Planet Yelnick

Big Up Move

I hold by the view of a final move up to the 1500s, likely getting close to or at new highs, a triple top of the 1550-ish level hit in 2000 and 2007. I now see other pundits joining in.  

Carl Futia is out with one of his bullish predictions: Big Up Move Ahead. His target is the high 1400s. The following chart shows the market bottoming at a confluence of levels - bouncing off the 1292 support level, hitting the lower trendline, and remaining above the 200 DMA - and having run about the same time in correction as the prior major correction:

All About Trends also gave a Long Side Trade Trigger Alert this morning in some specific ETFs, and is expecting the same for the S&P, given the retest of the 1292-1296 level and bounce off it.  

A lot of other wave bloggers report a break in the down channel, which is causing them to hustle into alt counts. Easier just to see the downtrend as ended. We shal see over the next few trading days.  

Prechter has released his recent Elliott Wave Financial Forecast for Club EWI members for free. It is of course über bearish, giving a plethora of reasons for a coming major decline. It is certainly valuable to peruse, particularly around the European contagion echoing history both in the 1930s and the 1830s, the first Great Depression in the then-new US. The EWFF makes a nice comparison between how Biddle's Bank of the United States and the Bank of England tried to stem a tide of bank failures between 1835 and 1839 and the Fed's similar efforts today. They both gave up in 1839, and we had a severe drop into 1842.  

Where I see the major difference to their view is the Euro contagion today is first leading to capital flight to the US, which is showing up in bank runs in Greece, Spain and Portugal; and a rise in Treasuries with the ten-year yield getting down towards 1.7%. This capital fight to US assets should spill over into equities, hence help drive a final run up in stocks.  

Final Market Rally: Market Bounces Off Key Support Level

The market bounced off S&P 1292 on Friday's "Faceplant Day". This is a key level, since it marked the peak of the initial Wave 1 rally off the October 2011 bottom at SP1075. This mid-day alert chart from AllAboutTrends shows the bounce: 

A lot of the doom-and-gloom Elliott Wave crowd were expecting it to break, confirming (in their counts) that the long-awaited and dreaded P3 wave down had begun. If we had broken it, the rally since last October would no longer be countable as an impulse wave since wave 4 (the current wave) would have breached into the range of Wave 2 (the wave after that 1292 peak). If we now hold above, the current wave since last October looks like a classic C wave, which breaks as an impulse in either a Flat or Zigzag correction.  

If this holds, we should expect my predicted final leg 5 up to new highs (since 2009), and a Triple Top at SP 1550 +/- (going back to the peaks 2000 and 2007). If this leg 5 mimics leg 1, it should run for about six weeks and go around 220 points, putting it above 1500. Structure isn't optimal, as we would have expected wave 3 to extend (ie go 1.6x wave 1 or 5). Also, historical patterns would point to a peak in August not July, to be followed by a September/October market drop, so this may run up more slowly than wave 1.   

Five Lessons From The Facebook IPO

Facebook: Fakebook, FailBook, FacePlant, pick your favorite euphemism for the epic fail tepid offering on Friday (it hasn't failed, yet, although perception here seems to have become reality - no pop, fail). The first half an hour of trading was a mess, and some retail trades ordered right away didn't get filled until after hours. Amazing.  

Whatever plagued FB also impacted a plethora of other tech stocks, including ZNGA, AAPL, NTFX, and INTU. Zynga in particular had a wild drop followed by a trading halt before recovering a bit. ZeroHedge's foresenic analysis concluded that software hammered the social software's IPO - software errors in the exchange routing systems.

The NASDAQ head defended his software this morning in the NYT, claiming his system didn't cause the stock to decline. He blamed order cancellations for the trading delays. I guess he doesn't realize that the glitch led to trading confusion, which caused the brokers to back off selling to their retail investors, who then stood aside. So, does he believe that a slackening of buy orders didn't contribute to the decline?

First lesson: FB would have been better off listing on the NYSE.

The expected first-day pop failed. Was this due to routing errors, gross over-pricing, or human mis-judgement?

A lot of the tech press blames the greed of insiders, who upped the amount of shares they could sell in this offering by a whopping 25% of the offering. Or the underwriters, who let it happen. Sy Harding has a more prosaic view, that Zuck's desire for advantaging the retail investor screwed up the normal process. There is also the Goldilock's view, that the offering ending flat means it was priced just right.

I think all these factors had an impact. Some whisper numbers suggested the institutions would have been happier at $36 not $38; and I suspect that when they got pushed aside for more retail investors, they had less incentive to play for the first-day pop (where they sell off some of their position for a quick skim). Worse, letting the enthusiastic retail investor in early removed the piling-on that drives a first-day pop. For the savvy retail investor, if you can get a piece of a hot offering, the offering ain’t so hot.

Second lesson: there is a reason IPOs are done a certain way, and it isn’t all greedy bankers. Google tried to change it, and got a tepid offering. Perhaps the same occurred here. Stocks are not like normal commodities, in that they increase in perceived value as they rise, whereas as normal stuff sells more when it goes on sale. BTFD.

Thanks to the greenshoe, the underwriters most likely have avoided taking a bath. They came in to support the stock at $38. A Reuters piece, widely linked, estimated the potential cost was $2B, well in excess of the potential profit on the offering  – indeed, in the JP Morgan derivatives “London Whale fail” level of a huge loss – but this reflects a common misunderstanding of the mechanics of an IPO. (Take a gander at this 'evil banker' sort of post on the economics of an IPO that exaggerate the upside and overlook the potential downside.) The greenshoe allows them to float an additional 15% in a hot offering - a potential profit enhancer - but also allows them to buy back shares in a cold offering as this one turned out to be. In effect, the 'shoe gives them a 15% short position which they can apply against buying back shares without cash. (And Reuters persisted with its misleading reporting even after the greenshoe was explained to them.)

Various investigations will sort out what went wrong. Fundamentally this is such a large float that the sort of first-day pop should not have been expected - even though the people-in-the-know almost universally expected a pop. I must confess, I too got caught up in the excitement; I thought it would open at $44, be driven down near $38 and then rise above $44 to end the day around $48. It did open around $44 – some services have it at $42.99 (WSJ), others at $45 – but of course it never climbed back above those levels. You can see the opening action in this chart:

Third lesson: Man is a herd animal.  That is why we get booms and busts, bubbles and depressions.

The biggest fallout of this IPO may be that it will not take the place of Apple in 1980 and Netscape in 1995 - the IPOs that rang the bell on the subsequent tech booms. Instead, it is more of another Google, a seminal offering that did not spark an early Web 2.0 boomlet. You can see a comparison to AAPL, MSFT, GOOG and AMZN in this cute infographic. 

My take: FB waited too long to go public.

Fourth lesson: It should have gone IPO in 2009, while it was still in the big growth stage.  THAT would have been one glorious pop! And a lot of the value would have flowed to the retail investor, not just the insiders and institutional investors, as they would have caught the great 10x rise from then to now.

I do not expect the FB IPO to put a damper on the upcoming onslaught of other social mobile web IPOs. There are about the same number of $1B+ valued private social companies as public ones, and most will attempt to get public over the next 18 months. 

Think of the pop that didn’t happen as the proverbial dog that didn’t bark. FB got out at a huge valuation! It now has a huge cash hoard to go roll-up the industry and solidify its tremendously advantaged position. It will spawn thousands of local millionaires, and they will become a new hoard of angel investors to increase the entrepreneurial fervor that has gripped SF and NY.

Final lesson: Don’t confuse buying a stock with buying a company. Facebook is stronger after their IPO, much stronger, even if the stock weakens.

Will The Stock Market Run to New Highs?

This chart, courtesy Contrarian Advisor, provides a great view of where we are, and it predicts that the S&P gets to above 1500, if not to 1600, in fairly short order:

The big picture view is that since 2000 we have been in a large corrective triangle that is leading to a triple top in the S&P around the 1550 range, with tops in 2000, 2007 and 2012. The shape of the triangle is a Barrier Triangle, with a barrier around 1500-1600 and an expanding bottom below Sp800. The implication is a drop from 2013 - 2015 down to the lower trend line, meaning to new lows below the March 2009 Sp667 intraday low.  

The doom & gloom crowd remains strident in calls for an imminent P3 wave down, despite the inexorable rise of the market. Their position is getting harder to support, if it has even been very supportable for a while. After a big drop as we had in 2008, the bounce usually goes 50-62%, but seldom beyond; if it gets about 70.7%, and especially 78.6%, it almost always goes back to the old highs. We hit the 62% retracement a while ago, and odds then switched to running up to a new high.

An alternative view to the Big Triangle is that the 2000-2009 drop is a classic Flat correction. This makes the wave up either the start of a new bull market - which should exceed the 2007 highs - or a corrective X wave with another down pattern to follow. Since that structure will be horizontal, given how this correction has so far unfolded, it also suggests the X wave will go back to the 1550 range.

X waves are not well understood in wave analysis, since they seem like a "plug" of a failed structure, but they are a very standard feature in markets, especially in extended corrective structures of a sort that don't break as triangles. So far the correction since 2000 has gone 12 years, so a wave analysts should look for a triangle or a series of horizontal corrective patterns connected by X waves.  

X waves tend to be simpler than the corrective patterns they connect, and therefore are usually zigzags - sharp rises, as we have seen since 2009. This one seems to be resolving as a large double zigzag, where the first zigzag rose into 2011, and after the big May to Oct correction, we started the second zigzag, which we are still in. Simple fibonacci analysis says it should go to the 1550 range: using the weekly numbers above, the first wave rose 680 points, and the second zigzag should run 61.8% to 100% of the first one. Using 61.8% of 680 points, we get a target of 1544.  

Usually stocks run up in an election year - and even more so in the year before - and then correct hard afterwards. Why is not hard to figure: the incumbent tries to get re-elected and uses whatever ways he can to pump the economy, then takes a huge hit in the first year to give his party a shot at another recovery into the next election. This is the Four-Year Cycle, the most predictable stock market cycle because it is driven by actions in the real economy. At a simple level, one could just stay long and pull out before 2013, when a whole bucket of negative events happen, like the repeal of tax breaks that are pumping the economy up.

Technical analysis supports this fundamentals view right now. 

Has AAPL peaked?

I was day-trading GOOG around 2007 when it went parabolic and then fell like a rock. A warning shot for what happened to the market in 2008. Been playing with AAPL in a  similar way, and just saw it go parabolic. Is history repeating? First the collapse of AAPL and then the whole market? Check this chart out from Doug Kass:

I have seen a lot of commentary on this chart. "This time it is different!"  GOOG was at a 50 PE while AAPL has drifted to a PE that is the same as the whole S&P (which makes sense given its market cap size - "regression to the mean" - It IS the mean now!). AAPL is still growing fast and has continued dominance of its sectors. Etc.

Stock predictions range from a low of $450 to a high of $750, with whisper at $1000, which would value AAPL at close to $1T. 

Now, I am an Apple fanboy, and use my iPad and iPhone 4S constantly, eshewing my Android phone (Google Nexus - you get it, prior Google fanboy untll the stock popped), hardily touching my Windows netbook, and sitting in front of an iMac dreaming of a Macbook Air with a touch screen. But I am buying a stock, not a company.

That stock has produced. Looking back, it got to as low as $3.18 in 1997-8, whle generally hovering below $5. Bill Gates bailed out Apple for $150M back then. if Microsoft had held that stake, it would be worth over 100x - over $15B. Microsoft also bought into Facebook in 2008, and that stake will be worth a lot too, but the AAPL return is truly outstanding.

Parabolc runs always end badly, typically with a fall off a cliff shape. When GOOG fell, it had the expected bounce (wave 2) and then fell hard - look at the chart. But parabolic runs have no clear rules. AAPL may keep running. There are a bunch of stock market aphorisms around this, including don't get in front of a moving freight train.  

One way to figure this out is to use techncial analysis. Here is a wave chart on AAPL, which says the recent tick at $600 could very well be the end:

The Fed Has Started QE3 in Disguise By Backstopping Europe

The surprise the bears feel over the continued rise of this market may be due to QE3 in disguise. ContraryInvestor has a good analaysis of how the backstopping of the European bailout fund LTRO by the Fed is acting like a wnother wash of liquidity, this time trhough Europe. (See chart).  

Given how the market inexorably rose with minor pullbacks during the last two QE episodes, we should expect something similar now until the LTRO backstop runs its course.

The bears will expect it to crest before getting too out of control, but they may be misreading both the Fed's determination and thye wave count.  If we count this structure as wave C since 2009 in a large ABC made up of two doubke zigzags internally, it could continue up like the QE2 period (the A leg of the second double zigzag) towards 1500, giving a triple top since 2000. 

Not a prediction but food for thought for the  bears.

Trendlines and Timing Point to a January Top

The seasonal pattern has a general rise in stocks from November to May, and we are seeing the market so far conform to that pattern. Usually within it is a February correction, leading to a number of January Tops over the past thirty years.

Sometimes that top marks a major reversal, as we saw in 2009 and 2000, but usually a month-long minor correction. Prechter has been predicting a major top now for the past two years, and a number of technicians have centered on a Jan 24 top prediction.

Now, often these timing predictions when they work mark a change of trend, but it is often hard to predict in advance which way. The market is in an uptrend right now, and might continue as such into next week, when this turn window occurs. This suggests a reversal down, conforming with the seasonal pattern. It still might be a minor correction, however. 

