Planet Yelnick

Explaining Why Retail is Up When Sales Taxes are Down (Hint: Retail is Survey, Sales Tax is Real)

A Recovery Conundrum: retail surveys say up, tax collections say down. Excuses were made, that Walmart results weren't included, or that better results would come in Dec or Jan.  No dice, Walmart reported weaker holiday sales, and Dec retail sales fell. 

A second shot at this: unemployment is up but the employed are spending again. A Tale of Two Economies. No dice. They would have to be spending a lot more to make up the huge drop in employed, down 8.4M; or to use the broader measure of unemployment, a 17% unemployment rate. This argument is made even more implausible by the dramatic increase in savings.

Mish explains all: the retail data are based on bogus surveys:

The published numbers are based on "same store sales". Think about all the companies that have gone bankrupt. Take Circuit City for an example. Gone. The doors are closed. Some of those shoppers went to Best Buy where same store sales rose.

Also remember that Best Buy and many other chains closed weak stores. The result: same store sales went up again.

Government methodology for reporting retail sales is based on sampling stores in existence. It does not factor in stores not in existence but recently were. Nor does it handle closed stores when the chain is still doing business.

Believe the sales tax numbers. They are real. As of Nov 2009, no State had any growth; as of Dec, 13% had growth (I guess that means 7 if DC is included), but this does not include big States like NY and TX. This might include Cal in the growth side, but it doesn't help - Cal raised its sales tax rate which increased receipts, but underlying sales were down.

Hard to have a real recovery when home sales are down, car sales are down (ok, blame Toyota and weather), and retail is down.

Weekend Thoughts

We have seen drama at the turn of the month, so if this continues the first few days should be up. We have also seen a Monday Pump, but recently it has been arbitraged into a Friday Anticipatory Pump, which happened today. So I anticipate a quick pop in the new month, but not more than a week. 

Overall the market is meandering, and until the down move turns out to be slower than the prior up move, we are still in a down trend. That "fall line" is still above 1130 right now. 

If you follow Neely, he is clear on this: the drop off the Jan high has been faster than the rise up, and the recent counter-trend move has taken about the time of the drop, but gone much less. These add up to: trend remains down. 

Curiously, Tony Caldaro has moved to short-term bullish, and seems prepared to conclude that Mar 2009 was a major low. He has laid out his logic in his last major weekend missive and his long-term reassessment. He also revisited the grand supercycle count. This all seems terribly premature, since we remain in a faster down move than the prior up move; but I recommend you read his analyses and draw your own conclusion.

Our friends at the STU remain bearish but note the recent drop off Sp1112 or Dow10438 have broken in three waves, which implies we have more upside to go. Curiously, they also note an alt count in the S&P that we are ending a small irregular flat, where the drop from Sp1112 to Sp1092 was impulsive, but the bounce to Sp1109 and then drop to Sp1086 are waves AB of a flat, putting us in wave C. That hasn't yet broken in five waves, so this also implies more upside to go.

What is interesting about that alt count is it mimics an earlier fractal that I posted out last week, and was first spotted by Evil Speculator: an irregular flat after the wave down off Sp1150 to 1072, which went:

• A to 1105
• B to 1045
• C we are still in

This time the irregular flat (irregular means the B wave goes farther than the start of the flat) follows the impulse down from Sp112 to 1092:

• A to 1109
• B to 1086
• C we are still in

Both the big C from 1045 and the little C from 1086 have more to go, but not a lot. We seem destined to close the gap at 1116 and maybe a bit farther, up to the fall line of around 1131 which if we breach makes the drop now slower than the prior rise, and de-confirms the downtrend. Given the Evil Count irregular flat, we need not be so concerned about the Fib retracements which say 1111 is the 62% level and 1126 the line of no return of 78%. Instead these both move up: the 62% is 1120, and 78% us 1133. 

If the Evil Count has predictive power, we pop above the 1116 gap and get into the 1120s next week. 

GDP Revised Up But Future Growth Revised Down UPDATED

This is discouraging news: GDP for Q4 was increased to 5.9% from 5.7% but the sustainable components were revised down. This table from Calculated Risk shows consumption (PCE) and investment dropping while the most transitory part of GDP, inventories, made up the increase:

	Advance	Second Estimate
GDP	5.7%	5.9%
PCE	2.0%	1.7%
Residential Investment	5.7%	5.0%
Structures	-15.4%	-13.9%
Equipment & Software	13.3%	18.2%

Worse, deflation also added to GDP. The nominal GDP stayed the same at 6.3%, but the price deflator was reduced by 0.2%, meaning less inflation, pushing real GDP from 5.7% to 5.9%.

Excluding inventory rebalancing, GDP would have been revised down from 2.2% to 1.9%. 

Let's look forward, starting with inventories. Will inventory rebalancing continue? It has gone back to a "healthy" ratio of 1.25 months, but the actual increase is modest, remaining about 10% below YE2008 levels, and actually declined in December. The good news in this chart is sales (red line) are rising faster than inventories (blue line) giving credence to continued inventory restocking in Q1 and Q2. 

 

Durable goods have been rising, supporting positive manufacturing data, but excluding aircraft ticked down in January. It had been rising for a number of months, and this it should be no surprise that business activity shows a V shaped recovery:

Parsing the durables, however, shows this chart, which says a lot of the growth is due to defense spending, not the private economy:

 

Overall the GDP chart looks like a V shaped recovery, but as The Big Picture reports, "even with the big Q4 GDP, U.S. GDP was down 2.4% in 2009 — the worst showing since 1946 (down 10.9%). [Also] 'In 2009, business investment fell the most since 1942, while imports fell the most since 1946.' "

All in all the data is a mixed bag, as manufacturing still seems on an uptick even as organic growth seems sluggish at best, with declining new and existing home sales for example. I have noted how leading indicators seem to be flattening if not beginning to dip. ECRI still insists that a double dip is out of the question:

“with the 6 percent GDP growth and the jobless rate having peaked back in October… a double dip is still out of the question.”

Hmmm. Unemployment is not looking that promising right now, having just spiked up. What if it rises again after the census temp workers flow through and out? ECRI says their flattening indicators suggest that the recovery "will begin to ease off by mid-2-10." They conclude that it is all but certain now:

 

An even more negative view comes from looking inside the leading indicators. A steepening yield curve is considered a positive indicator, since (as described in my recent Bond Fundamentals post) it normally means that business activity is picking up, and demand for longer-term debt is increasing; yet right now commercial lending is not increasing. Instead, the wide rate spread is an artifact of the Fed keeping the short end artificially low. Without that steep curve, the LEI would have dropped 0.1% last month. 

Mish's take on the leading indicators is the double dip may begin as early as Q2 this year. 

GDP models summarized at Briefing.com are begin to show a drop in projected Q1 GDP to 1% growth, albeit based on increased inflation not decreased business activity:

What's So Special About This Chart?

Guestblog [& Service Tout] from David Grandey at All About Trends showing a fractal setup from 2008 that seems to point to the markets direction in 2010. From an FTC point of view, I have no financial relationship with this service, nor have I used it, so no endorsement is intended. Enjoy!

It's the NDX 100 Index off the 2007 peak. Does anything jump out at you? It should! Take a good look:

 

We've talked about ABC's. 
We've talked about Fibonacci levels. 
We've talked about trend channels.

That's a big picture chart. Now let's zoom in and look a little closer at the chart above.

 

We've talked about ABC's.
We've talked about Fibonacci levels.
We've talked about trend channels.

We've talked about the 50 day average.

Now take a look at the chart below, see anything?

 

If the similarities of the two charts above don't make you go whoa? We don't know what will. Those who are long only? You better be prepared!

Those who are wise enough to take control of their own destiny vs. allowing a traditional wall streeter to do so? Better start to think about hedging the long side of your account. Those who have 401k plans investing heavily into equities, you might want to think about raising some cash. Those who have IRAs and can't short? Better be looking at inverse ETFs.

Those who see it for what it really is? Yep get ready to have some fun on the short side.

Look at the current chart of the S&P 500. Look familiar? It should, its' setting up the same way the NDX 100 did back in 2007 JUST BEFORE The Markets gave back 10+ years worth of gains. You don't want to potentially have to go through that again do you? After all those who fail to learn from history are doomed to repeat it right?

Right now there are two things missing.

1. The C Wave of the ABC down we've been talking about for weeks here. By the time that wave is clear the damage will already have been underway and as we've always said you're late to the party

2. And of course YOU!

So the big question at this point is? If this breaks are you going to be prepared to take action or be a deer in the headlights?

We've got a list of short sell set ups that have been triggering every day for the last few days.

Hopefully you have been paying attention.

Want to know when the market is going to turn? We know, and it has nothing to do with the stock market and everything to do with psychology.

Week after week we've been laying out the most likely outcome here based upon Technical Analysis and it's ALL been in advance of it happening too. Now we are not saying that what happens next is exactly what is going to happen as we are not one to tell the market what it should do because the market doesn’t care what you or us think -- it does what IT wants to do.

NOTE: Those who rode the whole market all the way down off the 2007 highs via a traditional Wall St. style of account PLEASE PAY EXTRA ATTENTION.

If you continue to think the way you've always thought you are going to get the results you've always got. If you are getting the results you want? Just keep thinking the way you've always thought. If you haven't been getting the results you want? Then you need to change your thinking.

To learn more, sign up for our free newsletter and receive our free report -- "How To Outperform 90% Of Wall Street With Just $500 A Week."

Yves on Financial Air Raids About to Start (Again)

Back in Mar 2007 Yves posted a prescient analysis of hitting the top of a Liquidity Mountain. He sent me this updated chart and said to start sounding the air raid sirens again. He sees stocks converging back to sentiment, which means down. You can find a complete list of his posts here. 

 

The Logic For Bonds: Fundamentals

When the Fed truly begins to back off its low rates and quantitative easing (QE), we should expect bond rates to rise and bonds to fall. The right strategy is to buy the short end, let the rise happen, then swap to the long end. This seems to encapsulate the Chinese strategy, which has been to sell the long bond and buy in the shorter end (two year primarily). Even if rates jump, and the short stuff drops, they can be held to maturity to maintain value - but moving short too early risks dreadfully low rates and dismal returns while the longer instruments reward their holders. 

