Planet Yelnick

Death Cross Approacheth

After the 200 day moving average (DMA), which we bumped against, briefly broke above and then fell below (a False Break), the next widely watched technical indicator is the Death Cross when the 50 DMA crosses back over the 200 DMA. We are perilously close to that in a market with huge downside momentum. (Chart courtesy Doug Short.) A Death Cross confirms the change of trend to a wide swathe of investors. 

 

A second widely trumpeted technical pattern is a large head & shoulders between the first shoulder in January, the head in April and the second shoulder in June. The right shoulder slumped at 1131 from the left shoulder at 1150, and today poked below the neckline at the Sp1045-1041 level.  Goldman this morning was setting the bar at Sp1040, saying if we broke below the next stop would be Sp865, calculated as the delta from neckline to head (1040 to 1220) as the minimum level to fall, or 180 pts down to the Sp860 range.  If it fails to crush through, it turns a bearish setup into a bullish one. (Chart courtesy The Big Picture.) 

 
EWI put out a special STU tonight. They are in their element, as the next wave down appears to be unfolding, and the elliott waves tend to give much better guidance in an impulse (down or up) than in a correction. The market today unfolded under their prime count - and if you have followed this blog during the Hope Rally, you will immediately recognize the change: during the corrective rally, the alt counts tended to be realized, but now we should see the prime counts give better direction. 

They note how today was an intense selling day. their wave count has us in the 3rd wave down, the most intense, and downside volume should accelerate - as it is beginning to. A dead cat bounce is to be expected, but for bulls who try to pick a bottom, or play a possible failed head & shoulders with a pop back above the neckline, a word of caution: unless we have that bounce by the end of this week (eg the turn of the month & quarter), we might see the sort of falling off a cliff that characterized 2008. 

Tesla IPO Building Momentum

Tesla is two weeks into its roadshow, and due to come out today. It is increasing the size of the float from 11m shares to 13m shares, a very positive sign. At this point in the process, the underwriters are getting feedback from institutions and building an opening day book of orders.  

Given the interest, the stock would be expected to sell at the high end or even above the range of $14-16/share. Indeed, it got priced Monday night at $17, valuing the company at $1.6B, a bit lower than a research estimate last week at $1.85B, or $20/share. The buzz last week was also generally positive. The last minute (unsigned) deal with Toyota also boosted interest.

There is a strategy to these sorts of IPOs to buy the dip six months after offering. Last Sept a much-hyped green IPO, A123, popped 50% on the first day ($29) but has since dropped below the offering ($13.50) to under $10. It has now come out of the 180 day lockup, where insiders begin selling and further depress the price. When that selling abates, the stock typically becomes a buy - especially in this case if Tesla does well, since A123 supplies batteries for electric cars.

A successful offering could strengthen the tech IPO market, which has gotten despairingly weak recently. Given the bellweather status of the first electric car startup going public, a successful offering could also bolster a whole slate of green offerings, such as Smith Electric, an electric truck startup that also wants to go out, and Fisker, the closest venture-back competitor to Tesla. It might also have a halo effect on solar IPOs, which were hot three years ago and have been downright chilly recently. eSolar may be the next solar IPO to test the window. 

Mother Market Springing the Trap

Mother Market seemed to be setting a trap last Thursday, and now seems ready to spring it. The trap was to first get the bears excited then reverse up, and then get the bulls emboldened and fall down. In a fractal finance pattern, the market hit a low last Thursday and since has been in a plateau - the characteristic market fractal of a thrust and plateau. The plateau represents the market seeking order, and in a fractal finance view, can break either way. Humans layer patterns on top to attempt to predict the direction, and in the most delicious of ironies, Mother Market has given them a plateau of maximum confusion:

1. the plateau could be a fourth wave triangle which is about to continue down
2. the plateau could be a B wave triangle which is about to thrust up

Triangles are very useful patterns for traders, as they always come as the penultimate pattern, the one before the final wave. In an impulse wave, which breaks into 5 waves (12345), they are common in the fourth wave; in a corrective wave which breaks in three waves (ABC), they are common in the B wave. But you need to know which way it is about to go! In this case, one can interpret the market either way. EWP shows the fourth wave triangle, whose implication is very negative: a sharp drop tomorrow:

 

The market dropped at the close, and so could be said to already be heading south. And indeed, the futures are down after the close. But there is an alternative way to look at this which sets up the first trap, a bear trap: the triangle is a B wave of an upwards correction, and should head north strongly sometime tomorrow. You can see the alternative in this snip from an EWTrends chart:

 

Tonight's STU discusses the two possibilities. The most noteworthy indicator in this market is how little buying interest there seems to be. Other than on Friday, when the Russell 2K index was rebalancing, every day for the past week has had negative breadth with (in the NYSE) more declining volume than upside. The STU suggests also that the huge negative TICK at the close today (minus 1141) indicates institutions dumping. 

Guidance: A break below the Thurs low (Sp1068) confirms a deeper fall is on and the bullish B-wave triangle is off; and a thrust up indicates the bear trap has sprung, and the market should fly above the gap at Sp1087 and probably head to the next trap, a bull trap, at around Sp1100-1110.

Double Dip Countdown: "8"

The surprise was not that GDP got revised down from initial 3.2% and first revised 3% to 2.7%, but that it was no longer consider "unexpected." While the punditry still talks of a "slowdown" and a "muddle-through economy" the broader expectations are coming to grips with the double dip. The main driver of the revision down was weaker than previously estimated PCE (personal consumption), dropping from 3.5% to 3% growth. Inventory was revised upwards a bit, and contributes over 2/3 to the GDP growth, but business spending was reduced from 3.1% to 2.2%. Since inventory rebalancing is expected to drop in Q2, this bodes very poorly for the next report. GDP growth has now dropped in half between Q4 (5.6%) and Q1 (2.7%). 

In comparison, GDP grew between 7-9% for five consecutive quarters after the 1980 double dip recession. GDP grew in the double-digits for four years after the 1932 bottom. 

ECRI dipped closer to the -10% level, which has signaled a recession 100% of the time for the past 42 years, dropping from -5.8% to -6.9%. Lakshman Achuthan, managing director of ECRI, now says a slowdown is inevitable, but found a way to add a dose of optimism:

After falling for six weeks, the uptick in the level of the Weekly Leading Index suggests some tentative stabilization, but the continuing decline in its growth rate to a 56-week low underscores the inevitability of the slowdown

ECRI is now back to the level of Dec 2007, when the recession started. 

 

An interesting debate on CNBC this morning (around when the Brazil-Portugal game sputtered to a 0-0 tie) on Stimulus vs Austerity sputtered out as well but got across the point that this isn't really a policy choice; governments always try to spend their way out of problems until austerity is forced on them. Last night the US Senate abandoned efforts to continue extending benefits to unemployed and cash-strapped State governments. The most relevant impact to the double-dip is that this worsens crumbling State finances. 

Politically, the US may be at the turning point and joining Germany, England and China in pulling back from continued stimulus (although Obama is likely to keep pushing for stimulus until the mid-term elections). It is doubtful the US calls for G20 to stimulate will have much credence. The Fed too seems to be frozen at a time when the money supply is gong the wrong way for a recovery. 

Curiously, consumer confidence rose, and is at its highest since Jan 2008. As you can see from this chart, it remains at a low level. I am constantly amused by people who argue that "restoring confidence" is all that is necessary for a recovery. Confidence is at its highest at the peak (2000, 2007 and I daresay 1929) and at its lowest at bottoms) - the consumer remains a lagging indicator. It is also always argued that as confidence returns, money comes out of mattresses and gets spent; but other than a blip around tax refund time this year, we have been seeing lagging PCE. It may be when government transfers money that appears as a windfall, it gets spent, but hard-earned money tends to be saved or spent more prudently. 

 

More relevant is that corporate profits continue to rise, and significantly profits beyond the banks that are TBTF. This of course supports the Hope Rally, assuming it continues (the report is of Q1 not current profits). Profits are a coincident indicator, and sometimes lagging, as rapid cuts in spending can temporarily boost profits amidst worsening economic conditions. Hence the good news on profits is not inconsistent with a future double-dip. 

 

Instead, the indicators that suggest the double dip are all speaking loudly: housing, unemployment claims, consumer spending. They then get picked up in ECRI and other leading indicators, all of which are dipping. You can pick out green shoots here and there, such as durable orders falling less than expected, but even there we are seeing a dip in the growth of tech and consumer electronics (iPhones and iPads notwithstanding). 

A final discussion out there is whether the yield curve is signaling recession. Mish has been showing this chart as the warning sign. It clearly shows there are no inflationary expectations in the US economy. Instead, it shows what happens when an attempted reflation fails. 