EWI has released through Club EWI a series of charts for the public, which add an additional factor, the approach of the market from below of a major trendline going back to 1932. As you can see from the chart above, the Dow in the late '90s crested the upper trendline, which previously marked tops all the way since the 1930s, and stayed above until 2008. The drop in 2002 bounced from above off the trendline, indicating continuation of the uptrend.

Since the reversal back up in 2009, the market has moved in 3 waves (a corrective pattern) to touch the bottom of the upper trendline. Failure to break through for more than a short time (a "false break") is bearish, indicting a fall down towards the lower trendline. Breaking back above and staying there is very bullish.

This suggests the January Top could be a major one, but step back and consider the broader picture. At trendline tests, a "jitter" or series of tests is common, and we might see a triple top or triple test over the next four to seven months. A false break is tested over the time frame of the pattern, and this one goes back decades, so a period which might seem longish to us (seven months) is but a blip in the broader time scale.

Hence it would not be surprising to see a test and a drop back - the February correction - followed by another test which might stay above the trendline for months - the typical bullish period of March to May at the end of the seasonal patern. If I can paint a scenario, we would then fall back in the summer and test one more time in late summer - the common August High before a serious Fall correction.  

Santa Rally in the Nick of Time

We didn't see a rally from the 2d week of December on, when it often arrives and shows strength. Instead, we have started the Classic Santa Rally, which comes in the last five trading sessions of the year and reflects the common rise on light trading during holiday periods. What to look for:

1. General rise on light volume into first two days of Jan (to Jan 4)
2. January Barometer over first five days - if up into Jan 9 it is bullish
3. December Low Indicator - very bearish for year if we break the Dec low (SP1205)

Last year the January Barometer signaled a strong year, and right now the S&P is barely up - and only because of the Santa clause rally starting yesterday!  So don't take this indicators too seriously.

A lot of economic indicators are pointing up. Some should be taken with a grain of salt, like housing (which just got the last four years revised downwards, making recent trends look more positive), but some are interesting. The shale oil surge has changed the dynamic of indicators ike rail traffic, since we are bordering on a net exporting of energy, especially due to LNG. Rail cars shows an increase which has been used to show continued purchasing interest, but in this case may instead be indicating exports.   

It also has meant a drop in gas prices, which acts like a tax cut. Even though Q3 GDP was downgraded in its third revision, Q4 is expected to report out higher than expected, giving a spur to stocks in January. When I scan the wave world, it is generally bearish (no surprise), so a warning that we might see a stronger than expected January, have the traditional correction into February, then fly into April or May before the bad economic news catches up with a short-term spur of lower gas prices.  

Worst Thanksgiving Week Since 1932

I have been quiet on this site for the past half year, focusing on venture capital not the stock market, but have received a number of requests for a quick market update. We should be entering the seasonal strong period (Nov to May), but instead have suffered the worst Thanksgiving week since the bottom of the Great Depression in 1932. We should be expecting a Santa Rally, which typically begins in earnest around the second week of December, but instead the doom & gloom crowd has suggested that money managers will stay home this holiday season, Grinches all.  

The comparisons to 1932 seem particularly telling. The market since 2008 has seemed to replicate other great crashes pretty closely - the best fit being 1907 - and has some parallels to the 1930s, especially if this time it is seen as unfolding at about 1/3 the speed. Specifically, what started as a pretty bad recession seemed to have turned around in 1930, but a sovereign debt crisis out of Europe in 1931 spread like a contagion to the rest of the world, and pulled the US down. In our case, the equivalent to the bounce of 1930 unfolded over three years, 2009-11, and now seems to have run head-on into another sovereign debt crisis out of Europe. If history repeats at 1/3 the speed, we head down, this time in a sickening slide over the next 4 - 5 years, not a dramatic fall in just the 18 months of 1931 to summer 1932.  

The pattern that unfolded in 1931 was the sovereign contagion led to capital flight from country to country. Hoover in his memoirs likened it to cannons moving back & forth across a ship on a tossing sea in a tempest (a quote you all have probably seen). Right now a run on the European banks is in process, the commodity currencies like the AUD have fallen hard, and Chinese currency outside of China seems to have dried up as stories emerge of Chinese oligarchs cashing out and disappearing. Back in the 1930s, capital flight led the wealthy to go into tangible assets like gold - transportable across borders as it were to escape currency controls. We may be seeing that in China, although the data is sparse, anecdotal and likely exaggerated. As capital sloshed like loose cannons in the 1930s, safe harbors skyrocketed then fell; recently we saw the Swiss Franc skyrocket until the government curbed its enthusiasm. Eventually money went into cash or mattresses.

This was all very dramatic, and given a slow-motion rotation this time, should unfold more as a surreal process of "this cannot be happening." The slowness gives time for the powers-that-be to find solutions, such as Eurobonds done right, but so far they have failed to rise to the historic challenge. 

The markers of the capital-flight stage will be clear:

1. The TNX (the US ten-year Treasury) yield should fall to remarkably low rates, at least below 1.4%. (Near the ed of the Great Depression, it got below 1%.) 
2. The interbank lending rates should skyrocket; watch the LIBOR

Looking at the near term, the big issue is whether this will simply spiral out of control or will we muddle through and kick the can farther down the road.

From a Fractal Finance point of view, this chart should give us pause.  

Wave practitioners have been trying to count the waves since the big drop last summer. In Fractal Finance, the process is simpler. The Fractal view is that markets normally are in trading ranges - corrective patterns with overlapping waves - as they try to seek order, meaning a direction. When the direction is found, markets thrust rapidly to a new plateau, where they pause to find direction again. Like all non-linear chaotic systems, markets tend to be on the edge of chaos most times and in rapid thrusts occasionally. 

The blue lines in the chart aptly convey the trading range, and the momentary breakout above. Often a trading range of a chaotic plateau shows a false break below (as we see at the end of September) followed by a false break above - which is what the whole month of October now appears to be. When a thrust fails to sustain above the prior plateau, a reversal is in order. We saw in 2009 a thrust out of a multi-month trading range, and the market never looked back. This time we have fallen back.

It is now crucial to head north again in that proverbial Santa Rally. If we do, the break above is still on. We should then run up into January, and we might confirm a prediction of several years ago by Bob Prechter, that the top would be in January 2012. But we really only have a week or so for this to occur.

One of my readers predicted I would blog again when the perma bears like Prechter went bullish. Alas, they remain super-bearish. Let me finish below the fold with a recent Interim Report from EWI so you can see for yourself their latest view. It may be that even their January 2012 prediction for a top was too bullish for the currenct circumstances.  

Skip Danger Forum

As I wind this blog down, I recommend readers check out the Skip Danger stock forum. Frequent readers of the comments know that it is a place to continue the sort of dialog that made this site worthwhile.  If you do go check it out, drop back and let me know what you think. 

Broken Pattern, Token Risk

I appreciate all the concern in the comments on my transit back through Narita, but it came and went and I still have my hair. I spent about an hour in transit, and the food on the return was worse than normal, telling me that it was not sourced from Japan. 

The risk I took was very low. I wrote about it in my other travel blog: Bananas Are Radioactive Too. The risk I took was about the risk of a daily commute. You guys who commuted for the six working days I was gone were taking on much more risk.

Investing trades in risk and investors get it wrong all the time. Right now the bet is not to fade the Fed, to believe QE Infinity will continue to pump this market. The calls to end both QE and the zero interest rate policy (ZIRP) are increasing. Andy Kessler just explained in the WSJ how ZIRP crushes capital formation and stifles the recovery. Risk on.

The other bet is that the four-year re-election cycle will pump the market. This is the most predictable cycle, and its causation is clear. Yet Obama shot this bullet early, right away in fact, and the Stimulus is already fading to the point it is acting as a drag on GDP. He is facing political headwinds from the grumpy Republican House, and if he loses QE, he is left with only a war to pump the economy. Libya? Yet another Middle Eastern war threatens to keep oil prices high, acting as a bigger drag than war-spending. 

You can see the impact of this in this chart showing the current market vs. the normal re-election market. Now, "normal" here is an average of many years, so we should not expect any one market to actually match the curve; also, the curve is not combined with statistical variability (eg. Bollinger Bands), so cannot we easily assess if this one is still within the bands of "normal". The key, though, is the extent the recent dive has taken this market off the normal pattern. Broken pattern betokens bigger risk.

Skip Danger

The news over here in Asia about Japan is not as strident as Americans see back home on CNN. My family keeps urging me to skip danger and fly some other way home than through Narita, but there is no evidence of radiation floating down towards Tokyo. Of course, winds may change. 

A more immediate danger I have been facing is to my pocketbook & digital lifestyle: Internet at my hotel sucks. To skip that danger, I scored a great deal on a 3G SIM in Singapore, and wrote about it in my travel blog. Just a few years ago we marveled at going hotel to hotel around the world and staying connected, but now the expense and limitations of hotel Internet are glaring. Rather than suffer $150 during my stay for lousy connectivity, I found a way to pay $15 and get complete 3G nirvana. If you travel, you might take a look. The wireless world is rapidly eclipsing the wired. 

For you traders, it has been a big week. Some of you are dog tired. Time to lay back and enjoy the weekend! Your favorite indicator, one way or the other, the STU, expects a bigger slide next week. So far this correction has fallen in three waves, and today's reversal has all the earmarks of a wave 4. If instead it pops on Monday above 1294, something else is going on. Better news on oil (Libya) and my flight home (Japan nukes) could spur the pop.

Of course, if the global winds shift, all bets are off. The G7 intervention is already fading, with the USD down to new lows. The toxic Dollar cloud may drift over Tokyo, too. Japan may begin to swap Treasuries for Yen, bringing the wealth back home, and unbalancing the Fed's QE plans. 

Another site you might want to check out is Mamma's new Skip Danger stock forum. Frequent readers of the comments know that it is a place to continue the sort of dialog that made this site worthwhile.  

If you do go check it out, drop back and let me know what you think. 

Transiting Through Narita

I just posted on Narita, the Nukes and United over in my travel blog. Take a look. If typepad asks for a sign-in, cancel and you will be in. It is a glitch on their site. Feel free to continue the discussion in this post.

Special Bulletin

It is with great trepidation that I post this, given my prior post, but the comments are overflowing & I wanted to give frequent readers a forum before you jump (or not jump) to "Mamma's" new place. Have at it, and as a treat a little technical analysis below the fold.

New Blog Platforms

Planet Yelnick began as an email exchange and then a private newsletter after the dot-com bubble burst. Been a great ride but I am changing focus. A new tech boom is on and my attention is there. My new blog platform is: http://bullpencap.com/.

For fun I will occasionally blog about travel and cultural issues. In a week or so the travel blog becomes the new Yelnick start page. 

Employment Brackets the Over/Under

The over/under is a betting level: the predicted points in a game. Last month employment disappointed, but it was blamed on weather. After that report, the catch-up level was 260k jobs in this report. We missed that by a mile. The catch-up number was lowered since then down to 196k by those mysterious "they" who set expectations. (At least in Vegas we know who the bookies are.) This report came in bracketing the over/under:

• 192k new jobs, below 196k expectations
• 222k private sector jobs, above 200k expectations

Stocks are down today, possibly reacting to an under. More on that below. The spinmeisters are out in full force, however. Just before the report the herd expected the over (60% thought it would beat). After the report the consensus of opinion appears to be this comment from CalculatedRisk:

This wasn't a great report. Heck, it wasn't a "good" report. But it was a little better than most recent reports.

At this stage in the business cycles, upward revisions are more likely going forward, so this report should improve with more data. What is less clear is if new jobs will ramp up, or just remain steady - the average between January and February is only 127K new jobs, below what is needed to keep up with new entrants to the workforce. The 192k number is a catch up from a dismal January number of 36k, which was revised up to 63k. 

The market reaction has been mixed. Bonds improved but reflect a reasonable chance of a rate increase later this year. Stocks may be reacting to a modest recovery, which makes QE3 less likely, and would remove the speculative pump under markets. On the other hand, the report shows no surge in wage inflation, meaning QE has not yet spilled over into wage inflation:

The below-the-surface issue with the report is a continued detrioration of the overall employment picture. While the unemployment rate is down, the rate of participation and the ratio of employed to population continue to fall even faster. This means statistically the unemployment rate has dropped not because of more jobs (numerator) but because of fewer workers (denominator). Without those dropouts, the unemployment rate would be 11%. 

Chinese Curse Bewitches the Dollar

Be careful what you wish for; it may come true - Chinese curse

China made a bold currency move Wednesday, and it barely registered in the West: it is encouraging the Yuan to be a reserve currency, to be used to settle transactions in and out of China, instead of the Dollar. For all those pundits and politicians pressuring China to float their currency, they just got their wish. 