It is tricky to throw the magic sticks and divine the Fed, since the Fed purposely obfuscates its intentions. Case in point: after the recent raise in the discount rate it has gone out of its way to say real tightening is a ways off. 

It is also tricky to listen to the pundits. Right now they go both ways:

• The Black Swan guy, Taleb, says "every single human being" should short Treasuries
• Everyone's favorite analyst, David Rosenberg, says to go long Treasuries

Too bad they are on both sides: 

the greatest returns are when a widely-held belief of investors proves incorrect

Instead we have a balance of views. You can see this in the behavior of bonds recently. The long bond was climbing (rates fell) through most of the Hope Rally, but beginning in October began to fall (rates rose). So far in 2010 it has been sideways. We sit on a cusp: will rates continue to rise to above 5%?  Or are they about to drop? 

This is a complex subject, and I will walk through it in a series of posts, beginning with the conventional wisdom of fundamentals. 

Recovery Stalls, Stocks Recover

A flood of bad news plus Bernanke saying he will keep rates low sparked a mid-morning pop in equities. If you think equities are tracking recovery, think again - they are floating on easy credit going towards speculation, not investment. Consider these news items:

• New home sales drop to record lows
• Home prices fall again
• Housing inventory (months of supply) rises again
• Bank lending falls in sharpest decline since 1942 (!!)
• Consumer confidence falls after it had been rising (double dip?)

Calculated Risk has a plethora of charts on this morning's announcement that new home sales (seasonally adjusted) fell to record low levels annualized as well as for a month, even below the prior record low of last January 2009, during the height of fear. You might think this a continued reaction to the end of the first-time homebuyer credit, but that credit was extended. Before the report Bloomberg reported that economists had expected a rise, so this report is unexpectedly bad - as bad as any period back before 1963, when the chart starts. Apparently the tax credit had already pulled forward new home buyers, so the extension has few suckers to pull in anymore. We should see a gap in demand for a while. 

Lesson to be learned: gimmicks do create demand, they just pull it forward in time. The implications for recovery are profound, as no real recovery happens without new home sales. 

New home sales are far more important for the economy than existing home sales, and new home sales will remain under pressure until the overhang of excess housing inventory declines much further

Housing inventory had been falling as banks worked through the subprime crisis, but are now rising again, indicating the second wave for foreclosure and mortgage defaults is beginning:

David Rosenberg of Gluskin Sheff pointed out this morning that housing prices are falling despite what you may be hearing in the mainstream media (chart courtesy The Pragmatic Capitalist):

The WSJ had a first page prominent article on bank lending falling, the sharpest decline since 1942 at the height of the war economy, which lowered private lending through industrial policy to retool for war. This too is really bad news, as it means banks are not lending but taking all the bailouts and cheap reserves and using it to buy financial assets (Treasuries, stocks). 

The rebuttal to those Keynesian cheerleaders is that government stimulus freezes private investment, a phenomenon quite visible in the second half of the the Great Depression. Simple formula:

Banks don't lend, business doesn't borrow, people hide their savings in Treasuries = economy is on government life support

 

Now we begin to have worries on retail. Retail numbers still seem to be improving, and Wal-Mart announced good earnings, but warned about declining store comps and deflation in prices, and now Nordstrom is warning about 2H10 results. When January numbers were announced, retail seemed to have normalized (see chart from The Capital Spectator), but we may be seeing a snap-back from distressed circumstances, not a return to recovery:

 

James Picerno had a sound conclusion to this news: 

No matter how you slice it, it's all about the labor market for the foreseeable future—and how the ongoing struggle to mint new jobs will impact spending. The next clue comes tomorrow, when the Labor Department updates the latest initial jobless claims. 

Nosebleed PE Ratios and the Greenspan Bubble Era

The market can remain irrational longer than you can remain solvent - John Maynard Keynes

Continuing with the question of could the market have bottomed when we still have nosebleed P/E levels, Barry Ritzholz posted a great chart on how Greenspan/Bernanke bubble policies have elevated P/E ratios well above historical norms:

  

The dot-com bubble took off in 1994 at the upper level of normal and shot well above. (The envelope is +/- one standard deviation of normal.) We briefly touched the upper envelope in Mar 2009 and then took off again. 

Most likely explanation for elevated PEs since 1994 is the excessive credit promoted by Greenspan and continued by Bernanke: elevated stocks are due to easy credit. Credit tightened at the two peaks and then was radically loosened at the two bottoms, in 2002 and 2009.

Normally any bubble returns to its start point, which still points to a true bottom at around Sp400. If earnings generally increase, the bottom should increase with it (ie the envelope is modestly rising), but the recent period of depressed earnings have turned this slow growth back down in 2009. 

Implication is: we do not fall to normal until the easy credit abates. Timing looks like 2011, as Bernanke seems likely to exit very slowly this year. Hence: 

Paradox of Recovery: when the private economy really shows signs of recovery, not just government life-support, easing will ebb and equities will fall

Dollar May Have Topped For the Moment

Be prepared for a moment when technical analysis (TA) trumps fundamental analysis (FA): fundamentals say the Euro should weaken and the Dollar strengthen, but technicals say instead the opposite is due. 

Big expose in the WSJ on how currency swaps and other off-balance-sheet tricks in Euroland allowed Greece cheat on the EMU (Euro) rules. (Swaps allow countries to accept liabilities for currency fluctuations that do not show up as current liabilities.) Of course Goldman Sachs structured these vehicles. That is what they are paid to do. Get mad at Greek leaders, not clever bankers. 

Assuming a Greek rescue goes through, according to fundamentalists it will force the Euro to remain weak and allow the Dollar to strengthen:

Greece, along with Spain, Portugal and Italy, all need to increase taxes to reduce the deficit, and higher taxes in a recession reduces economic growth. Consequently the central banks will have to keep the liquidity high and the rates low. This means the US, with an anticipated quicker recovery, will be in a position to raise rates quicker than the eurozone bankers, goes the argument. 

In contrast both Neely and today's STU think the USD has completed a wave pattern and may have topped for the moment. If so, the Euro is about to have the strongest bounce in a while. 

Later this week we will have an onslaught of Bernanke presumably to explain away the rate hike. He also may have to address weak Treasury auctions - another one today, where 30 year TIPS went out poorly. The yield came out 6 bp higher. Also markets are digesting the rolling over of ECRI's leading indicators, as well as China's. These are signs that the Fed may have to slow down its exit from QE, meaning it has to keep rates low.

 

 
In the race to the bottom of currencies, the turtle currency rises relative to the hare. While FA tsks tsks about the Euro, TA is signaling that regardless of exogenous forces, a USD drop is due. Later pundits can concoct the explanation that the US has to race a little faster over the next month to maintain Treasury auctions and deal with rate expectations even as the Euro hare struggles to figure out how to bail out the PIIGS without causing the internal politics of Germany & France to rebel against supporting their wastrel brethern in Club Med. Whew! Complex sentence. At least TA explanations are concise. 

A Few Charts For Weekend Contemplation

As we sit at the point of maximum entropy (indecision), here are a few charts proffered by readers for consideration. The first from wavechart.com shows how we have been hitting what used to be the lower trendline of the Hope Rally. (This chart comes from their newsletter - worth checking them out.) What was support has now become resistance. Not only are we at the 62% retrace, but also bumping into strong restistance. Any break above would need to be rapidly retraced - you often see a false break at a point like this. 

 

The second comes from Roger in a recent comment. It shows an alternate count which I think is worth considering: that we are in an irregular flat wave 2 that goes back to the first impulse down (irregular since the B wave goes beyond the start of the flat correction). This excerpt of his chart is from Oct 2009 to date, and is the e-mini futures, abbreviated ES, which tracks the S&P and is highly liquid, making it a good index to use to gauge mass psychology in action. 

What is delightful about Roger's count is the irregular flat is also a larger fractal of a similar pattern within the congestion zone at the end of wave 1 down. Hank from Elliot Fractals, please comment!

Let's review recent wave counts. The impulse down to what is labeled as 1 was first thought of as such, and the bounce to what is labeled A was first considered a wave 2. The impulse down to 1045 was then thought of as a wave i of 3 down, with the bounce as ii, and we got to the dreaded nested 1-2 count of EWI. When that bounce got too long, this view had to change. Two alternatives highlighted in my Friday post were:

• bullish: to consider the drop to 1045 as an ABC zizgzag and the bounce to Friday's 1112 as either an X wave of a complex correction, or a launch of a new leg to the Hope Rally 
• bearish: to consider the drop to 1045 as completing wave 1 down, living with a three-wave look and having to "find" waves 1-2 in the congestion at 1150 that launched the move down, and making the bounce to 1112 as wave 2 which really has to end around 1112-1116 

Since we seem to be barely hanging onto the bearish scenario, but the bullish scenario is building on hibernating volume, something else may be going on. Roger's ABC flat is quite reasonable, and deals with the odd declining volume. From a Zoran point of view, the break down needs to proceed faster than the move up. If we look at the upper trendline of Roger's chart and reflect it down, it is clear we are still falling faster than the rise, and could even meander upwards a bit farther before breaching that rule. The line in the sand (depending on how long it takes to get there) is around ES1133. 

The other model to consider comes from Neely and is not orthodox ewave. Neely finds that five-wave triangles often end moves, particular complex corrections like this whole Hope Rally. I have commented on this previously and then further explained how Neely's terminals often explain the dreaded nested 1-2s of EWI. EWI permits ending diagonal triangles, but Neely generalizes this and sees triangle terminal patterns more frequently. The Neely view as expanded upon by DG in the comments, is that "this rally is the A-wave of what will end up being a Contracting Triangle to end the rally from the March 2009 low." 

Here is a chart of the terminating triangle to end a complex correction; what is unusual here is the steep upwards slope of the Hope Rally, but otherwise this triangle would fit as the third corrective structure after two zigzags connected by two X waves. 