 
Gary North analyzes this, explaining why an inverted yield curve normally signals recession: higher rates out the curve are required to hedge against inflation, but as short term rates are raised to curtail inflation, the curve inverts and a recession follows. In this case, the Fed is holding down short term rates and the fear is of deflation. The obvious failure of central banks to reflate means that in the private market short term rates will rise, leading perversely to a liquidity shortage. Lenders compound this by buying bonds to lock in the longer term rates, driving rates down. Hence, this time around the inverted yield curve is produced by fear: 

• business borrowers fear of inadequate capital, so they pay up in the short end
• lenders fear a recession with falling rates, so they lock in the long end

As a consequence, the CMI indicator which tracks the demand side of the economy, is dropping and signaling contraction. Their explanation of the impact of continued government interventions and gimmicks is priceless:

[I]t has instead, unfolded so far as a mild but persistent kind of contraction, more like a 'walking pneumonia' that keeps things miserable for an extended period of time.

 

Mother Market Setting a Trap

Mother Market is a fickle mistress, and seems to be setting up an interesting bull trap with a bear fakeout. The market appears to be finding a bottom, or will after a final jink and jive today. We have had a pretty clear five-wave drop off the recent high at Sp1131, as can be seen on this chart from EWTrends. This should be followed by a 50-62% retrace back up to test the 200 DMA at the gray levels indicated (Sp1103-1110), setting up a nested 1-2 formation which normally acts like a coiled spring with a mad dash down. On the way to that moment, the bulls will feel emboldened, as if the Hope Rally is still on, and the bears may take short positions prematurely, as the corrective wave should have a fakeout down leg before finishing up. plus take longer than the eager bears will expect. 

 
 

Pushing the Wet Noodle on IPOs

As we await the seminal Tesla IPO (TSLA), the IPO market continues to disappoint. Last week's two tech IPOs, Motricity (MOTR) and Broadsoft (BSFT), both lowered their trading ranges then priced at the low end, and are currently 6-7% below even that. Solyndra, the solar startup that was visited by President Obama last month, canceled its IPO. Nat Goldhaber, a cleantech venture capitalist, remains bullish on cleantech IPOs but not on the solar sector, noting that Europe as been a center for solar and its austerity plans have dampened the solar industry. 

 

TechCrunch ran an assessment of IPOs and how the poor IPO market has impacted the leading companies. Their chart shows how meager the first day pop has been, and how the companies have tended to do poorly in the after-market. As a consequence, the leaders of this generation of new ventures - Facebook, Zynga, LinkedIn, Twitter, Skype - have so far eschewed the IPO and relied on generating cash flow and private investment to grow. Many of the later round investors are allowing the early founders and employees to partially cash out. 

It may be that we need a signature IPO - like Netscape in 1995 or Apple in 1980 - to spur the return of the IPO market. Many of the tech IPOs so far are not in that league, and instead fall into two categories: 

• late 1990s vintage startups whose investors are seeking liquidity after a long slog, and
• dashing cleantech ventures who need oil-tanker-loads of capital to build out at scale

Maybe Tesla can restart the IPO market, at least for cleantech deals. Even green-industry stock analysts are skeptical. It is a bit daunting to imagine a new company taking on the huge scale players in autos, many of which are already into electric vehicles, especially Honda and Toyota. Yet it is conceivable. Here is why:

• The last successful auto startup in the US was Chrysler in 1925. Chrysler got out when it was possible to launch against the scale of the leaders - it marked the transition away from innovation to scale economics
• There have been a number of other car startups between Chrysler and Tesla, but none with the game-changing potential of Tesla
• It seems inevitable that we transition the fleet to electrics. It will take several decades. Tesla marks the first startup of this transition
• Tesla may also mark the beginnings of a restructuring of the auto value chain, to become less vertically integrated and more like the consumer electronics industry, and to iterate models more quickly. If so, the scale advantage of the leaders will be turned into a cost disadvantage

Tesla is the bet on the future of cars, not the past. Electrics represent a generational disruption to the auto industry, and usually out of these periods new winners emerge. A discussion of their pitch is here, and you can see the roadshow presentation here. Key slide: building a platform, not just a car:

 

Disclosure: I have a small indirect interest in Tesla. 

Pushing the Envelope on Market Fractals

Mother Market is a perverse lover, always trying to fool. As we begin to understand that Mother Market is a nonlinear chaotic system, we can appreciate that fooling the herd is her essential nature. Chaotic systems always seek order, and occasionally find it. When they find it, markets react crisply and quickly - think Flash Crash. As they seek it, they live on the edge of chaos and jink and jive precisely to fool their followers: as too many take a position on one side, the market will jink to the other. 

The whole field of technical analysis comes from the classical world of linear thinking: patterns that emerge and behave consistently. Markets are fractal in nature, and behave with a constantly shifting underlying order which we can barely discern if ever understand. The fractal nature of markets was first recognized by Mandelbrot (the picture is the visual representation of the fractal Mandelbrot Set), and initiated furtive investigations of fractal finance. The herd instead believes in the Random Walk theory and follows the Efficient Market Hypotheses. If the market is fractal, it is non-random and potentially predictable via technical analysis. The leading Elliott Wave practitioners recognized the fractal nature of wave patterns a decade ago, but have not pushed the theory into the world of Chaos Theory. Zoran Gayer was making strides in this direction when he unfortunately passed away. 

Hank Wernicki of Elliott Fractals is going where no one has gone before, constantly testing fractal patterns as predictors of future market moves. He posts often in comments to this site, and exposes his work in realtime for success and criticism. I deeply respect that process. One of the great improvements in human knowledge from the Internet is to treat the community as a test bed in itself. Companies are being launched today using rapid iteration from realtime feedback and deep analytics to figure out what customers respond to. Hank is pushing the envelope on the usefulness of market fractals by field testing his fractals as he goes, and improving their accuracy and predictability. 

Over the weekend Hank got endorsed by Bob Prechter's EWT:

Fractal analysis: After watching Henry (Hank) Wernicki for a year or so,  I think he is onto something. Wernicki visually scans past short term patterns in the S&P for ones that look like “now,” and on that basis he attempts to forecast the market’s next move, usually a few hours or days ahead. When the market stops copying itself, his opinion is stopped out and he moves on to another picture. Hank makes bold calls, so if you are a day trader, you might want to check out his work. You can find him at www.elliottfractals.com.

He tells me his site was overwhelmed Monday, so I held off a day to publish this. Everybody loves Hank! Kudos! 

Today Was a Big Yuan

The market yawned despite gushy headlines like Bloomberg's "Yuan Strengthens the Most in 20 Months." Mish wryly notes that since China held the peg since July 2008, duh! Bloomberg later redid the headline to "Since 2005", but the move was only 0.37%, which machts nichts compared to, say, the Euro, which fell peak to trough over 1% today. The conventional wisdom on the Street seems to be (from Art Cashin):

• Treasuries should drop as China can buy fewer (higher Yuan buys more)
• USD drops, AUD and NZD rise
• Commodities higher as China can buy more
• Stocks will be mixed

The first point, long-term bearish on Treasuries, was picked up by many morning pundits, but curiously not David Rosenberg who instead thinks it is good for Treasuries, and signals a time to load up. After all, China has been unloading Treasuries recently anyway, and a higher Yuan will have its biggest impact in lowering the US trade deficit which lessens pressure to borrow from abroad. The STU agrees, as Treasuries appear to be ending a B-wave triangle and starting a C wave to drive yields down, with the 30-year targeting a drop below 4%. 

The second point, to go back into commodity currencies, depends on the third point. The AUD and NZD should pop for a bit, but if this is not bullish for commodities, they drop back. Indeed, since China needs to continue to tighten to stave off various bubbles, this move can be seen as simply another lever to tighten. That is bullish for the USD and bearish for the commodity trio of CAD/AUD/NZD. 

The third point, that commodities go higher, presumes China continues to increase growth, whereas it appears this move is partly intended to quash internal inflation. CPI inflation at 3.1% is above China's target, and PPI is well above, up 7% over the past year, largely due to rising commodity prices. Hence it might be time to unload commodities, especially after they popped a bit today. Here is a video analysis from MPTrader of how commodities have not responded as expected:

The final point that stocks will be mixed, is curiously unenlightening from Art. Nic Lenior had a much more insightful reaction: Houston, We Have A Problem! Here are excerpts:

The rebound which we managed to anticipate from 1,040/1,045 in the S&P future was purely technical. ... The market caught most bears trapped as it broke above the 200-dma, but the volume and price action did not really confirm a major acceleration. ... As such we were hoping to sell the rebound should it reach 1,150 in S&P futures. Unfortunately I don't think we will have that pleasure. 

