Planet Yelnick

Hemlines, Stocks and The Beatles

The Big Picture snapshots NY fashion and notes how the hemlines are below the knees. The NYT sees it as a backlash against the miniskirt. The hemline indicator goes back to 1926: 

• short skirts = bull ('20s, '60s, '90s)
• long skirts = bear ('30s, '40s)
• slit skirts = stagflation ('70s)

The "science" behind this is that stocks are a refection of social mood, and it also shows up most vividly in fashion, music and movies. They are concurrent indicators, and can confirm an imminent change of trend. When skirts get long, movies get dark and music goes in the studio, watch out.

This month's Elliott Wave Theorist doubles down on music as an indictor with a deep dive into the popularity of The Beatles, their musical transformations and the 1960s stock market. Even if the stock market angle is not interesting, the dissection of Beatles history is a magical history tour for Beatles fans and well worth the read. You can access it for free here. 

 

Looking at this chart, reprinted with permission, a couple of items jump out:

• Beatlemania precisely tracked the huge bull run from 1962-66
• Beatles Backlash tracked the subsequent bear market drop, with burning of albums (over a remark that they were more popular than Jesus), unsold venues on the second US tour, and personal problems that led the boys to take a break at the bottom
• Their great studio albums, beginning with Sgt Pepper, tracked the bounce into 1968 and captured the popularization of the drug culture
• They broke up during the deeper drop in 1969 that ended the exuberance of the '60s

The concept of social mood is captured in this album cover, quickly pulled, that reflected the darker mood of the late 1966 bear market drop. It presaged themes that would dominant the bear market '70s: The Exorcist, anti-heroes, heavy metal, disco dancing in dark venues. Good thing it was pulled, because The Beatles brand was an ebullient bull market brand. 

EWT's conclusion: a phenom like The Beatles occurs as a combination of talent, luck and timing. Once they become the symbol of popular mood, the manic stage is on. People pour their hearts into the symbol. Music seems to have a peculiar affinity for this, with similar manias around Sinatra ('40s), Elvis ('50s) and Michael Jackson ('80s). When the mood shifts, as in the end of the '60s bull market, the act no longer fits. The Beatles broke up, Elvis went to Vegas, and Michael Jackson became known as an oddball. 

Implication for investors: the hemline indicator is but one of a lot of indications of a hunkering down for a long bad patch. TV is flooded with shows on magic, the occult, and darker themes. The better movies explore darker side of human nature, such as The Dark Knight. Bull market acts are gone, and the state of the music industry is largely doom & gloom. 

The Big Tease Market is Doing Its Job

The Big Tease market scenario has the market in a course to tie the bears and bulls into knots, and it seems to be doing its job. The wave structure is an expanded flat since May25 as wave 2 of the Flash Crash drop off the Apr26 high. The target remains Sp1150 range. The timing remains the turn of the month, or around August 4.  

The STU has shifted their count twice, and now is in the most bearish version of the Big Tease, which has us in a final wave (v) of C. They too count it as an expanded flat off May25. They also track a nine-day turn cycle, which peaked yesterday, so under their view the Big Tease may be done. If so, it should drop tomorrow. 

They note another way to interpret this wave (v) of C, as having finished merely minor wave iii of (v) up, and now meandering in a typical wave iv. This allows for another "stab" up. They can draw a channel around this wave (v), and a drop below today's low (Dow10463) would breach the lower trendline. If we stay below, that confirms the change of trend; but at this point in a move we might see a false break and then have the "stab" up, living up to the principle of fooling bull and bear alike. 

An interesting alternative view comes from several sites: that this wave 2 is not an expanded flat off May25, but a zigzag off Jul2. In this count, the Flash Crash did not end until Jul2. Market Thoughts uses the chart above to show the wave structure in July. It shows the wave 4 of C hitting the lower channel, and a possible wave 5 to end this C wave. The bigger picture going back to April is captured in the next chart from Daneric, which shows the five waves down to the July bottom. This is the Naz chart; the S&P chart is similar. This chart shows a more bearish count like the STU, that we have ended wave C and therefore wave 2. The big P3 starts tomorrow!

What if it doesn't drop tomorrow? Where might it get to? Interesting is that both variants of the Big Tease give the same target: 1150 range.

• In the Big Tease with the expanded flat wave 2, the A wave went from Sp1041 to 1131, or 90 pts, and if normal relationships were to have held, the targets for C would have been 1100 (where C=A), or since that is busted, to 1155 (where C= 1.6x A)
• In the variant of the Big Tease with the zigzag, the A wave went 90 pts, and if C=A (a common relationship in a zigzag), the target is 1150

The second most common relationship in a zigzag is C=0.6x A, which gives a target smack dab where we topped yesterday. Could the STU be right? Far be it from me to challenge the masters themselves, but I do not like their wave count for the final C wave. It has a very small (i)-(ii) compared with (iii)-(iv)-(v). Eyeballing the top chart above, The blue 1-2 inside wave A is what the STU thinks is waves (i) and (ii), and then then what is labeled the rest of the big A is wave (iii), the big drop labeled B is wave (iv), and the incomplete C wave is wave (v). Seems disproportionate. 

The Big Tease may have a Big Trick up its sleeve. Note that in the expanded flat version of the Big Tease, what is labeled as the big blue ABC above would instead be labeled as subwaves within larger wave C, and in a flat, wave C breaks as 5 waves. The big blue ABC above would be waves (i) (ii) and (iii) of C, and we have (iv) and (v) to go. Wave (iii) all be itself may fly to 1130-50 range, perhaps by Aug4; and then we have a larger wave (iv) and a final stab up to the range of 1155-1175. 

If this happens, a gaggle of ewavers will consider wave 2 done at 1130-1150, and be placing bets on the big P3 down. Instead of a hard drop, we will see an annoyingly stultifying sideways wave (iv), which should end with a dramatic short squeeze to create the "stab" up. Then as the bulls pile on in surprising ecstasy, down we go. 

Yves in TV

For you fans of Yves, here is his upcoming broadcast schedule:   

  Thursday, July 29:

 15:00-3:00 P.M.

  Closing Bell on Fox  

 

Thursday, July 29:

17:00-5:00 P.M.

 Taking Stock on Bloomberg

 Friday, July 30: All day 

  Tech Ticker  on Yahoo!

Australia Real Estate Forecast Confusion

ZH posted this report on Australian real estate, which picks up on a theme of mine, that the Lucky Country has taken on too much debt, and is about to have their housing bubble burst. The conventional wisdom in Oz is that the housing wonderland will continue to rise. My on-the-ground contacts forwarded to me a comment by the chief economist of business forecaster BIS Shrapnel, who just said that the cooling off of the rest of the world did Australia a big favor by crimping risks. He expects a 30% rise over the next three years. What is curious about his analysis is he also expects interest rates to rise 2% and sees mortgage rates above 9% - not exactly the climate for a robust housing market. Indeed, that is usually the formula for bursting a bubble.  

My on-the-ground guy says he is simply confused over the conflicting analyses. 

The Broyhill Letter (Q2-10)

Beware Extrapolating from One Data Point

CNBC had a robust session on the housing data Monday morning, concluding that housing had bottomed and the bounce was on! Their single data point: a 23% bounce in June over May. No mention that:

• this was the worst June on record (back to 1963)
• May got revised downward 11%, a pretty steep change
• the 23% gain in June was elevated due to the May reduction
• April got revised downwards, too, by 15%, an even steeper change
• June was 17% below a year ago, June 2009
• June was the second worst month on record
• May was the worst, the all-time record low (back to 1963) for any month 

To the contrary, a commentator asserted that "housing bottomed in the first quarter of 2009." He must have failed math. Maybe now he can make the claim, after the two worst months on record. Some discussion that it follows a really poor May, which plummeted after the homeowners credit expired for new homes in April. The perils of government intervention. A reversion to the mean snapback was to be expected in any event. More data at Calculated Risk, a great source on housing.

CNBC was not alone in this irrational extrapolation. Bloomberg reported:

Sales of U.S. new homes rose in June more than forecast following an unprecedented collapse the prior month, a signal the worst of the slump triggered by the end of a government tax credit is over

A different but equally misleading error shows up at the normally reliable Pierre du Plessis blog. I think it inadvertent, since he is exploring an interesting issue. The ECRI indicator has dipped below -10%, which has always signaled a recession. The inputs to ECRI are a black box, but Pierre uses correlation with the S&P to argue that ECRI really tracks the S&P more than a cluster of leading indicators. Or maybe it is the S&P which tracks ECRI's indicators? It makes a huge difference, since the hoary old saw is that "the market predicted six out of the last three recessions."  ECRI may be more accurate than the S&P.

A third data point getting a lot of press is the Chicago Fed's Index, which shows a decline in June. In my most recent Double Dip Countdown post, I noted how the Empire State (NY) and Philly reports had shown a slowing of growth, but not a decline. The Chicago survey is national, and the decline is a bad sign - yet still just one datapoint, and one that needs to be understood: a decline means growth below the historical trend, not an outright contraction. The three-month moving average has gone to -0.05, but it needs to get below -0.72 to reliably signal a double-dip. 

 

A final pair of datapoints come from the regional Feds. The Dallas Fed Manufacturing Index, which was suppose to improve from -4 in June to -2.5 in July, instead fell to -21, the lowest level since July 2009. The Richmond Fed also reported a drop from 23 in June to 16 in July. Again, these drops do not signal contraction, just a slowdown in growth in manufacturing.

Individually, these single factoids can be used to create a bullish or bearish picture. Taken as a whole, they show consistent evidence of a second half slowdown, if not a double dip. 

1937 All Over Again

It's deja vu all over again - Yogi Berra

Bernanke's comments last week elevated to public view a debate over the Bush tax cuts expiring next year. Most of the rate cuts affect people below $250,000 in earnings, so letting it lapse as is would breach one of Obama's core campaign promises. The Sunday NYT headlines a big fight brewing over this. The problem of letting it lapse, however, is much more economic than political, and affects the future path of the stock market.