 

If we do not just drop next week (supporting the EWI wave 2 count), or drop after a little more upwards motion but below ES1133 (supporting the Roger irregular flat count), but continue to meander (thus undermining the bullish continuation-of-the-rally view), then I suggest we leave open a broader view: that we may be in a larger terminal triangle going back to Nov2, when all the odd "Monday Pump" and "Square Wave" market patterns emerged. Here is the model, which builds on DG's comment but starts earlier:

• the drop marked C to D in Roger's chart is an X wave before a final terminal triangle
• leg A or T1 of the terminal triangle went in three waves from Nov2 to Jan19 with a sideways triangle B wave in the middle
• leg B or T2 is what we are in and is breaking in a "3" pattern with another down leg to go
• leg C or T3 should take us back upwards to lower high

This whole pattern may resolves as a rolling correction in 2010. It should be a fairly horizontal triangle, although curiously enough if it continues upwards it could be considered a large ending diagonal for the whole Hope Rally. Given leg T1 was 2 1/2 months, we might continue in T2 and T3 another 4 -5 months into summer, then have shorter and sharper legs T4 and T5 to end where these things always seem to end, in a bad Sept/Oct fall. Food for thought as you watch the weekend Olympics. 

A Digression Into Those Nosebleed PE Ratios

A reader commented on my prior post, with the optimistic words "bullish" in the title, this question:

I've read recently from some bearish analysts that the real PE of the S&P 500 is well over 100. Other reports say it's in the low 20s. What's your take on the PE? A PE over 100 seems a bit crazy for the start of a new bull market regardless of what they're including or excluding to get 20 or 100. 

'Tis a good query. History says we have to get to single-digit PE to bottom, and anything above 20 is suggesting a top. Yet near the end of the Great Moderation with excessive debt, PEs have gone way above these levels and stayed up. This says either (a) Greenspan et al have found the new Sorcerer's Stone to turn lead into gold, and it is called unlimited credit expansion; or (b) we have continued to roll forward the eventual train wreck, and it is still ahead. 

The Austrians say you can push the disaster forward for a while, and it will be worse when it hits. We seem to be still in the Greenspan Petri Dish, his (and now Bernanke's) experiment with history to try to use massive credit to stave off a Kondratieff Winter. 

My blog post was not to suggest a "real" bull market but a continuation of the Hope Rally, which is a Bubble Echo Rally, a continuation of credit expansion to keep the party going. Obviously the benefit of credit expansion is hitting diminishing returns, since we remain well below the tops, and the trajectory of the Echo Rally is not promising. 

Another reader has been pointing to the Shanghai Market as a leading fractal model of our market. They are well off their all time highs, had a huge bounce, and came off that, and are now two steps down in what may be a staircase to shocking low levels if their huge real estate bubble soon bursts. 

Next week should tell. I put the odds right at 50-50 we fall hard or rise to new highs. The moment of maximum entropy to use chaos theory speak. If you believe the market is always technical - news and fundamentals don't matter except over long stretches (ie general rise of inflation and growth in earnings) - this moment can really go either way. Later pundits can argue what drove it. 

Even if we head back up, we don't have long to go. The most stunning financial news in the last few weeks was not the discount rate rise, nor the low inflation, but the record drop in business lending. I plan on expanding on this story, with charts and analysis. Suffice to say that we are beginning to see deleveraging in spite of credit expansion. This means the credit reflation trade is not just hitting diminishing returns, but rolling over to go the other way despite all the efforts of fiscal and monetary expansion. The end is nigh. 

If you want to keep track of the various PE numbers, the best place to start is with S&P itself. After registering, which is free, you can download a spreadsheet of PE data, both as reported and operating, and do your own analysis. Also worth Googling P/E10 as an alternative to smooth out the recent rough patch.  

Market is Looking Bullish

Surfing through uber bearish financial bloggers can lead one to look at every market move as confirming a deep dive. Yet when we broke Sp1105 it shifted the odds from an end to Hope to a continuation of the Rally, or at least evened out the odds and got us to Neely's point of maximum confusion. We have clearly stayed above the corrective plateau around 1183, and confirmed a break up ala Carl Futia's box approach. If we don't reverse down from here, the odds begin tipping towards the bulls, especially if we cler Sp1126. 

If you look at this chart, it seems the drop was a three-wave affair, which marks it as corrective. Sure, it fits in a channel down, but that is characteristic of both a zigzag as well as an impulse down. The chart comes from Walter Murphy, who remains mid-term bearish but now near-term bullish. Our prime gurus also remain bearish. The STU gives guidance in the Dow, and expects topping action next week.

 

Today we popped a bit above the Sp1110 retracement level at 62%. Technically a wave 2 can go back 99%, but seldom do they pass 62%, and we just did, albeit by just a little. (In some other indicies, notable the Dow, we have already worked up to the 2/3 retrace.) The next levels to cross are Sp1116, where we close a gap, and then Sp1126, the 78% level. During a deep & sharp drop we can get a sharp rebound that goes past 62% to 2/3 and then to 78% (we saw some 78ers back in 2001). Above 1126, however, odds are high we go towards Sp1200.  

The Evil Speculator has a Maginot Line on the 1120s, which is close enough to the 1126 level to be a similar call. He has deployed his bearish panzers at Sp1115, but he expects the bulls to break through. His main point is form: the rise back up looks impulsive. Sure, a C wave is a 5-wave impulsive-like structure, but this wave looks more like an extending 3rd wave. Final waves in a zigzag and especially a complex correction tend to slow down, not speed up. This one looks like it hit the Vancouver luge course:

For the bears to hang on, the market needs a sharp reversal down. A sloppy choppy affair simply won't do. While a 62% reversal is in the normal range of 50-62%, it denotes a strong retrace, and should spark a sharp continuation of the downtrend. If the reversal comes right away, the bears can take comfort in the 62% level being hit close enough. If we have the Monday Pump and cover 1116, traditional TA can take comfort that a gap was covered and now we can go back down. Either way, and despite the break of 1105, when the dust settles this would be a relatively normal wave 2 retrace. 

We would then chalk up the Maginot Line luge course to options expiration. Oddly enough for the bullish case, despite the look of the sharp rise as the bulls sally forth, volume has been retreating. This is not the characteristic of a kickoff to a new bull phase. 

Looking at the Maginot Line chart, I could see a Monday Pump (maybe to cover 1116), a drop or sideways slowing of the upper momentum for several days, and then a final move up to 1126. That at least keeps the bearish case hanging on. But the bears need to face up to the switch in the odds if the bulls bust through the panzers at 1115/6 and the entrenched artillery at 1126. 

After Market Signals Trouble Friday

I commented that all the after- and pre-market activity means we should look more closely at the overnight moves rather than wait for the machines to open in the morning. In the past the overnight futures misled more than informed, but volume has increased after hours and the market signals are getting more indicative. The odd square waves we saw prior to the Santa Rally show much larger volume coming in pre-market orders. The Vampire Market of the past three months, where all the gain happens overnight, shows the importance of the after market action. 

So what is happening right now? Here is a chart from a reader, Steven737, that shows how strong the move was after the market closed, sparked by the Fed's surprise rate hike:

Rate Hike Skewers Options Friday and Starts its Exit Strategy

Remarkable that the Fed would hike the night before options expiration, giving no chance to unwind positions. Karl Denninger notes they have done this before: in Aug 2007 just as the market was topping at all time highs. Did anyone notice that 2 million SPY shares were dumped right in front of the announcement?  

No surprise, futures have erased the whole day's gain in the after market. Right now the March S&P is down to 1095, below where it started this morning. Here is what we should now expect in stocks:

While the Fed made sure to say that this does not signal tightening, and it shouldn't affect commercial rates, it is and it will. The FX market knows what it means: the Dollar reversed a small slide and got above DX81, and the Dollar Carry Trade may be over. Higher US rates means stronger US Dollar. 

The discount rate hike itself is not a big deal - it is largely symbolic, since the intrabank borrowing action is elsewhere - but it is the start of the tightening process. Next we should see the Fed offer higher interest rates on reserves held in the Fed using term deposits: higher rates but locked up for a term. Think of them like Fed CDs. This is meant to keep the $1T of bank reserves in the Fed and not out in the wild, where they could be lent at up to 10x multiples and spike inflation. This as all part of their exit strategy. The actual Fed Fund hike that starts the tightening rise of rates should follow. 

The historical context is fascinating. Back in 1931, the Fed faced a brewing banking crisis out of Europe, with sovereign debt defaults starting with Austria and eventually ending with England getting off gold. The Fed had dropped rates after the crash as vigorously and quickly as Bernanke, but then began raising the discount rate too quickly as a reaction, as shown in this chart (courtesy Jesse's Cafe Americain):

Are we about to repeat, with Greece taking the place of Austria? The Greek debt is roughly the size of Lehman! It may be that the sovereign debt spreads "blowing out" over the past few months, starting with Dubai, is a consequence of the ending of QE and the beginning of tightening, meaning this specific hike isn't the catalyst; the whole reflation attempt and inevitable tightening is. This time we are tightening ahead of the sovereign debt problems, but consequences may be similar to 1931.

One scenario for investors to consider is that the Fed slows the tightening as the Euro crisis waxes, maybe slowing rate hikes into 2011 (which Goldman predicts). The Fed may also have to continue QE longer than they wanted. The other place to watch is the Treasury auctions. We had a nearly failed auction a few days ago. The Fed may find itself between a rock (the need to sell Treasuries) and a hard place (the desire to protect the European banks from the PIIGS). 

How to Handle Keynesian Cheerleaders

This trumps Dramatic Chipmunk! Thanks to my daughter for finding it - she is helping to promote Woman's Professional Soccer and posted it. 

Obama Declares Mission Accomplished! UPDATED

The Obama administration is out touting the Stimulus as causing a recovery, or at least averting a worse disaster. Is it time for Obama to declare Mission Accomplished? Perhaps he should have instead applauded the ability of the US economy to pick up from a deep drop, and kept himself out of the story. He risks jumping the shark. 

Let's first give him his due. We can all debate who gets credit when - my view in general is the prior administration gets tagged for the first year of the new one, so Bush was still to blame until a month ago!  Yet the chart he put out is pretty interesting. It shows monthly job losses bottomed in January (the last red bar is actually Jan 2009) and began recovering. We are still losing jobs, just not as fast. A curmudgeon might note that the worst months started in Nov 2008 when Obama was elected, arguing businesses anticipated a change an policy and fired faster; but more likely it shows decisions made previously taking effect. 