This marks a shift from an export-driven mercantilist economy, to a consumer-led capitalist economy. The internal pressures from mercantilism eventually create their own contradictions:

• inflation from laundering the currency conversions
• unrest by people who wish to cash in and enjoy the good life
• lost wealth from capital trapped in forced savings that act as a sinkhole of productive investment
• lost profits from excessive competition & multiple me-to factories

The curse is that it removes one of the largest borrowers of Dollars, and reduces demand for Dollars for international settlement. This has led the WSJ opine that the Dollar's role as the one reserve currency is coming to an end:

1. Technology is undermining the scale and depth of Dollar trading by allowing rapid cross-cirrency comparisons without translating in Dollar terms
2. Rivals of enough scale are emerging, especially the Euro and the Yuan
3. US fiscal policy (such as QE and huge deficits) are undermining confidence in the Dollar as a safe haven that is a stable store of value 

Asked rhetorically, can the Fed continue infinite QE (indefinite Dollar debasement) as the foundations for Dollar strength (oil trade, international settlement, safe haven) crumble?

The Fed has become the biggest buyer of Treasuries, which has worried Bill Gross to ask the question: who buys Treasuries when the Fed exits?

His answer: Treasury rates will have to go higher to attract investors. This could scuttle an incipient recovery, especially with higher oil prices. It would, however, be good for the Dollar - but it is months off until QE2 ends, and expectations of QE3 are increasing as fast as GDP fades. 

The Dollar, then, remains on edge. It has traded below the trendline of support that has held for the past three years. The longer down below, the more likely it begins to lose support and possibly crash. 

When measured in the Dollar Index, as shown in the chart (with the key trendline), the so-called crash would like more like slip-sliding away; but when measured against metals or commodities, it would look like gold and silver shooting north & commodities heading up parabolically - which is how they have begun to look recently. You can scan the blogosphere and pick up all sorts of predictions on silver ($130!) for example. It is pretty clear that Dollar weakness since last summer has led to commodities strength (Dollar in green, using the UUP instead of the DX; commodities in blue):

Another leading indicator of a Dollar collapse would come from the commodity currencies - the CAD, AUD and NZD, which indeed have been showing recent strength. You can scan the blogosphere and pick up all sorts of predictions on the CAD (Fifteen reasons to love the Loonie!) as well as the AUD. 

A further (but in this case misleading) indicator is oil, which is undergoing a dramatic spike - up 15% in five days. Such a spike is rare and almost always fades back quickly (the one recent exception being the invasion of Kuwait in 1990, which led to the first Gulf War). Such an event-driven spike gives little guidance on the direction of the Dollar since it is likely to be temporary; indeed it may be the primary explanation of why the Dollar Index has fallen below the support trendline and stayed below. When the immediate Libyan crisis abates, oil should fall, and the Dollar recover. 

Bullishness on the Buck is below 10%, according to the STU. This is what happens around a Dollar low, so they wait for it to bounce, but add that the wave structure is unsettling. The bounce that began at the QE2 announcement has now faded more than 78.6% off its peak in November, and the wave structure is ambiguous. Normally a fade beyond 78.6% means it is going beyond 100%, but they expect the opposite. Again, the explanation for the ambiguity may be the temporary oil spike. 

In the longer term, the Chinese move should be good both for China and the broader world, as China rebalances toward a more Western-style economy, which will come with opening it up more for imports. The move will put pressure on the US to get its economic house in order, also a good thing in the long term. Also, the multiplicity of reserve currencies may smooth a transition to a different form of reserve currency, one not tied to any domestic set of policies, what Keynes called the Bancor. This frees the reserve currency from the tyranny of domestic policies, and lets all currencies float against a standard. 

In the near-term, with turmoil in the oil-bearing countries and a painful adjustment domestically to get off the drug of stimulus and back into a sound economic foundation, the US may have to live through the other Chinese curse: "interesting times."

This Time the Tech Boom is Driven By Reality

Last time, the dot-com boom was driven by a frenzy over gaining eyeballs. Valuations went through the roof well before revenues.

This time the hot companies are growing real revenues remarkably fast. The WSJ noted how much faster the leaders like Groupon and Zynga have raced towards $1B in revenues, much faster than in prior tech booms and perhaps the fastest in history:

Groupon’s revenue in 2010 rose more than 22 times to $760 million in its second full year since its daily deals site launched, up from $33 million in 2009. Zynga, the maker of online social games like FarmVille scored revenue of $850 million in its third full year in 2010, more than triple the year before, and Facebook’s revenue rocketed to as high as $2 billion in 2010, its sixth full year.

Their ridiculous revenue growth rates actually rival those of the four largest Internet companies–Google, eBay, Yahoo and Amazon.com ... 

Compare all of this with the software industry. [L]ess than one-third of the nation’s top software companies reached $50 million in annual sales in six years or less – and the fastest to $50 million, Novell, took three years. Microsoft crossed the $50 million barrier in eight years; Oracle, 10 years.

It should be no surprise, then, that Facebook has crept back to a $70B market cap in private trading, and JP Morgan just raised a $1B fund to buy into the private market of shares for high-fliers, beginning with Twitter.  Something big is brewing, and the smart money is leaping in.

The tech trade press is beginning to figure out that these valuations fit within normal metrics, assuming the incredible growth continues.

It is not 1999 all over again. Not yet. 

It is too facile to knee-jerk and call it a bubble when we have revenue growth of this magnitude by the leading social companies. 

The Fed on Commodity Inflation: What, Me Worry?

Is it inflation or speculation? The Fed Chairman spoke very plainly today, but what he left out is important. Coincidently, he spoke right after the ISM Report on expectations. Good news: manufacturing expectations are booming. Bad news: inflationary expectations are also booming.

These CPI expectations (the blue line) do not predict inflation, but a lot of folk are worried. Not Ben. He said commodities price increases are NOT a concern. 

His comments have been picked up by the punditsphere, and you can get a quick read from Barry Ritzholz thinks ("I disagree") and Cullen Roche at PragCap ("totally oblivious"). Here is Ben's view of surging commodities:

[T]he increases in commodity prices in recent months have largely reflected rising global demand for raw materials, particularly in some fast-growing emerging market economies, coupled with constraints on global supply in some cases.

Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of the dollar are unlikely to have been an important driver of the increases seen in recent months. 

The rate of pass-through from commodity price increases to broad indexes of U.S. consumer prices has been quite low in recent decades, partly reflecting the relatively small weight of materials inputs in total production costs as well as the stability of longer-term inflation expectations.

I think all three assertions are true, but hide the truth: his QE2 policies have driven up speculation, and that has driven up commodities across the board. Let's look at his assertions:

• demand and shortages have driven up prices - ok, but why would all commodities be going up in lockstep due to weather here or there, or other local causes of shortages? And why up so much when the great demand generator, China, is slowing down? As Cullen Roche opines: "There is nothing normal about cotton prices rising 200% in six months."
• prices have risen across all currencies - ok, inflation is the result of weaker currencies, and normally the whole world does not weaken at the same time in much the same pace. Also, QE2 does not 'print money' in the way people casually toss out. Still, his core assertion is too loose: prices have gone up faster in Dollar terms than Euro or Yen, bespoking Dollar relative weakness since QE2. Still, the inflation argument would have more weight if the Dollar were falling faster than it is, given how much commodities have risen. 
• commodity price rises are not being passed through - ok, so far anyway. I see blogosphere comments about official stats hiding the real inflation going on, but it is pretty clear that other than food and energy, where costs have an easier time being passed through, most industries are having a terrible time passing on the rise of input costs. This is why corporate earnings are about to run into a margin squeeze. 

Under the New Austrian School of Economics, interest rates are mechanisms to adjust business investment behavior. Normally low rates speak to longer investment horizons, but in the deflationary depressive aftermath of a credit bubble, keeping rates artificially low as the Fed is doing has the opposite effect: it spurs short-term, speculative investments over the long term. You could think of low rates as destroying the returns on sunk capital, leading to low replacement of existing plant - pretty much what has been going on during the Great Recession. 

BTW Bernanke let out his own estimates of how much he has lowered longer term rates - 75 bp. ZeroHedge extrapolated his formula across all his various QE measures:

The sum of QE 1, QE lite (the top off of QE1) and QE2 is $2.35 trillion. Using Bernanke’s formula you get a range of 4% to 5% as the approximate interest rate consequence of QE. 

That is an extraordinary number. The Fed’ ZIRP policy set interest rates at zero. QE has brought that to -4.5% (average) based on Ben’s numbers.

I don’t think that this has ever happened before in the USA. The examples I can think of in history outside of the US all ended badly. Ben has set monetary policy so that interest rates are 5-6 % below inflation. There can be only one possible result. Inflation of everything we use is going to explode. 

Maybe. The ISM reports are clear in seeing price increases on inputs across the board, and maybe American industry will not accept the margin squeeze and will try to pass it on. If so, prices should begun to push up in the next six months, and while this might make GDP tick up (see chart), it could just as well depress consumer spending:

The other explanation than coming inflation is that the speculative fervor is about to cool. We will likely see this first with oil and the Dollar. A strong Dollar reversal will unwind the speculative positions (priced in Dollars), and a break in oil will remove the biggest driver of cost-push seen by the ISM managers. 

Dollar Double Tests the Trendline

At the start of February, on Groundhog Day, the Dollar came down and tested a trendline that has provided resistance since Bear Stearns Day in 2008 (the day Bear went under). Apparently the Dollar saw its shadow when it bounced last Groundhog Day, and has remained in the winter of its discontent - it is now back to that level, a double-test in less than a month.

This trendline has provided resistance since March 2008, at lows in August 2008 as we began the great slide down, in Nov 2009 as the Hope Rally appeared to stall, and more recently in Nov 2010 at the kick-off of QE2. It is now Groundhog Day all over again for the Dollar, as it once again has come down to the critical support level (chart courtesy EWTrends):

If it does not hold these levels, it is poised for a fall based on technical, fundamental and cyclical considerations. PIMCO even put out a comment today that the Dollar was about to lose its status as the reserve currency. SImon Black added that "the Dollar is finished."

The primary basis for these assertions is the oil trade, which has been primarily in Dollars since a deal was cut in 1973, after Nixon went off gold. Given the Brent Crude market, an increasing quantity of oil is being bought directly with Euros, which suggest that the world's reserve currency is moving to a basket of at least the Dollar and the Euro. 

Still, these pronouncements seem grossly overblown. Sentiment is very bearish against the Buck, at similar levels to the Nov 2009 and Nov 2010 bounces, and according to the STU, the total net positions against the Dollar are at the extremes of the Bear Stearns low and the Nov 2009 low. This suggests another bounce is imminent. 

A lot of folk are watching for a first-day stock bounce as we march forth to a new month. I suggest watching the Dollar instead for an indication of what is to come. 

That Analogy to 1937 Looks More Like 1907

On and off I show market analogies to famous corrections & rallies in the past. These are more like one-off events than predictive patterns, but are interesting to show that this time it is NOT different no matter how much investors would like to think so. Here is the prior 1937 analogy, which for a time looked spot on:

Updated and re-based by the Chart Store, here is how it now looks:

Not so good. First thing to note is how the basing of these analogies can make them fit or throw them off. In the first case, the basing was to the 1932/2002 lows; in the second, to the 1938/2009 lows. Caveat Investor. 

Doug Short does this all the time, and he has a recent 1937 analogy chart where he based it on the peaks in 2007 and 1937. It shows we have gone a bit higher in 2011 than the market did in 1940, but then again, back then Germany invaded France with tanks, whereas now the Fed invaded Treasury with QE2. 

Back to the issue of basing these charts, the initial 1937 chart above based on the 1932 low & the Oct 2002 low, and the match since remains uncanny. We peaked in 2007 ahead of the 1937 peak (in trading days), and fell farther. Rather than shooting beyond the red line in the prior chart, using the 1932/2002 low basing, we would be coming up to the break point where the 1940 market took a sharp fall and ran down to the 1942 low. 

Today The Big Picture shows two analogies: 1974 and 1907. The Hope Rally looks ominously like the rally after the Crash of 1907:

Pondering this, both were banking panics. Both also came after a long runup in stocks and a plateau; we had a great rally from the late 1870s to around 1900, when we entered a long trading range around Dow 100. At the next bottom, we created the Federal Reserve. At the next bottom this time, will Ron Paul get rid of it?

GDP Misses, QE3 Gains, Oil Looms

We had a chance of snow on the streets of San Francisco, but the weathermen missed. We had expectations of GDP being revised up (from 3.2% to 3.3%, with whisper at 3.4%) but the economists missed. Now the reaction is coming in:

• JP Morgan lowered its Q1 forecast from 4% to 3.5%
• QE3 is now considered more likely (bolstering stocks)
• The dreaded double-dip is now back in the punditry

Quite a leap. Even with the downward revision, Q4 GDP at 2.8% was up from Q3 (2.6%) and Q2 (1.7%). CalculatedRisk provides an historical chart to show where we are in context; you will see that GDP on a quarterly basis often jumps around a bit:

Still, it remains clear that this recoverlyless recovery is much less robust than prior ones, which is even more surprising given the depths of the fall in 2008; usually after a deep drop we get a rapid pop. Just look at the pops after the double-dip in 1980 and 1982, the start of the chart. The recovery in the 1930s had multiple years of double-digit growth, while we remain below the 3.3% long-term average. 

Worse, the trendline is now turning back down, albeit we remain a ways from a double-dip. From Econoday:

What is driving the reversal seems pretty clear:

1. Oil prices
2. State government austerity

There is something else, swimming under the surface. We had been told that the consumer was back and spending was up. In this revision, a drop in the prior consumer spending estimate had a major impact on the revision; and overall real domestic spending dropped 0.6% whereas it had grown 4.2% in Q3. Purchases of durables went up in January but had been declining in Q4. The January blip was solely due to aircraft orders, which tend to be extremely volatile. 

