are hedging against both deflation and inflation by investing at both extremes (eg Treasuries and gold) - a barbell trade to coin a new term.  (If you are not familiar with David Malpass, he was a long-tome economist at Bear Stearns and former senior official at Treasury. He is one of the most astute commentators on the big picture.)  He explains:

We think the Fed is in a box of its own making. By denying the connection between dollar weakness and inflation (Chicago Fed President Charles Evans didn’t mention the dollar in his detailed September 9 speech on inflation), the Fed undermines its credibility. This allows market momentum to create dollar weakness to test the Fed’s limits. The euro at $1.60, $1.80, or $2.00 would probably mean oil at $100 or $120 per barrel, quickly pushing CPI inflation above 2008’s 5.6% rate.

By giving no confidence in the dollar, the Fed is inviting a circular dollar crash. The weakening dollar pushes capital away from the U.S. The resulting economic weakness invites the Fed to keep interest rates low, bringing more dollar weakness and U.S. underperformance.

My perspective is that the crisis is now entering a new phase. The first phase was back in 2001-2, where Greenspan was so worried over deflation he reflated the economy by lowering rates and holding them down too long. He specifically was trying to hold off a Kondratieff Winter (his words). In doing so he created what I call the Greenspan Indian Summer, a false period that led to an even bigger and worse type of bubble. Technology bubbles like 1995-2000, or the auto bubble in 1915-1919, or the two RR bubbles in 1873 and 1893, are primarily investment bubbles, leave behind an asset of great value (RRs, roads, internet) that provides a foundation for future growth. Credit bubbles like Greenspan created and like we had in 1925-29 or 1830-35, are primarily consumption bubbles, and simply pull demand forward from the future without creating a foundation to pay off the excess debt. It must be written off, and that creates a terrible deflation and depression. The Greenspan Indian Summer doubled US Dollar debt from $25T to over $50T in five years, and yet only bought us a cumulative $10T increase in GDP, leaving a $15T or higher debt overhang that must be repaid or written off.

The second phase of the crisis we just lived through. Bernanke applied the Bagehot Remedy (named after Walter Bagehot, the editor-in-chief of the Economist, who proposed it in 1873 at the beginning of what was soon to be called the first Great Depression) by providing liquidity to avoid runs on banks. It worked to stabilize the situation, whereas TARP did not nor was it used for the purposes intended. Despite the stabilization, governments around the world coordinated an historically unprecedented stimulus. (Japan had stimulated excessively after 1989, incurring eventually $6T of additional debt and pushing debt:GDP to well above 100%, to little avail except to put the economy on life support; but this was not a worldwide effort.) 

This stimulus must be expected to have an impact, and a consequence. The impact appears to be a rise in GDP that showed positive in a few places last quarter and should show positive in the US this quarter (Q3). I expect Q4 to be up as well, and maybe Q1, but doubt it sustains any longer. 

The consequence of the stimulus leads to the third phase of the crisis. Equities are meandering up, and the little guy (the retail day trader) is jumping in strongly right now. This might continue well above Dow10K and SP1100. But the massive stimulus is fundamentally being sold as "something for nothing": the debt incurred will be made up by a revitalized economy. History teaches that one can delay the inevitable consequences of a credit bubble, but cannot avoid them; and the delay just makes the inevitable much worse. We already see that with how the Greenspan Bubble was much worse than the prior Tech Bubble. 

So the powers-that-be are conducting a huge experiment with history, and we are the petri dish. The first experiment by Greenspan failed, and now they are doubling down. 

The consequence of the Stimulus is the drop in the Dollar. At some point it must be supported or the world economy will spiral out of control, and those positive quarters will begin to evaporate. Simply put, commodities go way up again, oil gets expensive, and financing the huge future US deficits gets even more problematic. 

The barbell trade described by David Malpass - swap into short term Treasuries at one end and gold/commodities at the other - is terrible for the US, whose economy will be squeezed from both ends. Capital flows to the wrong places (government debt and commodities) and away from investment in the future. Already we see that the stimulus has NOT helped private investment or consumption: consumer credit is falling, private investment is falling.    