Nic adds that a lot of traders have been waiting for the Sp1150 level to go short again. When a lot are on one side of a trade, Mother Market will fool. On the technical indicators, the STU notes that we hit Sp1130, the 50% retrace, and did so in a thrust (the gap up at the open) out of a fourth-wave triangle. We have been in an ABC flat correction, which means the final C wave will break as a "5", and could be considered complete after the fifth-wave thrust. They note how breadth closed negative on every index they track. If volume picks up to the downside, the top may indeed be in.

My take: we are in what I call the Big Tease, a name chosen to fool the maximum market participants before the end. Take a look at this nifty chart, recommended by a reader in a comment to the prior post. The Dow hit the 50 DMA and fell back. So far it has done two head fakes:

• it double bottomed around Dow9800 (Sp1041), creating a bear trap a couple of weeks ago
• It now has backed off the 50 DMA after the bullish enthusiasm had increased, creating a bull trap and springing it

So why not drop a bit more, getting the bears short, and then thrust up in a final spike to Sp1150? A final bear trap. This wave 4 triangle and wave 5 thrust can be considered the end of the third wave of C, not all of C, requiring a larger fourth wave followed by the final thrust up. 

Watch two things:

1. does volume increase to the downside?
2. do we hold above Dow10320/Sp1105, the low of the prior fourth wave triangle?

Double Dip Countdown: "9"

The Double Dip Countdown ticks down as the ECRI leading indicators have dipped even lower into negative territory, falling from -3.7 last week to -5.7. This is only the second negative reading and it will take a sustained drop to signal a recession, but the previously dismissive tone of the director of ECRI, Lakshman Achuthan, is showing heightened concern: "We're definitely rolling over."  The -10 level is considered conclusive of a coming recession.

 

Global industrial production is up but continues to roll over. China (yellow line) is flat, Japan (red line) soared from a deep drop but is now clearly turning down, the Eurozone (dark line) still looks like it is improving, and the US (blue line) is rolling over and approaching zero to negative growth. Production is still positive, but a few more ticks and the US will be negative.

 

China is saying it will allow the RMB to float a bit, which might spark a stock move early this week - futures are up strongly on the announcement - but then they announced no change as of Monday. This might just be a bit of posturing before the G20 meeting, but it is interpreted as a vote of confidence in the global recovery despite the warning signs of a turn down coming. In any event, Chinese increase in exchange rates coming on top of labor unrest and higher wages further confirms my post of several weeks ago that the era of cheap labor is ending in China. The Chinese are likely to move slowly, but looking beyond any vote of confidence, this will put another damper on global production.

A good discussion of the implications of this move is here. Marginal exporters may suffer or go under - as I have discussed previously, many of them run on 2% margins, extremely tight - but a stronger RMB makes imports cheaper. Watch the AUD tomorrow - it might pop due to expectations of increased raw ,material exports to China.

Are Munis Next?

Warren Buffett is all warns of a "terrible problem" of municpal bond defaults as signaled by increasing credit default swap (CDS) spreads. With all due respect to Warren, his worries over the rising CDS spreads in California and Illinois bonds, however, are misplaced. Illinois is in deep trouble, but it is not the next Greece, nor is California about to join Club Med. The Big Picture does a nice treatment on why muni's are not in as much risk as sovereign debt despite scary charts like this one: 

 

Simply put, a State cannot go bankrupt. They can run out of money, as California is wont to do every year, but then they scale back their commitments: first education (50% of budget), then interest on muni's (7%), using California numbers. The shortfall has to be 43% before California muni's get at risk of default. Also, they simply cannot let their State debt go down. Individual cities or districts can, but the State cannot survive without debt. It needs the debt to bridge across sporadic tax collections. I discuss this at length in my longer post, Investing in Munis.

The muni rating agency Fitch recently re-calibrated their ratings, increasing them. As the WSJ reports, Fitch took into consideration the fact that many municipalities are under intense stress, but “historically, the level of [muni] default was very minute as compared to other sectors.” Investors have basically shrugged off the risks, as yields have not moved much in the face of rising CDS spreads (see chart, courtesy WSJ).

To top it off, the Stimulus has provided a large bridge to the States: $135B of the $150B estimated State shortfall will be covered by Stimulus. A lot remains to be drawn down, particularly for education, giving the debt service segment even more leeway. See next chart. Instead of dragging down muni's, State problems will drag down the Federal taxpayer. 

It seems inevitable that Greece and other PIIGS in Poo will default. It turns out sovereign nations tend to default much more frequently than muni's. They have armies and can get away with it. Here is what I wrote as the Greek Tragedy began to erupt and gold began to be hoarded:

What happens when the debts of the issuer are vastly beyond their productive capacity? Well, the country defaults, and the fiat currency is forcibly exchanged for scratch. A 2008 paper by Harvard Professor Rogoff and Prof. Reinhart, both members of the NBER (which calls recessions and recoveries) entitled This Time Is Different demonstrates that instead of fiat regimes making good, they have defaulted over and over throughout eight centuries of financial crises:

We find that serial default [repeated sovereign default] is nearly a universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies. 

Before we take comfort in the US being already an advanced economy, the imperial power of its day has typically defaulted after over-extending. Rich European countries have defaulted, including Austria, France, Portugal Spain and Germany. The reunified German defaulted in 1873, bringing the whole world into a long depression, including the United States. In the last century, Germany defaulted twice: 1932 and 1939. Russia three times, beginning in 1918. England in effect defaulted in 1931. 

The interesting conclusion: Treasuries, gold and Muni's stack up as the safer places to be. Even corporate debt from quality issuers may prove safer than sovereign debt. 

Testing the IPO Window UPDATED

The IPO window will be tested this week with six offerings, two of which are venture-backed companies: Broadsoft (BFST), a 1998-era telecomm software company, and Motricity (MOTR), a 2001-era mobile software company.

UPDATE: Broadsoft priced at the bottom of its range, a poor sign. It fell 8% in its first day. Motricity dropped the size of its offering and lowered its range quite a bit from $14-16 to $10-$11. Watch Friday to see how it does.

The last tech IPO, ReachLocal (RLOC), priced below its range and fell below early last week, only to rise back slightly over the offering price. From the first day close, it has dropped quite a bit and is still down (see chart), but a few more days like today and it goes back to positive in the after-market. 

The keystone IPO is coming up: Tesla Motors (TSLA), the first serious auto startup since Chrysler in 1925 and the biggest auto IPO since Ford in 1956, should price the week of Jun28. The lead underwriters, Goldman Sachs and Morgan Stanley, announced a price range today of $14-16, valuing the company at $1.5B and seeking to raise $167M from the public and another $50M from Toyota. This is an increase from their expectations back in January when they first filed. Unlike Ford, which was profitable very quickly, Tesla has yet to make a profit; yet is highly awaited as an IPO. The increase is a good sign of confidence by the underwriters. 

While the tech press is generally positive, we do have the headline Blockbuster or Dud? based on recent green IPOs. A123 (AONE) jumped 50% on its first day but since has fallen to 33% below the IPO price with an aftermarket return of -56%. The Wall Street crowd may be even less kind, saying: "The car business is a fairly weak business, and there's lots of room for Tesla to run out of juice before getting plugged on." 

After Tesla, ZipCar intends to IPO, followed by GM re-IPOing after its LBO by the US Govt. The Tesla and Zip IPOs may be coming out a bit prematurely for the market to be ready for high-burn unprofitable ventures which lack the scale of competitors. Still, they both have enough sizzle to make up for the lack of beef. 

Tesla will test the IPO appetite and likely determine whether it remains open or shuts down for the rest of the year. 

Double Dip Countdown

A double-dip recession is unusual. We may have had only one - in 1980 and 82. We had a double dip depression in the '30s, but the dips were five years apart, and the whole period is more of one slow slog of government life-support and a moribund private sector than a happy recovery and a fall back. It shows up in this unemployment chart - we never got employment back to pre-Depression levels until after the war. The question right now is will we have a double-dip in the Great Recession? 

 

The buzz to start this week was of the second coming of the double-dip, set off by David Rosenberg. What spooked him was the ECRI index falling below zero (see next chart, courtesy Pragmatic Capitalist). When ECRI drops below -10 (from its current -3.5), it has signaled a recession 100% of the time. Rosenberg ranks the odds at 80% of the double-dip. ECRI's indomitable leader continued his optimistic take, saying that while the drop "assures a significant slowing in US economic growth in the coming month, the recent weakness has not lasted long enough to signal a new recession threat." Others have backed his stance, saying it is premature to call the double dip or this is not a recession signal but a reaction to the sharp rise off the bottom. Fair enough, but the countdown has begun.