Capital goods outside of transport actually plunged in January, down 6.9%. Sy Harding reports on Alan Abelson's column in Barron's this weekend, which quotes David Rosenberg: 

Demand for these capital expense items tells you a lot about the strength of industry. It was a prominent linchpin of 2010’s 15% gain in capital spending, which in turn helped mightily to power the recovery – such as it was. Last month’s drop in orders was the worst since January 2009, when the economy was up to its nostrils in recession. The consensus estimates for GDP, as Dave points out, are well north of 3% for the 2nd quarter – and that doesn’t quite square with the minus build in core capex orders so far this quarter.

The wildcard in the double-dip vs QE equation is oil. The turmoil in the Middle East strikes many like the Fall of the Berlin Wall, but as it works its way through, oil prices will be on edge. The impact of higher oil prices on US GDP is being estimated vigorously right now. High oil acts like a tax on consumers. One estimate is that the recent oil spike, if it sustains over 2011, will act like a $700 tax on families, lowering GDP by 0.5%:

Reuters provids an interactive graphic on oil and GDP, courtesy ZH:

One thing to keep in mind is blind extrapolation leads to poor decisions. The oil spike may be peaking, not trending. If the US were to restore drilling in the Gulf and elsewhere, the drivers of high oil prices would bend quickly, but even short of that, whatever else happens in the Middle East, they need to keep the oil flowing to feed the rioting people. Europe is apparently pushing the US to to stop the bloodshed, which is out of control by a despot trying to maintain his grip at any cost, and get Libyan oil flowing again. The start is the UN launching sanctions, and getting Qaddafi investigated for war crimes, only the second time the UN has taken that step. 

Put all of this together and 2011 looks like a slower growth than expected but not an outright double-dip, which makes QE3 questionable. Being in the muddled middle freezes decision-making. 

Buy The Dip?

The biggest drop since last August got the bears out of their hibernation, as well as the triumphant buy-the-dip crowd. This drop so far is but a blip in a relentless rise, and buying dips has been the right approach. Zerohedge made fun of it in a series of BTFD pictures (parent alert - risque language), my favorite being:

Neely jumped on this today with his second top call. His first was in June 2009 after the initial runup off the March 2009 low. It tainted his reputation when the market turned inexorably back up, so this call is all all-or-nothing move by him:

Applying NEoWave’s advanced market confirmation techniques, Mr. Neely explains that today’s collapse confirms the end of an old pattern and the start of a new one. This new pattern suggests a 1- to 2-year bear market has begun and will likely result in a 30+% drop in market valuation. ...

Instead of financial institutions and real estate markets being devastated, Mr. Neely suspects the most likely justification for this future market decline will be severe financial problems for federal, state and local governments. The result could be local and national transportation disruptions, public service problems and government employee layoffs around the country. Other circumstances that might justify a 30+% decline in the stock market could be a substantial increase in the cost of energy or a drastic increase in the value of the U.S. dollar (i.e. deflation).

So Neely is calling for the bursting of the final bubble, the Government Bubble. Could be. "Austerity" is the new black. States are all cutting back. The irony of the protests in Wisconsin is that the protesters are trying to hold onto the status quo, whereas the Libyans (and Egyptian, Tunisians et al.) are trying to upend it. Which side is history on? We shall find out. 

Neely's logic on the USD is that once the Government Bubble bursts, the stimulus and subsidies end, leading to improving the prospects for the currency. Why? A falling currency is really a bet against unsound government policies; and at the same time rising gold becomes a hedge against bad government. At some point excessive stimulus/subsidy/easy-credit has to end, and we may have reached that point. Deleveraging will follow, with a vengeance, and the Dollar will soar. 

No surprise then that commodities took a huge fall today, other than oil of course. 

Tony Caldaro also went bearish: he says a "significant pullback" has begun. He was the first major wave analyst to turn bullish, and gets credit for being on the right side of market history for the past year. He remains mid-term and long-term bullish. His prognostication is crisp:

Technically, the market has just experienced its largest pullback, (32 points), since the Intermediate wave four low at SPX 1173 in November. The short term OEW charts suggest that the SPX 1344 high ended Minor wave 3 of Intermediate wave five. Should the high of Minor wave one at SPX 1303 be penetrated by this pullback, then this count would be questionable and Major wave 1 may have completed. Should the SPX 1303 level hold during this pullback a Minor wave 5 rally should follow to new uptrend highs. With support at the 1313 and 1303 pivots it appears to be “make or break” time for this Major wave 1 seven month uptrend. 

Normally we would expect a bounce tomorrow, and then the real test. Sp1303 is not that far from the low today at 1313. Robin Landry put out a bulletin a little more cautious than Neely or Caldaro that explains what to look for: 

If events in the middle east worsen overnight we could see the market accelerate to the downside. The decline today broke the trend channel on the hourly chart so a rally back to the underside of the trend channel at 12,300 area would not surprise me before turning back down

Even more cautious is EvilSpeculator, with an admonition of "Don't Be Stupid!" They had expected this drop, but warn that it is not yet time to go fully short. Their advice is to fade the buy-the-dip crowd - a delicious twist on the dippers' fade-the-bears strategy (which has been working!) - meaning go short once we see a double-top:

We have dip buyers at every step of the way through this rally. What we want to see is that the dip buyers, even POMO powered, cannot push it to new highs. At that point the fix is in.

A general theme across the punditry is to wait for a little more downside before calling a bifurcation down. You can see how in this chart from Contrarian Advisor we have just come down to a recent low without breaking it, as a bifurcation needs to do:

MarketThoughts also charts how all we have done is come down to the lower trendline. A break is needed, and usually after the break a bounce to retest the trendline from below. If it then fails (the "kiss goodbye"), we have a bifurcation & with it confirmation of a trend change:

Finally, number of pundits noticed that we broke down off a bearish wedge, and came down in a five-wave pattern, which denotes a trend change. The question is always what degree of trend? WavePrinciple sees this as a minor degree, but notes that a five-wave start suggests a bounce tomorrow and another five-waver down in a classic sharp correction:

 

Playing with the wedge concept, if we fell 32 pts peak to trough, a normal wave B bounce would be back 50-62%, or 16-20 pts, meaning back to Sp1330-1334. A final wave C of a sharp correction would normally go 32 points again, targeting the Sp1303 area that Tony Caldaro thinks is critical. To make it simple, watch for a break of 1300 before getting unbearably excited. 

Get Ready to Party Like it is 1995

1995 was one of my favorite years. Silicon Valley had been in a funk for over a decade, with a fading memory of the last tech bubble, the PC IPO craze that flamed out in 1983 but launched some really great companies. The peace dividend from the fall of the Berlin Wall had impacted engineers in local defense companies (remember the movie of a laid-off defense worker in LA going postal?), and an area-wide initiative called Joint Venture:Silicon Valley was formed to revitalize the place. Was Silicon Valley already over? 

Then along came the Netscape IPO and the dot-com boom was born. It ran for five more years. 

This time around our Netscape is Facebook, and it has its own social network of other high-profile IPOs. LinkedIn, Groupon, Twitter and Zynga are expected to go out before Facebook gets forced out by our SEC by April 2012.

The question du jour is will it spark the next great tech boom, and the most encouraging (nea joyous) answer is that people are still skeptical. They expect this bubblet to burn off fast and for Silicon Vallley to sink back into the abyss of the past decade. The herd was also full of skeptics in 1995, and in 1996, and 1997; it was only after the eBay IPO in 1998 that the stampede began and people opined that this time it was different. Of course it wasn't, but the Nasdaq doubled from late '98 to early '00. 

I led a local panel two weeks ago, with VCs squaring off against Angels and SuperAngels. When asked whether the slew of social IPOs would spark a new boom, they demurred and said these would be one-off events, like Google was - special companies that get out, not the start of another bubble. This attitude is good news; in 1999 the same sorts of opinion leaders would have said they know things are nuts but they have to keep investing to keep up. (You can look that up - a real quote from a well respected VC.) It is the attitude of greed, which is just fear - fear of falling behind. 

Point is, we are still in "1995", not "1999". 

Last week, however, the new tech boom began to be recognized. It started at GigaOm, where their European commentator asked whether we could avoid another bubble, and answered that we have already been in one for 20 months, it just hasn't been recognized. Then the inestimable Om Malek compared some of the bubbilicious valuations (Twitter at $10B!!) with the salaries paid to baseball stars by the Yankees. He made them make sense. (If you have been following this blog, you know that for the past year I have reported on ever-rising valuations of SuperAngel startups, the signature of a new tech boom.)

The recogniton began building across the week, with Dick Kramlich of NEA telling Bloomberg how the coming social IPOs would be the first blockbuster IPOs since the '90s! (NEA invested in Groupon when it was called ThePoint, at a normal venture valuation, before it ran to over a Billion Dollar value two years later.) It culminated with a report across the wire at MarketWatch about here comes dot-com 2.0!

The MarketWatch gushy wire got me worried, so I scanned more news items, and breathed a sigh of relief. The general thrust of the commentors is still coming in skeptical. The SF Chronicle ran a piece today about the incipient bubble, and concluded that the skepticism is curbing the hype. The head of the very successful incubator, Y Combinator, calmly explained that there is no tech bubble, since unlike the '90s, almost all of these companies have real business models (Twitter excepted). Mark Cuban, who became an overnight billionaire in the dot-com bubble by selling a Broadcast.com to Yahoo for $5.7B, a business which then promptly disappeared, expressed disdain, calling this not a bubble but a "pyramid scheme"; he would know! Paul Kedrowsky, an industry watcher, opined late in the week that Facebook is not a bubble value, and it could go higher in secondary-market trading before its IPO.

Ok, this 'we don't believe it yet" got me comfortable again, until I saw the advance cover for next week's Fast Company: Mark Pincus, CEO of Zynga, will grace it. CEOs are back, as celebrities - we haven't seen that since 1999! 

The problem: it is well known that when a magazine like Sports llustrated shows a star quarterback after a big game, he is likely to bomb the next week. Getting on the cover of Sports Illustrated was the kiss of death for a sports star. In the 1990s, getting on the cover of Inc had the same impact. Is Pincus peaking?

This weekend the WSJ laid the issue to rest. We are not like 1999 in one huge respect: money is leaving venture capital, not rushing in. This is not a general bubble but a narrow-based boom, with VC fundraising still very challenging, leading to haves and have-nots in the VC world. In the late 1990s, investors were piling money into VC firms. This time, especially because they use 10-year returns to allocate capital, capital is still leaving the venture world, not rushing into it. (VC ten year returns are really bad compared with other asset classes. The technical term is that VC ten-year returns have sucked, big time.) This actually bodes very well for future VC returns, as less money chasing these funds should make the brave & the few still moving into VC very successful. 

I discussed this with Rory O'Driscoll of Scale Ventures (formerly Bank of America Ventures). Rory is one of the great thinkers in this industry. He does his homework and respects numbers, as you can see from his blog VC Matters. He constructed the following chart, which shows how VC returns do best when VC finds are on a diet, and he expects future returns to rise:

Curiously, no one has yet named this era. I call it the Social/Mobile/Web, and while the social web has dominated to date, the mobile side is shaping up to be huge. Mary Meeker was one of the great analysts of the dot-com bubble, and now she is at Kleiner Perkins, dong what she does best. Her latest work shows how the next decade will be shaped by the new face of mobile. From her point of view, it is 1996 all over again. 

Near Term Market Levels

The market grinds higher, and the bears still call for tops. The most immediate is the double-double level of 1334 that we touched today - a double off the 667 bottom by the two-year anniversary. Bespoke notes that a double has happened only nine times since 1928, and The Big Picture adds that a double-double (a double within 2 years) has only happened two prior times: 1934 and 1937. After those double-doubles, those markets continued higher by another 35-40%, which would put this market back to to the 1550 level, a triple-top since 2000; after which those markets fell hard back down:

The STU discussed their target levels today, as promised. Last Friday they had drawn a line in the sand at 1341, but curiously that has dropped from sight. Here they have one way to count which puts the 1341 stop out to 1346, and another which puts it in the 1352 area, where C = 62% of A. (Wave C from July 2010, wave A from the Mar 2009 bottom), with some leeway to get above 1360. In addition, we are nearing the upper trendline, which gets to 1339 on Friday, and may provide resistance after a brief throw-over. There is a lot more in this STU for those who are interested. 

This upper trendline is shown in this chart from Robin Landry. He put out an update, discussing two possible wave counts, shown in green (the near-term top count) and red (the very bullish count).  He notes that if the Dow gets beyond 12444, then wave 5 would be longer than 3, and make 3 the shortest wave, which violates a core rule. Hence while he expects an interim top before 1244, he notes how the wave structure would turn to very bullish above that level. This was explored at length in Prechter's recent EWT as well. If we blast through that level, under these wave counts, expect this market to continue to run into 2012, and to approach the triple top at the 1550 level. 