The next shoe to drop is probably raises in foreign interest rates, putting even more pressure on the USD and the financing of the US deficits. It does not help the US to finance with short term Treasuries (two years or less) as they are likely to roll over at much higher interest rates.  

China Bubble Update: Free Week!

For those of you following the China Bubble and the Shanghai SEE, EWI is offering free access to their International updates. You may need to be a subscriber to one of their US services already to see it.  More info here.  At least, you'll see some free reports to explore.  

During FreeWeek, You Get Access to 2 of EWI's Top Services...

(Sun, Tue, Thur)	Asian-Pacific Short Term Update | What's Inside?  Every Sunday, Tuesday, and Thursday in the Asian-Pacific Short Term Update, you will get updated analysis and price charts for these key markets: Japan Nikkei 225 Australia ASX200 Hong Kong Hang Seng India S&P Nifty Singapore MSCI Singapore Taiwan MSCI Taiwan South Korea KOSPI China Shanghai Composite
(Mon, Wed, Fri)	European Short Term Update | What's Inside?  Every Monday, Wednesday and Friday in the European Short Term Update, you will get updated analysis and price charts for these key European markets: Germany's DAX stock index Britain's FTSE-100 France's CAC40 The Netherlands' AEX Switzerland's SMI Spain's IBEX 35 Italy's S&P/MIB Eurozone's Dow Jones Euro Stoxx 50 Russia's RTS

Last Chance to Get Out?

The market is poised to rollover. This chart from 1930 (courtesy EWI) shows how we have traced back to the same area of the end of the rally in 1930: the 'fourth of the prior third' of the big drop the prior Fall. The 'fourth' is a bounce after a deep fall in the third wave; the psychology is that this where a lot of folks bought into trying to catch the bottom back then, and got caught out; now they are given a last chance to bail out and recover their paper loss. 

Will they bail? Right now insiders are selling, institutions are lightening up - and the poor sap retail investor is jumping in. A perfect time for the smart money to get out! 

If they do, this rally stalls and down we go. If the little guy jumps in enthusiastically, the smart money will steadily sell into him, and the market could continue a slow creep up towards Dow10K. Watch the arena the small guy tends to ignore, Forex: a Dollar reversal signals a Dow top.   

The S&P has already gotten to the fourth-of-a-third level; the Dow got right into the middle of that range today at 9714, right between 9654 and 9794. This morning the little wave ii had a continuation, then the wave iii was the strong rise during the afternoon. Perhaps a wave iv pause tomorrow or Thurs, then a final pop up. If this wave structure is correct, the market could meander up to the autumnal equinox of Sep20, this Sunday; meaning topping Friday or Monday.

It is a bit disconcerting to watch volume be so light, even after the pros returned from the four day week last week. Even in Forex we see lighter volume, with the USD dropping but an end nearing. This lighter volume is a validation of a topping market (and bottoming Dollar). 

The edginess is a reflection of a brewing lack of trust. The Obama Bubble burst in August, and seems unrecoverable. He just had his little 'wave 2' rally, and it was brief. A populist rally surged into DC on 9/12, and was barely reported despite having at least half a million protestors (estimates range broadly; see photo for your own estimate). What can the public do to grab the attention of these leaders and get them to wake up? Their edginess is shown to be impotence, and is turning to anger. Not a mood to drive a rally! 

This edginess has a simple cause: unemployment is worse than the official figures say. The reported 9.7% is people receiving unemployment benefits over the presumed labor force. Most people know that 9.7% understates, since many of the early unemployed are no longer getting benefits, and many others have taken part-time work and dropped off benefits. Perhaps most telling is the calculation of the presumed labor force is itself suspect. The Labor Dept has birth/death adjustments which skew the whole analysis.  

Here is a simpler chart: employed over population. It tells the story: employment peaked in 2000 and has dropped since; currently it is falling off a cliff.

These charts and a lot of concurrent analysis was released today in Prechter's monthly EWT. Worth reading. He notes in several areas, such as real estate, the private economy is NOT coming back. Again, the populist anger emerges when people see this around them. 

The now famous Congressman who broke protocol and shouted out that Obama was a liar caught the popular mood: who would you want us to believe, Mr. President: our eyes or your lies? I hear he is raising record amounts of campaign money from small contributors. People are voting with their pocketbooks, and it is not into stocks, nor into the economy, but into a popular revolt against the faded icon of Hope and Change.   