 

You will see a lot of Keynesian cheerleaders out, such as Brad Delong arguing the $100M a day interest cost of the Stimulus is really only $40M a day given the hypothetical Keynesian Multiplier effect (you'll have to follow his logic to get there). Obama still claims he "saved" 2M jobs even as 8.4M have been lost so far, and well more than 2M have been lost since his blue bars above began shrinking towards zero monthly losses. His people can find only about 600K of them, most in Q4, which is similar to a hard estimate by the CBO of 640k new or saved jobs, although the CBO can "find" a possible million more by using those vaunted Keynesian multipliers in their estimates. 

UPDATE 2/18: The Stimulus claims turn out to be preposterous. Obama's web site claims 1.2M jobs "funded". Funded, not saved, and certainly not created. Andrew Cline comments:

The administration switched from jobs "created or saved" to jobs "funded" for accuracy's sake. Or maybe to stop the mockery. Either way, it's a telling methodology.  

Cline dissects the claims from the site itself: of 634K jobs "funded" through Q3, 601K were funded by grants to State offices, meaning it went "save" government jobs and suppliers to government. What happens when the life-support runs out? These are "Cash4Clunker jobs," not permanent jobs, and not private sector jobs of the sort necessary for a sustainable recovery. No surprise that CBS/NYT poll finds only 6% of Americans believe the Stimulus created any jobs. 

In any event, this switch to jobs "funded" at least politically helps them hold on to the dwindling circle of faithful, giving them hope that their vote wasn't just a change for the worse. It provides Obama a better position to be in then their original claims of how the Stimulus would keep unemployment below 8%:

 

The problem with this cheerleading is it is premature. The data remain mixed. We seem to have what Forbes calls Two Economies: we have continued drop in employment and long-term unemployed that does not appear to be turning; and we have recovery of spending among the employed that is helping GDP. Total employment to population is not yet turning - it isn't even flattening. See chart:

 

John Mauldin has taken to calling it the Statistical Recovery - in the case of unemployment, the chronic unemployed who drop out mean the statistical base of potential employed shrinks faster than job losses, so the rate improves! 

UPDATE 2/18: We might do better in the next two years. The Stimulus is shifting from saving government jobs to *finally* funding infrastructure. Only about $20B for infrastructure was let out in 2009, but $160B remains to be released. Also, one of the innovations in the Stimulus, the Build America Bonds, seem to have worked pretty well to allow muni bonds to continue flowing for public works and infrastructure. About $64B were issued in 2009, 3x the amount of Stimulus for infrastructure. While infrastructure spending leads only to modest job growth (much of the work is mechanized) and these can be temp jobs, it can build a better foundation for future economic growth (assuming it is spent on wise projects, not just slush jobs). 

My take is we have a W that starts as a V. Evidence of the V is mounting, including a continued increase in industrial production. The infrastructure spend in 2010 should help add an estimated 1.4% to GDP. We shall have to wait a couple of quarters to see if the balance of GDP growth is still inventory rebalancing or the start of a real recovery. ECRI has been bullish on the V for a bunch of months (they publish a leading indicator index) but now they see growth "throttling back" by summer 2010, the Summer of Disillusionment. They do not yet see a double dip. 

Japan too claimed their stimulus "saved" them from a depression, but they still haven't found a recovery going on twenty years. Let's hope all the cheerleading does not put lipstick on bad policies that lead to a twenty year flat patch. 

France Disenchanted with the Euro

Yves sent me a fascinating poll from France, that the Euro is more unpopular than ever before:

Eight years after euro notes and coins hit the streets, 69 percent of French people said they regretted the passing of the French franc, the Ifop poll for Paris Match said.

That compared to just 39 percent a month after the arrival of the euro in February 2002, and 61 percent in 2005.

The Euro may implode faster than anyone thinks (although not presently). The rescue of Greece is not done, since they first must show some fiscal restraint. While this is unlikely to be ratcheting the stock market - the moves in and out of the Euro have a bigger impact - it will have an impact over the bond market. The moral hazard of rescuing the Greeks is pretty clear, as the rest of Club Med (Spain, Italy, Portugal) will wish to also be rescued. While Greece is affordable, is a bailout of Italy? Yet backing off the rescue risks the concept of the Euro. How to square the two needs?

Downhill Market Delayed Due To Fog

The market move today means the wave count has shifted to where the end of the first wave down is Feb5 at Sp1045, and we are in the normal wave 2 counter-trend move. After a bit more, we should restart the downhill run. Although this view remains bearish, if we break above Sp1110, the odds shift to the view that the Hope Rally is still on, and we go to new highs in April or May. 

Today's special STU remains bearish, although they got rid of the dreaded "nested 1-2" count. It was Prechter's signature call in 1984, and they find it a lot, but I don't recall a time since when it worked. Yet they remain in a fog over what happens next:

There is no clear wave structure on a short-term chart for the blue chips, so we cannot publish one. What we can say is that the upward push from February 5 counts much better as an upward correction versus an impulse wave. That is, there are multiple overlapping waves, which categorizes this push as a countertrend move. 

This chart from Tony Caldaro can be used to show the shift in the count: he has marked the Feb5 bottom with a big 1, and if we move the prior 4 over to the spot marked ii (Sp1104.73) we get the new count:

 

Tony thinks that a number of possibilities now emerge by the move today, including that the spot marked 1 is actually the end of a corrective zigzag down, and we are now continuing back up above the January high at Sp1150. This is also Carl Futia's view, the alternative I highlighted in my Downhill Racer post. We have broken above the upper trendline of the move down and now stayed above for a trading day. Since we never broke below the 200 DMA this increases the odds that the zigzag drop was another X wave and a third and final move up towards Sp1200 or higher is to follow. 

The market closed a gap at Sp1086 and went to Sp1095. We have done a 50% reversal, which is a good end point for the wave 2, but it seems incomplete, only 3 waves in the final wave, meaning a drop and pop are left. Perhaps a correction at the open tomorrow and a final move up. The next stopping point is the prior fourth wave at Sp1105, and after that Sp1107-1110 range, hitting 62%. If it goes beyond that, my bet is the Hope Rally is not done, and we go to new highs.

This new count makes more sense to me, especially because it has a better impulsive structure in waves 3 and 5. What remains odd is the stub first wave, and so Tony's zigzag should be seriously considered IF we break above Sp1110, the 62% retrace. Still, a stub 1 happens when there is a big 3 and a long 5. Similarly, a truncated 5 often comes after a big 3 with a long 1. Having a stub 1 and a short 5 as in the prior count is unusual. 

I also think we stop viewing those gaps up or down at the open as impulsive; more volume has gone to the after-market than previously, and surge at the opening of the machines in the morning in NY makes the wave structure look like odd square waves. If instead we put the nighttime or weekend time scale in, these gaps look like more normal corrective wave patterns (overlapping). 

Downhill Racer

Opening ceremony tonight at the Olympics Without Snow. Must be global warming. The downhill race winner may turn out to be in a different venue: tonight's STU has the market stacked in the dreaded nested 1-2's at four degrees of scale, which is the set-up for a deep drop next week, maybe as soon as the next trading day on Monday Tuesday next week. They have been on a roll lately, with better predictions than during the Hope Rally. Here is tonight's chart to complete their wave count this week:

 

Let's count up all those 1-2's: the Hope Rally top is a big 2, the Groundhog Day top at Sp1105 is the next 2, the Running Triangle Thrust top of yesterday is the third 2, and the intraday top at Sp1080 is the fourth. It is possible that a fifth 1-2 also developed to end the day. 

There is some contrary opinion. Carl Futia thinks instead we are set up to blast up to Sp1155 on the way to his target of Sp1200. He notes we broke above an upper trendline yesterday and stayed above it today, a breakout indication. We also completed the time and distance (meaning upper right corner) of his box around the corrective plateau of the past week, indicating a break one way or the other is due. Here is his analysis, followed by his chart:

The sideways trading range that has developed during the past week on the upper chart is I think significant. It is bigger than any sideways range we have seen in the past year, and occurs at the bottom of a break in a bull market (still above a rising 200 day moving average). This combination of circumstances generally occurs prior to the start of a new bull market up leg. Counting across this base formation (horizontal green line) yields a target of 1155, a new bull market high.

Reggie Bush Market Ready to Cut Downfield

For the first time since the Super Bowl, the market has a complete wave pattern. The B wave that extended now forms a beautiful running triangle (running means a large b leg) with a sharp thrust out of it today. The wave C can be counted as done, although looks like it it might subdivide one more time, edging up at least to the Sp1083 +/- target. Tony C has a 1090 pivot. There is also an open gap at 1086. 

This triangle & thrust is shown in a lot of charts today. Here is the STU chart:

 

Tonight's STU was a special addition, which means they are firmly convinced the top is in or will be tomorrow. They nonetheless hedge a bit, noting (among many other indicators) that we are entering a three-day weekend followed by "ski week", which often leads to a general upwards bias as trading slackens tomorrow and next week. This year many erstwhile skiiers are snowed in, in the NY and DC areas, and the Winter Olympics are starting. While it is a delightful time to ski during the day and watch the world's best race at night on TV, people may instead stay home to watch. Hard to use this tendency to predict the market. Also, some sites like EW Trends and Kenny note how the McClellan Oscillator almost got back to a bullish sign, and it might get there tomorrow. 

Can't do much with on-the-one-hand followed by on-the-other-hand advice. Instead, let me share a stronger tendency I have seen over the years: the Friday before a long weekend often leads to traders lightening up, especially when stuff is happening that might jink the market before it reopens. Besides Greece, we have a funky Euro today and a nearly-failed Treasury auction. 

A break above Sp1105 means something else is going on. A break below 1060 pretty well confirms the downhill run.

Reggie Bush Market Looking for the Hole in the LIne

The sloppy overlapping waves indicate we are in a correction, not a new move up. The drop fits beautifully into a channel down - see chart from today's STU - which suggests we head down. But when? The market seems to be butting against the upper trendline as it bends downward, and this can continue, annoying bull and near alike, as markets are wont to do.