In a special added page today, the EWT looks at the large channel going back to the 1932 low, and discusses another level to watch. The STU also adds to this discussion with more detail. A line drawn from the wave 2 low (which they put in 1942) and the wave 4 low (1974) is the lower channel. A parallel line drawn off the wave 3 high in 1966 creates the upper channel. The line in the middle of those is the mid-channel. Here is their analysis:

• The 2000 high went above the upper channel, a throw-over
• The 2002 low fell to and bounced off the upper channel
• The 2008 drop broke below
• The 2009 low bounced off the mid-channel
• The Hope Rally has come within 100 pts (in the Dow) of the upper channel

 This upper trendline may prove a line of resistance. It is indeed interesting that the 2002 low bounced off the upper channel and the 2009 low off the mid-channel. 

So are we at the critical juncture? Either we top real soon, or we shoot to 1500? And "shoot" is the only term to use; under the bullish wave count, we would be entering the most explosive phase of a bull market, the midpoint of the 3rd of the 3rd. This market would accelerate, rising at a steeper pace. 

If we grind further up past these 1340-ish or 12444 levels, but do not accelerate at a steeper pace, something else is going on. A contributor to SlopeofHope gives an alternative viewpoint that puts the level at 1361. The wave counts above pick the July 2010 bottom at 1011 as the start of the final C wave up, yet both Neely and Fractal Finance dispute that. The Flash Crash fell hard into May and then went sideways all summer long. The bifurcation out of that trading range happened at the end of August, coinciding with Bernanke's QE2 speech. Using that as the start of the final wave, we get a different picture: it is breaking not as a "5" but a "3" in a distinctive zigzag form:

 

A very common relationship in a zigzag is for A = C in length, which pegs C as stopping at 1361. So look for a pullback there.

Curiously, if it rushes past that level, the wave would begin to take the shape of a five-wave impulse with an extended third wave. A normal extension is 1.618x, targeting a run to 1475 area before a wave 4 pullback. A normal wave 4 retraces 38%, putting the market back down to 1361. A wave 5 would follow, and again a normal relationship is 5 = 1, which would peg the end of this whole wave at 1550. 

Another curiousity is that the Hope Rally into 2012 would take the following form:

• wave A from 667 (March 2009) to 1220 (April 2010) over 14 months
• wave B from 1220 (May) to 1040 (Aug)
• wave C from 1040 (Sept) to 1590 in Nov 2011 if A = C

Sometimes the time relationship is not A=C but A+B = C, meaning C might end around Feb 2012. Food for thought, but not honey for the bears. Right now the bears are sharpening their sweet tooths on their levels between 1334 (double double) and 1361. 

Presidential Stock Cycle Analogy

Continuing the name-that-tune game of market analogies, The Big Picture gives us the current market overlayed on the generic four-year cycle driven by Presidential re-election policies. It supports the view that we are in a large sideways market since 2000, and should hit a triple top of the 2000 and 2007 peaks, both around Sp1550:

Of the many technical tools and analogies, this one is the easiest to decipher, since it is based on pump-priming for re-election. The Obama budget indeed continues a huge spending splurge with large deficits, a formula for re-election. Maybe the budget is DOA in the Republican House, but don't under-estimate their craven nature and culpability in reckless spending. The Obama budget gives them plenty of room to announce phony "cuts" against a huge baseline increase. Party on!

This Market is a Typical Secular Bear

I have oft commented on the many market analogies proffered, such as to 1929, 1937, and 1987. MarketThoughts compares this market on an inflation-adjusted basis to other long bear markets (secular bears, as distinct from cyclical bears), including 1966-82, 1929-49 and 1901-1920, and shows that we are so far fairly normal, albeit we dropped farther during the 2007-09 Big Drop:

The implication from the averages is that a drop is due, although their analysis concludes that we have more upside before that drop, in a break from the average pattern. Worth reading. 

Another Line in the Sand for the Bears

A new line-in-the-sand is SP1341. The current wave up started at the end of January at 1275, and based on its internal structure, should not break 1341 before a serious correction. Curiously, this level was explained on Friday by the STU but largely ignored by the pundit-sphere, other than a small mention by Daneric:

If this count below is accurate [see chart], wave (iii) is shorter than (i) therefore the upside for (v) is limited by rule (cannot be longer than 30 points in length on the SPX)

The rule is that wave 3 cannot be the shortest, which (since wave 1 was longer) limits wave 5 to less than the distance of wave 3, or 30 points. Wave 5 started at 1311, limiting wave 5 to 1341. You can add this level to the levels I discussed last week:

1. the Gann double-or-nothing at 1334, twice the low of March 6, 2009 (667), which for Gann perfection should occur around the two year anniversary of that bottom, or around Mar 5-9, 2011
2. the false break of the upper trendline, which is touching the 1334 level early this coming week; and a false break may pop to 1340 before dropping back below
3. the 1352 level, where the larger wave from July 2010 would equal 62% of the initial wave off the March 2009 bottom, a typical relationship
4. the 1375 level, where the whole Hope Rally would retrace 78.6% of the big drop from 2007 to 2009
5. the April Analogy, where the top is already in but the bifurcation down is a week away (in April 2010 the sharp fall was over a week after the top)

I still find it telling that very few bloggers bothered to mention this latest level to watch; it is as if the relentless QE2-driven bull market has caused a domino effect of capitulation across the blogosphere. This may be the most bearish signal of all! Capitulation precedes a peak. 

Back in April 2010, the petering out of Quantitative Easing happened about when the Flash Crash came about. At the time it was not generally seen as a cause, as everyone focused on the drivers of the Flash Crash itself; but since the rise of the QE2 market, pundits looking back have conjectured that the liquidity pump of QE is keeping the market relentless in its rise. This points to June 13 week as the next endpoint, when QE2 is supposed to end, unless QE is extended (the Fed has commented on extending it further out but at a lower level of intervention so the total intervention is still $600B cumulative). 

Given my prior post and comments being floated by Fed members about ending QE, it may be a consensus will form that QE will be ended prior to the official Fed decision. Recall that this market began rising when QE2 was announced in late August, not when it was actually started in November. It may peak when the end of QE is clear, before QE actually ends. 

It is not clear that will be the decision right now, as these Fed member comments may be in the nature of planned leaks to test the market waters, not signals of a policy decision. More likely a decision will be driven by economic data, and in particular an acceleration of recovery (if that is what happens) and more signs of inflation. The inflation data may be clear by mid March, and the economic signs may be clear at the beginning of May when Q1 GDP is announced. Thus suggests the danger zone begins around the vernal equinox (Mar 20), skips across April Fool's Day, and extends into May Day. 

Inside the Numbers: ISM Reports and the Great Margin Squeeze

Richard Fisher, head of the Dallas Fed, flagged the risk of monetizing government debt and bashed the government for out of control spending. He felt the Fed was now "an accomplice to Congress' fiscal malfeasance" and came out against further Quantitative Easing (QE). He further said he would back Fed tightening at the earliest signs of inflation. 

He may be facing that prospect as early as March. The January ISM Reports showed economic activity growing at rates not seen since August 2008, which is good news, but the "prices paid" index grew even faster:

Bespoke notes how the ISM prices paid is outpacing the official inflation rate, and the last time commodiites prices rose this much, CPI rose 5%, over 3x higher than currently reported:

Pierre du Plessis looked at the inflation data and concludes that the CPI excluding housing tracks closely to the oil price with a month's lag. if oil holds up in the $90+ range through Feb, the CPI ex-housing should hit 3.5% in March:

These factoids put the Fed's policy in a vise. If QE2 has succeeded by improving economic activity, there is no need to continue it. If it has driven prices up faster than growth, it would now need to try to put the inflation genie back in the bottle by ending QE and as Fisher noted, tightening instead of loosening. 

A third factor is the drop in inventories and the rise in imports seen in December. There have been some stories of stockpiling of materials by US companies, as a reaction to rising prices; but overall inventories have dropped. This may indicate a demand problem: since pricing cannot be passed through, rather than be caught in a margin squeeze, producers are pulling back in stock. In addition, and also explaining the drop in inventories, both new orders and inventories have been trending down for most of 2010:


The Fed talks about how the "wealth effect" can spur recovery, and seems to believe the rising stock market (since the QE2 announcement last August) is responsible for increased spending. Presumably that has contributed to increased spending, especially among the well-off, but more ominously, we have see middle-class consumers increasing spending by pulling money out of savings, as shown in this chart from Econophile, who concludes that the wealth effect and reduction in savings are both ephemeral consequences of QE, not signs of a sustainable recovery:

 

So now the Fed is caught in a three-way vice:

1. they need QE to continue an apparent recovery 
2. the recovery politically undermines the need for QE
3. especially because they risk inflation getting out of control

Patient Market, Impatient Pundits

I see lots of pundits trying to pick the top. Fool's errand. Better to watch for a bifurcation off the top before betting on a change of trend; otherwise ride it up. The recent bifurcation carried down into a trading plateau, but not below, meaning no break of trend. We would need a sharp drop below 1275 that stays below to confirm a change.

The market is in a channel and is touching the top trendline. The recent trading range was right on the mid-channel between the upper and lower trendlines. A bounce off the midline confirms a continuation of trend. You can see this in the following chart comparing the Dow with the Trannies (courtesy EWTrends). The Dow remains in the upper half of the channel while the Trannies have broken down, a divergence in Dow Theory, which would require a reversal back up in the Trannies to support a continued bull market:

Typically a trend ends with a false break, which in this case would be a thrust above that quickly (relative to the length of the trend) falls back below. Right now the trendline is above where we are, both on a closing and intraday basis, at 1328 Wednesday and climbing 1.5 pts/day. The STU is doing a good job of watching this closely and positing potential turn levels. 

I see a lot of the pundit-sphere pointing to a 78% retrace level (of the drop from Oct 2007 to Mar 2009) as the next key level. The exact 78.6% level depends on counting from intraday highs/lows or daily, or (for more precision) bifurcation points, but a reasonable level to use is 1375. Before we get there, we have another typical turn level ahead, 1352, where the recent wave C from the July 2010 low to now gets around 61.8% of the prior wave A from March 2009 to April 2010. A typical relationship in a sharp or "zigzag" correction is for waves A and C either to be equal or to relate by 61.8%. 

If this is a wave 2, the 78% level is really the point of no return. Theoretically a wave 2 can go 99%, but the odds say once past 78% then almost always this was not a wave 2. I can make a stronger case that once a wave 2 goes much past 62%, it is unlikely to be a wave 2, and statistically once past the repetition level of 70.7%, it rarely is a wave 2. The prime exception is a wave 2 that retraces a really sharp drop of the sort we had back in 2008 (call it a "crash"). The role or psychology of a wave 2 is to make the vast majority of market participants believe the sharp drop was an anomaly and the market is back to the prior trend. The sharper the fall, the further the comeback. 

Psychology may also come into play on the two-year anniversary of the Mar 6 low. Interesting is that we bottomed intraday at 667, and are close to the double, at 1334. Whether enough astrology or Gann traders are still out there, this might cause a stutter. 

Finally a lot of pundits have been comparing this market to April 2010, where the market went into a three-week trading range with a couple of sharp drops that were recovered before we bifurcated down. The high was in the middle of this range, and the eventual bifurcation down that led to the Flash Crash occurred about a week after the top. The implication is we have begin a three week or so plateau punctuated by a final high (1330? 1334?) that will be followed by another sharp and deep drop. One of the best discussions of this comes from AllAboutTrends: 

While a slight pop to say 1330 may mark the end, or a stutter around 1334, more likely we bump along the upper trendline up to 1350-1375 before a serious pause occurs. Given the trend slope of 1.5 pts a day, this points to a turn around 20 or more trading days out, or around the vernal equinox. We might test the midline again before then, but don't get too excited. 

You Can Skip the Game and Still See the Commercials

Ah, SuperBowl Sunday! And a really promising game to boot! But for those of you who watch the game just to see the commercials, now you don't have to! Mashable has pulled together all the commercials that have already leaked into YouTube.  Isn't the Internet cool?

Some are just teasers, like this Motorola "1984" ad which is trying to one-up the classic Apple 1984 ad. Sadly, it reminds me more of the awful Apple "Lemmings" ad that showed at the 1985 SuperBowl and ended Apple's career of SuperBowl ads.

I think Doritos will win this year. Check this out. Predictable, yes, but funny.

Most shocking, no cats. The Internet loves cats. TV is a dog medium I guess. 

Inside the Numbers: Unemployment

This month's report has a some serious statistical anomalies. New jobs (36k) badly missed expectations (146k) as well as whisper (180k). At the same time, the unemployment rate inexplicably dropped sharply from 9.4% to 9.0%, the second steep drop in a row (it had been at 9.8%). This is the largest two month drop since 1958 (see chart, from Bespoke). How can this be, given the dismal job growth? 

As MIsh succinctly puts it, to get the rate down in two months from 9.8% to 9.0%, the BLS simply did not count 2M workers. The workforce needs to absorb about 1.5M new workers (eg college grads), but last year the BLS says the labor force fell by a net 167k, with 2.1M former workers simply dropping out. He concludes:

Look on the bright side, at this rate we will back to full employment in no time

It should be noted that the BLS uses two different surveys for these numbers. The new hires come from business surveys, and the rate comes from household surveys. While the business survey shows 36k new jobs, the household survey showed 117K new jobs, but 504k people either dropping out of the workforce or dropping out of the population! Yes, the survey said we lost 185k people out of our working-age population. This is assuredly wrong, a statistical anomaly coming from incorporating new census data. Without this change, the rate would have dropped to 9.3%. 