For the stats minded, here is a look at its record of prediction. The recent decline is the largest before any prior recession. Also, ECRI tends to be late in predicting a recession. Other leading indicators are also rolling over, such as the Conference Board LEI, which at least shows a slowdown:

 

Morgan Stanley holds out for just a slowdown, arguing primarily that global growth is rebounding. Indeed, there is some glass-half-full optimism even over in Europe, where the UK just raised GDP estimates for next quarter - ironically due to the Euro crisis and a cheaper Pound - but lowered their 2011 estimates. The same goes for Germany and a cheaper Euro, where the expectation is it helps more than austerity in Club Med hurts. Still, the OECD indicators for the global recovery are all rolling over to slower growth. Peaks are evident in the US, Japan and Germany, and are now showing up on the UK, France and Italy. Worse, China too is rolling over:

 

The poor retail report Friday also casts doubt on the recovery. It was the biggest decline since last September, and if we remove Cash4Clunkers, the biggest since March 2009, over a year ago. It may be that it reflects distortions from the first-time homebuyers credit, which caused a surge in April and thus may have led to the largest sector drop, a drop of 9.3% in May of building materials; but other sectors were down as well, including general merchandise and clothing. Auto sales are also looking weak, as fleet sales are up much more (32%) than individual sales (13%) in the first part of 2010, leading George Pipas, an analyst of Ford, to opine that consumers are back to deferring big purchases due to economic uncertainty. Savings had dipped a bit, but savings has gone back up, suggesting that a flood of tax refunds and other government checks may have temporarily boosted retail around April 15. That is now over. 

 

If we look at other GDP factors, two elements which had boosted GDP are now lagging: the inventory surge is now over, and State spending from stimulus is also on the downswing. State sales taxes are also likely to shrink, as we see in Texas, putting further pressure on State spending. The impact on GDP may be a 1/4 point, and comes on top of a drag of 1/2 point from the lower Stimulus and a further drag from the loss of the 1.3% inventory adjustment on Q1, making Q2 in the range of 2% lower than Q1. 

John Hussman gives us five leading indicators of a coming recession:

1. Widening credit spreads (check!)
2. Flat yield curve (almost there!)
3. Falling stocks (check!)
4. Moderating ISM growth (check!)
5. Moderating employment growth (check!)

The countdown to the double-dip is on. 

Big Tease Countdown

Over the past two weeks our three market scenarios (and a wildcard) have steadily shrunk to one: the Big Tease. The Big Tease has completed the minimum requirements for a bounce, and could be done; but odds favor a bit higher and a bit longer to go. Nonetheless, we are now on a countdown to the next fall. Let me walk through the odds and what to watch for.

 

This chart from MarketThoughts is a reasonable starting point for the Big Tease. The first wave down started Apr26 at Sp1220 and followed the requirements for an impulse down:

1. it broke in five waves with the third not the shortest
2. the second and fourth alternated in structure
3. it ran down a channel of parallel trendlines marked by waves 2 and 4
4. the main waves down were all impulses, with the third wave the most violent (the Flash Crash) and the third of the fifth wave having a sharp fall with gaps down. 

(For Neely followers, the form fits MEW 5-2 but fails the test of an extension, where the longest wave should be more than 1.6x the next longest. In this case wave 5 ran from 1174 to 1041 or 133 pts and wave 3 ran from 1209 to 1109 (truncated fifth wave) or 100 points, so a 1.33x relationship.) 

The countdown has to do with when and where the wave 2 bounce will end. The first wave down was an 180 point drop from Sp1220 to Sp1040, and took 21 trading days from Apr26 to Mar25. The wave 2 bounce so far has gone just under 38% in 13 trading days, or 62% of the time of the first wave. This is about the minimum retrace, so it could be over. The odds however point to more to come:

• 50% of the time a wave 2 retraces 50-62%
• 20% retrace less than 29.3% (requiring instead a fib relationship in time)
• 23% retrace 30-50%
•  7% retrace more than 62%

(The 29.3% is a repetition number related to the square root of 2 and comes from the use of squares to mark time/distance targets, a technique in Neely's MEW and used currently by Carl Futia. Half the square root of 2 is 70.7%, and 1-70.7% = 29.3%. The stats come from Zoran's work.)

Applying the thinking of the Monty Hall Effect, once we went past the 30% level, the odds shifted to 2:1 to the 50-62% retrace (50% vs 23%), giving a target of 1130-1150. This is also the range of the inverted head & shoulders (1140) and where wave C of wave 2 (marked as the yellow Y in the chart above) is 1.6x wave A (1147). 

The main supporting factor of today's high being the end is it marks the third time in three weeks the S&P has tried to break above the 200 DMA. Each attempt has come with less volume and fewer advancing issues (there is a good chart on this in todays STU.) As the STU comments: "These figures suggest that the effort to rise above the moving average is becoming exhausted." Strike Three! calls Bespoke:

Wave 2 counts pretty well as a flat correction, with A=C at today's high and the B wave retracing essentially all of the A wave - typical relationships. Still, wave C is not clearly a five-wave pattern, and the STU notes that it could extend further, at least to cover the gap at Sp1115 / Dow 10444. 

My take: I expect this to take more time, closer to the end of the month (and the quarter) or even past the fourth of July weekend. If we do pop above the 200 DMA, it is likely to be a fairly sharp thrust and then quick fall back below (a false break). For all of this to happen, we might see the simple flat now begin to break into a more complex corrective wave, staying in the 1080-1105 range before the false break up. 

The triple witching Friday is a good moment to watch for a sharp move as positions get cleared out for the quarter. The cash settlement index options allow a form of gamesmanship which might explain the odd pattern of a sharp rise or dip at the close. A major player can take a much larger options than stock position, and then either buy or sell enough of the basket of index stocks to move the index, benefiting with the leverage in the options. A small cost in the stock basket can return a much larger options profit. If we presume the option holders are long into Friday, look for a spike in the S&P before the cash settlement. It will look like a short squeeze, which it probably is, but self-induced. 

Corporate Bonds: The Next Safe Haven?

In the New Normal of low interest rates and low returns, institutional investors engage in a Global Scramble for Yield which makes them stretch for a few extra basis points, often assuming a disproportionate level of risk, as we all found out since 2007. Now we see a whipsaw market, which bounces between a jump back into risk or a Global Scramble for Safety, such as the run on gold coins that infected Europe after the Flash Crash. When the obvious safe havens get driven up, such as Gold, Treasuries and even cash (Dollars); and the hoped-for safe havens get their day, such as Munis; where to put the marginal safe investment? Jennifer Gordon of ForexIndicators.net (not .com) weighs in with high quality corporate bonds as the next place to catch before the scramble for safety drives rates down here, too - but with an eye to the exit! 

This is a possible safe harbor not well covered in the punditsphere, so your comments are encouraged. 

Whipsaw Market Roasts the Bears

For the past two months the market has begun to swing between panic and greed. Robert McHugh reports that we have had eight 90% down days and five 90% up days - very unusual, and not conducive to a continued rise. This sort of whipsaw action is more typical of market tops and bottoms, where divergences emerge - and we are seeing extreme divergences. Friday's STU reports that Friday was another odd day, with volume the lowest in two months (before the 90% up/down days started) and yet the lowest TRIN in 58 years and the highest TICK since 1987. A record low TRIN indicates that huge buying pressure was need to move the market up just a little bit. The STU concludes:

it's got to be one for the record books of bearish setups

Bloomberg Businessweek will run a cover story on the market bears, which normally would be considered bullish: when a story finally hits the popular press, the trend it celebrates is usually just about over. Most of us know this as the Sports Illustrated Effect: a quarterback or pitcher who gets on the cover lauding success one week typically has a disastrous outing the next time. It is clear, however, the point of the story is to roast not toast the bears. Prechter is not the main course (Roubini is), but is grilled well-done:

One of the most famous of these extremist outsiders is Robert Prechter. In the 1970s he revived an old system of measuring investor psychology called the Elliott Wave Principle and used it to advise subscribers of his investment newsletter on Oct. 5, 1987, that they liquidate their stock holdings. Two weeks later, the market crashed. Prechter was hailed as a genius—though the label didn't stick. In 1993, The Wall Street Journal ran a page-one story headlined "Robert Prechter Sees His 3600 on the Dow—But 6 Years Late." He stayed pessimistic through the 1990s, and in 2002 said the Dow Jones industrial average would fall below 1000. It surged 25 percent the following year and kept going up until 2007. 