While most ewavers, and now the STU, count the high yesterday at Sp1079/Dow10139, it is possible to count the market as still in a B wave, which leaves us with a move up (the C wave) to complete the corrective action. Volume is softening, which is indicative of a correction not the start of a move up or down. I therefore think they all called the end of the correction too quickly, and we have more sideways to go. Like Reggie looking for the hole to run through, wait for the break down - a break of Sp1056 is pretty bearish, and of 1041 very bearish. Breaking 1029 confirms the next wave down is on us. Breaking Sp1105/Dow10315 means the count is something different. 

Reggie Bush Market Should Rush Downhill After One More Head Fake

I loved to watch Reggie when he was at USC - his moves were fabulous, and he often counter-turned around the whole pursuit. No surprise then that a couple of days after his team won the Super Bowl, we see a nice set of moves in the market. Beginning Friday at around 2p, we had the spike up that faded at the open on Monday and ran up around 11a to Sp1071, and then began a slow fade. The slow fade should have been a signal that the counter-trend rally had more to go. Today it popped up, dropped sharply, and ran up even more strongly - the signature of waves 123 of a five-waver. Since then it has done the slow fade again - typical of a wave 4. This chart from Kevin shows the detail. 

 

Many ewavers have called the end of this move at the high today (Sp1079), which is close to the 62% retrace at Sp1082. Seems to me it hasn't finished yet. For one thing, the slow fade is not how this should end; instead I would expect a sharp break down. For another, the final wave needs to break in five waves, and hasn't yet. 

• Count the wave from Fri at 2p to Mon at 11a as wave A, a zigzag that broke as a "3"
• Count the slow fade Mon as wave B, which also broke as a "3"
• Today we have had only four waves (waves 1234) with 5 to go
• Wave 4 has retraced about 50% of 3, so could be over or just about over
• Wave 5 would normally go the same as A or 15 pts, to 1084

Hence I expect a pop up tomorrow to Sp1083 +/- a bit. 

Market Should Now Geaux Down As Fast As Reggie Bush

The weak follow-through to Friday's rush up at the close indicates we now should accelerate down. The pre-Super Bowl huddle of market options that came from that Friday Pop have now gone the way of the Colts. (Geaux 'Aints!) Today's STU points out that downside momentum is increasing. If this had been a fifth wave down, or a final C wave, momentum should be decreasing. We saw this with the whole Hope Rally, where it started much stronger and faster-moving than it finished. The strongest A/D and Up/down day was last Thursday's big decline. We have actually dropped more so far in 2010 than we did in 2009, which had the deep dive to Sp667. Rather than slow down, the market has just had the strongest down momentum since the Rally started:

  

The next move should rush by the critical Sp1029 level and break Sp1000. Over in the Dow we rush into the low 9000s. If perchance we get a bounce instead, bringing the boo birds out in force, it simply means this wave (ii) bounce will have one final jink and jive before the dive. 

The other arena of interesting action is in bonds. The STU had a lot to say on bonds tonight, particularly minis, and I will work now on a bond prediction. 

Did Friday Pop Due to Front-Ending the Monday Effect?

Market patterns tend to get arbitraged away. The Monday Effect of a bounce on Monday is now widely known, and had occurred in 20 of the past 22 Mondays (and one of them was merely a time shift to Dec 1, which came on Tuesday). Did we pop up last Friday as an arbitrage against the Monday Effect? Or maybe we grant traders with too much prescience - did the shorts panic and cover? 

If the pattern has shifted, the fun will happen this Friday, not next Tuesday (next Monday is a holiday). The pattern I suggested last night of a B wave drop at the open and then a rise to 1075-1083 seems on, albeit we only hit 1072 so far. If we drop hard in a minor wave 3 down, we might hit the wave 4 counter-trend around Friday afternoon. 

Super Bowl Commercial MVP: Dramatic Chipmunk!

Yesterday's Stupor Bowl was quite good, and they seem to have become more competitive recently from the prior blow-outs. Many viewers, however, still tune in to watch the commercials. The most watched events can support the most expensive ads. Simple rule of commercials: the higher the production value, the better the ad, or the bigger the miss. There were some huge clunkers yesterday - two in a row with fat white people in underpants, yuck - and some delightful winners. Even Google did an ad, a nice one. Most surveys pick the winner (at least in buzz) as the delicious satire of the Green Police in the Audi ads. Snickers did well, as did VW in its retro slugbug ad. 

From an insider point of view, however, the biggest winner was Dramatic Chipmunk. There was not one but two homages to the little guy! If you have never seen it, take a look: it is only five seconds long, but it generated a huge number of remixes and helped spawn the remix trade that later erupted in such clips as This Is Sparta! Here is the original:

Here is a Carmax ad with two different Dramatic Chipmunk moments: 

With the basic Chipmunk Moment in your mind, catch the Dramatic Chipmunk moment in this Vizio ad for connected TV - note the accompanying sound clip: 

Super Bowl Suppositions

The old saw, the Super Bowl Indicator, will have to point up for 2010, since both teams are former NFL teams (the Colts switched leagues). This indicator is silly with no predictive value, and to me is a paradigm of correlation without causation. If you feel you have to make a bet anyway, take the 'Aints plus 5. Stay out of stocks if this is how you invest. To demonstrate to you the foolishness of it, I will once again dive into a prediction for Monday, and will probably be shown up by Monday Morning Quarterbacks. 

The market has tended to go up over the weekend and pop on Mondays, a pattern going back three months. The pattern has been weakening in the past few weeks. I expect it to pop again Monday, but this time it may start with a short selloff. My bet is we get to Sp1083 intraday Monday before truly reversing down.

I still think taking the Saints and the points is a better bet. An alternative view is that an ABC correction off the top ended Friday and we are about to continue the Hope Rally. Hard to tell until we see how Monday plays out. 

Let me run through my reasoning, starting with this chart from Tony Caldero:

 

The wave down off the Jan19 top seems to have ended at Sp1072 last Fri, as shown in Tony's chart; although it could have ended Thurs with an A-B up-down on Fri as many ewavers count, including Friday's STU; or even the prior Fri with a lot of congestion in the 1085 range that all could have been a correction off the initial thrust down. In any event, the pop above the range to 1105 ended that corrective period, and the sharp drop since is impulsive. We thus have then two impulses down and one corrective period in between - a three wave pattern so far.

The best attempt to count a five-wave pattern down comes from this chart by Evil Speculator. He uses the little waves i and ii down at the start of the move to make the first impulse down wave iii and the congestion zone ending with a wave iv. The second impulse down is then wave v to end wave 1 down.  They are good thinkers at this site, and see this as merely one of three counts. The waves i and ii in this count are small relative to the drop, which gives it a poor look. (Their third is the bullish count that we ended an ABC down and the Hope Pump Rally is still on.)

Without a 5 wave pattern down, we cannot conclude that a wave 1 has ended down. The possibility remains open that is is all a noisy ABC zigzag correction, and the Hope Rally is still on. Tony C points out that all the way during the 2003-07 bubble, we didn't have a 10% correction.  We haven't dropped 10% here either. He suggests this is a consequence of massive central bank liquidity and "managed capitalism", and we are still somewhat in that environment. Also, the type of strong bounce at the close mirrors what we say on March 9 last year, and on Oct 10, 2002. If we continue with a very broad rally on Monday morning, this alternative view will need to be seriously considered. 

Most likely, however, we are in wave iii of a much deeper wave 1 down, as shown in this chart from the STU: 

 

This has been one sharp drop, even with the congestion zone around Sp1185. The steepness down is a strong indication of much more to go. The first impulse down went from 1150 to 1072, or 78 pts. This second impulse down has gone from 1105 to 1045, or 60 pts so far. It is very unlikely the first wave down to start a major correction will be longer than the third wave, so expect further downside. Even if this is an ABC zigzag correction of the Hope Rally, usually the C wave equals the A wave, which points to at least a low of 1105 less 78 pts or 1027, which breaks the crucial level of 1029 of last Nov 2, and means a deeper correction if not a complete trend change has happened. 

At the moment the sharp retrace in the last half hour on Friday looks like a bunch of positions clearing out once the market broke the 1061 level. The retrace so far has gone to 1067 or 22 pts, which is really close to a 38% retrace. Given the prior wave ii ended just over 38% off the Sp1072 bottom (and almost precisely 38% off the Thurs bottom in the STU count), this one might end here too, giving us a sharp down Monday for the first time in a while. 

A 38% retrace is more in character with a wave 4 than a wave 2, or with a slow wave 2 like the congestion zone we had around Sp1085, not a sharp reversal. Given that this is wave iii of 1 down, the retrace Friday is inner wave 2 of it, and so I expect more of a 50% to 62% retrace, or to Sp1075 - 1083. The congestion zone around 1083-1088 is a prior support level, so my bet would be a pop up to 1083 and then a reversal. What was support becomes resistance.

To summarize: a pop up Monday to Sp1083, and then a continuation of the drop down. Note that the retrace wave is likely to breaks as an ABC zigzag, so a drop at the open (the B wave of the zigzag) might finally break the Monday pattern, but not for long. 

As we saw in 2008, a bear market can drop faster than the prior bull, and from Mar 2008 (Bear Stearns) to March 2009 (Obama Hope Rally) we fully retraced the 5 year bull market into 2007 and half of the five year bull market into 2000. So far in two weeks we have gone back over three months and are approaching the critical Sp1029 level (Dow9679) of Nov2 that started the final up move of the Hope Rally, so far. Breaking that and with it the 200 DMA of the S&P pretty well locks in a major and sustained change of trend down. But we are not there yet.

Lies, Damned Lies, and Unemployment UPDATED

Unemployment went up but the rate went down. The total unemployed rose a whopping 1.4M more than we had thought, from 7M to 8.4M. And yet the unemployment rate improved!? We have entered the the Bureau of Labor Statistics (BLS) twilight zone.

Let's start with the 1.4M increase in unemployed. Several days ago the BLS admitting that they had "created" 1.8M statistical jobs, which is more than the Obama administration claims the Stimulus "saved or created" in real jobs! 