The Original Double-Dip

The lapse of the cuts amounts to a large tax increase in the middle of a recession, a lesson we should have learned not to do. Back in 1937 FDR tried to return to normalcy after his re-election in 1936, and instead threw the economy back down in a large W shaped recovery - the original double-dip recession. (See chart from WSJ.) 

The cluster of mistakes:

• new social security tax ('37)
• "soak the rich" tax ('36)
• surtax on undistributed profits ('36) 
• increased bank reserve requirements ('37)
• letting a bonus to veterans lapse ('37)

Of these mistakes, three were tax increases. 

The Potential Impact of Tax Increases

Christina Romer made her economics reputation on the impact of taxes on growth, and she "cringes" at the thought of repeating the mistakes of 1937. She became Obama's head of economic advisors, and her policy brief on the 1937 problem can be downloaded here. It is an interesting read since she suggests that fiscal stimulus has a modest impact, while monetary and tax policy have a much bigger impact; and yet the current policies of the administration are the opposite: heavy on fiscal stimulus, sanguine about the coming tax increase, and nearing the end of monetary stimulus. Her reputation-making conclusion on taxes is that each 1% increase in taxes causes a 2-3% decrease in GDP - a huge negative multipler of around 3x (download her paper here):

My purpose is not to rehash the debate over the mistakes of 1937 - there is plenty of that going around. It is useful to appreciate, however, that what passes for conventional wisdom - the Keynesian view of the 1930s as one of a hapless Hoover and a stimulative Roosevelt - is itself revisionist history: Hoover had ramped up Federal spending to deficits of 4.5% of GDP, and FDR kept that relatively constant, averaging 5.1% in the first three years of the New Deal. The economy swung in much broader strokes between 1932 and 1936 than such a minor difference would indicate. 

What is clear is that the New Deal did not get us out of the Depression. Unemployment was still above 12% in 1937, and got back to 19% in 1938. Also, government spending did not decrease in 1937, although the deficit did shrink (see chart). The degree to which we fell back down after modest changes in policy throws into question the New Deal narrative, and how effective its fiscal stimulus really was. Certainly it has an impact; but it may not fix things. 

This seeming failure to explain the swings in the '30s by fiscal stimulus alone has led many revisionists (beginning with Milton Friedman) to consider the contraction in credit (monetary policy) as a much bigger driver of the 1937 double-dip than any slackening of fiscal stimulus. Yet one of the most troubling analogies to 1937 and today is the dearth of business and consumer lending. Keynes of course called this the Liquidity Trap. Even if the Fed's low interest rate and QE policies of today are theoretically expansive, the monetary fix is not working, and the fiscal stimulus did not work to get us past the Liquidity Trap either. Worse, the recent FinReg bull already has tightened credit even more - for example, the criminalization of rating agencies (a little plum slipped into the bill at the last moment) has caused Ford to have to pull a bond offering as the agencies have stopped rating instruments pending clarity on the new rules. 

I wonder if FinReg will go down in the revisionist history of the future as the equivalent blunder in its effect to Smoot-Hawley in the 1930s: the tipping point to a disastrous contraction. 

Despite the revisionists, Romer's view that to withdraw stimulus now would repeat the mistakes of 1937 represents the conventional economic wisdom.

The Diminishing Impact of Fiscal Stimulus

In some respects our current environment is very much like 1937:

• Back then, the banks sat on high reserves rather than lending - as now
• Back then, the interventions and meddling of the New Deal (so-called Regime Uncertainty) froze corporations from investing, and they sat on huge stocks of cash - as now
• Back then, the low rates of return made it dis-economical to invest in new plant - as now

In other respects, however, we stand in a very different place:

• In the first wave down from 1929-1933, the over-capacity built by the bubble in the 1920s was worked off, and both production and capacity were in better alignment in 1937 than today
• Growth from 1933-36 was double-digit (above 10%), whereas our growth off the bottom has been in the low single-digits, and we still have very poor capacity utilization
• Although Hoover and FDR ran 5% deficits, the overall size of the Federal spending and debt (as a percent of GDP) were lower then than now

Perhaps most profoundly, back then the economy had not been on continual fiscal and monetary stimulus for decades as we have now. Back then we may truly have had a "multiplier effect", where incremental spending from borrowing led to 1.6x returns; whereas now, as I have analyzed recently in the Peak Debt post, we may be approaching a point where incremental fiscal spending has very little impact on growth. We borrow $1 for each dime of growth so to speak, digging a deeper grave. (See chart, courtesy The Economist.)(For more on multipliers, read this.)

We are in effect in a wartime economy in terms of stimulus, without the war. 

And it is not working very well. The political opposition to more stimulus is mounting, just as it did back then (see cartoon). Given an ebbing of stimulus, a tax increase with its 3x de-multiplier would likely push us into another double-dip, especially with Bernanke running out of monetary weapons. 

 

The Impact on Stocks

The WSJ updated their take on 1937 with a discussion of how closely the stock market has tracked the 1937 market (see chart). (This link works without WSJ subscription.) In the two weeks since this chart, the market has continued very close to the 1937 market, and seems poised for the Summer Rally seen in August 1937. Interesting is the timing has shifted right by three months, so adherence to this pattern would see a rally into the November elections:

While the market is a fractal, a one-time event like 1937 should not be considered a precise roadmap to 2010, but at least it shows how a market reacted in a somewhat similar situation. If policy mistakes drive us into the double-dip, the crushing drop after the summer rally is very likely to repeat itself: another 50% drop from the summer high, which I guesstimate at Sp1150 +/- 20 pts. That targets below Sp600, which means below the Mar09 lows. Ouch.

Compare 1937 to 1929 (next chart), and you see the mismatch to 1929. After the crash of '29, we bottomed in November and had a five month rally that went back 50%, then began the sickening slide to the 1932 bottom. After the crash of 2008, we bottomed in November and had a five week rally, then fell to a deeper low in March. Off that low we had a 50% rally, but it took much longer, almost 15 months.

 

Doug Short has run a constant series of charts comparing various crashes, and even if you line up the bottoms in 1929 and 2009, the 1929 analogy breaks:

 

This time delta between the 1930 bounce and the Hope Rally has caused the Elliott Wave Theorist to opine that we are unfolding in the same way, just at 1/3 speed. This points to an ultimate bottom in 2016, 3x the time of the drop from '30 to '32. Curiously, the Kondratieff Wave 'false plateau" that preceded the credit bubble in 1929 took 8 years, whereas our recent Great Moderation took 25 years - also a 3x. 

While an interesting speculation, this simplistic approach does not really fit Fractal Finance. The 1937 analogy seems to fit better, although imperfectly.

The Road to Recovery

We are left with a troubling question: what policy moves can we count on to get us back to normal? Until we get on that path, the stock market cannot be expected to return to a secular bull market. What policies "work"?

To borrow a phrase from Clinton, it depends upon what the meaning of "work" is. 

It is loosely said that the Great Depression ended in 1942 with World War II. Most of the 7M unemployed were absorbed by the military, which grew to 8.6M. The draft ended unemployment, but was not a recovery. GNP rose, but not for the private economy: consumer spending declined, goods were in short supply, civilians were essentially forced to save, and business investment fell. To think it "works" to "fix" the economy by borrowing huge amounts to produce lead & steel that are wasted in the jungles of the Pacific or the beaches of Normandy is abject nonsense. 

Even worse are those who wonder where the war is that will get us out this time. Economic debacles tend to end in war, but is not something to be sought just because it might "work".

Many of the justifications for massive stimulus in peacetime claim they "work" as long as we avoid a slide back down. But what if this is not sustainable? It does us little good to try to bridge across a GDP chasm with government life-support if we plunge back down when the life-support is withdrawn. The scary part of 1937 was that the changes in stimulus were modest, and the plunge was huge. At best we end up like Japan, a terminal patient: 20 years of an L-shaped recovery, ever increasing debt, taxes soon less than interest on the debt, and a day of reckoning that is not much further off.  Japan seems beyond the point of no return.  A good slide presentation on this point can be downloaded here. 

 

Now compare the Japan chart to the next chart, which shows the CBO's forward projection of US debt, and comes with dire warnings over the US's unsustainable path of increased deficits ... we are turning Japanese if we continue on this course. It does not "work" to put us on a path of terminal life support. 

 

The common sense conclusion is a policy bundle "works" if we return to a sustainable path of recovery in the private sector. It doesn't work if we just kick the can down the road. If we slide into a double dip this time too, the Keynesian solutions will have failed again. We will have to find a different set of historical analogies to help us out than the New Deal. 

The 1946 Solution

The one analogy year which has so far been overlooked is the remarkable turnaround in 1946. There was grave fear of a return to the Depression after the war. Keynesians and central planners gave dire warnings of the "Depression of 1946" - the one you have never heard about - and urged a continuation of New Deal policies and central management of the economy. These suggestions were completely rejected, and the Depression of 1946 never happened. Instead, the US ended the New Deal: it stopped meddling in the economy, slashed spending by 2/3, canceled war contracts, and ran a budget surplus to begin paying back the huge war debt - the exact opposite of the current convention wisdom. The speed with which government controls over the economy were removed validated the confidence of the private sector and emboldened investors. Rather than return to double digit levels, unemployment among the huge influx of veterans remained under 4.5%. Unshackled from the New Deal, the private economy roared back. 

The 1946 story has been recently popularized by Jason Taylor and Richard Vedder in a Cato Institute paper called  Stimulus by Spending Cuts: Lessons From 1946 that has run around the blogosphere. The 1946 "Shock of Peace" (a Shock of "De-Stimulus") worked quickly. 

While economists, including Nobel winners, are picking up on the policies of 1946 if not the meme itself, and debating the merits of the 1946 analogy, it has not yet emerged into the political debate today about what "works" except as some sort of latter-day Reaganism.