Ironically, the dismissive tone towards bearish advisors turns the cover story indicator from bullish to bearish. Since the market is flat or up 80% of the time, random darts and rally monkeys will seem more prescient than bearish pundits. Fear unfolds faster than greed, so the timing of bearish predictions needs to be much closer to the event. This raises the stakes for bears preserving their hides. Fortunately for Prechter's reputation, despite his Lost Decade from 1994-2004, he predicted the 2007 top and the 2009 bottom with pretty close timing. After two premature calls for the end of the Hope Rally, he made a correct call right before the April top. Still, he tends to intersperse a longer term bearish view with the short term calls, as this analysis of Prechters record demonstrates, where the 4/2/09 quote they attribute to him, for example, misses his call a few days earlier of the coming Hope Rally; and the report simply ignores his correct 2007 call. Acting on that one call before a 50% fall would have cured a lot of prior misses, although his complete miss of the dot-com bubble is simply inexcusable. 

So what about now? The bullish Thurs and Fri took out the STU's über-bearish triple nested 1-2, but did so on volume 40% below average, which gives no comfort to the bullish case. The simplest way to count the market right now is to make the end of wave 1 down the May25 low (although Daneric makes a case for a leading diagonal down that ended on Jun8, which leads to similar predictions as the Big Tease count). The May25 first wave creates either:

1. June Swoon II: a new nested 1-2-i-ii, with the end of wave 2 the recent Jun3 high at Sp1106/Dow10315 and the inside i-ii being the Jun8 low and Friday's high
2. Big Tease: the wave 2 bounce off Mar25 has barely started and should go back at least beyond the Sp1115 gap if not the 1140 head & shoulders target to the 1150 range

The June Swoon count will emerge or die pretty shortly. It might start with a pop on Monday then a drop. A bounce above Jun3 levels kills it, and a fall below the recent low at Es1075/Sp1080/Dow10108 pretty well confirms it. 

My take: given a month-long wave 1 down to Mar25, the bounce in the purported June Swoon wave 2 is a bit short and fast: a 38% retrace that took place in a week. Normally a wave 2 would go back 50-62% of the drop, and take more time. So while you might want to be prepared for a reversal this week, expect a slower and longer retrace. We head into a triple witching Friday (quarterly close out of options), so also expect the whipsaw market to continue.

Big Tease is Back!

The rally Thursday got the Dow back over 10K, but volume was anemic, suggesting investors have gone to the sidelines. Indeed, it is now clear that the "buy the dips" mentality is leaving the retail investor, who might rather be "selling the blips" (see the red trend dropping in the first chart). 

We have been following three scenarios for stocks: 

• Summer Rally: new highs!
• Big Tease: after a dip, back to Sp1150!
• June Swoon: Dow9K!

The Big Tease seems most plausible right now. Carl Futia finds a pretty good bottom has formed and now sees a run to at least Sp1140, which is the minimum to satisfy the recent reverse head & shoulders. Without having to buy into his Sp1300! exuberance, the wave structure may count best as a first wave completing at the flash Retest bottom of a couple of weeks ago (Flash Crash is wave iii, Flash Bounce iv and the Flash Retest is v completing the first wave down). 

The June Swoon's swan song may have been today, as the triple nested 1-2s went away, but Robin Landry has come back with an alternative wave count which maintains the nested 1-2s and points to an end of this inside wave ii around Sp1105/Dow10300 (see chart). What you would like to see in a nested 1-2 is that the inside waves are smaller than the outside. The second 1-2 are both shorter than the first, by are longer in time, so not perfect, but plausible:

 

EWI's alt count in the STU yesterday come to fruition today. In that count, the Flash Retest is the end of the first wave down, and we are in a wave 2 that is breaking in a more complex way, but it still remains a June Swoon count. It first needs to go above the recent wave A high at Sp1104, but if A=C, it should end around Sp1106-7. It would have traced out a nice flat correction, and the June swoon would then loom. 

We can put aside the leading diagonal as today busted above the upper trendline. As MarketThoughts put it, dies is kaputt, but it may be setting up a bull trap:

ObamaCare Killed the Recovery

Fascinating analysis shows that the V-shaped bounce off the bottom and steadily improving unemployment was stopped in their tracks by the introduction of ObamaCare. Even before it passed it started to kill the recovery. Could it be that the expected increased burden of adding an employee scuttled hiring plans? 

If we had stayed on the prior trend, we would be in a clear jobs recovery in three months (Sep 2010). Now it trends out three to three more years.

Stocks in a Coiled Spring, Fundamentalists in a Fetal Position

Scott Adams (Dilbert) had a priceless column in the WSJ on why it is smart to put your money on companies you hate. He of course picked BP (which he argued is at a bottom) and Apple, which he says he has hated for five years and should have gone in then. In the course of it he trashes most investment approaches, including Technical Analysis:

Technical analysis involves studying graphs of stock movement over time as a way to predict future moves. It's a widely used method on Wall Street, and it has exactly the same scientific validity as pretending you are a witch and forecasting market moves from chicken droppings.

Wonderful satire, but sometimes the real world is dumb and dumberer - such as today, where the pundits asserted one cause of the market's rise and the same cause for its later fall:

• the market went up on the Fed's remarks that the recovery was still on but the improvements in employment were only "modest"
• the market fell on the Fed's Beige Book which showed that the recovery is still on but in some areas growth is "modest"

This reminds of a recent day when in the morning the fundamentalists stated that the market went up due to higher oil prices, which pointed to improving demand; then later in the day when the market fell back said that the market fell due to higher oil prices. which pointed to a future slowdown. 

The fact is these sorts of justifications du jour are simply nonsense delivered in ponderous tones of authority and have no better weight than astrology. Scott Adams take note!

To push this point home, simply note that the fundamentalists are all over the map on what happens in the next few days, and if anything are a bit bullish since we have tested the Dow9835/Sp1045 (the Feb low) now four times and not sustained a break below. 

The STU notes we are now in a coiled spring of a triple nested 1-2 which typically precedes a major move, in this case hard down. Whereas during the run up the right move was to buy dips, this time it is to sell blips, as the market is unable to sustain a rally: "Each near-term rise is swatted back." While investors are watching the Feb5 intraday low, we have now had two days closing below the close that day, and the two lowest closes since seven months ago, last November 4 at 9802. 

We could fall off the cliff tomorrow, or fall after a little more sideways action to swat back another bullish attempt and wear out the bullish interest with a fifth probe of the 9800 level. In either case the chicken droppings and all that are forecasting a coming fall. Let's see what contradictory and hopelessly shallow pontification the fundamentalists concoct when that happens. 

The TRIN Early Warning Siren

Bespoke uses the TRIN (TRading INdex, aka Arms Index) to show extremes in selling or buying. The TRIN formula is deceptively simply and forecasts distribution of stocks:

• Near 1 is balance
• Above 1 is a rollover into selling
• Below 1 is a rollover into buying

As it spikes up or down it also measures the buying or selling pressure it takes to move the market. As Dick Arms interprets: 

The Index seems to work most effectively as an overbought/oversold indicator. When the indicator drops to extremely overbought levels, it is foretelling a selling opportunity. When it rises to extremely oversold levels, a buying opportunity is approaching.

The recent spike above 13 shows it took a lot of selling to move the market down. This can signal exhaustion of a trend and a buying opportunity if it comes at a bottom, but can be used as an early warning signal if it comes in the middle. Bespoke smoothes the TRIN to a 10-day average to take out noise, and came up with this stunning warning shot across the bow: the TRIN spiked in March 2007, signaling the coming credit crisis:

 

It may be signaling the second wave of that crisis is ahead.  

China Factory Suicides Signal End of Cheap Labor

Ten workers (mostly young women) have committed suicide at Foxconn factories in China - the same places that make iPhones and iPads. At least 13 have tried, and some reports are of 11 suicides out of over 20 attempts.  Foxconn may not be running sweatshops as Upton Sinclair exposed in The Jungle, but the impact may be similar: the Chinese government is demanding changes. 

This may signal the end of the cheap labor era. A recent strike at a Honda plant shows workers resisting exploitation. The inflationary forces surging inside China is also putting pressure for increased wages. 

Honda workers on strike in China factory (LA Times photo)

The Beijing Youth Daily dissects the problem and finds conditions are a modern version of hellish: long hours, trapped at night in dull dormitories, severed from the social constructs of the farm villages, precluded from overtime pay, and regimented to minute details in the tasks they perform. They call themselves "pubic hairs", an exemplar of their low self-esteem. 