Also without this change, the new jobs would have been a much higher 589k, way out of line with other surveys. Gallup does their own survey, and it has shown an increase in the unemployment rate:

Weather was blamed for the mixed unemployment report. Outside jobs were down, like construction (-32k) and transport (-38k), while inside jobs like manufacturing were up (49k), its best rise in 12 years (!!), although non-durable manufacturing dropped (-13k). If weather is to blame, the February unemployment report should beat expectations as delayed hiring catches up. Look for 260k new jobs in Feb.

The simple explanation for the fewer-new-jobs but lower-unemployment-rate is the 99ers are disappearing from the stats faster than new jobs come in. 99ers are the unemployed who have maxed their benefits (the number refers to 99 weeks of benefits), and disappear from the official stats even if they are still seeking jobs.

We saw this last month as well, and it should continue for several months as the 99ers reflect the big job losses at the start of the crisis.

In the past year, the number dropping out has increased by 2.2M, while the number of "official" unemployed-seeking-work has dropped by 1.2M even though job growth remains below the 150K monthly rate just to absorb new graduates into the workforce. It should not surprise, then, that labor participation continues to fall, now at a 26 year low:

The fate of the 99ers is supposed to be captured in the U6 number, which includes discouraged job seekers. This month the seasonally-adjusted U6 fell a huge amount, from 16.7% to 16.1%. Good news, right? Nope, a drop like this is also a statistical anomaly. The non-seasonally adjusted U6 surged to 17.3%, and is now seriously out of whack with the adjusted numbers:

As you can see from the chart, something screwy happens at the turn of the year, and it will take several months to see if the seasonally-adjusted number is too low or the non-seasonally-adjusted number is too high. The seasonal adjustments include the impenetrable BLS birth/death model (of small business, not people), which during the Great Recession showed expansion of new businesses! They get the Darwin Award for that brilliance. The BLS did a major recounting of their birth/death model in January, and it now shows business destruction where they used to show creation.

When the BLS revises past numbers down, it makes the new numbers look better.  

Another statistical adjustment is last year's job creation numbers also get readjusted in January, and this time 400k jobs were removed from 2010! Given we added only 36k jobs in January, it was as if 12 x 36k were eradicated last year, removing a year's worth of Januaries. In total, 538k jobs have now been removed from the prior two years of stats. Hence the recoverlyless recovery was worse than it was reported. 

My take on all of this is we remain in a flat period and have been for a year. Cut through the noise and the household survey showed a 117k increase in January, much less than its 297k in December but very much in line with monthly numbers over the past year, and slightly less than we need to absorb new entrants to the workforce as the population grows.  

Cutting through the stats, take a look at the trend. The revised BLS surveys show a flat 2010 that has begun to trend down, not up, although I expect that to change in February due to the weather effect: 

You can also see this in the percent change chart, comparing this recession with others:

Sadly, we remain well above where Christina Romer and the Obama Administration predicted we would be after the Stimulus:

 

Groundhog Day for the Dollar Again

It's Groundhog Day and the USD is once again giving a wake-up call. AUD popped above parity and the USD is heading into a key support level. Phoenix Capital Research raises the Alert Level with this chart, which shows the mighty Buck once again hitting a key support level:

If it breaks below, and does not quickly come back above (a false break), it raises the awful spectre of a Dollar collapse. The report also sees a possible head & shoulders pattern which suggests a 50% further drop:

Now, H&S patterns are oft seen and seldom realized, because the underlying requirements that need to be met are more than appear in the pattern: 

The EWT recently laid out the theory behind the head & shoulders pattern (EWI makes it available for free, in case you would like to peruse an EWT on point to today). Edwards & Magee's book says that the first shoulder should rise on heavy volume, but the second shoulder should have "decidedly less volume" than either the head or the first shoulder. ... The EWT notes as well that the whole formation should come after an "extensive trend". ... Many purported head & shoulders patterns fail these two tests. The weak volume indicates exhaustion of trend and a coming rotation to the other direction. 

The current weakness is driven by oil dynamics, specifically the risk of spreading turmoil in the Arab world. Oil and the USD are pretty well locked into an inverse relationship (Oil up. Dollar down), although it often is not clear which is the driver. It could be said that after the US went off gold in 1971, it backed the Dollar with an Oil Standard by making a deal with the Saudis in 1973: you trade your oil in Dollars, and we will defend your oil fields. The US gets a great seiniorage benefit from this, as the rest of the word has to maintain high Dollar reserves just to pay for oil. 

Tonight's STU notes that at the intraday low today (DX76.88) the Dollar Index has retraced 78.6% of its prior rise from Nov4 (75.63 on election day!) to Nov30 (81.44), a level that almost always is the extreme for a wave 2 counter-trend move. The percent of Dollar Bulls also fell to 7%, in the range seen at previous bottom (3%-7%) since the April top at 88.71. They expect a rally "now".

The trendline in the first chart stands at 76.08, below this 78% level, suggesting that we may break the 78% level and fall to test the trendline. Wave theory at that point no longer supports a reversal. Watch this development closely. 

You Know Global Warming is Over When ...

MSNBC (not Fox!) blames the food riots in Egypt on "speculation" not Global Warming (ie. food shortages due to unusual weather such as the Russian summer heat wave):

Visit msnbc.com for breaking news, world news, and news about the economy

One of my predictions for this year is that blaming every funky weather event on global warming will now get a mocking roll of the eyes not a knowing nod of the head. Happening faster than I thought it would.

Coincidently, I am in a heated debate with a reader over this issue. He blames the food inflation on a series of unusual circumstances that are causing shortages, whereas I ask him why almost all commodities took off in a parabolic surge (a signature of a speculative bubble) just after The Ben Bernank announced QE2 in August. Hard to argue that recent floods in Queensland (coal) or last summer's heat wave in Russia (wheat) or whatever all caused a spike in commodities of all sorts at the same time.  Sure, these events contribute to spikes in particular commodity prices as they occur, and corn jumped a bit after the Russian heat wave, but the parabolic run-up began after the QE2 announcement:

What the Big Mac Index Says About Inflation

I was shocked to hear from a friend that a Big Mac in Philly now costs $7. I haven't kept tabs, being long-past my kids' Happy Meals days. The Big Mac Index must not be very happy right now. And I hope he meant a Big Mac meal not a mere sandwich. 

The Big Mac Index was a cheeky concoction of The Economist as an exercise in figuring out purchasing power parity between currencies. In its early days, everyone would make a beeline for the China price, and cluck cluck about their cheap currency.

Today it has a much better use: testing the reliability of official inflation figures. I am of course shocked, shocked! to learn that governments fiddle with their figures. As you can see at a glance from their chart, Argentina is the biggest cheater, with the US and China not that far behind:

During the height of the Great Recession, McDonald's was one of the Four Food Groups of the Apocalypse, along with Campbell's Soup, Hershey's Chocolate and Hormel Spam. With food costs rising and difficulty pushing through price increases, how are they faring now? They should be a canary on the coal mine of the Great Margin Squeeze. 

McDonald's has made menu changes since 2008, rotating to higher margin food to keep ahead of rising food costs. So far analysts expect the change in product mix to allow McD to maintain flat margins, although just in the past week (after the Q4 earnings release) more analysts have begun lowering earnings than raising. While Mickey D's has been pushing healthier food, a lot is riding on their re-introduction of the ever-popular and calory-heavy McRibs. Yum!

Oh, and I did stop by a local McD's. Out here in the Left Coast, a Big Mac is only $2.99 and the meal $5.19. I don't suppose that is a dime or two more than it has been for a while. No rampant inflation here. 

BRICs-A-Bracked

The BRICs are a' breaking, with three of four sharply down and below their 200 DMA, indicating a trend change to a protracted bear market. Russia is now largely an oil-bearing State, and belies the trend down of the manufacturing States, but would follow if when the oil bubble echo breaks. From Bespoke:

This speaks to a shift from investing in emerging markets - a major theme of the past few years - back to developed markets. Emerging markets are down 3% in January, with India down over 10%, South Africa down 9%, Indonesia -7% and Brazil -4%. Inflation, arguably exported from the US be QE2, has thrown them all a curve ball.  

Markets Shrug Off Egypt, Look to Economic Data

Markets are generally up even as the Egyptian situation worsens. This makes the financial press look pretty foolish for attributing the fall on Friday to Egypt. I commented in my weekend post that all the time a market move is said to be caused by a news event when instead it was driven by technical factors, and this is just another of a myriad of examples. Yet the punditry persist in this error. 

Much more important today were some good economic reports, including the Chicago PMI at really high levels. Tomorrow the national ISM report comes out and should show an increase in production. Also income was up, although income less transfer payments was essentially flat, meaning much of the increase is government life support. Spending was up much more than income, meaning it came out of savings, and seems to have been largely driven by rising food and energy costs, not an increase in core demand.  

Over the weekend a lot of commentary on the GDP Report came in. The most interesting is from Econophile, a former bear who has been ahead of the curve on noticing a bottoming and the start of a recovery. His take on this GDP report is that it too is due to government life support, in this case largely a consequence  of QE. He thinks the positives are largely a "mirage" and may be revised away next month 

Three Things to Know About the GDP Report

Pre-market GDP disappointed at 3.2%, below expectations (3.5%) and whisper (4%) although above Q3 (2.6%). GDP hit an important milestone: we have recovered from the drop and are back at 2007 levels. The Great Recession is over! So why did the market react so badly?

The consensus opinion points to Egypt, not GDP, but Egypt had been in turmoil for several days as the market kept blissfully rising. The financial press always try to pin a market rise or fall on some news event, when technical conditions are the more likely culprit. Lost in the noise were disappointing earnings from Microsoft, Ford and Amazon, which may have had more to do with the fall. 

The best line was that the market that was looking for a reason to correct and got it in the form of Egypt's public protests. This market had been peaking since Monday and was showing signs of exhaustion. The past few days show a Fractal Finance plateau that was bifurcated to the downside by the close (see chart, courtesy SlopeofHope):

The pattern looks ominously like last April, right before the Flash Crash. As one bear pundit put it, if the market gets smoked Monday at the open, the hedge funds may short with a vengeance.

Past Monday, the question is: does the GDP report give guidance as to the future direction of the market? Is this just a momentary overreaction to a spike in oil prices and fears of a widening Arab revolt, in which case stocks will resume their upwards trajectory, or does the GDP Report throw doubt on the recovery and thereby corporate earnings? Three key things to watch:

1. Final Sales vs Growth. Final sales were up strongly, a good sign, but overall growth is mediocre at 2.8% YoY, meaning the consumption-driven Q4 is not sustainable. The trajectory is for less growth in 2011, a warning flag for a recovery, where we should be accelerating growth right now. 
2. GDP Deflator vs Inflation. The inflation indicator the BEA uses came in very light at 0.3%, with the core PCE component at 0.4%, the lowest level since 1959! If it had come in at expectations (1.6%), real GDP would have been almost halved to 1.9%. It may be it was light due to rising imported oil, which gets subtracted; but the core GDP deflator (which the Fed prefers) also declined. This very low inflation seems inexplicable given rising food and energy prices, and is likely to be revised up, lowering GDP. 
3. Inventories vs Imports. Inventories were down, lowering GDP, and imports were down too, helping GDP. Usually nventory drawdowns are good, as they presage future production to refill, but in this recoveryless recovery, Econbrowser observes that we seem to be substituting imports for inventories. As a consequence, while they expect inventories will be less a drag on GDP as they have recently, imports should go up and exert a drag of their own. See final chart for the inverse relationship.

This report looks inexplicable, with a ying/yang across those three things to watch, and is likely to be revised downwards. Karl Denninger took a look at the core conundrum in this report (I paraphrase):

how do you get an acceleration in spending with a decrease in imports, since we are not suddenly moving all those electronic gadgets back to being manufactured in the US?

He concludes that consumption number is driven up by inflation, an increase in energy and food costs, not a large increase in units. The inflation indicator for personal consumption increased to 2.1% compared with 0.7% in Q3. (The GDP core PCE deflator mentioned above excludes energy and food.) Use that 2.1% instead of the 0.4% of the report and GDP would be less than 2% again. 

My take: the year-end optimistic reports by Goldman Sachs and others of an increase in 2011 GDP as compared with 2010, to 3.5% or higher, looks at risk. Instead, it looks like the period from 4Q2009 to 4Q2010 may have been the high water mark, and we are beginning to slow down as stimulus abates.

Yesterday's op-ed in the WSJ from economist John Taylor (who would make a really great Fed chairman), which was adopted from his testimony last week to Congress, is the best I have seen to explain the conundrum we are in: the very ad-hoc and one-time efforts to jump-start the economy has kept it in a funk, unable to heal itself:

The one-time stimulus payments to people did not jump-start consumption. The stimulus grants to states did not increase infrastructure spending. Cash for clunkers merely shifted consumption a few months forward. The Fed's purchases did not have a material impact on mortgage interest rates once changes in risks are taken into account. At best these actions had a small temporary effect that dissipated quickly, leaving a legacy of higher debt, a bloated Fed balance sheet and uncertainty—all of which slow growth and job creation.

An economy on life-support is not an economy in recovery.