Slow Roll, so 1938 Yet Again

Markets appear to be meandering to a top.  Given that we should have seen more volume last week and this, the market is showing signs of exhaustion with this rally rather than conviction in a new direction. The biggest 'news' is the brewing trade war between the US and China, with China firing back against our tire tariff.  Obama is taking some flak from the left, for example Brad De Long, a Krugmanesque cheerleader for ever more stimulus and one of the leading neo-Keynesians on the Left Coast (he is at Berkeley): 

"Why oh why can't we have better Democratic presidents? 

Barack Obama does something stupid."

So is the market climbing a wall of worry or just waiting for news?  Cannot say from the myriad of opinion as to fundamentals.  Wave count is a bit more illuminating.  The STU count is that we are in the final throes of this rally: the final fifth wave of the final C wave of the second zigzag (and presumably the final zigzag).  The fall Friday and the gap down this morning were a minor wave ii and we now have started wave iii, which means tomorrow may be a robust uptrend. They would like to see the Dow get above 9654, the 'fourth of a third' level (which the S&P has already beaten). The S&P is approaching a resistance level (trendline) of SP1057, which is increasing by 2 pts a day. A break above that suggests we continue up to the 50% retrace at 1121. The Naz is already above the 50% retrace, and is approaching the 2106 level, which makes the second zigzag at 61.8% of the first, a common relationship.

Slope of Hope reports that the Russell 2K is also at 50%. As a bear who misses last year, he is reacting to a general belief that we are about to fill that drop a year ago with a similar air pocket up in the S&P to catch up to the Russell 2K and the Naz. He explains why a drop can fill a gap but seldom a rise (fear outstrips greed).  

Neely is watching his fractal. The S&P is about to hit the outside time window, which could spur a drop. Ideally it should hit SP1075 (cash) about at the end of the window. Neely trades futures, and he is watching the Dec S&P, which is lower than the cash close. His service has specific future levels with stops for those who wish to trade.  

The US Peso bounced today, and oil fell back below $70. Gold is back near $1000. The SSEE (Shanghai) got back to its 50 day moving average and is now above the 3000 level, while the whole rest of Asia was showing red.  

Evil Speculator had yet another 1938 comparison where he compares the initial drop off 1937 and bounce with the drop in 2008 and bounce. He notes that this is the C wave of a flat off 2000 (his count) whereas that was an A of a zigzag. (In general, the first leg of a zigzag is the most intense, whereas the final leg of a flat correction is the most intense.) The fractal comparison is intriguing.  See charts, courtesy Evil Speculator.  

Play Global Remembi: Dollar, Gold, Treasuries

A big-belly politics game of rochambeau (the game paper-rock-scissors, but it has another meaning) is brewing in global markets. The Bank of China said that "the real economic crisis is just starting." The US just imposed stiff tariffs on Chinese imported tires - this just before the G20 meeting. China continues to call for an alternative to the USD as the reserve currency, and continues to encourage accumulation of gold. Data from China suggests they really are on a recovery - permalink here but it may be broken or hacked/see Sept 11 post at that site - but the stimulus-driven recovery is making China more dependent on the US, not less. 

This suggests to me a continued meandering uptick in the market into the G20 meeting in two weeks, and lots of maneuvering in the background.  A breakdown of G20 concerted action could then cause a rapid movement of hot money out of current investments. 

The key to all markets remains the USD.  This chart from the Friday STU shows how the Dow and Dollar have been in an inverse dance.  Another good chart is here.  The wave pattern of the USD says it is in a final move down, a fifth wave out of a triangle.  When it ends, there should be a strong reversal of fortunes, with the US Peso coming back strongly.  A framework for thinking of this is that the rally has caused a return to risk, including in emerging markets; and a strengthening USD will signal a return to safety. Fear of a trade war would cause sentiment to reverse.  