Foxconn workers (Bloomberg photo)

Bloomberg adds additional color. Perhaps most striking are these factoids:

• 80% of assembly line workers work standing up, sometimes 12 hours a day, 6 days a week
• 86% of workers live in dormitories with 8-10 per room
• Making friends is hard since they are not allowed to chat on the line

Apple is caught up in this mess and will add to the pressure put on these factories for change. Apple's initial response was to say they were not "sweatshops", but this missed the forest for the trees:

The word "factory" is something of a misnomer: It would be more accurate to describe Foxconn's facility as a manufacturing city, according to the AP. Large-scale industrial production is booming in China on a mind-boggling scale. Imagine a gated industrial complex that sprawls across five square miles and employs hundreds of thousands of people on assembly lines running 24 hours per day. The workers live there, eat there and shop there. And they make your iPhones and other electronic devices.

Steve Jobs comments at D8 conference still seem an effort in spin not resolution:

On the matter of the recent spate of suicides at Foxconn, the Chinese company that manufactures electronic devices for Apple and several other major consumer electronics brands, Jobs said the company was very concerned about the issue. “We are on top of this. We look at everything at these companies. I can tell you a few things that we know. Foxconn is not a sweatshop. It’s a factory — but my gosh, they have restaurants and movie theaters. But they’ve had some suicides and attempted suicides, and they have 400,000 people there. The rate is under what the U.S. rate is, but it’s still troubling. We’re trying to understand right now before we try to go in with a solution.”

This all may be a blessing in disguise. The US went through this at around the time of The Jungle, and greatly improved working conditions - plus found it came with improved productivity. At the time the US had two huge advantages over China: innovation (think: Edison) and efficiency (think: Carnegie in steel, Rockefeller in oil, Ford in manufacturing). When Japan went through this, they innovated in process (think: the Toyota manufacturing system). China now needs to step up their game, and move beyond cheap labor in virtual slave camps to push for innovation in products and process. 

The Chinese story sounds an awful lot like the immigration story that has been replayed across the world: off the farms, into the cities, exploited ruthlessly, struggle in sweatshops, and slowly pull themselves out of the bottom and into the middle class. The Chinese government has been acting like a modern-day Midas, hoarding the gold (foreign reserves) and keeping their citizens relatively impoverished as they chase the mercantilist dream. Their citizens are now clamoring that the powers-that-be spread the wealth around, and let them in on a little bit of it. It is time. 

Did Friday's TRIN Spike Signal Bearish Exhaustion?

On Friday the Arms Index (TRIN) spiked to 13.5, one of the highest levels ever, the sort of spike seen on days like the 1987 crash. A high TRIN means it took (in this case) almost 14x the bearish volume as bullish to push the market down. As Dick Arms describes it, they represent "a sudden rush for the exits .. a sign of fear and panic." Normally they come with a downside breakout, and mark a bottom. 

We did not have such a breakout Friday. Even after the drop Monday, we remain above the Feb5 level. The market remains in a sideways pattern. This suggests more downside ahead, but Dick Arms believes it means instead a bounce is due back to Sp1150, confirming the right shoulder of a head & shoulders pattern back to the January top. Curiously, he also notes that the sideways pattern since May 6 creates a smaller inverse head & shoulders, and a bounce right away would complete it. It also targets a return to Sp1150. 

Adding this to my two prior posts gives three bearish paths ahead that should all be clarified in the next couple of trading days: 

• the LD down towards Sp970 with a bounce to Sp1100 before the Big One down
• the Mother Market surprise first to Sp1070-1090 then the Big One down
• the inverse H&S back to Sp1150 before the Big One down

Dick Arms from The Big Picture

That Sinking Feeling: Stocks on Edge of Cliff

The drop today increases the potential for a deep drop tomorrow. We are right on the edge of running below the Feb5 low and confirming the next big drop. The primary two trajectories are the Leading Diagonal discussed in the prior post and picked up by Daneric and other sites, and the Big One down now elevated to very likely by tonight's STU. 

While we saw less downward pressure today than Friday, this does not so much support the fading bullish case as suggest Mother Market has a little surprise in store: we may set up a third nested 1-2 before the coiled string of the Big One unfolds. The first 1-2 is the Flash Crash and Flash Bounce. The second 1-2 is the inside Flash Retest and smaller bounce. The third 1-2 could come from the wave structure in the following chart (courtesy Wave Principle): we are finishing a small degree wave (i) down, and seem to be in the fifth and final wave of it. This sets up a little wave 2 bounce either right away tomorrow or after a little more downside (eg. to Sp1047). If that bounce comes, it might get back to the Sp1071 level before the Big One. 

Psyching the Market: The Leading Diagonal Pattern

Stock market patterns reveal market psychology. Wouldn't it be better for market psychology to predict market patterns? We are living through a great example right now with the potential Leading Diagonal pattern.

The market is a nonlinear chaotic system which at times follows order (impulses) or (more often) lives at the edge of chaos as it seeks order (corrections). Impulses typically stretch as the psychology is one of piling on. We saw this in 1987 and again recently with the Flash Crash; and to the upside in the 1984-6 and 1995-7 bull runs. The impulse patterns require one of their segments to stretch or extend, reflecting this piling-on psychology. 

At times impulses instead compress and form what are called Diagonals or (at the end of a wave) Terminal patterns. This compression comes from a market psychology of anticipating a major event or policy change. In Mar08 we saw an Ending Diagonal (ED) as the market anticipated a bailout of Bear Stearns and slowed the piling on. Another recent ED happened right before the GM bailout in Nov08. I discussed ED's at some length a few months ago.

A leading diagonal (LD) is more rare and indicates hesitation in the kick-off to a strong move. The chart from EWI shows a bullish LD. They give trader tips on diagonals as well. 

In a diagonal, unlike normal impulses, wave 4 overlaps wave 1. In addition, the wave ends converge in a wedge. (I explored the expanding ED, and concluded it was not a proper structure; it doesn't fit the psychology of compression.)  Also, wave 1 is longer than 3, and 3 is longer than 5. It compresses. 

The LD starts a wave like a nested 1-2 structure while the ED ends a wave like a triangle. The LD pattern breaks as a 53535 structure, while the ED is 33333. This avoids confusion as to where one is in a larger wave structure. (The site I cited in the prior post argues an LD can be 33333, which I think is unsound.)  

When one sees nested 1-2s, as now, the antennae should perk up for an LD. When technical analysts call out a Diamond Formation, the antennae should perk up for an LD. Whether it is nested 1-2s or an LD pattern cannot be confirmed until the fifth wave:

• if it gaps down and is shocking in its intensity, we have had nested 1-2s 
• if it is anemic with overlapping waves, it is the fifth leg of an LD

We had smaller degree nested 1-2s off Apr26 and then a stunning drop - confirmation. 

We have larger degree nested 1-2s into Friday and then overlapping waves - caution flags. Today is more of the same. 

How can market psychology inform us as to which it is early enough to place bets in the market? In contrast with the prior ED examples where we fell hard and were momentarily saved by government bailouts, this time we were rising until belief in bailouts began to fade. The fall off April 26 coincides with the Greek Tragedy in Europe and a whole series of ever-increasing bailouts. This weekend the G20 met to discuss continued global stimulus, and the Europeans are backing off. This does not end the matter, as a major G20 meeting is upcoming in Toronto in two weeks. 

My conjecture is the current overlapping waves down reflect the fifth leg of an LD. Today the market is so far in a trading range as well. The tell from market psychology: we are in a wait-and-see period for the next and possibly final bailout attempt. 

if we are in an LD, it should drift down but no farther than Sp970-1000, shorter than the third leg from Sp1174 to Sp1041. After that the retrace should head back at least 50% into the 1095-1107 area. The 1106 and 1115 gaps may remain unfilled. Then we start the next Big Down. This could all look like a June Swoon followed by a Summer Rally and then yet another August Peak before an October Crash. 

That Sinking Feeling: Stocks Stuck South of 200 DMA

The S&P has closed below the 200 day moving average (DMA), a widely-watched indicator, for 11 straight days. This is now moving into the length seen at the top in 2007: 19 days below in Nov 2007 (the first dip below the redline in the chart). It stayed well below in 2008 with a slight blip up in the Spring. Is the extended period below signaling another bad year ahead? 

The WSJ has picked up on this, noting that "some pretty smart people are cautious". Specifically, John Hussman has noted that only 19 times in the past 50 years have technical indicators been this bad, and they signaled a further plunge of 7 - 20% over the next year. Worse to consider is that bear markets tend to run for two decades (eg 1929-1949, or 1966-1982), and this one has only gone for one decade so far. If the Hope Rally is done, we have a decade of hurt ahead. 