These statistical jobs come from the BLS birth/death model, which they know is flawed. Today the BLS began adjusting away those statistical jobs, dropping 1.363M jobs (617,000 in 2009 and some 750,000 in 2008). Total unemployed since the Great Recession started is now higher than we thought, at 8.4M. The BLS "thought" it was only 7M as of three days ago. 1.4M more jobs lost, and the unemployment rate improved! These jobs were "lost" in prior periods:

 

The workforce is still shrinking, and except for a blip in Nov due to temp workers (retail!), has dropped for 25 straight months (over 2 years!). Yet the unemployment rate has improved.  

We remain in a land of statistics that are masking the underlying reality. One reason the rate improved is the post-Christmas seasonal adjustment; without seasonal adjustments the rate would have risen to 10.6%, not fallen to 9.7%. With them, the rate now looks like it peaked in Oct and is dropping:

The pop up in Oct provoked a rant about seasonal adjustments from the NYT, that the rate should have held steady at 9.5% at that time since the seasonal adjustments were based on flawed retail patterns. Retail has many fewer outlets after the bankruptcies in 2008, so using the prior pattern of temp hiring into Christmas overstates unemployment by expecting more temp jobs than occur. In the same way, using the prior pattern of a drop in those temp jobs in Jan would now understate unemployment by adjusting as if more would be lost than were. 

You can see in this next chart how large the January "not in labor force" adjustment is (the blue line below, with that steep drop every January). These are guesses that get adjusted again later, and you can see how far the adjustments have gone in the last two years (the red line that ends in a hockey stick):

The rate also went down because the total population seeking work dropped more than unemployment. The way the BLS figures it, if you are not "actively seeking work" for 4 weeks, you disappear. You can see how large the disappearance is in the lengthening period of unemployment, spiking up to levels not seen since 1949, when they started measuring it this way:

 

The really scary part of this is it appears we are rapidly creating a huge chunk of the workforce that will be chronically unemployed. I suppose that starts with the housing bubble, which drew a huge workforce into pounding nails in places like Nevada. After a real estate bubble, jobs don't come back for 5 - 7 years. One of the tragic consequences of a credit bubble is it gives misleading signals of what jobs to pursue. The Austrians call this malinvestment; in human terms it means chronic unemployment. Here is how bad it is in construction:

The chronic unemployed are left out of the unemployment rate.  The BLS concluded this month that the "number of persons unemployed due to job loss decreased by 378,000 to 9.3 million". They do this every month, and the cumulative miscount is now huge:

There are now a whopping 2.5 million people without a job but want one, yet are not counted as unemployed

This breaks down into 1.1 million discouraged workers who not currently looking for work because they believe no jobs are available for them, and 1.5 million people who had not searched for work in the last 4 weeks. You can see from the next chart that:

1. removing the seasonal adjustment pushes the rate to 10.6%
2. including the discouraged workers sends it to 11.2%
3. including the ones who haven't looked for four weeks sends it to 12%
4. throwing in the underemployed (U6) sends it to 18%

 

Let's look at the unemployment problem a different way, which removes all those statistical adjustments: TOTAL EMPLOYED, not the unemployment rate. Sadly, it continues to drop. Our total workforce is back to 2000 levels. A lost decade indeed! When this figure begins to turn up, we will know a real recovery is underway. 

 

Karl Denninger points out what is striking about this chart: things looked like they were improving for a bit in Q2, but then we faded back down. 

The good news is that the rate of loss is lessening. This chart shows the rate of loss, which looks like a V-Shaped recovery, but is still below the 0 line, meaning jobs are still being shed, just at a slower and slower pace. 

 

The official rate should now improve for reasons having nothing to do with a real recovery: we are hiring 3x the normal census workers over the next 6 months, and the addition of 1.4M temp workers should be visible in the rate. 

UPDATE 2/8: Mish has a great analysis of how the seasonal adjustments are getting out of control, causing larger swings in results. January was 50% higher than the swings for the past ten years. Even if we have no change in unemployment in the next three months, he says the seasonal adjustments alone can drive the rate up 1.3% to 11% by May! Even with the census temporary hiring, the overall effect will be for rate to rise on seasonal adjustments. And even if the census keeps the rate low, when the census hiring abates, the rate could skyrocket up - right about the time of a double-dip in GDP (Q4).

I expect some big adjustments in the next few months. The BLS marries together two separate surveys: one of households and one of big business, or 'establishments'. The household survey got way out of whack with the establishment survey, and one or the other will have to be adjusted:

 

UPDATE 2/8: The King Report looked inside the numbers and found an oddity in the recent Household survey. The blip in the chart is of 541K new jobs, half are part-time, is entirely due to one category of workers: "Woman, 20 years and over" which increased by 529K. Further, this is only because of seasonal adjustments; this number actually only increased by 7K. Also, withheld taxes declined in Jan, which suggests that employment didn't rise at all. The King Report's conclusion is the Jan report is bogus, whether from faulty methods or a "clumsy attempt to craft a better employment report for political expediency (fraud)."

I still see a V-Shaped recovery for the next few quarters, and with it a real underlying improvement in unemployment. I just think the "unemployment rate" is a poor place to look to understand the underlying dynamic. Too many shenanigans. As Ed Harrison concluded after looking at the BLS report:

the unemployment rate downtick has nothing to do with people dropping out of the workforce; it is an statistical aberration due entirely to seasonal adjustments in the household survey in the number of people employed and unemployed

GDP & Unemployment: The Morning After

We are coming up on another unemployment report. Preliminary indications are not good. So far we seem to be in another jobless recovery. A deeper look at the recent GDP Report plus the upcoming unemployment report supports my view that this will be a V-Shaped recovery, albeit a jobless one, and not much of a V, with a high risk of a double-dip W to come.

The Q4 GDP report was driven by inventory rebalancing, a transitory factor. David Rosenberg's morning-after comments start with "expect big-time revisions", meaning downward. A key insight is that real domestic demand slowed from 2.3% in Q3 to 1.7% in Q4, as shown in this chart from Prieur du Plessis, where inventory is removed and the underlying final demand trend is bared:

 

This chart is bad news, as it says there really isn't any recovery. One would expect a sharp V after the fall we had in 2008, and we do not appear to be getting it. Pierre comments that this pattern "doesn't live up to past recoveries at all. ... Without stronger demand growth, a V-shaped recovery is not on the cards and the unemployment rate will not start heading south."

The Pragmatic Capitalist has a series of comparison charts of production, retail, employment and income, and all of them show more an L than a V so far. Here is the production chart:

 

An even bigger problem comes from unemployment: 

We saw history in the making — an eye-popping 5.7% GDP growth rate the exact same quarter that the unemployment rate rose 40 basis points, to 10%. It is like Houdini’s rabbit! This has never happened before. Normally, when we see a GDP number like this the unemployment rate declines 20 basis points during the quarter in question. The flip side is that in the past, when the unemployment rate rose as much as it did in the fourth quarter, believe it or not, in those quarters real GDP actually contracted fractionally (at a 0.5% annual rate).

A huge red flag was just raised about unemployment, which makes you wonder how far off the official stats have become from reality. The BLS is going to revise down its job estimates from April 2008-March 2009 by a whopping 824,000 jobs. This chart from Bloomberg shows how the prior reports change:

The whole Bloomberg article is worth reading, as it has other charts on point that make this issue vivid. The recount is due to how the BLS counts birth/death of job positions/companies, which they admit is flawed, but have no plans to fix. Instead, the next revision comes out in 2011, and will affect the whole Hope Rally period from April 2009 to March 2010. Over 990,000 jobs were added based on their flawed model.

The total over-count is 1.8M jobs. Wow. This means rather than the initial 4.8M jobs lost, it actually was 5.6M, and with the added miscount since, 6.6M. Oops, only off by 45%. I wonder what that would have done to the 10% unemployment rate?  Up 6% fromthe prior low rate to up 9%, or 13% overall? 

Obama claimed in the SOTU that he had saved or created 2M jobs. Only 600K or so could actually be counted from his own people, so that was a bit (!!) of an exaggeration. The BLS actually "created" more jobs than the Stimulus. 

A third shoe to drop is the Stimulus itself. I have written how once it passes its peak level per quarter, it will act as a drag on GDP. GDP is calculated using the change quarter to quarter, which is why less of a decline in inventories in Q4 ADDED to the GDP number. In Q4 government spending contributed a negative 0.2% to GDP, even though stimulus outlays remain high. From now on Stimulus outlays will decrease, even though a lot remains unspent. It will drag down future GDP even more. 

Now, all of this stresses my point of view that every W starts as a V. What if we get no V? So I dug deeper to find indications of a V: 

First, the trend seems to be turning to positive. The BLS birth/death model added fewer artificial jobs in Nov and Dec than earlier in 2009 and back in 2008. Maybe the revisions next year will lower jobs early in 2009 and increase them later in 2009, potentially answering the problem Rosenberg flags of how can GDP rise when jobs are falling?Regardless of that, the worst fall is behind us, leaving room for the V-shaped recovery despite Rosenberg's misgivings. 

Second, we are in another jobless recovery, as we had in 1991 and 2001. Many economists follow the Okun Rule, that a 2% drop in GDP causes a 1% rise in unemployment. This rule no longer works, probably because it was constructed in a time of cyclical unemployment: the job is lost but the position remains so the person gets hired back. Instead we have entered a period of structural unemployment where the job is lost and the position goes away. After 1991, it was defenses jobs - the so-called peace dividend. Movies were made of disgruntled middle-aged defense workers. After 2001, it was dot-com workers. Commercials were made of lonely sock puppets. After 2007, it is construction jobs. Not much work pounding nails in Nevada these days. 

Third, we are really in a 100-year-flood type of event. Looking at what is usual or unusual since 1946 misses that this Great Recession is not like any other since the Great Depression: it is the morning after of a huge credit bubble. In a normal recession, Fed tightening strangles a boomlet that usually comes with excess inventory. As we go through inventory rebalancing, things slow sharply but not for long, and away we go with growth again. Unemployment rise quickly, then shrinks quickly as workers are brought back to factories and retail. In contrast, we just came through a different dynamic, where people were using their homes as ATM machines, and when the real estate party ended, they began cutting back, well before unemployment rose. To the extent they retained savings, they can start spending again before employment begins to go back up - explaining what Rosenberg found unusual.