Perhaps the reason is the prescription seems too extreme. Given how heavily the US budget is stuck on entitlements, how would it get cut by as much as 2/3 as we saw in 1946? It may be inevitable that we have to do this, given the unsustainable direction we are currently pursuing, but it would entail more "Change" than the current political leadership could envision (consider for example this speech from James Galbraith). Hence the politicians would rather believe in "Hope", kick the can down the road, and wait for the patient (the US economy) to die before tackling the disease. 

There is a plan floating around to make these big changes, and it starts with tackling the big four expenditures (see chart): defense, social security, medicare and medicaid. Without any endorsement of the particulars of it, it at least is an exemplar of how we could do today what they did in 1946, making deep cuts in spending while maintaining the safety net, freeing the economy to grow again. 

The initial post on the plan is here. 

Weekend Bits

When the market bumps along a trading range, it frustrates bull and bear alike. I think we are about to sprint up in the Summer Rally. First, let's look past the news, which is mixed at best: 

• ECRI below 10% signals double-dip but UK showed surprising GDP strength avoiding double dip
• Some banks failing EuroZone stress test, but Euro remains bumping up near $1.30, further depressing Euro recovery
• Bernanke seeming to back off monetary stimulus in favor of fiscal, which has huge implications for the double-dip. 

For ECRI fans, here is a good chart by Doug Short which shows we have entered recession territory, accompanied by analysis of what this has signaled in the past, which I can summarize as: the Fed bailed us out of negative ECRI indications previously by lowering rates, but they cannot go any lower this time

 

Unemployment shows we are still in a jobless recovery, and it may be structural since we rely so much on production overseas rather than filling our factories. As David Rosenberg opines, the bad news is good for bonds, and can be good for stocks in the short run. How good? 

We may now be in the proverbial Summer Rally, and it may be short but sweet. Consider this chart from EWP:

It says we remain in the Big Tease, and the market is about to run up fairly strongly into the turn of the month towards Sp1150. The Big Tease has us still in a wave 2 corrective mode since the Flash Crash, an "expanded flat" where the B wave breaches to a lower low but reverses: the bounce up to Sp1131 was wave A, the drop to Sp1011 was wave B, and we remain in wave C. Given waves (I) and (II) as shown above, we would now be in wave iii of (III) of C, and should now run fast. To support that view, EWP notes how we have been rising in 5 wave moves and declining in 3 wave moves, indicating the direction is up. This would be the happy Summer Rally.

Of the major pundits, Neely thinks we are in the middle of the his wave B and hence the least predictable part. He has wave A being the run from Feb5 (1045) to Apr26 (1220), and the Flash Crash and its aftermath as a wave B triangle. Leg A down was the Flash Crash, leg B was the bounce to 1131, and we remain inside leg C.

Prechter's service had a high-odds count earlier this week that got blown up yesterday. Tough business being a pundit. Their special STU yesterday held to Sp1100 as a barrier, but we breached it today. Their alt count allowed for that, and today they posited their continued view of a nested 1-2 i-ii. The inside wave ii has gone 78%. Theoretically it could go back 99% and go really close to 1131, but practically it shouldn't be much beyond 78%. Hence they may have to fall back on their other alt count, which is similar to the Big Tease, albeit they expect the final wave to end around the June high at 1131. 

Curiously, if it does push to 1131 level and then drops, rather than setting up the dreaded 3 of 3 down, it might instead signal an inverted head & shoulders with an upside target of 1250. The head & shoulders is often seen and seldom realized. A number of bloggers today also anticipate a leading diagonal, again a rare pattern which some pundits (Neely) do not recognize. Here is the inverted h&s chart at Slopeof Hope:

 

I am working on a posting a discussion of 1937, which seems to match the current economic climate better than 1929, 1987, or a plethora of other analogies that fly around the blogosphere. A good summer rally and then a terrible plunge match the market pattern in 1937. 

Insights Into China Markets

EWI has been getting smarter on investing in China, and prepared a fairly insightful report on Chinese and Japanese markets that weaves together cultural as well as economic trends. The result is a roadmap for their future. As an affiliate, I get broadsided with various EWI reports, and generally let them fly by. This one, however, I highly recommend. You can download it here. 

The starting point is the huge credit bubble inside China. This has led to an ebullient social mood, as shown by the hemline indicator among other items in the report (see picture). (Short skirts = bubble mood. Short skirts in Army = govt-led bubble.) The report compares China today to Japan in the '80s, and lays out a roadmap for China that begins with the evaporation of a lot of credit-fueled illusory wealth. 

Beyond the report, other indicators support their roadmap. In order to fuel the growth and keep their currency pegged at a low rate to the Dollar, the Chinese workers have been forced to save at low rates (earning less than the inflation rate), or put their earnings into real estate which has trapped massive amounts of capital. Trapped? The resell market in China is near zero, on the order of 1% annually or less. Buyers would rather jump into a newly constructed flat than look for an old one. Ken Rogoff thinks the property collapse in China is already starting. Capital is being badly malinvested, and the fault lines across the lucky and unlucky are beginning to fray. What happens to social mood when the bubble bursts?

An interesting on-the-ground observation from a Michigander's visit to China is worth pondering. He comes from Ground Zero (Detroit) of the huge collapse in US housing (values and vacancies), and he sees the same signs if not worse in Chengdu, especially the many vacant buildings:

Chengdu seemed worse [than Detroit]. I couldn’t tell what or why I found myself gawking at massive developments at 3 pm in the middle of the week without signs of construction, occupancy, or any activity. These were not mere strip malls but giant commercial, industrial, residential cities within a city. Skyscrapers, street front shops, apartments, malls, many I observed were vacant. 

A recent study by NBER concludes that the recent rise in home prices in Beijing are driven by land values, and they have increased in real terms by an astounding 800% since 2003, an increase they characterize as "unprecedented". This could be bigger than the Japan bubble of 1989.

An increasingly-large portion of purchases has been by a decreasing number of buyers, specifically a handful of of huge companies backed by the central government (so-called SOEs), who overpay believing they are too big to fail. Apparently what is driving them is to hedge against the rising inflation in China - but the socioeconomic perspective of the EWI analysis says that explanation really reflects one of many rationalizations for simply acting to an ebullient social mood. As the breadth of purchasers narrows, the end is nigh, and in the end only the government will be left to keep the party going.  

Econbrowser looks into this study and has a telling chart which shows the housing bubble in land prices, and discusses the differences and similarities to the recent US housing bubble:

Mish goes further and finds evidence of Ponzi Shark Loan operations that are driving this bubble: local officials, required to meet central government growth figures, give permits for real estate development in return for bribes. The loans for down payments to buy these new flats come from locals who have no good place to invest their earnings and pool it for high-interest loans to property buyers, keeping the bubble going. It may be the SOEs are bailing out the collapsed loan sharks, but more likely they have emerged to now be over half of all housing purchases to also keep the party going (see last chart, from the NBER story above) because real buyers are unable to keep up with the horrifically expensive prices, now 22 times average incomes. This is similar to our Fannie/Freddie eventually owning 90% of the final stages of our housing bubble. 

The Big Tease Continues ... to Confound

It has been noted how whenever EWI launches a Free Week - in this case for energy - their primary market view tends to blow up. This is why this blog is called "Yelnick"! All pundits get hoist by their own predictions, especially when they are most visible. In this case Hochberg's nested 1-2 at four degrees in yesterday's STU failed shortly after the open.  

We still seem to be in the Big Tease, and it is doing its job of making bear and bull confused to the max. What I have noticed is the least likely wave count is almost always the best choice! The market scenario that ruins the most positions is the most likely. It probably has to be this way, at least during corrections.

 My take: still in wave C of 2, the Big Tease, and it is heading back to Sp1150 area. Might just run up close to that area in wave iii of C, then go through an annoying trading range before a final spike up and bifurcation down. Timing remains around Aug4.

Fading the Fed as QE2 Embarks

Last week the market rose into the mid-week Fed Open Market Committee (FOMC) statement and fell after. This week the market rose for one day into the Bernanke pronouncement (breathlessly touted by CNBC) and fell hard after. This is a typical pattern of fading the Fed. 

Bernanke's comments did not inspire nor illuminate. What ZH inartfully described as the "latest compendium of mendacious vomitus emanating from the primary orifice of the Fed chairman" can be summarized in this line from Ben: "The outlook remains unusually uncertain." A riff on Rumsfeld's "known unknowns"? Worse, isn't the Fed culpable at least in part for uncertainty - especially after today? If too much leverage was the cause of the crisis, why would even more leverage be the solution? It appears the Fed is in a trap of its own making. 

The market reacted by reading Ben as about to embark on QE2, another round of quantitative easing. The Fed did not elaborate on what action they are prepared to take, but two-year Treasuries made a fourth record low in a week, and commodities popped today, probably on inflation expectations. 

 Note: given that commodities pooped, it is a useful coincidence that EWI is offering an Energy Free Week for their services. I wouldn't normally tout this except the jump in commodities today means something dramatic may be about to happen over in the pits. Worth at least checking this out.

Regardless, I believe that the inflationary expectations are ill-guided. Would QE2 drive inflation? Seems unlikely. Some reasons why:

• Mish thinks that Bernanke has met his match with consumer attitudes swearing off more debt. 
• The vaunted $1T of new reserves are not waiting to be lent out, but substituting for intrabank loans, so even if the Fed stops paying a nominal interest on them, do not expect the banks to suddenly start lending again - or the consumer to start borrowing. 
• Buying more Treasuries or MBS's will hold down long rates, but even with historically low mortgage rates the housing market is in the dumpster. 