Richard Shaw of QVM has a nice analysis (the charts are from him) which points to the 200 DMA level as now becoming resistance. A close look of the past few months shows how the market has bumped along the 200 DMA:

 

Doug Short adds this compendium of global markets, all sharply down, with the Shanghai Index already into bear market territory (26% off the Nov-Aug bounce peak):

 

Many investors follow fairly straightforward metrics (PE ratios, earnings growth, 200 DMA). A look into their way of thinking is a good way to predict how they are about to react. Here is a another chart from Doug which shows another widely watched indicator: will we close below the Feb5 low on a weekly basis (smoothing out intraday spikes)? We are sitting right on that level, and this time we are below the 200 DMA, setting up a much deeper drop:
 
   

The next two signals (if we drop next week) that will be widely watched are the 20% "bear market" drop and the "Death Cross" where the 50 DMA runs below the 200 DMA. Here is a look back at the 50/200 DMA crosses since the 2002 bottom:

 

Finally, we got the first-of-the-month signal of Daryl Montgomery mentioned in my June Swoon post of last week: the first four days of June were down, for a double-down month in a row. His comments:

Even worse was that all four major indices were down for the first four trading days of the month. This is a typical bear market pattern. It does occasionally happen in bull market rallies though, so to be significant there needs to be two months in a row with a loss in the first four trading days. May also saw just such a loss, so the two down months in a row have now taken place. A bear market doesn't mean the market isn't going to go up again. Bear markets are known for their sharp and sudden short covering rallies. Traditionally, it means that traders should switch to shorting the rallies instead of buying the dips. 

So far we have a wealth of worry but no clear direction, although odds favor a down week if not a down Monday. Futures are down as this goes to press, albeit this often misleads by the morning open. Asian markets are red across the board, but they tend to follow not lead, so view this as a reaction to US markets on Friday. Can wave theory provide more precise guidance?

Neely notes that despite the "scary, news-induced sell-off" the market has not even retraced 50% off the low of eight days ago, and so he expects a bounce. Kenny notes that we had a lot of overlapping waves on Friday, not typical for an impulse wave down to the depths. The way this gets squared is to count the whole drop as a five-wave leading diagonal (LD), where wave compression and overlapping minute waves can be expected. If so, the downside target is around Sp970-1000. (For those of you who follow the comments, I discussed this several times over the past few days, including here.)  MarketThoughts provides a good discussion of this LD view, which he sets up with this chart:

 

Under this view, the Flash Crash was a wave 1, the Flash Bounce a wave 2, the Retest Wave 3 and the meager 38% retrace last week a wave 4. This satisfies Neely's concern, since wave 4's tend to retrace 38-50% while wave 2's usually go back 50-62%. Here is the LD count and predicted drop (just don't be distracted by the grey fib retracements, as they are not off the start of wave 1 but of wave 3):

 

The third view (after Neely's triangle with upside this week & the LD count) is the nested 1-2. This is the prime count of EWI and was reiterated in the Friday STU. They begin with the S&P futures, which hit Es1107 in overnight trading, a perfect 50% retrace of the prior wave down (from the Flash Bounce high), and also 38% in their alt count, which makes what is labeled a blue 3 in the prior chart the end of wave 1 down. Both reflect minimum and satisfactory retracements, setting up a deep plunge. Also, in their nested 1-2s, the inside 2 remains shorter in distance and time of the prior 2, a proper relationship. This chart from EWPrinciple captures this nested 1-2 view:

 

Interesting is that the STU also caveats their bearish count: the TRIN on Friday was the third highest in 22 years, behind the October 1987 crash and a warning drop in Feb 2007. This might signal a momentary bearish exhaustion. Last week (Wed) they had expected a higher retracement for their alt count, which I called the Big Tease. It could still be on, especially with a bounce Monday. 

After all these points of view, we are left a bit adrift. Sometimes that is the best you can do. If we pull back, however, it is clear a fundamental shift has occurred. EvilSpeculator provides a very interesting sets of charts in their private section for subscribers, which they have allowed me to publish in part. They have graciously allowed me access to their private service, which I have found quite interesting as a complement to EWI and NEoWave. The final chart and analysis is a good exemplar of why - they are pushing the envelope on TA. 

This chart looks at the percent of stocks above their 50 DMA. It gives an advanced warning of divergences. In this case the percent above peaked around Nov and pointed to the Jan drop ahead of time; then bounced to a lower high and have fallen with the market since. The early warning is key. It shows how the fundamentals in the market have been turning over, and pointing to a coming distribution (meaning: big drop). A similar signal was given in early 2007. 

That Sinking Feeling: G20 Busts the Government Bubble

The Keynesian Cheerleaders have met their moment of truth: gas or brake? Geithner went to plea for more stimulus from Europe and Japan, betting that more deficits now will produce growth and future taxes to pay down the debt. The Europeans have hit their limit and politely told Geithner where to go. 

The Government Bubble has just burst.

Hungary is about to join the PIIGS with unsustainable debt, and the Euro has broken below the recent trading range and is below $1.20 - down from $1.50 not so long ago. The next support is around $1.16-1.18. It is in a wave 5 down and could easily overshoot these levels. 

All the rescue plans have been for naught, as the wolfpack continues to call the bluff of the finance ministers. Now even the core countries of Europe are seeing spikes in their CDS spreads. This witty video from Australia gets across the point that investors have figured out: indebted nations cannot bail out the broke nations. 

While the sudden surge in core country CDS spreads may abate, it appears we have crossed a very critical threshold: belief in the wisdom of assuming debt for temporary stimulus. The Illusion of Stimulus has been punctured. The Keynesians have no clothes. 

There is anger brewing over the failure of Keynesianism: people feel like they have been sold down the river with false promises of easy money in order to line the pockets of overpaid public workers, nefarious bankers and corrupt politicians. 

There is no one in the blogosphere better at projecting that anger than Karl Denninger, who rants that the attempt to re-ignite private credit growth has failed. By his calculation, we borrowed 12% of GDP last fiscal year, and are on track to do it again this year - levels well above the 5-6% of Hoover and FDR in the Great Depression. With the backlash against this growing, the US may be forced to pull back to a more sustainable 3-5% level. That drop of around 8% will come out of GDP by the way it is calculated, whether it is a drop in spending or a massive increase in taxes, icing the coming double-dip recession.

With total government debt at 130% of GDP in the US (including State and local debt as well as unfunded future obligations), this point was inevitable here as well - our leadership simply has not been prepared to come to grips with the dimensions of the problem, blindly having faith in Keynesian prescriptions. 

 

Obama's Summer of Disillusionment is upon us. His cool, collected style is now viewed as a profound failure of leadership. Already his most visible gushers of support have begun to publicly air their disappointment (Maureen Dowd, Tom Friedman, Frank Rich, even Chris "I get a tingle down my leg" Matthews). James Carville rebukes him for his failures with the oil spill. Quietly, his army of true believers are bailing. 

What happens now is laid out by Karl: we are entering an Austrian-Economics style debt-deflation spiral, and there is no longer anything the government can do to prevent it. 

The size of potential fall in private debt is well beyond the ability of the government to fill ($52T of total debt vs $13T of Federal deficit). We were at about half that total amount of debt just a few years ago when the Greenspan Bubble began ($26T vs $52T), and we may be headed back that far. Bubbles tend to retrace to their start. Hang on to your hats. And wallets.

That Sinking Feeling: Underwhelming Unemployment Underscores the W

When a Keynesian Cheerleader says a double-dip is now 50-50, you know the recovery is in trouble. Robert Reich so opined on CNBC this morning. Clearly the recovery is not a typical V shape, and it now appears headed to a W.

Before the unemployment report, the pundits were predicting a good report, with BNP Paribas stretching to 645K. Goldman's Hatzius, whose prior predictions were pretty good, got caught touting a 600K number. It came in at 431K, below both the Goldman 600K and the consensus 536K. The key to watch is not the total, skewed by the census number at 411K, a whopping 95% of the total (see chart courtesy Innocent Bystanders), but the private payroll number, which came in at 41K, well below the consensus of 180K. 

There is evidence of systemic fraud in the census hires being hired and fired and rehired, but this should not affect these numbers as they are based on surveys. The fraud seems to be for the benefit of supervisors who must have some sort of incentive pay based on hires. What a mess. But just as the census hires should be redacted to look at the underlying strength of the economy, when they start getting laid off in droves the firings should be added back. It is the private sector trend which is critical to projecting a recovery, or not. 

The 41K private jobs is a drop from the prior month's 231K (which was adjusted down to 208K) and a reversal of five months of improvements. The moving average is around 150K. 