Supporting that perspective is this chart, which shows PCE (personal consumption) rising in a V-shaped recovery off the bottom. If PCE is increasing, employment should follow. 

 

How to square this chart with the chart above, where "final demand" dropped in Q4 over Q3? Well, this chart is a year-over-year comparison and we were in serious freefall in late 2008. The quarter-over-quarter comparison has a downtrend, but Q4 was up over 2008. More to the point is an informative look at PCE by Ed Harrison at Credit Writedowns:

• personal income has fallen off a cliff, and we are in the worst patch in 50 years, but we have begun digging out of that hole since Aug 2009
• disposable personal income fell as well, but not as much, meaning the tax rebates and transfer payments have softened the fall, which is good - my position has been we should bailout people and not banks - but is still the worst performance since DPI records were first kept
• consumer spending also fell off a cliff, but dropped BEFORE income, which while unusual fits my scenario (above) that we used housing as a big ATM machine, and pulled back once the machine went dry, before jobs were lost
• savings spiked up, then went down, then up, and are now trending down - meaning we are reactive, tending to spend as the bad news abates and save as it returns

He concludes that PCE has been on a 4-5 month increase. Let me add that we had spikes up in PCE in July/Aug and then again in Oct due to one-time government gimmicks (cash4clunkers, first-time homebuyer credit), followed by deep drops. These gimmicks perversely disguised the trend up in PCE by pulling demand forward a few months, followed by a "morning after" air-pocket down. The retail and housing drops in Dec and now Jan are a result of the last of those gimmicks, which ended in Nov, but the trend may reverse back up presently. 

A further data point is retail sales. It came in good in Nov, softer in Dec, and now ominously softer again in Jan. But not by much. Yet.

Business loans are weakening, yet the ISM index shows manufacturing is strengthening (more inventory!). Also, while net exports have been a problem, there has been some improvement. With cheaper oil (lower imports measured in $ not #) and a continued increase in exports, net exports could surprise in Q1. 

So it appears that Q1 should also come in up. If Q4 gets revised down, even a modest Q1 increase could be up QoQ. 

This bodes well for a V-shaped recovery, albeit a shallower V than typical. My primary caution is that PCE is doing better than income tax collections, which indicates a lot of it comes from tax-free contributions, such as Stimulus transfer payments (tax rebates, unemployment extensions, etc.). As with inventory rebalancing, this is not sustainable. 

It looks like Q1 (and maybe Q2) will be driven by continued transient inventory rebalancing plus government temporary transfer payments, but not by increases in income nor business investment. 

I stand by the double-dip. Every W starts like a V.

Mid-Morning Comment UPDATED

Dow10K is getting closer! Crossing such lines usually leads to fireworks, so I expect to bounce up before it. In the spirit of "yelnick", don't put too much behnd that comment!

My midnight post shows the perils of trying to divine the market from minute wave structure. Easier just to see how it fell 78 pts (1150 to 1072) and then rose 32 pts (1072 to 1104) or a bit over a 38% retrace. The prior wave ii can be simply counted as an ABC with a triangle B wave. By clearing (just now) the prior low, the trend is *probably* confirmed down, and we also have a steeper down advance/decline day to boot.

The spark was a sell of in Europe due to England ending QE and the deepening problems with PIIGS, renamed STUPIDS by ZH by adding the UK as well as Turkey and Dubai, and dropping Ireland. Ireland I guess is getting a handle on its excessive sovereign debt; the others seem to be nearing a meltdown.

Possibly, however, this is a large flat wave ii and we have experienced the B wave, so it will take a more decisive break down to get rid of that possibility. In the meantime, off to look at bonds. 

Yves on One Revealing Observation of Treasuries for 2010

Yves is back. His firm has been bought by Macquarie, the Australian powerhouse, diversifying into wealth management in Canada. After a hiatus to let the transaction settle in, he is back with a continued claim on the title of Bond Guru. 

One revealing observation of Treasuries for 2010 

A unique look at bond behavior will serve to illustrate how risk is lowered in holding long Treasuries for the coming year. The graph that we produce today is based on data from the St. Louis Fed. The Treasury bond data reflects the constant maturity 10-year bond and includes the coupon plus price appreciation. You are looking at the annual return of the 10 year bonds since 1928.

 

A startling observation is the large upswing following a negative year. The year 2009 closed with a negative return of -11%. 

The readers will notice that over the last 80 years plus rarely has this phenomenon been proven incorrect. The only exception is the period at the chart point 28 and 31 which represents  the time frame of 1955 to 1956 and 1958 to 1959 where one negative year was followed by a second negative year. In both instances the following negative year amounts to either -2.26% or -2.65%. These two events are the exception to an 80 year period. 

This simple correlation for bonds to turn positive following a negative year is compelling. On a positive note, negative years are often followed by a string of positive years.

To be clear, the consensus is for bonds to drop “again” this year. This market observer will hedge his bets on the simple fact that 80 years of history has demonstrated.

Yves Lamoureux, Investment Advisor, Macquarie Private Wealth Inc.

The opinions contained in this report are those of the author and are not necessarily those of Macquarie Private Wealth Inc (MPW) 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 MPW 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. No entity within the Macquarie Group of companies is registered as a bank or an authorized foreign bank in Canada under the Bank Act, S.C. 1991, c. 46 and no entity within the Macquarie Group of companies is regulated in Canada as a financial institution, bank holding company or an insurance holding company. Macquarie Bank Limited ABN 46 008 583 542 (MBL) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. MBL is not authorised to conduct business in Canada.  No entity within the Macquarie Group of companies other than MBL is an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia), and their obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any other Macquarie Group company.

Macquarie Private Wealth Inc is a member of CIPF and IIROC.

Midnight Market Guess

With the chorus of bearish technical market analysts, it is refreshing to see that Carl Futia believes we are still destined to get to Sp1200: that the break down so far is like the prior two major breaks (in June and Oct), and until it breaks the 200 DMA it remains on the Hope Rally trend:

Over the years I have found that the best way to identify the reversal of a trend is to look for a break in the trend's rhythm of reactions. Reactions within an extended move up or down show a strong tendency to be of the same length when measured along the price dimension. Sometimes they also show a tendency to last about the same number of days. ...

From this point of view the bull market which began from the March 2009 low point in the S&P is still going strong.

His chart shows the line in the sand (the green line) around Sp1029, the bottom of the Oct drop:

 

Interesting. The bears may be able to test his view in short order. Tonight's STU thinks the counter-trend rally is close to done. They especially point to the resumption of the uptrend in the USD and the drop in the Euro (and by implication problems in Euroland, where besides Greece two other PIIGS are beginning to raise concerns, Portugal and Spain). This may be why their current Free Week promo is for Forex - they hope for some action. 

The STU buys into the alt count (the one shown in charts in the Mid-Day Guess post) that this is an upwards flat from last Thurs. This suggests a final pop up tomorrow to end the counter-trend move, and probably an end in the low end of the range (Sp1110, based on wave 5 = 1 or 16 pts, and starting at the wave 4 low today of 1094). If we are still on the prime count, the impulsive nature of the rise since Friday suggests a zigzag is unfolding, and an end in the upper end of the range (Sp1122), which is also the 62% retrace of the whole wave ii. In both cases we would see a small pop tomorrow of around 13 pts followed by a drop, and in a zigzag the B wave drop can be pretty deep, back to the persistent support level of this recent market plateau around 1085. So the B wave drop could fool. Fun if it works out that precisely. 

I am preparing a long-delayed Bond post, delayed since we have been in a sideways ratchet for months. The STU thinks we are on a bond drop/yield-rise towards 5% in the long bond. Neely also thinks rates will be increasing. 

Free Week for Forex

You get a week of forex reports. Click here. 

 
 

China Driving Australian RBA Policy - Sydney Housing Bubble About to Burst?

Australia was the first major economy to raise rates, and the Australian central bank (RBA) was widely expected to raise again last week. They held, and it started a parlor game of why the dog hadn't barked. The RBA's explanation was clear in its obtuseness. Today the WSJ seems to have found the answer, and reported it not once but twice, here and here, with the following explanation: 

Last month, China moved to reduce commercial bank lending and increase rates on some central bank bonds. Because a reduction of credit in China will ripple through to demand for Australia's raw materials, China essentially did Australia's tightening for it. ...

Economists completely missed the bank's intentions. All 20 economists surveyed by Dow Jones last Friday had forecast a rate increase. 

If China tightening is bursting their housing bubble, will this now ratchet back to Oz? Mish has been on this issue, and notes that the Oz Prime Minister, Rudd, had pushed through a A$14,000 first-home buyer credit. Almost half of them are already struggling to make payments. Sydney is also rated the second least affordable major city, ranked by severity of housing. Rudd made the same serious blunder Barney Frank et al. did in the US, of spawning a govt-sponosred housing bubble, driving housing prices way too high. Recent tightening of the relaxed rules on down payments should cause a sharp decrease in home sales. This type of change drove UK prices down in 2008. 

Steve Keen, one of the best economists in Australia, had forecast this drop by the end of 2009 - and lost a bet on it. Why? He hadn't anticipated how far Rudd would go to keep the party going. Mish notes that once the trend changes, the party is over for a long time (5-7 years); but attempts to prolong the fun often lead to blow-off tips. We may be at that point right now. Here is a chart of how far people are stretching to join the real estate party in Oz:

 

Is the China Real Estate Bubble Bursting?

China's SSEC broke below the 200 DMA. It was the first to start up, in Nov 2008, and the first to break down, in July 2009. The Pragmatic Capitalist sees this as the classic post bubble price action: 

[A] bursting bubble followed by a relief rally based on false hope which is ultimately followed by years of sideways or negative market action (think Japan circa 1995 or Nasdaq circa 2005).  Without getting too technical and simply using this very basic definition the Shanghai index has now officially entered bear market territory.