To add fuel to the fire of creating unusual uncertainty, Bernanke was ambiguous as to how much QE2 he would actually undertake. As reported by the online WSJ (emphasis added):

Bernanke calls the outlook 'unusually uncertain' and notes that the central bank is prepared to take additional action if needed. His economic outlook sees lower than expected inflation and at best a slow pace of falling unemployment levels. He notes financial conditions are hindering growth and expects interest rates to stay low for an "extended period." At the same time, he says the Fed is continuing to think of ways to shrink its portfolio, and any asset sales will come gradually. Bernanke's comments to Congress are largely as expected, but some may be a bit taken aback by his comments on shrinking the balance sheet, which doesn't suggest much central bank appetite to provide additional stimulus to a troubled economy. Stocks are taking it on the chin while the two-year Treasury yield is hitting yet another record low. The dollar is holding pretty steady.

The punditry will opine that stocks fell on the pronouncement, but they were falling all day from the opening gap up. That gap was closed, suggesting an exhaustion gap, a bearish signature. Today's STU was fairly sanguine about the market, ignoring the Fedspeak altogether and noting that the reversal back up was merely a day long and went back a normal amount for a minor degree wave 2 (60% in the Dow). In addition, they have seen a sharp spike to end rallies since the Flash Crash, and today was no exception: the gap up was due to enthusiasm about the Apple earnings after the close yesterday. The "gotta own it" stock was unable to sustain any sort of rally. After a possible gap down tomorrow, they expect another, smaller rally and then a rollover, which would be the dreaded 3 of 3 of 3 at four degrees. 

 The bullish Tony Caldaro has a different take:

Looking back, this market has now spent the past two weeks essentially between these two pivots [Sp1058 to Sp1099]. We continue to believe the market is currently building a base after the initial rally from SPX 1011 to 1099. The next couple of days should be important for this potential new uptrend scenario.

The bullish Carl Futia, who also thinks the market is building a base to run to Sp1145-1150 (consistent with the Big Tease count) had expected a start to it today, not the mid-day fade back down. Here is his mid-day chart from yesterday:

 

Tomorrow will give us a bit of a read, but the real threat is late Friday or next week if the STU Rollover comes to pass. 
 

The Real Yield Curve and a Double-Dip Recession

The yield curve right now is steep, which normally predicts recoveries, the logic being the long end rises on demand for corporate investment. Since we do not have any strong evidence of corporate borrowing for investment in growth - instead, corporations are sitting on record cash - this creates a conundrum that needs to be explained. 

The yield curve short end is being held down artificially by the Fed. The last time this happened for a long duration was in the 1930s. The yield curve bent positive after 1929 and was positive for most of the time we were falling hard into the 1933 bottom - the Fed held the short rate down except during the sovereign debt crisis in 1931 when the Fed briefly raised short term rates to prevent gold flowing out of the US. Even as we came out of the bottom, we fell back down in 1938 when the yield curve was positive. Check out this chart from January 2007 when the curve ran negative (good timing!): 

 

The Cleveland Fed put out a report on the yield curve recently concluding that a double dip is unlikely - but they are tracking experience post the Great Depression. Their dataset does not include any deflationary periods, and deflation changes the real rate on short-term instruments (it raises them - see analysis below). Since we are in the fourth credit collapse in US history (1837, 1873, 1929 and 2008), the best precedent would come from those prior eras, not the in-between times. Japan has had a positive yield curve for both of their lost decades of flat to down growth and continued deflation. 

Also, the Cleveland Fed's chirpy conclusion is belied by reports that the Fed is getting ever more worried about a double-dip. The Fed lowered GDP forecasts in their FOMC meeting on Wed. 

The curve is flattening right now: The Fed holds the short term rates down, but now the mid term rates are dropping to record lows, and the longer term rates are lessening. Not a promising sign. 

David Rosenberg argues the curve would be inverted right now if the Fed were not holding rates at essentially zero. A back-of-the-envelope calculation of the real yield curve shows it is inverted: 

• the near-zero short rates less -3% deflation are running above 3% real
• the 4% long rates less a longer term modest inflation rate of 3% are near 1% real 

Australia is the Most Overvalued

The Economist looked at housing bubbles worldwide and found Australia the most overvalued. The basis for the conclusion is price-to-rent. 

Prices rose in Oz 20% in the year ended in Q1, faster than the prior clip of 13.5%. The RBA has been raising rates, in part to stem the frothy housing market. 

Sometimes when the central bank raises, it pops the bubble. We saw that in 1929, 2000 and 2007. 

Recent anecdotal data has led observers to say the housing bubble is bursting in the Lucky Country. 

Mish reports on similar stories in other frothy countries in this report. 

Prechter May have Nailed This One

Prechter's trading service, the Short Term update (STU), had been holding firm on the nested 1-2 wave structure. I discussed several market scenarios earlier this week in the latest Big Tease post: the new bull, the expanded flat correction into August, and the nested 1-2. The outside limit of the nested 1-2 was Sp1100, the point at which the inside wave 2 was no more than the outside wave 2. (If the inside waves get bigger than the outside, this is likely not a nested 1-2). Mother Market hit that level several times and could not break through. The fade off it for the past two days is fairly large, and brings us back to the level of the Flash Crash: Sp1065. 

Tonight's STU discusses the odds of the dreaded wave iii of 3 down having started. The weekly decline was broad-based, and in general an increase of volume indicates the direction of trend, in this case down. SlopeofHope had noted an EWI pattern of an 8-9-day rhythm of market turns, reprinting the following chart from EWI. These sorts of patterns come and go, but this worked this week to peg the change of trend down. The topping this week was "ragged" according to the STU, so now we might now see this 9-day pattern fade away, and have a general down trend without a turn back up in the next 9-day window (the turn of the month the week after next). 

 

The STU discusses some of the alternate wave counts of its readers (as reflected in blogs such as this), and added this very gracious commentary, which I hope they do not mind me repeating:

A lot of readers were absolutely certain that the market's main indexes were headed above the June 21 highs, and even higher into August. Leaning against the prevailing sentiment can be difficult at times, but it is something that a wave practitioner gets used to quickly. That certainly does not guarantee one's success, but it helps to recognize emotional extremes when forecasting an impending trend change. And in fairness, there are still alternate potentials, albeit waning, that allow for a market recovery that carries above 10,600 (1132 in the S&P) prior to the start of the next big down phase of the bear market. The odds however, continue to favor the wave count that we've consistently showed over the past month or so in these pages.

If we do head south, we should at least get to the Sp860 level (Dow8200), which probably seems beyond belief to most investors right now. Along the way we will have sharp and deep reversals - this one went beyond the normal 50-62% to come back 74% (S&P) to 81% (Dow), bracketing the outside retrace level of 78%. You can see similar deep retracements in the period after 2000, and in the sickening slide after the 50% Hope Rally in 1930. 

We are in a channel downward which points to a much deeper drop. AllAboutTrends had a nice crisp commentary about the market staying within a downward channel on Friday, and the market acted to their prediction. Mike Paulenoff concurs, finding the dominant downtrend intact after the S&P failed to hurdle the upper channel resistance:

The other indicator to watch is the Dollar Index. The USD has corrected about 50% of the rise from DX74 last December to DX89 on Jun7. It fell sharply yesterday and bounced today. The Euro got back to $1.30 and the AUD to 89c before falling today. A turn back up should coincide with the wave 3 drop. If we see a USD drop and Euro rise on Sunday evening/overnight, we might also see a snap-back stock rally Monday/Tuesday. Both moves should be short-lived.

While the odds of the big drop have increased, the downturn in the last two trading days does not yet confirm it. One of the alternative scenarios is the BIg Tease, which has the market in a large ABC flat wave 2 since the end of the Flash Crash movement down, rather than a nested 1-2 i-ii structure. You can read more about it in Mother Market is a Big Tease. We would be in the C wave of the Big Tease, and it would break as a five-wave move. This drop would be a wave 4 of C. Wave 4's normally correct 38-50% of the prior wave 3, which went from just below Sp1020 to just below 1100, or a little over 80 pts. We remain in a normal corrective range. Wave 4's can go farther, and it would take a breach of the range of wave 2 (ie. breaking below the top of wave 1) to confirm that something else is going on. Take a look at this chart from Carl Futia of several days ago:

 

Carl puts boxes around waves 2 and 4. (This is the e-mini chart, so slightly different than the cash S&P chart.) The top of the first box is the end of wave 1, around es1040, which works to Sp1042. The second box is wave 4, which in the two days after he posted this has broken below the bottom of the box, invalidating Carl's bullish prediction at that time (the red line). It would take a run below the 1040 level to break the Big Tease count.

Carl has a bullish bent, and even if we break the 1040 level, there still remains a bullish count. I have previously dissected Carl's simplistic count, and think the bullish structure is different. One of the problems with calling the Hope Rally since March 2009 a new impulse wave is the awful internals - overlapping waves and lack of smaller degree impulsive structures. Even this Big Tease C-wave is very ugly and difficult to call impulsive. Take a look at this chart of the S&P (courtesy EWTrends) and eyeball the sloppy overlapping structure and the odd look of waves 1-2 (blue) relative to the rest of the pattern:

 

Now, sometimes it is better not to see the sausage factory, and a smoothed version of this like Carl's e-mini chart above shows the pattern more clearly. Nonetheless, given the lack of impulsive waves, a second alternative is gaining in odds along with the dreaded iii of 3 down: Neely's triangle count. The simplistic bullish count sees five waves up in the Hope Rally, with two major corrections before April 2010: the run to Jun11 (wave 1), the drop into July9 (wave 2); the long run into Jan 2010 (wave 3) and the drop to Feb5 (wave 4); and the final run into Apr26 (wave 5). Given the sloppy overlapping character of the so-called impulse waves (1-3-5), especially 3, Neely instead counts the whole pattern as a double correction where wave 2 is part of a triangle off Nov 2008 and 4 is an X wave. (Neely's view also works if you view the Hope Rally as a triple corrective pattern with two X waves connecting three corrective structures.) He finds us still in a corrective pattern, and counts it as an ABC flat where the A wave ran from Feb5-Apr26 and the B wave is still on. Given this is a flat, and wave B has already gone lower than the start of A (the 1011 bottom several weeks ago is lower than the Feb5 level of 1044), the C wave may not go to new highs but truncate below the Apr26 level of 1220.