Back to the Future: 1938 Again

We have been following several historical analogies, including 1929 and 1938.  You might recall that as the market was bouncing off the Mar6 low, the STU commented about how the drop into that low was a truncated fourth wave, a rare event that also was seen in 1938, and the bounce off was matching 1938 pretty closely.  We have now meandered beyond the time of the 1930 retracement, which took five months, and are heading towards the 1938 retrace, which took eight months.  This chart from Market Mike updates the analogy to present.  Daneric also is looking at it, and found an interesting fractal today and back in '38.  Worth looking at: his fractal says we are peaking right now.  

The strict analogy suggests we peak in early Dec. (1938 ended on Nov14, but the rally started in late Mar).  A simpler analysis says we peak around Oct10: often a double zigzag correction will have equal time between the first and second zigzags.  In our case the first W wave went from Mar9-Jun11, and the second Y wave started on Jul9, pointing to Oct10, ominously the anniversary of the 2007 peak.  Since Oct10 falls on a Sat, this means Oct9/12 or thereabouts. 

In the near term, we are at a turn window, which extends into Wed next week.  Market may be rolling over; we will know a lot more next week, assuming volume picks up.  As I have mentioned, it is unreliable to extrapolate from the low volume around a four-day trading week.  Friday's STU noted how both advance/decline ratio and up/down volume has been declining.  We are also seeing divergences, such as Utilities not confirming the move.  The China SSEE remains down from its August high, as is the Nikkei. We might see a pullback, but if the analogy holds, it will not mark the top, but may mark a plateau or topping pattern bopping along the SP1044/Dow9700 level.    

Dow 10K in Sight

 We still haven't breached the Aug28 highs in the Dow nor S&P, but have in the Naz, and seem likely to in the major indexes as well. Volume has been remarkably light, 40% below average, so as discussed yesterday, the market action may be misleading, and momentum indicators are weakening not strengthening.  This chart from Contrarian Advisor paints us in a triple top around SP1038 since Aug24 - a big fat trading range, or in Zoran parlance, a plateau after the thrust off the Aug18 low. "Action is neutral, and volume is bearish." As you can see the MACD is turning over. 

The rate of decline has slowed enough that both major pundits, Prechter and Neely, expect higher highs ahead.  Neely is using a fractal based on the price action last Nov to Jan & the time action since, which suggests an end to this rally within a week or so at a level of SP1080 or thereabouts.  The STU is using normal levels of retracement, with either the "4th of the 3rd" down or around Dow9700/SP1044, or the 50% retrace, or Dow10330/SP1121. (The Naz is right at the 50% retracement level.)  Walter Murphy in contrast is watching SP1053.  He sees the move as corrective, possible a diagonal triangle, which is an ending pattern that is usually followed by a fairly violent reversal (in this case, down).  Daneric has a detailed chart of a possible ending diagonal.  He is looking for a pullback to SP1016 before the next move up.  He expects a pullback tomorrow.

If instead we decline below SP992 then the case for an Aug28 top is much stronger.  

What might drive that fall?  A real bottom in the USD.  Right now it is ratcheting off that lower wedge line (see yesterday's post), hovering around DX77, with negative sentiment piling on.  Fibonacciman has bailed on the USD, expecting a drop to DX75 +/-, and says to kiss goodbye the deflationary depression! Others have predicted a drop to DX71. Whoa! Wave structure however suggests a lesser fall. We broke out of a fourth wave triangle at DX78.70, and are in the thrust down, which should be over quickly. A return above that level means we really have bottomed.  

In addition, a plethora of timing models peg this weekend as an important turn date.  The turn window begins Sep10 +/- a day according to Peter Eliades, and extends to the dreaded Lehman Anniversary of Sep15. Gann noted how such anniversaries had an impact on market psychology. Of course in the middle of this turn window is 9/11.  

Hence, whatever the market and USD are about to do may happen within the next five trading days (the four day turn window plus the day after, since the turn may only be clear the day after a top).  

For you goldbugs, this also suggests the gold rally is about over.  It too thrust out of a triangle, in the reverse direction as the USD.  That spike to $1K is likely more related to USD weakness than gold strength.  

Equities can be seen as inverse to the USD. As explained before, commodities and US equities can be seen as a hedge against USD weakness, especially by buyers in foreign currency who take the forex risk. A bottom reversal of the USD will likely signal the top in equities, gold and commodities. I lost my Dow10K bet in time (maybe I should have pegged Sep20 as the end of summer, not Aug31!); if the USD bottoms within a week, I may not see Dow10K for a while, as this puppy may go to only a sightly higher high. 