QE2, Inflation and the Great Margin Squeeze

Don't confuse speculation with inflation

Global food prices are soaring. Market speculation fueled by QE2 as well as one-off events like the Great Queensland Floods in Australia and US subsidies for ethanol have driven up prices from coffee beans to prime beef, from coal to corn, and just about everything else. The WSJ reports that eateries have little pricing power, so they have to scramble to avoid a big margin squeeze.

Mish takes it a step further, noting how commodity prices have increased across most industries, especially driven by oil and energy prices. Finished goods prices rose 1.1% in December, driven primarily by a 3.7% increase in energy inputs. Finished food rose 0.8% while wholesale inputs rose 23%. Mish concludes that "every step of the way, a decreasing portion of costs are passed along."

• prices are up 15.5% for crude goods
• prices are up 6.5% for intermediate goods
• prices are up only 4% for finished goods

Even less gets to consumer prices. The great margins squeeze is on. And the rise in oil could scuttle the recoveryless recovery. (Picture courtesy Pierre du Plessis.)

This is NOT inflation. Inflation is a general rise of prices, whereas this is a rise among commodities but not end prices or wages.

Let me use an analogy. A while back I discussed "good" deflation vs "bad" deflation. The steady drop in HDTV or PC prices is an exemplar of good deflation - price drops due to the ruthless pursuit of productivity and efficiency. A general drop in prices is a symptom of bad deflation - the rise in the purchasing power of the currency. Good deflation can continue for years in certain factors of production - such as oil in the 1890s, autos in the 1910s, PCs in the 1990s and HDTVs in the 2000s - without in any way presaging or sparking bad deflation.  

Similarly, a rise in classes of prices, such as commodities, is not the same as a general rise in prices. The commodities rise is likely to spill over into inflation gauges, such as the CPI, as energy and food prices tend to get passed through. But the core CPI - excluding food and energy - is unlikely to budge much. This commodities bubble echo (an echo of 2008) can continue for months without causing or presaging any general inflation.

When it bursts, it might paradoxically accelerate deflation. In our economy, debt creates money, and commodities speculation that uses margin piles on more debt. As the positions unwind, the margin is paid off and money disappears. If the effect is large enough, it can lead to deflationary pressure. 

This is not to downplay very real inflation outside the US. China in particular is seeing the inflation monster threaten to swallow their economic miracle. Some argue this Godzilla is caused by Bernanke and QE2, and certainly the commodities bubble contributes to inflationary pressure inside of China, but the source of Chinese inflation is much more prosaic: their money supply is growing too fast, fueled by a credit bubble from Chinese banks, not the Fed. Chinese M2 is up 55% in two years, and its PPI is up 5.5% year over year. Chinese steps to quell inflation have been tentative so far, as they seek that elusive "soft landing." If inflation crests double digits, they may need to find their own Chairman Volcker to slay the inflation beast. Andy Xie, one of the best observers of Chinese financial markets, suggests that China may need to devalue the Yuan, slowing capital inflows and likely causing internal interest rates to rise. 

What the Great Margin Squeeze means going forward is pressure on domestic US profits, headwinds from rising oil prices, and the possibility of a bursting Chinese credit bubble shocking world markets.

Demand Media Kicks Off Social IPO Season With a Bang

Amidst a nice little Obama SOTU Rally since late in yesterday's session, Demand Media (DMD) priced at $17, above the range, and is now trading around $23, a fine opening to Social OPO Season. DMD is now valued at $1.5B and is the largest Internet IPO since Google. The offering was also super-sized, from 7.5M shares to 8.9M. 

DMD has about the same market cap as the venerable New York Times. 

DMD has a different model than the NYT: it creates on-demand websites based on expected hot search keywords rather than create news stories based on, well, news. It covers topics that are of current interest, and should be compared to Time-Life or McGraw-Hill rather than a newspaper. This sites are a new form of the sort of special-interest magazines that McGraw-Hill used to cherish. Some of the most popular are ehow.com, livestrong.com, trails.com and the guy site cracked.com. 

A popular term in the websphere these days is "curation", the use of a human editor to organize and select content. DMD is a hybrid of machine-generated and curated, where the keywords help guide DMD to construct a site that matches how prospective readers are trying to find information on the web, and the human curators construct and update the site. In effect, they are using keywords to drive editorial content, and humans to make the site interesting. Although DMD is the subject of derision from old-fashioned editorial sites, it is better thought of as using modern, social techniques to determine suitable groupings of editorial content.

Its bet is the crowdsourced keyword editorial context drives better editorial content. So far its sites collectively are the 17th most watched sites on the Internet, an incredible achievement. The most read is ehow.com. 

If you wish to play this new category, a good read is this TradingIPOs analysis by Bill Simpson. He says to watch the operating expense ratio, essentially the spread between paying contributors and monetizing the sites. DMD uses freelancers for the most part. In an accounting decision which is controversial, DMD amortizes the cost of content over five years, rather than expensing; this turns a loss into a profit. He thinks fair value is $14-16, below the current trading range. 

The other issue to watch is Google's steps to rank search results differently, which could lower DMD sites in the search stack. Right now 41% of DMD readers come in from search results. The initial move of Google is to encourage searchers to report poor results, which I do not expect to lead to much of a response and therefore to have little impact on DMD. The war between quality results and synthetic sites from DMD will continue. 

The Social IPO Onslaught is About to Commence

The new wave of tech is the Social Mobile Web, and its leading companies are lining up to go public. We haven't seen such a lineup since 1995, when Netscape went out and rang the bell on the dot-com mania. Further back, this happened in 1980 when Apple went out (in an overall poor market climate) and set off the PC bubble. Will lightening strike a third time?

The first out is Demand Media (to be Nasdaq: DMD), run by Richard Rosenblatt, who had been CEO of the parent company to MySpace. DMD is a next generation style content site, which mass-produces sites based on hot keywords. Google search begats synthetic content, designed to rise to the top of search results and skim clicks.  Blogger Paul Kedrosky describes DMD's business as: “find some popular keywords that lead to traffic and transactions, wrap some anodyne and regularly-changing content around the keywords so Google doesn’t kick you out of search results, and watch the dollars roll in.” This modern way to produce content has produced hockey-stick growth, but Google just announced modifications to search results to undermine these synthetic web sites. DMD is highly dependent on search optimization and will quickly modify what it needs to to stay ahead of Google.

How this business dynamic plays out is anyone's guess.

How this IPO dynamic plays out will set a tone for the coming IPO Season. DMD should go out at over a $1B valuation, and be the largest Internet IPO since Google itself. It is supposed to price at the close on Tuesday (tonight) and begin trading Wed. 

On its heel are LinkedIn, Zynga, Groupon and eventually Facebook. LinkedIn is now trading at a $3B valuation. Yes, trading, even though it is not yet public. Markets fill gaps, and a secondary trading market for private shares has evolved for these social IPO candidates. Demand for these shares is hot hot hot, and Facebook ticked to a $70B valuation even as Goldman Sachs did an organized sale of $1.5B at a $50B value. 

You might wonder why they have to subject themselves to Sarbanes-Oxley and other nefarious regulatory schemes when they can raise and trade effortlessly in private markets. Well, the Empire eventually strikes back, and the SEC has put pressure on Facebook to go out as its tradeable shares close in on the 1934 Act limit of 500 shareholders.  

Until the Empire shuts it down, SecondMarket is a great resource. Here is its current hot list, showing which social IPOs should be hot:

Tech Stock Smackdown

Uncertainty creeps into the tech world on soft cat's paws. Last week was full of surprises: Eric, Steve, some guy at AMD, half the HP board, gone. Apple has tremendous momentum and had blow-out earnings, but maybe it is all priced in? Google still beat, but a close look suggests it barely made it, and largely on currency hedging, not core business. AMD beat and the stock gets hammered the next day on chip pricing weakness. And maybe it is over for the PC-centic Intel Architecture? The sharp reaction suggests the stock was priced to perfection.

Perhaps next week will be a general tech stock smackdown, as the whole market is priced to perfection. 

Small caps have taken a dive (see chart). 

The major indicies didn't fare much better, other than the Dow, driven up by GE and strong earnings, plus a hint of crony capitalism. We have a clear divergence which will resolve one or the other:

Tech is where the action is. First AAPL. Casey Research had done a bearish number on them last June, but reconsidered this weekend as the iPad has blown past all expectations. AAPL is poised to be the WinTel of the tablet era; it might garner the combo value of Intel+Microsoft as of the 2000 peak. They find the current stock price in line with expected earnings. And add this:

Now that Jobs might be gone for good, would we recommend shorting the company?

Apple had its Q1 2011 earnings call yesterday, and results were again better than anybody could have expected. Revenue for the quarter of $26.7 billion reflected an increase of 31% from the previous quarter and 70% from the same quarter a year ago. Earnings per share came in at $6.43, a full $1.79, or 38%, increase from last quarter. What’s more, iPad unit sales came in at 7.3 million, indicating an average of 2.43 million per month – more than 20% higher than the 2 million units we assumed for the conservative earnings forecast above.

So, for now, Apple is running like a well-oiled growth machine. An amazing feat given its size (with a market cap over $320 billion). And we expect this to continue for at least the next several quarters whether Jobs is at the helm or not.

The test for AAPL will come when it hits the 50 DMA, which has provided support during prior Whither-Steve-Jobs episodes:

Over to GOOG. Larry Page was the initial Google CEO, and he stepped aside for Eric Schmidt for a decade. Now he has gone back into the drivers seat.

Is the second coming of Larry Page the return of a Steve Jobs, or of a Jerry Yang (YHOO)?

Other founders have returned to run their company and done middling, such as Michael Dell right now. At moments of market transition a successful tech CEO needs to bet the company on a new vision. Google is at such a moment, losing momentum to Facebook and the whole social mobile web phenom.

Most tech companies fail to come up with a second act: IBM, DEC, Lotus, Yahoo, to name a few. Consider the fate of Microsoft since the departure of Bill Gates:

Ballmer completely fumbled the transition for PC to mobile. Compare MSFT to AAPL during the Ballmer era:

Will there be a general tech selloff next week, bring the broader market down? It seems much more likely afer this past week. Uncertainty begats profit taking. 

QE2 Working the Wrong Way - Has the Fed Redefined the Mission?

 Monetary policy responsibility cannot substitute for government irresponsibility - Jean-Claude Trichet

A funny thing happened on the way to QE2: rates rose rather then fall. It appears The Ben Bernank has now redefined the mission from keeping long rates down to pushing stock prices up. He says he wants to create a "wealth effect" among investors that pulls the economy out of the slump. Never mind that rising commodities prices (especially oil) create a corresponding "poverty effect" for the middle class. How will this end?

John Mauldin's latest, Thinking the Unthinkable, is a must read. (Also available here.) He notes how Bernanke in 2002 believed that the Fed could target an inflation rate such as 2%, raising short rates to stifle inflation and lowering long rates to fight deflation by buying forward in the Treasury curve. This buying forward is what Ben means by Quantitative Easing (QE). John's comment on QE2:

Then a funny thing happened on the way to QE2: long-term rates began to rise all over the developed world. As Yogi Berra noted, "In theory, there is no difference between theory and practice. In practice, there is." It’s got to be driving Fed types nuts to see the theory of QE, so lovingly advanced and believed in by so many economists, be relegated to the trash heap, along with so many other economic theories (like that of efficient markets). The market has a way of doing that.

So, Liesman asked Bernanke about one minute into the clip (link here) about the little snafu that, following QE2, both interest rates and commodity prices have risen. How can that be a success? Ben’s answer (paraphrased):

“We have seen the stock market go up and the small-cap stock indexes go up even more.”

Really? Is it the third mandate of the Fed now to foster a rising stock market? I wonder what the Fed’s target for the S&P is for the end of the year? That would be an interesting bit of information. Are we going to target other asset classes? 

So isn't rising stocks goodness? What could go wrong? Richard Fisher of the Dallas Fed has been plainspoken about the risks:

The new Congress and the new staff in the White House have their work cut out for them. You cannot overstate the gravity of their duty on the economic front. Over the years, their predecessors — Republicans and Democrats together — have dug a fiscal sinkhole so deep and so wide that, left unrepaired, it will swallow up the economic future of our children, our grandchildren and their children. They must now engineer a way out of that frightful predicament without thwarting the nascent economic recovery.

So far the new Congress does not appear serious. Only three House members joined the Tea Party Caucus. The first major action is to try to repeal ObamaCare - a futile and symbolic effort at best. The stated goal is to reduce $100B from spending - a drop in the bucket. 

What has gone wrong for Bernanke is the rise in rates. The 10 yr is approaching a record spread with the 2 yr: 273 bp where the record is 283 reached in Feb 2010. Normally this spread is goodness for banks, as they can borrow short and lend long in the spread; but most of their mojo would come from mortgage lending, and new mortgage applications are "plumbing" 15 year lows. So instead of profiting, they are seeing the value of homes drop, pressuring the asset values for their carried mortgage base. At this point either he has to reconsider steps to reduce long rates, or hope Mother Market takes care of it for him.

What may go wrong next for Bernanke is a drop in stocks. A stock fall would show that the Fed Emperor has no clothes, that his justification for QE2 is baseless. A serious correction eradicates the wealth effect, and the continuing rise in commodities extenuates the poverty effect from high oil prices. In any event, the purported wealth effect has been studied and found wanting - not much there, and very little trickle down to the middle class. 