The important thing right now is the B wave. It seems to be breaking as a triangle, where what EWI counts as a 1-2 followed by a i-ii, a four wave pattern so far, Neely counts as legs abcd of a five-wave triangle. We would be in leg d, and the correction the last two days may just reflect a middle wave B of a three-wave leg d. Unlike the wave 4 of the Big Tease C wave, Neely's leg d could breach the 1040 level and still be on. Usually, however, a minor B wave in an ABC zigzag (which is what leg d appears to be) does not go back more than 50-62%, which means a break of 1044, the 62% level, would stress his count.

Summary:

• watch the USD/Euro overnight/next few days for a major USD bounce
• watch for a break of 1040-1045

A failure of both indicates the market is still in its Big Tease.

PS - the potential reversal in the USD to back up is a much bigger play than shorting the S&P! It may be the inordinate focus on the stock market is simply missing bigger opportunities elsewhere.

Double Dip Countdown: "6"

The count down is getting closer to the double dip: 10 - 9 - 8 - 7 - 6: ECRI's growth index is now at -9.8% after a pretty big drop from -8.3% last week (which was revised this week to -9.1%; even the revisions are making the case for a double dip). It is hovering right above the -10% level that David Rosenberg has shown from past examples has always predicted a recession ahead (42 years of data). We should crush through that next week, but that is now just a technicality; Rosenberg gave the -10% level as an easy line in the sand; -9.8% also in the past 42 years always predicted a recession in about six months, which puts it in 1Q11. 

 

Another major leading index is from Consumer Metrics Institute, and it is showing even worse conditions that ECRI. The CMI index is in contraction mode and dropping (blue line is 2010):

 

Manufacturing had been looking like a V-shaped bounce, but recently has weakened: both the Philly Fed and Empire State surveys have turned down and are approaching the zero line (which means contraction):

 

Shipping indicators are looking weaker as well: imports surging but exports lagging means we are back to consumption exceeding production:

• The containers out of LA/Long Beach and NY/NJ are continuing to grow, which is consistent with seasonal trends (this is the period of inbound shipments to stock up for back-to-school and holiday sales). Inbound is up 30% over a year ago, and is up 1% (essentially flat) over two years ago. Exports increased 7.7% from a year ago, but remain down 13% from two years ago. This means expectations are for a stronger Christmas but our exports are slackening, a bad sign that is consistent with weakening manufacturing domestically. 
• The Baltic Dry Index is falling so hard it led to a delightful headline: Market Going Down With The Ship? The BDI is used to track Chinese activity across the oceans, and the predictions of a sharp slow-down in 2H10 have increased, suggesting after restocking for the holidays imports will begin to drop.
• Rail cars had been trending up, but recently dipped below 2009 levels and are 20% below 2008 levels (see chart). When looked at more broadly as including intermodal traffic, the trend had been up but is flattening. This would be consistent with a rolling over from recovery to a second dip, but does not predict it. 

Ed Harrison of CreditWritedowns notes that the bearish pundits other than Rosenberg are playing down the double dip: Stephen Roach says only 40% likely, and Nouriel Roubini is at 20%. He thinks they are expecting a late inning save by the Fed or by more fiscal stimulus. While fiscal stimulus is looking less likely, deflation is now emerging, and that might force the Fed to begin QE2, a another round of quantitative easing, a topic is discussed in the Peak Debt post. 

The CPI fell for the third straight month in June, dropping -0.1% after -0.2% in May and -0.1% in April. The CPI is now flat for the past 8 months and down -0.3% for the past six months.

 

Mish notes how the powers-that-be tend to exclude food and energy and talk about the core rate, but this is not really valid, since those matter hugely to the people affected. As he puts it, people tend to note each penny's rise in gas prices, and ignore the drops. When gas is going up, the cries of hyperinflation! ring out; but when they drop, the silence on deflation is deafening. 

The core rate is even more misleading on real estate: it uses an imputed rent, not real housing price changes, which of course have been dropping more than the CPI shows. Oddly enough, as natural gas prices rise, the imputed rent drops; and as it falls, the imputed rent rises. The BLS assumes rent is constant and they impute a windfall in the rent due to rising heating costs. Even though a survey of real rents will quickly show they are falling with housing prices, although not as fast, since natural gas has also fallen, the imputed rent has actually gone up, keeping CPI afloat. Nuts! 

In any event, this chart shows how the CPI of all items peaked about the time the Stimulus peaked in spend rate, and has been dropping since:

What is going on behind the curtains is an historic contraction of consumer and small-business credit: the Consumer Metrics Institute notes how consumer credit has decreased in 15 of the last 16 months, and the drop in April is the second largest in history, after the drop the prior Nov (2009). The cumulative drop is the largest since 1944, when FDR pushed consumers to buy war bonds rather than borrow and spend. This contraction is part of an overall deleveraging of the private sector (especially in real estate), and is causing the total debt in Dollar terms to drop off its peak of $53T. That decrease in total debt is happening faster than government borrowing is making up, leading to deflationary pressures. As the next wave of mortgage defaults hits next year, this deflationary tendency should become very strong. 

The Fed may feel forced into QE2 to stave off the inevitable slide into deflation. Keynesian Cheerleaders like Krugman find the Fed's silence feckless. If they initiate it - perhaps to backstop Muni's, since they already have backstopped Treasuries and Mortgage-Backed Securities - it might delay the onset of the double dip. 

The Incredible Shrinking VC Industry?

The golden goose of US innovation continues to get plucked. The NVCA released data which shows the industry is shrinking at an accelerating rate. This reflects the New Normal for venture capital, where capital efficiency is gaining share against traditional VC. Many large funds have moved into CleanTech, where the investments required are huge and long-term. 

Curiously the WSJ looked at the similar data and had a rosy spin on it. Their estimate for 1H10 commitments to venture capital is $7.5B across 72 funds vs $6.6B across 68 funds a year earlier. Promising, but still half of 2008, when in the same period $14.2B was raised. 

The WSJ data shows money flowing to early stage and multi-stage but shrinking from later stage funds - sucking the middle dry. This is consistent with anecdotal experience in the heart of venture capital, Silicon Valley, where the mid-sized funds are the most challenged, and many larger funds are raising smaller this time. 

Possibly the way to square the two reports is to distinguish funds for US investment vs. funds for global investment. TechCrunch reports that the number of funds and overall capital are expected to continue to decline for traditional markets, but to expand for China, India and Brazil. Sequoia for example just closed a $1B early-stage China fund, which I believe would be excluded from the NVCA data (it counts based on location of fund, not of sponsoring firm) and yet skew the WSJ data upwards. 

Muni Bond Update

The state of Muni's matters to a lot of investors. I have argued in Investing in Munis that the States will be loathe to damage their ability to go to the Muni market, so will cut everything else they can first before defaulting or delaying payment. That argument passed its first test in the last few days. 

July starts a new fiscal year for most State governments, and some of them (Ill, Cal, NY) are in dire straits with huge deficits, ebbing Federal stimulus, and disappointing tax revenues. Bloomberg reports that they are cutting pay and letting bills go unpaid to protect their Munis:

"States have taken all measures so far to make sure they keep capital markets open by honoring their debt payments,” said Richard Ciccarone, a managing director for McDonnell Investment Management LLC in Oak Brook, Illinois, which owns $7 billion of municipal bonds. “They are doing everything they can.” 

The story repeats the comforting history of Muni defaults: at 0.03%, much less than similar corporate bonds at 0.97%. Most Muni defaults have not been general obligation bonds, but bonds tied to specific projects. Hence investors in Munis need to read through to the party really at risk; a special industrial district, hospital or similar project is much riskier than the State itself.

The CDS spread between Munis and similar corporate bonds has been higher for Munis, which might seem odd given the default history above, but it reflects the differing positions: US corporations are sitting on record cash, and their bonds are one of the safe harbors right now, while States are in deep deficit for the most part. The good news for Munis is the spread is narrowing as the fears of Muni default begin to ebb.  

Mother Market is a Big Tease

After the Flash Crash, I posited three scenarios: Summer Rally, June Swoon and Big Tease. The market has been in The Bg Tease: rather than a big drop or a new bull market, it has been teasing bull & bear alike. First it fell to a new low, scaring the bulls and pushing the small investor out of the buy-the-dips mentality; and now it is on a tear, scattering the bears and pushing the retail day traders out of their short positions. With Intel's earnings showing they are cashing in their chips, a strong start is expected Wed, and the Tease should continue; but what then to expect over the rest of the month? 

The Bulls Are Back!

This has been a pretty compelling start to the proverbial Summer Rally: since the Death Cross on July 2, the market has run straight up for six days, including the sixth 90% up day today with a 35% increase in volume (stats from Walter Murphy). (So much for the Death Cross indicator!) The bullish view is well stated today by Carl Futia: 

The chart above this post shows the cash S&P from the start of the current bull market on March of 2009 at the 666 level. I have traced in green the first upward leg of the bull market which divided clearly into a classic, five wave Elliott pattern. Elliott's theory asserts that a five wave movement up from a low such as was seen in March 2009 is never a completed bull market. Instead it will be followed by a three wave corrective movement, and then by at least one more, five wave move up to new highs.

The drop from the 1219 level of the April 26, 2010 high subdivides into a classic, three stage, "flat"correction: three smaller waves down to the May 25 low, then three smaller waves up to the June 21 high, and finally a fast, scary movement down to the final low of the correction at 1010. I have traced this wave sequence for you in red.

Not only is the wave pattern of this correction exceptionally clear, but the correction ended almost exactly at the .382 Fibonacci retracement of the five wave up leg. 