Watch the Dollar, not the Dow.  

Yankee Curse Day

These are certainly interesting times for US markets. Today was a plethora of mixed signals. 

Equities tantalized by jumping to the 62% retrace and hovering there all day - a break above is bullish. The Trannies went mild - Dow Transports did not confirm a bullish trend. Yves posted at Zerohedge on unusual bond behavior - spreads have narrowed but Treasuries are still being hoarded, suggesting a rate drop and bond rise - wave 3 up of bonds! Gold broke $1K and the world didn't fall apart. The USD fell, with the Dollar Index (DX) breaking 77.50, a key level, blowing the wave count. Is this now the Dollar Break that drives the US Peso to DX71? Or as Nathan's chart points out, is it touching the bottom of a bullish wedge and will bounce?  

Dollar Break, or Dollar Brake?  

Finally, Robin Landry weighs in on timing, noting the 38% retrace in timing from Oct 2007 to the Mar 2009 low is Sep11 (closing high) and Sep14 (intraday high): this Friday and next Monday.  Is the market still in a summer slumber?  Next Monday may tell.  

Doug Short on the 1938 Comparison

I thought I would continue in the theme of historical analogues to the current market.  This seems like a good moment since we are in a slow patch: volume dropped late last week as the Labor Day weekend loomed, and is expected to continue light this week as it is a four-day week in the US.  (Typically four-day weeks have light trading and a slight upwards bias; note that typically the market is in an upwards bias 80% of the time.) Hence the technical indicators can mislead.  Friday was a mixed set of signals. Let's wait for a pick up of volume and clearer indications of whether this rally is truly over or has a ways to run.  

In US history this is the fourth Credit Bubble that seems destined to be followed by a Deflationary Depression.  The other three were 1837, 1873 and of course 1929.  We also have the 1989 Japan Bubble to consider.  The first chart is from Doug Short's great site and shows how the current market compares to 1929 and 1989 when you inflation-adjust the results.  The timing between 1929=2000 and 2009=1938 is intriguing.  It would suggest a lengthy down period but not a deeper drop than around Dow6K.  Since 1929 continued after 1938 to a lower low in 1942, this suggests the bottom would come sometime in 2013. 

Will it take a war to turn things? A similar bottom in timing was seen in Japan, but they also bottomed again 20 years after, and have not yet broken out; no war for them, only the Greenspan Indian Summer, which pulled their economy up amidst the global credit bubble.  For the US, even with the war, a good argument can be made that the Dow did not break out of the Depression Doldrums until 1949, or 20 years later.  This would peg our bottom at 2020.  Or after if we fall into the Japanese interminable funk.

Much of what I read tries to assess this crisis as if it were a "normal" albeit deeper recession.  In between the four depressions, we have had a lot of recessions and panics, but there is a fundamental difference between the setup to a recession and the setup to a depression:  a recession comes from excessive inventory and is triggered by tightening, whereas a depression comes from excess credit and is caused by loosening. I like to put it this way: 

• Before a recession, people borrow to buy forward, but are careful to stay within expected future earnings - they borrow against income.  When the recession comes, they can cut back and continue to cover their debt.  They ride it out.
• Before a depression, people borrow much more aggressively, and the bubble spurs them on - they borrow against asset appreciation.  In the '20s, it was against stocks; in the '00s, it was against houses.  When the bubble bursts and the assets drop in value, they are trapped  Their income is insufficient to carry the debt, and they get washed out.  

Which one sounds like today?  

Before the modern management of the economy that came with Keynesianism, recessions were relatively short - under a year.  After the Keynesian belief in managing an economy, recessions have lengthened, but not by much  The normal economy has enormous recuperative powers, especially if left alone.  Excess inventory is cleared out and the factories run again.  During the Great Moderation (1982-2007), we only had two recessions. Before that, we had them around the same frequency as prior to Keynesianism. (Thanks go to Milton Friedman for that, or Alan Greenspan.)