 

The question is whether China will now lead us down. Graham Summers at SeekingAlphanotes that China's stimulus was announced in Nov, and their market took off; the US stimulus was announced in Feb, and the market took off in March. The SSEC began its recent decline in Dec when the Chinese authorities began tightening credit. The US QE is scheduled to end this March. Here is a comparison of stock indexes:

 
I think too much can be made of such comparisons, Something else is driving China down, and it has the potential of being a huge tsunami across global markets: the Chinese real estate bubble seems to be bursting. Home sales in Beijing fell 70% from Dec to Jan, and 50% in Shanghai. Well respected Chinese analysts agree. Here is a six-part series if you wish to explore further. 

This bubble was spotted before the recent tightening of Chinese credit, for example here, here and here. The most noteworthy crash prediction came from James Chanos, and was highlighted in the NYT as well as many financial blogs, such as here and here. A critical assessment of Chanos' views agrees with them. The ever-present currency-speculator and Obama-supporter George Soros also agrees, as does Jim Rogers. 

You can find some contrary views, such as here; but the anecdotes floating out of China nail this point: they clearly show speculative excess rushing in, as always happens near the end of a bubble. There is even some evidence that the some prices are higher than in Japan's bubble in 1989!

The warnings of an accelerating credit disaster in China came from Chinese observers, not just the Western financial press. These comments are worth pondering:

The high export growth era is over for three reasons. 

• China's market share in global trade is twice as big as its GDP share. The odds are low that China could continue to expand its market share. 
• Second, the tide won't rise as fast as before. The Greenspan era saw a credit bubble supercharge western consumption, but the bubble has burst. Odds are that future trade growth will be half or less as in the past. 
• Finally, a western employment crisis will lead to protectionism targeting China. Other developing countries may gain market share at China's expense.

One possible way to prolong the bubble is to appreciate the currency, as Japan did after the Plaza Accord, to contain inflation and attract hot money. Such a strategy will not work in China. Japan's businesses were already at the cutting edge in production technologies and had pricing power during currency appreciation. They could raise export prices to partly offset currency appreciation. Chinese companies don't have such advantages but rely on low costs to compete.

After export-led growth peaks, consumption is the alternative to sustaining growth at a lower rate. This transition would require a wholesale change in the political economy. The key is to increase middle class disposable income and lower consumption costs. No East Asian economy has made this transition.

Now, he thinks the RE bubble won't burst until 2012, based on a 24 month lag between excess money growth and inflation. I agree on inflation - here is a great analysis by Goldman Sachs - but I disagree on cause and effect. Inflation should actually fuel real estate. Instead, the withdrawal of credit should burst the bubble, as it did in the US in 2005. That has started. 

In addition, the excessive stimulus did to China what it always does: huge waste and malinvestment. The Chinese stimulus went quickly into infrastructure, roads to nowhere and ghost towns, with nothing in them. 

The ghost towns are a modern wonder. You can see a video of them from this post.  Those developments need continued investment to maintain, or they fall into ruin quickly. Where do you think they will be in ten years? 

The most contrarian take on China also supports the bubble scenario, from a wholly different perspective: the Chinese currency will soon begin to appreciate. This needs to be examined. The Chinese have pegged it to the USD and it has become seriously undervalued. The Chinese had been letting it slowly appreciate until the summer of 2008, when they quietly ended that; the commodities bubble burst almost concurrently, and oil began its sharp fall. If the peg continues, as the USD appreciates, the RMB will also rise against other currencies, even with no policy change. But the call for it to appreciate is to rise more than the USD. This will put huge pressure on Chinese export industries.  They rely on cheap labor, not high quality as the Japanese did, and may not be able to handle the appreciation. The Chinese will resist, but can they?

In order to contain inflation, China will have to do more than raise rates. It needs the RMB to appreciate above the USD, since otherwise it lets to much currency out as it sucks up Dollars in exchange for RMB by the export companies. (It has to do that to keep the RMB pegged.) As exports increase, they should feel more room to allow the slow appreciation again. Earnings from export can be used to continue investment, rather than cheap loans. A second reason for appreciation is the threat (and reality) of tariffs being slapped on it, as the Obama administration has begun to do. And so has China, back. The WTO has begun to look into Chinese hoarding, presumably to take action. Bad josh, as they say in Hong Kong. Who needs a trade war with the huge collapse already in global trade? 

China has caught itself in the Mundell Incompatibility Triangle: a nation cannot manage all three of - 

1. a pegged currency
2. its own monetary policy
3. free flow of capital

China has chosen to manage the free flow of capital by containing it inside, which leads to excessive accumulation. This leads to excess export capacity and asset bubbles - precisely the position China now finds itself in. Trying to manage this via rate hikes and jawboning banks will fail - and anecdotal stories suggest despite the tightening, many banks are finding ways to get around the new rules. As a consequence inflation should continue to accelerate, as explained by Paul Krugman. Inflation right now may be over 10%.   

How to play this? The quickest way is to short oil and other commodities. Falling with Chinese real estate will be all those commodities it has been buying, hoarding, and plunking into ghost cities and roads to nowhere. Oil should fall the steepest. A second way is to get out of emerging markets. China sneezes, they catch serious colds. A third way is to short the AUD, which is way above PPP (88c today vs 68c PPP).  

In rebuttal to this thesis, Thomas Friedman recently said: never short a country with $2T in reserves. Really? Twice before in modern history a nation ran up similar reserves: US in 1929 and Japan 1989. QED. 

Mid-Day Guess UPDATED

Sp1114. Why? Bottom 1072. A wave 16. C wave starts at 1188. C = A means 1104. C must break in 5 waves but only done 3. C = 1.618x A means 1114. 

UPDATE: Close today looks like we are in wave 4 of C. Some could argue wave B ended yesterday at 1083 not today at 1088 when the bifurcation up occurred. This makes the end of C at Sp1109, close to the 50% retrace of the whole drop at 1111. A normal wave ii would go 62%, or Sp1120 range. 

Alt count is for the bottom not to be Friday's low point (Sp1072) but Thursday's bottom, counting the big up/down last Fri as AB of a flat wave ii. Under that scenario we would be targeting Sp1114 for the 50% retrace and 1122 for the 62%. There is a gap at 1116 that probably needs to be closed. Here is a chart of this alt view from EWP, followed by a similar chart from EW Trends (the site that is blocked in China):

 

On the alt count, if minor wave 5 of C = wave 1, it should go 16 pts above the end of 4, which may not have ended yet. Giving it a 1102 end, the target is 1118. It likely will drop a little lower, to 1100, giving 1116 as the target. 

Final view comes from Carl Futia, and uses a tool very much like Zoran would use. Carl places a box around the plateau, looks for the false break below (which we recovered from) and is now waiting for the break above. When that occurs, if we go back to the box quickly, we fall hard; but if we stay above, something else is going on, and this whole break down may be a minor wave in the continuation of the Hope Rally. This way of looking at it skips all the minutae of counts and focuses on what is important: has the trend changed and when to place bets: 

 

Choppy Waves in a Pathetic Rally

The overall trend remains down. This wasn't much of a counter-trend move, and less than the prior Monday Pumps or start of new months. It should continue tomorrow, but may end at the low end of the target range, around 1101-1105. Given where we bottomed, a 50% retrace is 1111 and 62% is 1121. 

I scanned a number of counts, but the easiest one to work with is pegging the lowest point (Sp1072) as the end of wave i down. This is the STU view.  Here is a way to count that from the site that is blocked in China:

 

A choppy downward trend like this shows the downward pressure is strong. At some point we get the sort of sharp retracements that were so noteworthy from 1931-32, but not yet. If we break Friday's low, the counter-trrend rally is over and down we go. 

January Effect

As the stock season rolls, we get the perennial favorites: the January Effect, the Superbowl Indicator, the June Swoon, the Summer Rally, the October Surprise, and of course the Santa Rally. Here is a pretty good debunking of the January Effect. Here is another, simpler analysis:

 

Since the S&P is up 73% of the time, this is less impressive than it looks. The monthly pattern shows Jan tends to be 10% of the whole year, so after an up Jan the market can be up for the year even if the rest of the year is flat. In other words, an up Jan biases the market up for the year, but says little about the next 11 months! 

The venerable WSJ has pronounced on the January Effect: they see a modest correlation. Going back to 1900, when Jan is up, the median rise for the rest of the year is 10.4%. Curiously, they find that the median rise in the next 11 months after a down Jan is still positive, but only slightly so at 0.28%.Perhaps this is due to the other stat, that Jan is up 62% of the time, while the average for all months is only 57%. Jan is part of the seasonal strong period from Nov to Jan. This chart also shows the June Swoon, the Summer Rally, and the October Surprise, which happens in September but ends in October, then bounces into the seasonal strong season:

 

A focus on monthly changes highlights the real Jan Effect, that Jan tends to be an above-average month (note that this chart only goes back 100 years, a slightly different base than the WSJ chart):

Doug Short also sees a modest correlation: going back to 1928, about 73% of the time there is a correlation between Jan and the rest of the year. The average up year when Jan is up is +12.9%. The average down is -2.8%. He concludes here is a modest January Effect, and then goes on to state that any benefit is easily overwhelmed by the outlier years, such as last year, where Jan was down hard but the year ended up. He concludes:

[T]he extreme outlyers make these stats more a curiosity than a 'take action' indicator.

Well put. I go with the deep quant jocks, the first analysis debunking the effect. Also, down markets tend to come in bunches, and are not independent. We of course call them secular bear markets. This is another reason why you should not make a prediction off January alone. 

Perhaps more indicative of where we are is how the down Jan distributed across major markets: China and Hong Kong are taking a beating. 

 

Monday Pump Signals a Counter-Trend Bounce

The Monday Pump (+ New Month Pop) suggests that the wave down ended on Thursday at Sp1178, and are in the wave (2) counter-trend move. It has gone too far back up this morning to be part of a wave 5 down. The big swings Thurs and Fri would be waves AB of an ABC wave (2). I guess I shouldn't be surprised at this since the plateau between Sp1104 and 1083 was breached in a false break lower on Thurs, signaling a change. We should now head to the Sp115-1121 range over several days.