A simlar view can be found from Tony Caldaro. I have previously dissected this case, twice; and nothing has changed in that analysis. Just because we see a five wave pattern does not mean it is an impulsive wave that starts a new bull leg. It needs to follow additional rules, including:

1. Rule of Alternation. Waves 2 and 4 must alternate in time, form and/or distance. Instead, they both fell about the same distance in about the same time with the same structures (zigzags). Possibly the first drop could be said to have started on May10, not at the Jun11 peak, and broke as an irregular flat (where the B wave went to a higher high), which would alternate in time (slower) and structure; but curiously the bullish advocates have not made this case to my knowledge. 
2. Impulsive Structure: The three impulse waves 1-3-5 should have internal structures that are also impulsive (fractals of the larger wave). Instead they have dreadful internals, with overlapping waves, especially in the wave 3 from July to January. It seems to be difficult to consider the huge stairstep of overlapping waves from late August into November as impulsive. 
3. Extension: Neely adds a further rule that one of the impulse legs should extend, being 1.6x longer than the others. Instead, the first two are about the same length (wave 1 = 290 pts, wave 3 = 281 pts, wave 5 = 175 pts), and none extends beyond the others, albeit wave 5 is 61.8% of 3. Wondering whether if we end wave 1 at the early May top of Sp930 on May10 would we get an extended wave 3? Nope. 

The End is Nigh!

The bearish EWI view is that we are in a nested 1-2 pattern since the Apr26 top, and it is about to spring loose into a deep drop to at least Sp860 range. Their first 1-2 is the fall to 1041 and bounce to 1131. Their second "inside" 1-2 is the fall to 1010 and the current bounce. 

This view is about to be busted. The inside 1-2 cannot become larger and slower than the outside. The outside wave 2 ran 90 pts, and the inside one is likely to exceed 90 pts Wed in the Intel rally if it breaks Sp1100. The inside wave 2 has already busted the 62% retrace - normally a wave 2 ends within the 50-62% range - and seems likely to break the 78% retrace at 1107. Although theoretically a wave 2 can go back 99%, they rarely break 78%. In any event, the inside wave should not beat the outside. 

I don't know what alt count they will come up with, but will report back after tomorrow's STU. If we reverse right at the Sp1100 level and start their bearish fall, give them huge credit. ZeroHedge gives a good rationale for a potential pullback inthe next few days: we have seen a short squeeze play out. David Rosenberg sees a liquidity pump over the past two weeks from a sharp spike in M2, and sees it moving into speculation in the e-mini S&P futures: a swing from a 15,155 contracts net short position to a 28,172 contracts net long position in those two weeks. 

The Summer Rally!

This is becoming everyone's favorite, but can it fit a bearish scenario? 

The structure I posted in the last few days is gaining support: a running flat correction. (A flat whose B wave exceeds A was called "irregular" by RN Elliott and "expanded" by EWI. A triangle whose B leg exceeds A is called "running" and that terminology is now becoming a more popular way to describe the expanded flat.) We would not be in a nested 1-2 but still in the outside wave 2. Rather than end at Sp1131, that would be the end of wave A, and the drop to Sp1010 is wave B. 

Currently we would be in wave C. Possibly it truncates (C ends below A) at Sp1100, the same level as the outside range of the nested 1-2 count, where A=C in length. As you might expect, truncation is not uncommon in a running flat. Normally, however, C matches or exceeds A, and goes 1.618 x A in length, which targets Sp1155. Since Sp1151 is the 62% retracement of the wave 1 down (1220 to 1041), we have a target range of 1150-1155 for wave C.

If wave C goes beyond 1155, an alternative count comes into play: a leading diagonal (LD). When one sees nested 1-2s, a prime alternative is a leading diagonal, but that choice cannot resolve until the sort of circumstance we have now, where the inside wave 2 is about to exceed the outside, and the whole pattern has slowed down rather than accelerate. (A nested 1-2 is like a coiled spring that should resolve in fast move.) An LD is a 53535 pattern where waves 2 and 4 overlap, and rather than fit in parallel channels the pattern fits in a converging trend lines like a triangle, showing compression of the move.

 Daneric has gaining conviction around the LD, as can be seen by his chart tonight (below).

Since an LD ends with a compression of trend, it often is followed by a very sharp wave 2 rally that usually goes back 78%. In this case the LD would cover the whole drop from 1220 to 1010, or 210 pts, and a 78% reversal would head back to Sp1175. Hence:

• first watch a pullback quickly at 1100
• then expect a run to at least 1150
• if we pass 1155, the next (and presumably final) stop is 1175

 

The Herd Leaves the Market to the 'Bots

The WSJ noted two odd phenomena in this market: small investors have largely bailed out, and (perhaps as a consequence) individual stocks in the S&P 500 have been tracking the index itself to a degree not seen since the 1987 crash (see chart, courtesy WSJ). There is a good discussion over at TradersNarrative. 

The average correlation is 44% (since 1980), but is now 81%, higher than in the crash of 2008 (79%) and approaching the all-time high in 1987 (83%). The conclusion from the correlation: fear drives investors to treat the market as a homogenous entity. Adding in the exodus of retail traders, this time the implication is the market has been left for the index 'bots. 

For traders, two things to watch:

1. Breadth indicators may no longer be useful .. this perhaps explains why this market has been floating on diminishing volume: the sellers are leaving faster than the buyers. 
2. Leading indicators may now be coincident .. this explains why new highs/lows and the A/D line no longer give early warning, but all topped together with the market in April. 

Carl Futia notes how the exodus of retail means rampant bearishness, which is a bullish sign. Perhaps, if they participate and not abandon the market. When they take short positions, it often allows the market to drive higher on squeezes. When they simply leave, the market is vulnerable. 

The STU commented on this tonight as well: the high correlation is an extreme example of herding behavior. Despite our vaunted individualism, Man is a herd animal. EWI has been on an All-The-Same-Market argument since the Greenspan Bubble got recognized in 2004. From 2004-2008 all markets went up as the USD went down. After the 2008 crash that linkage broke, but since the Hope Rally we have seen an all-one-market return. 

My take is the floor can drop out of this market rapidly, as we saw with the Flash Crash, as it is floating on arbitrage and program trading, not real conviction. The STU thinks we have about ended the second countertrend rally:

• the first was after the Flash Crash, and got us back to Sp1175
• the second has been over the past few weeks and run up from Sp1010 to 1081 today

The second retrace has gone 62% of the fall from Sp1131 to 1010, and could be considered complete, since in their count this is a wave ii, and wave 2s normally go 50-62%. 

Mother Market will pick the path that frustrates bull and bear alike. My speculation is that we continue to rise back towards the Sp1150 level into August, with Aug4 a key date; then the floor drops. This rise will embolden the bulls and scatter the bearish herd into a loss of conviction. The wave count would shift to a large irregular flat. Put simple, we would still be in the first retracement after the flash crash:

• wave A went from 1041 to 1131 (90 pts)
• wave B fell back down to 1010 - a lower low than where A started 
• wave C is what we are in, and C=A at Sp1100 and C=1.6x A at 1155

If we get much past Sp1086, this alt count gains in likelihood; if we break the 78% retrace of STU's nested 1-2 i-ii at 1106, that count should be abandoned. Although the STU has not posited an alt count, this one should be considered. 

Neely considers us in a corrective wave since the April high, breaking as a triangle B wave (the Jan drop is an X wave and the rise from Feb5 to Apr26 is wave A). A C wave would follow but it need not break the April high. Hence Neely's count might lead to a similar result, albeit a bit slower in time. 

Peak Debt

There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved. - Ludwig von Mises

The Government Bubble has burst. This is the last bubble, after housing (2005), stocks (2007) and commodities (2008). The Tea Party spirit has infected concerned citizens worldwide as part of the Global Political Awakening, a term coined by Zbigniew Brzezinski to describe the effect of technology (television and the Internet) on the global community. The awakening has been a reaction to transnational elites and manifests in many ways locally. In the West it is leading to a pullback from stimulus and a return to fiscal austerity. 

The recent G20 meeting was a repudiation of Obama's call for more stimulus. Before the meeting, Geithner revealed the US agenda, to encourage the rest of the world to stimulate so as to improve US exports. After the meeting, although Obama tried to spin it as a success, the G20 communique roundly rejected any further stimulus, with a target of halving deficits by 2013 and reducing debt-to-GDP levels by 2016. 

We are all Greece now (see picture): austerity measures are being put in place well beyond Ireland, Greece and Spain, and now include the UK, Germany and France. The German efforts are focused on more than deficit reduction; they plan to cut spending as well as debt. 

China has been tightening for a while, and the effects are beginning to be felt: slower car sales, softening manufacturing, beginnings of a collapse in property sales, and rising risk to Chinese banks. The Baltic Dry Index, which measures ocean shipping costs and is driven by Chinese activity, has continued to fall: down over 50% and falling for 31 consecutive sessions. It is now back to March 2009 levels and seems headed to the generational lows of the Lehman crisis in Sep 2008. 

Even the lone holdout, the US, is having difficulty pushing the Stimulus Agenda forward. The Senate blocked Stimulus III and seems unlikely to bend. The House has tried a Stimulus Lite bill to extend unemployment through November (mid-term elections - get it?) but that too is likely to fail in the Senate. 

The US may still pass the financial regulation bill (FinReg), although even that is a bit uncertain with the passing of Senator Byrd, Democrat. (And in a truly odd moment where politics make strange bedfellows, or perhaps he just has a tin ear, the first Black President, Obama, spoke at Byrd's funeral, even though Byrd was notorious for being a leader in the Ku Klux Klan and for leading a filibuster against the 1964 Civil Rights Act.) Despite characterization as a major change in regulation, so far the banks which are TBTF seem to be unconcerned. The FinReg bill has been denuded of most of the major changes (eg. derivatives, proprietary trading), turning it into vacuous soundbites without teeth. 

The FinReg bill will have the perverse result of further freezing credit to consumers and small businesses. Instead of setting rules, it primarily sets up new regulatory bodies who will take several years to promulgate new rules. Community banks and business credit to consumers is expected to stay frozen during that period, exacerbating the credit crunch that is stifling the growth of American business. 