In contrast, after a credit bubble, the depression seems to last around 40 months. The 1837 one ended sometime in the early '40s; the 1873 one ended within four years.  The 1929 one bottomed in 1932. The troubling question is why we fell back down in 1938, and why has Japan never left theirs?  The major distinction between 1929/1989 and prior periods is the massive intervention of the governments to solve the problem.  Could it be stimulus extends the disaster rather than ends it?  We shall soon find out.  

Our current problem started in Dec 2007, and 40 months later would peg the end around 1Q 2011. We shall see if the massive interventions get us out early, or extends the disaster to the end of the next decade.  

One thing should be clear: we are not about to start a new bull market, even if this bear market rally extends for a number of months up towards the 62% retrace (over Dow11K and SP1200). Among many other reasons, consider this other chart from Doug Short. The recent bottom in March was not even close to a level that is a lasting bear market bottom. This chart uses the Shiller methodology to compare P/E ratios to E10, the moving average earnings over the past 10 years. Bear bottoms come with a single-digit P/E10, as low as 5 in 1921 and 1932. We touched 13 last March, not that close to a bottom indication, and have since bounced back up, approaching 20, a level which normally signals trouble ahead (overvalued). In 1938 we got down around 10, and in 1942 below 10. The lasting bottom in 1949 was at 9. This suggests the market can fall another 50% before we approach a lasting bottom.  

In the meantime massive stimulus is rolling over. The grand experiment is ending. Welcome to the petri dish!

Russo on How Low Could We Go

This blog has shown historical comparisons for guidance, to 1938 in particular, with 1929=2000.  Another way to look at this is to consider the huge Auto Bubble in 1915-1919 as the analogue to the Dot-Com Bubble from 1995-2000.  The Dow fell 72% from 1919 into the early '20s before we ran up in the second bubble to 1929, on a similar time frame to the drop from 2000 to 2002. 

What if 1919=2000, and 1929=2008?.  Joe Russo adds to the speculation by overlaying where we would be right now with 1929-1932=2008-2011. 

Intriguing is that it ends smack dab in the range of the 1987 crash (Dow 1700-2200).  A common relationship is for the bottom to be in the range of the 4th wave of the prior 3rd wave, which the 1987 crash represents.  

Russo goes on to show his long count, which characterizes the current corrective pattern as a large triangle.

Now, historical analogies only go so far, and it is an extreme leap to extrapolate from one data point (the 1919/1929 analogy).  Nonetheless, it is striking how our bounce from March to August mimics the similar bounce from Nov29-Apr30. 

Yves on Gold Panic UPDATED

I don't follow gold much, not being a goldbug and finding a lot of the gold commentary at the fringe of financial sensibility.  And the ads for buying gold on talk radio are almost as annoying as the Technorati 'teeth' ads you see on a lot of low-traffic web/blog sites.  

Sure, a return to a gold-back currency would right a lot of what is wrong with the economic ship of state, but it is not in the cards right now, despite a push by China and the BRIC nations for it, and the rumors of a November deadline looming for China to continue to buy Treasuries.  (If I were Bernanke, I would call their bluff on that.)  

But sometimes gold as a trade gets interesting, and we may be at such a moment.  Yves sent me the attached chart with a few comments.  His fundamental view is gold should drop due to deflation.  If you doubt deflation is with us, check out the second chart in this recent post. 

Yves' chart suggests a wave 3 UP is upon us, gold having run up a bit already today. Similarly, the Prechter view is a serious drop in gold as deflation picks up, but their wave count also suggest an UP wave right now.  The STU on Monday showed a chart of an ABC correction in gold with an alt count of ending a triangle B wave, and now starting a sharp spike up in wave C.  A break of $972 confirms that gold will run fast towards $1050-1100/oz.  We got to $955 spot overnight, and over $978 in Dec gold futures today. Neely has had his aggressive traders in gold, and is now lightening up a bit, but also expects the run to continue in a gold panic, a "feeding frenzy" as the goldbugs rush in to avoid missing the big move.

(Note: in markets, there is not fear and greed, only fear; greed is fear of falling behind.  A buying panic is a moment of fear.) 