The biggest risk comes from theory hitting reality. Niall Ferguson (economic historian) decries the economic theorists for believing in some form of neo-classical equilibrium, that things tend to stay in balance. Neo-classicists, including Bernanke, completely missed the 2008 crisis because it was outside their view of how the world works. They thought markets were self-correcting and changes incremental. The history of booms & busts, however, says that change can be rapid and dramatic - crashes not slow slides.

In other words, QE could spiral out of control. Already it is not working as Bernanke expected. As Niall concludes:

Complex systems look like they are in equilibrium, but they are not: they are constantly adapting, highly decentralized, interdependent systems and this process of adaptation can continue for quite a long time. And you think to yourself when you look at it, that's in a wonderful equilibrium. That's how we think about the economy. That is how economists teach economics. They talk about it in terms of equilibrium.The bad news is that in fact we inhabit a complex system that has virtually nothing to do with the neoclassical model that you are taught in Econ 101. And that's why the economists failed to predict the financial crisis ...

For me American power if you generalize beyond the realm of finance through the geopolitical system is a perfect example of a highly complex system which looks like it is in equilibrium but like all the great empires of the past is quite close to the edge of chaos. And our nightmare scenario should be that something happens to us like happened to the Soviet Union... It suddenly just falls apart.

And I think the trigger, the catalyst if you want to switch to chaos theory the butterfly in the tropical rainforest that flaps its wings and posits the distant thunderstorm is going to be the credibility of fiscal policy. That just seems to me like the obvious place where things can turn nasty, and they turn nasty with amazing speed."

Oil Approaches the Breaking Point

Oil has three cracking points: when it gets refined, when it stops rising, and when it breaks the economy. Econbrowser analyzed oil prices and the economy and concludes: 

Every recession (with one exception) was preceded by an increase in oil prices, and every oil market disruption (with one exception) was followed by an economic recession.

Merrill Lynch’s Sabine Schels, a commodity analyst, calculates that $120/bbl will break this recoveryless recovery. This price makes the energy sector 9% of the economy, and she says we saw that in the 1980s and in 2008. Since oil tends to rise into the summer, this puts the cracking point out in Q2.

Might oil peak before $120? Oil's price is approaching a key level at $105/bbl (see chart, courtesy Market Oracle), the 61.8% retracement (this is the Brent Crude level; in the US WTI, oil fell a bit more on a cash basis, to $32, so the US level is just above $101/bbl.)  You can see how it oscillated around the 38% level for a while before testing the 50% level at $90/bbl and falling back. It has now crushed through $90 and fallen off a bit, but stayed above $90. Watch to see if it falls back below in short order, indicating a false break. Otherwise we seem headed above $100 in short order. 

 

The Fed Follows The Market, Usually

It is commonly asserted that the Fed sets interest rates. Instead, history shows the Fed follows the market - and gets the economy into trouble when it diverges too long from what the market is saying. Tony Caldaro has an excellent piece on the Fed and rates in the 'Oughts. He shows how the Fed sets the Fed Funds rate (red line) based on movement in the 1-year Treasury Bill rate (black line):

In 2003 the Fed held rates too low compared with the 1-yr, and the Greenspan Bubble of excessively easy credit was on. In 2006 the Fed held rates too high, and the Housing Bubble was burst. The signal for being too low or too high appears to be 50 bp - when the 1-yr is 50bp or more out of alignment, the Fed Funds rate needs to be changed.

Given this correlation, wouldn't it be more consistent policy if the Fed Funds rate were simply set by the market, and not the Fed? Or the Fed behaved by rule and not discretion?

Right now the Fed Funds rate and the 1-yr are very close. No short term rate increase is on the horizon. The 1-yr would need to crest 0.75% to spark a possible change. With a commodities-based inflation emerging due to QE2, this may happen sooner than investors, and the Fed, think.

Great stuff by Tony!

Will Steve Jobs Bring Down the Market?

It is difficult to imagine a world without Steve - he has been the prime driver for three generations of computing: Apple // begat PC and MSDOS; Mac begat Windows; and iPod begat a whole new mobile experience, with iPhones and iPads. This is an unparalleled achievement. Whither technology if Steve really retires, or his illness worsens?

His leave was announced a day before earnings, which suggests Steve's situation is too serious to wait even a day. 

Apple is expected to announce blow-out earnings tomorrow, but AAPL is down 7% in German markets, and the Nasdaq 100 futures are down hard (see next chart from SlopeofHope). Apple has had such a run that stories are beginning to emerge that the stock has no place more to go. The next frontier would be to conquer TV, but Steve has insisted the Apple TV offering is but a hobby - which means his vaunted Steveness has not yet figured out how to conquer the world of Mad Men. Most likely it is his failure to negotiate deals that would enable Apple to offer a $30 cable TV bundle over the Internet within iTunes. It could be this is the time to sell AAPL, not buy the coming dip.

Of course, last time this happened, the stock dipped 10% and then tripled. This time Steve's condition may be worse. 

This drop started before the Steve announcement, which suggests the expected January correction has begun. This event could trigger a series of falls. Investors are best described as jittery. 

One Interesting Insight From CES

The public side of CES was very incremental. Nosing around the floor can sometimes unveil that which is hidden. I spent some time with a very well-connected character in mobile and he laid out the case that Oracle will have to enter the smartphone race, and may be in the best position to challenge Apple and Android. 

When HP bought Palm I commented on their logic: rather than be a box supplier for Windows or Android, they believe they need to have architectural control. Palm's new WebOS is the most developed alternative to Apple and Android, and gave HP the best starting point. They intend to eschew the mobile handset space (at first) and race ahead in tablets. WebOS is easy to program in for web designers, giving HP a possible developer community to leverage. (Apple's iPhone leveraged the Mac base, and now has a whole new base; and Android leveraged Java). How well they do will now depend on execution and great apps.

HP seems a bit slow to get out of the starting gates, however, which opens up room for another challenger. Nokia's Symbian seems out of it. RIM's Blackberry is making their play right now with their new touch line, and it still has a strong following, as you can see from this recent Nielsen market survey:

What remains is a huge Java phone installed base, estimated at 3B feature phones, all of which rely on Java. That base dwarfs the smartphone market. Sun (now Oracle) is the prime licensor of Java, and Java gets into handsets via 'stack' suppliers like Aplix and Esmertec (now Myriad). The world remains firmly Java even as the high-end is going Apple or Android. 

Oracle bought Sun and now is in a series of battles to maintain royalties for Java. Esmertic (Myriad) has defected and sued Oracle, claiming excessive royalties; Android modified its Java engine and claims not to owe to Sun. Oracle has sued Google and counterclaimed against Myriad. 

Rather than play defense, their next move is to go on offense and launch a Java-based smartphone OS (or embedded java stack that the handset makers can add on top of their proprietary OSes). They have a 3B user market to convert, scads of handset makers to sign up (all left a little high-and-dry by the onslaught of Apple), and a huge Java developer base to keep in the fold and out of the clutches of Android. My source says they are already making moves:

From the directions that Oracle is taking (and deeply investing in) it is clear that they are making a large client move with embedded Java. They have made it clear to the JCP executive committee that JSE 7 will be their technical competition for Android. They are setting up to support the eco-system and willing to make the moves needed to recapture and grow the Java market share. They will be pushing JSE 7 changes into OpenJDK that they have partnered with IBM on. ... This will exceed the openness of Android, but they will still need to meet the service value of Android.

Watch and see whether Oracle goes a step further into a branded Java smartphone community with an apps store, mimicking Android. Investors take note that an apps store for Java already exists in a company called GetJar, which might be snarfed up by Oracle as their strategy gains substance. Game on!

Australian Real Estate At The Brink

While Northern Australia suffers from floods of Biblical proportions, the Southern (big city) property market seems poised for a devilish fall as the Oz Tulip Mania is about to crash. The Aussie answer to David Rosenberg, Steve Keen, has been on this for two years, and last summer Jeremy Grantham weighed in as well. Now Mish piles on, noting that the purported eternal housing shortage is a myth of Biblical proportions: property listings have surged in a flood tide by 44% last year, an indication of panic listing at the peak. 

Steve Keen noted before Christmas that a large Australian bank, Westpac, had been dumbing down its lending standards to keep the bubble afloat. He commented on Mish's post, adding to his series that explains the recent bubble in simple terms:

One factor that I'm following closely in all this is what Biggs, Meyer, and Pick called "The Credit Impulse": This is the change in the change in debt.

[A]ggregate demand in a credit-driven economy is the sum of GDP plus the change in debt, [and it] follows that change in aggregate demand is the sum of the change in GDP plus the acceleration of debt.

Australia got out of the crisis in 2009 by exploiting the upside of this factor: if you can encourage people into debt, then aggregate demand grows as debt accelerates--so even slowing down the rate of deleveraging gives a positive boost to demand. ...

That's how the USA looked a bit better in recent months--you slowed down deleveraging. But since Australia went from marginal deleveraging to releveraging, the acceleration in debt was all the more extreme--and we had a apparent boom.

That appears to be ending now, since though the Credit Impulse is still positive on a yearly basis, it's turned negative in the last few months.

Mish gives the following recommendations, and expects they will also soon apply to Canda, China and the UK:

• Exit the Australian stock market
• Get out of the Australian dollar
• Pick up some popcorn
• Stay on the sidelines and watch the collapse unfold

Our Hollow GDP

"Weak Hiring Casts a Cloud" -  WSJ
"For Jobs, Signs of Recovery" - USAToday

Is the recovery finally on? Or is it all an illusion, where the increase in spending is due to transfer payments from big deficits? Let's explore the reality and the illusion. 

A lot of pundits have caught the optimism. Consider these factoids:

• Holiday retail sales highest in years
  • but it turns out it wasn't - it was a dud
• Q3 GDP revised up
• Q4 GDP on track for even higher
• GDP in 2011 revised upwards due to Tax Deal
• Latest ISM report up showing increased business activity
• Job openings rebounding (see chart)
• Commercial lending *may* be picking up

The best green shoot of them all is the WSJ story that bank lending may finally be picking up. Commercial lending to finance growth is the real key to a recovery. Yet if there is an uptick, it is barely discernable (see second chart).

The other big positive news is the Tax Deal, which puts off the dreaded double-dip by not hammering the economy with a massive tax increase.

Yet at the same time the recoveryless recovery faces severe headwinds:

• Housing - double-dipping
• Jobs - growing too slow 
• Oil - rising to dangerous levels
• Debt - used for transfer payments, not growth

Make no mistake, there are signs of improvement, and they have been trending better for the past four months - ever since QE2 was announced in late August. We saw a similar burst of optimism last year at this time. Is it real this time, or another illusion, driven by massive transfer payments, which boost GDP but not the real economy, and pile on more debt for transient spending?

Let's walk through all four headwinds.

Predictions 2011

That time of year again.  I did surprisingly well in 2009, with 7 of 9, including predicting the Dow would exceed 10500 at a time when it was in free fall below 8000 heading to 6400. Not as well in 2010. Where 2009 was Hope, 2010 was to be Change, and it was, with an historic election and the emergence of the Tea Party. Got that right, and a few others, such as 2010 being the Summer of Disillusionment, which it was, and no double-dip until 2011; but while I was directionally right I was too bearish in the predicted levels. Thought stocks would top in Q1 and bounce, and they did, but did not go as low as I predicted. Thought bond rates would rise then fall, which they did, but not as much a rise as I thought. Expected the Dollar Index to break 90, and it got to 89. Close but no cigar. Let's see about this year:

1. 2011 is the year of Chickens (coming home to roost) - kicking the can down the road is ending. The Tea Party really has an impact to stop Keynesian stimulus and cut the growth of government. But you never know - the GOP may screw it up. 

2. Housing will drop 20%, if not all in 2011, over the next three years

3. Margins get squeezed as inputs (commodities) rise but pricing power is not there, causing a flattening of domestic profit growth. PEs go up! Stocks go down! Timing dependent on how long oil stays up.

4. Commodity Bubble Echo peaks and then drops hard - it is already at the 50% retrace and could drop from here, but more likely goes a bit longer to the 62% retrace (another 10% higher in the CRB)

5. China slows enough that the Chinese bubble is said to burst. Already growth is slowing and the Shanghai index is showing weakness. China raised rates again to stem an inflation that is at least at 5% and rising. NIxon imposed wage/price controls in 1971 and junked the entire world financial system (Bretton Woods) when US inflation got to those levels. 

6. Dollar surprises by rising. This year it really does break DX90.

7. Stocks move sideways all year. We may see a peak in January but will rebound and head to new highs, above Sp1300. The Hope Rally may end in 2011 but more likely limps into 2012. If we get a double-dip in Q2, October could be a cruel month. 

8. Muni bonds do not face the sort of disaster predicted by Whitney among others

9. GDP starts strongly but heads south by end of year. We might get a negative quarter if oil stays high for the first half of the year. If not, 2012 will have the dreaded double-dip. 

10. The Social Mobile Web boom continues, with high-profile IPOs. The Nasdaq100 should therefore outpace the broader indexes. 

11. The world gets colder. Climate Change becomes a joke. Every weather event that is blamed on "global warming" is now done with tongue in cheek. Political support chills for subsidies for green technologies, whether carbon taxes, cap & trade schemes, cheap loans or outright subsidies. CleanTech VCs switch focus to real breakthroughs which can compete without subsidy.