There was some recent blather about an improvement in consumer credit, but this was due to a new reporting requirement, not any change in the real world. (Tea Partiers like to describe the government as incompetent; but it is also ceaselessly dishonest.) As this chart from the Fed shows, consumer credit continues to fall:

 

A report today on consumer credit was stunning: it fell in May by $9B, almost $7B more than expected; and that blather about a rise in April mentioned above was revised from a $1B rise in April into a $15B drop instead! The apparent flatlining seen in the chart above did not happen; instead we kept falling and the April flatline at the end of the blue line is now a huge drop. Consumer credit is back to March 2007 levels and has fallen for 18 of the past 20 months. The only holder of consumer credit which had any growth was .. (envelope please) .. the US Government. Once again all that is going on this economy is government life support, and that is no longer capable of withstanding the drop in the private sector: 

 

Karl Denninger dissects this report into charts that show consumer spending broken into revolving (credit cards) and non-revolving (cars, etc.). The YoY drop is revolving is quite steep:

 

The drop in overall consumer credit of both sorts is also clear:

With Peak Debt comes the spectre of deflation. Since credit (debt) creates money, a tightening of credit and lack of lending can lead to a fall in money aggregates. The FinReg bill combined with the shrinking of debt worldwide will shrink the money supply as well as lower the velocity of money. The money supply has been growing slower, and on some measures actually shrinking; Peak Debt might send it negative on all measures. This is the formula for deflation. The Keynesian Cheerleaders such as Krugman are oh so worried about it now that we are hitting Peak Debt.

There is confusion around the Fed's emergency measures last year which created a $1T increase in bank reserves - why isn't that hyper-inflationary? The Fed has patiently explained what they did but this seems to be largely ignored in the blogosphere, and so this 'hyper-inflation!' meme keeps circulating. At the risk of grossly oversimplifying, consider that one of explosive risks during the Fall of 2008 was inter-bank lending. A lot of checks wing back and forth between banks, and rather than physically move cash reserves around, they lend to each other. With Lehman cratering, the risk of counter-party insolvency loomed large. If some banks went under, all those inter-bank loans with them would go down too. In order to keep the checks circulating, the Fed used various methods to assume the inter-bank risk, creating reserves in the Fed but not creating new money - simply assuming existing liabilities. (This is not inflationary, simply prudent central banking.) Money of Zero Maturity (MZM) jumped $1.5T, but total debt did not - instead it peaked at $53T just as the crisis hit and began declining on the Fed's moves:

 

A little broader explanation (than just inter-bank lending for checks) of why the new reserves created no inflationary spike  is as follows:

How is this possible? It's a direct consequence of the massive intervention by the Federal Reserve: it took problem loans and structured bonds onto its own balance sheet, removing them from the likes of Lehman, AIG, Bear Stearns. In exchange, the central bank essentially "printed" money, i.e. obligations of the US federal government. Many of those bonds have since proved to be worth a lot less than the money printed in exchange, and many of them are entirely worthless.

The increase in MZM in 2008-09 was $1.5 trillion, the same as total debt. Net-net, therefore, zero. Obviously, no 10X multiplier effect came into play here, since the Fed's money went to replace debt gone bad and not as high-powered money to make fresh bank loans.

The US is about out of weapons to throw at deflation. The final play is more quantitative easing (QE) where the Fed buys up Treasuries and other financial assets, putting fresh money into bank accounts of US agencies. A target of $5T is being bandied about. Not all Fed directors are on board to set sail on QE2. 

The problem with QE2 is the marginal productivity of debt makes it of limited if not negative value. I have posted versions of this chart several times, and it shows the same phenomenon: for each new $ of debt, we get less and less increase in GDP. We are now approaching a point of no return, where we get zero improvement for every $ of debt. If you ponder this for a moment, you realize we could borrow ourselves into a hole so deep only default would get us out: more debt with no increase in production to pay for it.

With the Fed's QE1 a sinking ship, how would they do QE2? Ed Harrison speculates they would Federalize the muni market to keep our Greeces afloat (Cal, Ill and NY in particular). The Fed has already tried QE with Treasuries, MBS's from Fannie and Freddie, and similar agency paper. 

QE2 would also mirror what is happening in Europe. The ECB is buying sovereign debt to bolster its Greeces, and although its stated policy is to sterilize those purchases by selling Euro bonds (buying sovereign bonds puts money into the system; selling bonds sucks it back up), it has had at least two failed auctions where it couldn't sell enough to cover its QE purchases. This may be its policy, disguised to avoid spooking the bond vigilantes; or it may reflect diminished appetite for Euro bonds. The Bank of International Settlements put out a warning about QE, that trying to cushion austerity with purchases of bonds to keep rates down risks continued speculative bubbles and misallocation of capital. 

A Little Summer Rally

The market has run up enough in the last two days to confirm that the recent leg down is over and a major retracement underway. Tonight's STU concludes that this is more than a wave 4 correction, which seldom goes back more than 38%. We should now expect a retrace of 50-62%, or to Sp1071-1086 (Dow10100-10200). Looking back at the sickening slide from the 50% rally in 1930 to the bottom in 1932 we saw a series of sharp rallies that faded. The sharp spike today looks like a short squeeze, and is to be expected as we slide down. One target to watch is to fill the gap down at Sp1074 (Dow10138), which can be seen is the chart of the SPY from SlopeofHope. There is also a gap a little higher, at Sp1092. This particularly rally might be over in a few trading days, but I suspect we shall see a more complex correction that continues into early August. 

Canadian Real Estate Imploding?

Coming on the heels of weakness in Australian property markets, evidence is pouring in of a housing bust in the frozen north: Statistics Canada reports a 10.8% drop in building permits. In addition, home sales in June fell 30% in Vancouver and 42% in Calgary. These trends may be blips and reverse, but the sharpness of the drop mirrors the US experience in 2006. 

The commodity countries like Canada and Australia trade on Chinese growth. With China tightening, a fall is not surprising. Home sales in China itself were down 50% in May. More predictions are coming in of this tightening popping the Chinese housing bubble.  As Ambrose Evans-Pritchard reports:

Standard Chartered has told clients to prepare for a fall in property prices of up to 30pc in Beijing, Shanghai, Shenzen, and other large cities in China as the delayed effects of monetary tightening begin to bite.

Fallout From the Tesla IPO: Investing in Advanced Batteries

Tesla had a warm welcome at its IPO with a 40% first day jump and a 60% run to over $30 from opening at $19, but has since given back most of the after-market gain to close back at just above $19. This pattern is eerily like the IPO of A123 (AONE) a lithium-ion battery maker for electric vehicles: a first day pop then a drop. AONE continued to fall in a long slide to 35% below the offering price six months out. Tesla's trajectory created a "very ugly" inverted hammer candlestick at the top, which denotes a legion of quick flippers speculating rather than long-term holders. Tesla priced at $17 but opened at $19, where it garnered a lot of buying interest. It may find support there; if it breaks below, it could be dumped. 

Goldman Sachs helped underwrite the Tesla offering, and about the time of the IPO, launched a research report on lithium-ion battery companies which had a Neutral rating to reflect "a multi-year waiting period prior to clarity on plug-in hybrid and electric vehicle mainstream market adoption." Their main observation is that these advanced battery stocks are no longer trading on news but the market is awaiting proof points. Even this relatively cautious research report was found to be too optimistic due to expecting a too-steep drop in advanced battery costs due to economies of scale and a race by Asian makers to strive for share over margin. 

Let me be the optimistic here. We saw the sort of price drops Goldman expects (if not even steeper) in DRAMs and LCDs due to massive investment in Korea, Japan and China in scale manufacturing facilities. We also see rapid innovation emerging - for example, an apparent breakthrough in quick charging of these batteries: three minutes to 50% charge, about the time at the gas pump, or five minutes to 70%. Gas stations could add this as a new type of pump - and the price will be a lot lower per mile traveled. 

For Tesla investors, the Goldman report has a message: the premium in cleantech stocks seems to be gone, and now these companies will trade on results. Whether Tesla can remain above $19 is a good test of Goldman's thesis. Even so, if the stock decays as flippers abandon it, it should then find a strong bottom as A123 seems to have. At that point this becomes a bit of a long slog, but one with upside. Tesla as a business will grow in the near-term on technology deals with partners like Mercedes and Toyota, and in the longer term on getting its new S line out in 2012. 

Australian Real Estate Bubble Bursting?

The land of Oz is called the Lucky Country, and it could not have been clearer during the past two years as the Great Recession barely touched the shores down under. In the past two months, however, the real estate market has taken a sharp dip, and may be signaling the beginnings of trouble. Could there be danger lurking just below the surface?

This drop has been essentially ignored in the global business press as the travails of the Euro, the fall of stocks and the repudiation of Obamanomics by G20 have led the headlines. Softness in the Oz property market began earlier this year as the central bank raised rates, causing a slight drop in price of 2.7% in Q1. Recently home sales have dropped and a glut of homes has emerged in major cities, including Melbourne and Brisbane, although not in Perth, the center of the resource river to China. 

The tenor of these stories is still positive, and it seems the newspapers down under got more animated over a rainfall of drunken parrots than the potential drop in housing. Such should be expected in a Lucky Country - bad news needs to slap them in their faces to be taken seriously. But I have heard anecdotal evidence of sharp drops in the 15-20% range, such as from this recent comment, and the softening of the market is leading to predictions of a "record fall in house prices" in Q3 and Q4. A similar fall is also seen for the other Lucky Country, New Zealand. 

There have been warnings, such as a warning reported in early May in The Australian. The most interesting debate has been between the Roubini of Oz, Steve Keen, and plenty of glass-half-full property pundits. Keen has been very visible in Australia warning of a housing bubble as early as 2008, and has suffered the Chicken Little fate of being premature in his calls. He lost a bet on the price collapse and had to endure his Walk of Shame recently. He may now be getting ready for the last laugh, as his predictions seem to be starting to be realized. 