Now, normally the USD and Gold are inversely related, and the USD has been in a bottoming process rather than a fall, with an upwards bias; yet gold is spiking.  Question is where is it coming from? Sentiment for gold remains essentially neutral.  

Let me speculate that it is coming out of Asia.  The China Bubble has burst and the SSEE is down around 25% in a month, with apparently more to go (at least below 2000 if not down to 1000, where the parabolic rise began).  The Chinese government has been buying gold for the past six months (at least), and I suspect the middle class in China is rushing in for a safe haven against the equities collapse and likely real estate crash to follow.  The recent rise in Copper may also have the same roots, of China rolling its long-term Treasuries into shorter terms, and then stockpiling commodities, including gold. 

UPDATE 9/4:  It appears China is encouraging its citizens to buy gold!  Presumably preparing them for the day they try to move the world off the USD into a new reserve structure partially backed by gold. 

Whatever the cause, the wave structure is predicting a gold buying panic that will drive gold over $1000. Watch and see if it is correctly gauging the psychology of a buying panic.    

Stocks at the Edge of Chaos

Ilya Prigogine, Nobel Chemist and one of the foundational thinkers of Chaos Theory, believed living systems were their most efficient at the edge of chaos, at the border between predictable and unpredictable. Seemingly random or chaotic systems are constantly seeking an underlying order, which causes them to self-organize.  This process has a common fractal, of a plateau at the edge of chaos, followed by a thrust in the direction of order.  When the new order emerges, the system bifurcates into one or another direction.  

The chaos is clearly reflected in two contrary views: the V shaped recovery is at hand, vs. is it a False Spring?, both from the same site.  Similarly, I have been following the China Bubble collapse (just scan down to prior posts), and note that after a sharp thrust down and a plateau, it has continued down, falling almost 7% yesterday with a very minor pause today.  Bargain hunters are preparing to go back in, and yet this report sent to me by one of my readers should chill them: despite the purported GDP growth, internal Chinese rail traffic was down in 1H09.  It is as if the China Transports are de-confirming the China Dow. Bad joss, as they say in Hong Kong. Arguments that the Stimulus Bill somehow got a $13T economy back on track should ponder the attached chart, courtesy Seeing Alpha. The actual fiscal stimulus is trivial.  

Thus we see the edge of chaos as the confusion over what the stats foretell. If the China Bubble is what pulled up Europe and made the commodity countries like Australia look like they avoided a recession, the expected end of the China stimulus by year end, as is being "predicted" by the fall of China's equity markets, and the peak of US stimulus, which is occurring right now, should give the bulls pause.  

The markets themselves can give us guidance as to which direction the plateau is about to head. If the drop down continues with the same or more speed as the rise up, and breaks below the trading range of the plateau, we have bifurcated down off the plateau and will drive lower.  

The past rally can be seen as a thrust off the low in Mar with a plateau in August. The trend has clearly shifted downward. The risk of buying the dips right now is huge; better to stand aside until or unless this downtrend slackens beyond the downward slope we are watching. That slope is the trend up from Mar9 to the recent top, the Thrust off the low. Within that Thurst we have fractals of smaller thrusts and plateaus.  We have blown past the first such plateau to confirm that this downturn won't be quick (the SP1016 level mentioned in my prior post.); and we appear to be in thrust down to a new plateau. If we now break SP978, we have broken out of the next fractal plateau, and the market should then run below the Jul8 low towards the the lows last March and Nov.

In ewave terms, we had a nested pair of down-up 1-2 waves, the first on Friday and the second on Monday (which covered a gap left in the downdraft in the morning). The drop this am is a minor degree "3 of a 3" meaning the strongest thrust down of this pattern.  

In the meantime a whole series of prior investment positions are unwinding. The USD seems *finally* poised to run up. Treasuries are strengthening.  Both show a return of risk aversion, perhaps sparked by the China drop and the Japanese election, where the new party is anti-US and anti-Free-Market. Continued bank failures and the shocking weakness that remains in the US banking system suggests that credit spreads will now begin to widen. Oil broke an important level today, and should drop faster, along with other commodities. 

Perhaps most significant is that the start of the new month did not bring a rally, a new surge of buyers. It appears rather that selling pressure is increasing.  Stand aside and watch the slope of the decline.