In addition to the 411K census, there were 31K temporary jobs, meaning permanent jobs actually came in a negative 11K. Also, the birth/death model estimated 215K jobs, meaning arguably this report should have come in a negative 226K. 

The unemployment rate fell to 9.7% because the total workforce fell from 65% down to 62.5% of the population, well below the normal level of 67% for the past 20 years. This decline comes from people leaving the workforce. Usually during a real recovery people return to the workforce and the unemployment rate paradoxically rises. We saw that last month. This workforce decline is bad news for a recovery. 

 

The best summary of the employment situation comes from Calculated Risk and the following chart. It shows how much deeper and longer our current plight is, and how the apparent bottom of the last five months appears to be rolling back down to a double-dip in employment:

 

That Sinking Feeling: M3 Falling at 1930s Pace

This should not be happening: the US money supply is falling hard. We have stimulated, liquidified, pumped, swapped, backed, TARPed and done about everything years of academic analysis of the Great Depression told us to do. Ambrose Evans-Pritchard (AEP) of the UK Telegraph penned US Money Supply Plunges at 1930s Pace that headlines: 

The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history

This plunge has no precedent since the Great Depression. The fall seems due to debt deleveraging, which is accelerating, without any corresponding new commercial debt issuance. Credit remains frozen. In a fiat currency economy, debt creates money, and write-down of debt reduces the money supply. 

In a growing panic, the Obama administration is now thinking of throwing more stimulus onto the fire of debt deleveraging. This risks repeating the mistake of Japan, pushing public debt even faster to dangerous levels. The IMF is already quite concerned over US fiscal policy:

Under the Obama administration’s current fiscal plans, the national debt in the US (on a gross basis) will climb to above 100pc of GDP by 2015 – a far steeper increase than almost any other country

Ironically, Ben Bernanke, the student of the Great Depression, built his reputation on credit, and follows what AEP calls "creditism", explained here, an untested theory that disavows the seminal work of Milton Friedman on how Fed mistakes in the early 1930s exacerbated the Great Depression - and ignores M3 and other money supply measures. Creditism has failed to restore the velocity of money, which would be a consequence of restoring normalcy to credit. Bernanke may now try to adopt an explicit inflation target, which may crash markets (bonds and stocks). He cannot "go off gold" and reflate the currency (see chart, courtesy Jesse's Cafe Americain). He may, indeed, have run out of magic bullets. 

In the 1930s the rapid deflation in effect reset the system. This time Bernanke is trying everything he can to avoid deflation. Yet:

The Fed has been largely ineffective at doing anything but fattening bank cash flows by squeezing savers and allowing banks to collect generous margins on the performing consumer loans they do have. The bailout money sits in bank coffers, withheld from an economy that now depends on loans for its very survival

There has been a lot of reaction to AEP's dramatic headline. The most common is the plunging money supply is foreshadowing a double-dip recession. There is increasing data from sources like the BEA that show slower GDP growth, and have been interpreted to predict negative GDP as soon as Q3.  ECRI's leading indicators have also been slowing, and had the biggest plunge in a long time in mid-May. While they are still showing positive growth, the fall is ominous. It is dropping at a rate that would make it negative 5% or more by Q3, an area consistent with forecasting a recession. 

 

M3 was dropped by the Fed in 2006 due to its sensitivity to portfolio balancing, making it over and under-shoot. There are more money supply measures than M3 - AEP chose the most dramatic. Also, Jesse points out that Eurodollars are often left out of these calculations, and that the Fed often is jerky in managing money aggregates - pedal-to-the-metal than back off and see if the car takes off. So momentary hysteria over M3 may abate if the Fed reverses its course. The other M's have plunged in rate of growth, but not yet gone into negative growth on a year-over-year basis. Does this discredit AEP? No - the other M's have seen a recent drop in total supply, like M3, and this means their YoY growth is destined to run below zero shortly. This drop in M3 is now showing up in other economies, such as Australia, indicating there is more to it than momentary Fed clumsiness. Here is a chart which shows money metrics growth falling, albeit not yet below zero:

One of the lessons of the 1930s is the Fed tightened prematurely in the summer of 1931, responding to the collapse of the Creditanstalt bank, Britain leaving the gold standard, and an international banking crisis that caused the Fed to try to protect the US gold supply from a run (see chart courtesy Jesse).   

We may be making adifferent but equally tragic mistake this time around: we are backstopping the wrong banks and letting Main Street whither on a drought of credit. We are in thrall to the theories of an academic elite that lack worldly experience, have spent their careers pampered by commissions, conferences and cushy positions, are captivated by their big bank sponsors, and have never left the incestuous little world of elite universities, Wall Street advisory positions, and government jobs. 

Big Tease is On!

Our three scenarios (and a wildcard) have resolved to the Big Tease: a run up to the range of Sp1120 - 1150, then a drop again. Today was a 90% up volume day, so this could be the kickoff of a run to hew highs, but that seems unlikely, as volume remains larger on down days than up days, and was the second lowest in the past three weeks. 

The prime count is captured in this chart from EWTrends, which also supplies fib targets of 1107 (50% retrace) and 1122 (62%). Given that the market believes we will see a promising unemployment announcement Friday, partly based on temporary census workers but also including a broader increase in employment than we have seen in a while, we seem likely to run past the gap at 1115 into the 1120 level. 

 

As I have commented, often the EWI alt count provides better guidance than their prime count, which tends to be the more bearish view. Today's STU continues with the prime count but has elevated the alt count to higher visibility. In the alt count, the recent bottom is seen as the end of the first wave down, and the Flash Crash becomes the end of wave iii of 1 down. This means the current correction is retracing the whole drop from 1220 to 1041, and gives different fib targets than the prime count and targets in the chart above:

• 50% retrace: 1130 (not 1107), near where a=c of this bounce (1133)
• 62% retrace: 1151 (not 1122), near where the head & shoulders targeted (1140)
• 4th of the prior 3rd: 1160-1174, the fourth wave of the Flash Crash

Neely still has us in a contracting triangle B wave, which allows for new highs later this summer. His count explains the anemic upside volume, since it wouldn't be expected to kick off until the C wave. We seem to have finished his leg c of the triangle, and are in leg d. His leg a was the Flash Crash and leg b the Flash Bounce. Given the pattern of a contracting triangle, he would expect leg d to finish below leg b, meaning not get back to 1174 but end around 1150; and drop in leg e to below 1040. Hence his view would be consistent with the Big Tease - a bull trap fake-out around 1150 - and would be followed by the Little Tease - a bear trap when we break 1140. A double fakeout trap! 

June Swoon Looms Soon

Today was the second worst start to June in 50 years, a 90% down day, and a surprise as we have tended to see positive rises on the first few days of each month. Short weeks (Monday was a holiday in the US) tend to rise on light volume, but maybe not this week. Today's meltdown at the close was ominous. Taken together, these factoids increase the odds of a June Swoon, which we may confirm by the end of the week. Daryl Montgomery posits in SeekingAlpha that the first few days of a month are a tell:

Money tends to get reallocated at the beginning of the month. The behavior is more pronounced at the beginning of the quarter and most pronounced at the beginning of the year. In bull markets, much of this money gets allocated on the buy side for stocks. In bears markets, a higher percentage of investing money will go to safe haven assets. So in a bull market the first four trading days (not five as many sources claim) of the month tend to see a nice rise in stock prices. The first couple of days are almost always positive.

He counts four negative signals in the Hope Rally: July, September, February and May. A poor opening here or there indicates caution, but four such months indicate that the Rally has a weak foundation, especially combined with lessening volume to the upside and rising volume to the downside. Two down months in a row would pretty well confirm a bear market. We have until June 4 - Friday.

Lots of trouble brewing. Japan PM resigns. Israel stumbling into conflict. Criminal investigation into BP. Obama losing his most ardent supporters (eg. Chris Mathews, Maureen Dowd). Eurozone seems nearing an implosion as Euro bounces along the $1.22 level, getting as low as $1.211 this morning and bouncing, perhaps on central bank intervention. Rumors swirl of France being the next PIIGS. 

The Shanghai market did a death cross. Chart here. Maybe it is not predictive of US and Euro markets, but the drop in the SSEC can now be seen as having preceded the slowing down of manufacturing which has now shown up in the Chinese PMI. In any event, a few more days like today and the Death Cross (50 DMA crossing below the 200 DMA) will happen here, too. 

Waves are pointing to at least hitting the 62% retrace at Sp1065. Walter Murphy's newsletter comments that a break below that likely drives us to and below to recent low at Sp1041. EvilSpeculator notes that 1041 on the low side and 1104 on the high side mark the June Swoon vs Big Tease scenarios.