Keen notes how Jeremy Grantham just pricked the Oz real estate bubble, and uses the following chart to show how bubblicious Oz property has become: 

It is clear that Oz property has been on a tear, but the cause is not the Lucky Country so much as playing catch-up with US mortgage debt levels. Since 1990 Australians have increased mortgage debt as a percent of GDP three times faster than the US, and have now reached similar levels to those of the peak of the US bubble in 2006. It is clear that not all the drunks are parrots - the whole country has been on a bender:

Steve Keen attributes the rise in part to gimmickry of each new Prime Minister: first the Hawke government (Labour) in 1988 pushed an incentive for homebuyers that spiked sales; then the Howard government (Liberal) repeated this in 2001 (not, however, as a way to launch his new government since he had been in power for a while by then, but as part of post-dot-com reflation policies), and now Rudd (Labour) began his short regime with a similar giveaway to create happy voters following the change of government: 

 

The last twelve months have shown, however, an accelerating fall in loans to homeowners (vs landlords), meaning real demand is falling below actual supply. Rudd's incentive last year cleared out the buying interest, and along with those drunken parrots the sky may be beginning to fall on the Australian property owners:

Slow Weak Ahead

After over a year of a relentlessly up market, we now have ten consecutive trading days down (Naz) or 9 out of 10 (S&P). This is the worst consecutive string of down days in this bear market, which hit a losing streak of 8 days in Oct 2008. The Death Cross of the 50/200 DMA is a fraction apart. Friday's STU notes that the RSI (relative strength index) is at 8.6, the lowest level since Feb 2009, giving another confirmation of a major change of trend: the end of the Hope Rally and the start of something really bad ahead. 

Stocks tried to rally as they usually do before the 4th of July holiday weekend, but sold off at the close - an indication that institutions did not want to hold positions over the three-day weekend. The most likely prognosis based on wave structure is that we are in (or have just ended) a small wave 4 before the final thrust down (See chart courtesy EWTrends). This wave 4 may have ended as a flat, which implies a gap down Tuesday; or may be breaking as a triangle, which implies a sideways week on light volume. 

EvilSpeculator has been exploring the indicator of stocks above their 50 day moving average (50DMA). Right now the number above has fallen to the level of the bottom last March 2009 at the kickoff of the Hope Rally. I suppose on a short-term basis this indicates an oversold condition with a bounce due - one that should come after we complete waves 4 and 5 - but look back a little farther to the Fall of 2008 (pun intended) and you can see how much lower this indicator can go. 

 

Another way they are looking at this is the percent of stocks above or below. Here is a longer term view. You might check out their site as they explore the usefulness of this. 

Double Dip Countdown: "7" UPDATED

We continue to count down to the double dip: 10 - 9 - 8 - 7.  The unemployment report today shows that the slowdown is accelerating. Jobs dropped 125k, and because the workforce fell faster by 652k the unemployment rate actually improved to 9.5% (see chart).

 

Taking out the census workers, we actually increased by 100k, but a tell of the poor state of the economy is that temp workers only increased by 20k, the smallest in a while. Temp workers typically lead permanent hiring by four months. Not happening. While the numbers fall within expectations, Goldman's take is "much weaker than headlines suggest." You can see how after steady improvement during the Hope Rally, we have now had a fairly large drop to negative in one month:

 

The BLS runs a separate Household survey, which tends to be more volatile (larger swings) but has been more positive for the past six months than the widely-repported Establishment survey. It also tends to be a better leading indicator. For June, it too disappointed, with a 322k drop. The normally optimistic Califia Beach Pundit is morose in interpreting the next chart: 

Looking at the trend in both, using Dec. '09 as the low, the two surveys show a total of between 600K (establishment) and 1 million (household) jobs have been created in the private sector this year. The truth probably lies somewhere in between; jobs probably are up this year at an annualized pace of about 1.5%, and that's not very impressive. In good times, jobs rise 2-3% per year.

 

UPDATE: a recurring issue with the BLS numbers is their birth/death model (of companies, not employees!) which may be misleading during this period because it is based on models from the Great Moderation. Mish in particular has been harping on how the B/D model can be distorting matters. Today Jesse's Café Américain comments on the B/D model, noting how it created 146k imaginary jobs. Jesse also has calculated he seasonal adjustments used by the BLS, and finds them surprisingly small and hence not distortive (note: I think that is fair except during this last holiday sales season, where the adjustments expected too many temp workers and so was depressed leading into Xmas and optimistic leaving it).  Jesse comes up with a look at the seasonally-adjusted unemployment numbers without the birth-death model, and finds things are much worse than the BLS would lead us to believe:

One *might* conclude that without the temporary Census jobs and the Imaginary Jobs from non-existent small businesses consisting largely of unemployed people turned consultant, there has been no recovery in net job creation.

 

One way to parse through the data and get passed these imaginary jobs and other adjustments is to look at total employment. Using BLS data from May and June, we have now lost 652K plus 386k people seeking work, or closing in on 1M in fewer in the workforce in just two months, a huge plunge. These people didn't die or retire; they gave up looking. Perhaps many are at the aged end of the workforce, nearing retirement, but what about new college grads? Roughly 6m grads in 2010 (college and high school), a significant group of which should have entered the workforce. Instead, teenage jobs added in June is the lowest since 1951. Ouch. This chart from CalculatedRisk shows how we are bouncing along the bottom of employment:

 

In addition, total workforce is dropping again after a brief bend up:

 

No surprise that the weekly ECRI indicators continue to drop, now down to -7.7%. At this pace (a percent a week) it will confirm a coming double dip in three weeks, when we get below -10%. 
 

 
Most telling is that factory orders fell more than expected, showing the recovery is withering on the vine. Manufacturing had been a bright spot, but orders just dropped the most since March 2009, and manufacturing expanded at the slowest pace this year. With housing in the biggest drop ever, autos slowing, stimulus ebbing and inventories back in balance, what is left to drive growth? Europe is tanking and China is slowing, so no help from exports. 

While all the indicators are showing slowdown, not a dip to negative, their trend down says we will soon dip. Projecting this out shows skimming the treetops in Q4 and a dip in Q1. 

Death Cross History

The death cross is interesting not because it has much predictive power but because it has been widely perceived as predictive, and can spook the herd. Yet I wonder if in the age of the Internet is the herd so easily moved? Whereas in the past (about a decade ago!) investors would be heavily influenced by brokers, or simply rely on mutual fund managers, today there is a great flood of commentary pummeling the attentive. In the past week there has been a stampede of death cross comments, most of which pointing out its self-congratulately character: when the cross occurs, the trend is already pretty clear, so what does it add? 

 

The last Death Cross occurred in Dec 2007, right at the start of the big drop; and the last Golden Cross happened in June 2009, shortly after the Hope Rally kicked off, confirming a longer trend up. In both cases it would have given guidance to ride the trend. Many clever contrarians who thought the Hope Rally would end at its first peak in June 2009 were shown up fairly quickly; and the great mass of fervent fundamentalists who dismissed the warning sign in late 2007 lost an Ark's worth of wealth over the next year. With recent 20:20 hindsight, the Crosses look pretty useful. 

This hasn't stopped the fundamentalist sheep dogs trying to keep the herd away from technical analysis. The WSJ proffered a debunking a few days ago, using an interview with Pierre Lapointe, global macro strategist at Brockhouse Cooper, who said:

The death cross IS nonsense. They’re no better than a flip of a coin to predict future returns. Check out these odds: Since 1970, only 10 of the 21 occurrences actually resulted in a market pullback a month after the death cross. Three months later, the market was down only 43% of the time.

This morning they had a slightly less breezy market note:

Such a death cross has also marked every other bear market since 1972, notes Ed Yardeni, president of Yardeni Research. And the market's 50-day average is currently less than 1% above this tipping point.

Dow Jones ran a more considered piece that look into the stats, concluding:

There have been nine occasions when the 50-day moving average crossed the 200-day moving average since 1998, and five could be considered false signals. One might say they seem pretty good at marking contrarian turning points.

The particular market analyst went on to note the bigger head & shoulders pattern shown in my prior post, and added that breaching the neckline (which we have done) with the death cross pretty well confirms a deeper drop. Overall the point was that a Death Cross in itself doesn't say much (other than that the herd might be spooked) but in concert with other indicators can give guidance. I agree with that - none of these indicators in isolation is worth that much, but the bundle of indicators can predict market direction. What I get amused by in this case is combining the self-congratulatory Death Cross with the often-seen and seldom-realized head & shoulders: dumb and dumberer so to speak. 

But if they spook the herd, they can be acted upon. We should get a really good test in a couple of days: will a Death Cross spur a bearish dump? Or, if the Internet has leveled the paying field between "experts" and investors, we might see the herd fading the experts, in effect betting for a bounce just when the "experts" say they should be spooked. 

Over at The Big Picture, from the Chart Store we have some deeper stats on Death Crosses. Two charts are presented, one where the 200 DMA is still rising (as it was in Dec 2007) and other where it is falling and the 50 DMA catches up (as we see now):

  

If we return to Pierre's comments on the Death Cross, he does add that there have been nearly two dozen death crosses over the past four decades, and the S&P has declined by 0.4% on average one month after such a formation. After six months, on the other hand, the market on average had gained nearly 5%. Here is how he continued:

Fundamentals is the only way to go… until risk moves investors’ attention away from them. And this is where we stand right now. Risk is dominating. The global economy is in much better shape than it was in 2007 before the credit crisis and global recession: home prices are much lower and less of threat; mortgage rates are at all-time lows; and companies are back in hiring mode (albeit at a slow pace). But investors are parked on the sidelines.

Funny comments! The world is in better shape after the greatest drop since the 1930s in the global economy? Such is the wisdom from fundamentals. The corner is always about to be turned. 

In bull markets, investors rely on fundamentals - why not? everything is going up. In bear markets, they turn to technicals - especially when they get tired of being told to buy the dips because happy days are almost here again. At a real bottom they don't listen to the siren calls of brokers at all, and that is the time to buy back in.