Planet Yelnick

How Can Retail Be Up And Sales Taxes Down? UPDATED

The King Report (courtesy the Big Picture) explains the conundrum: a new sampling technique makes year-to-year comparisons "futile", plus the report did not account for price changes aka discounts. After the type of severe downturn as last year, retailers go out of business, meaning the sample for the survey has to be changed. The Nov increase of 1.9% YoY is within the sampling error. The big news, however, is that the results did not account for discounts. The sales tax data may be giving us a better picture of retail this year than the surveys. An it has been down so far.

If the holiday sales this year are late as well as discount-driven, we might see a better sales tax report in Dec as shoppers wait wait wait for their sale price, then buy as the season ends; but overall this assessment puts a real damper on the Santa Rally.

UPDATE: story to hit tomorrow is Falling Rates Starting to Hit Electronics Retailers. BBY reported Nov sales were up, especially due to netbooks and smaller HDTVs, but warned that the next few months could disappoint due to severe discounting and buyers trading down to less expensive items. The CEA forecasts revenues to fall 6% in Q4 despite a unit increase of 6% - a huge swing because "deflationary pressure has accelerated." They cannot make it up in volume ... Santa (Rally) may stay home for Xmas.

ClimateGate Will Change the Rationale From "Warming" to "Green Jobs"

Steven Chu, Energy Secy, was on CNBC this morning adroitly handling some 'tough' questions. Most interesting to me was how his remarks might affect CleanTech investing. When pressed on why the EPA would issue carbon regulations in the light of ClimateGate, he reframed the issue as one of innovation and green jobs by touting his many CleanTech innovation programs. 

In the '80s the crusade against fossil fuels was all about "Energy Independence." In the '90s the ClimateGate Cabal began to gain more control over the core data and climate models, and the rationale shifted to "Global Warming." This got to alarmist levels in the 'Oughts under Al Gore and drew out the skeptics to fight back despite huge derision and mocking. Their main point is that the data show that warming has stalled, and may have started dropping. 

Two years ago I suggested that the top was in on global warming. Around that time the rationale changed to the androgynous phrase "Climate Change", a concession to the skeptics case that warming has essentially plateaued for the past ten years. Well, with "Climate Change", even a drop is Global Warming! Since that post, it has become clear that some sort of top was in, as support for GW has steadily eroded. A new rationale is needed, now more than ever with the revelations of ClimateGate. 

If the "Green Jobs" approach were based on economic reality, it would be a good direction. I have written how we will eventually really come out the Great Recession with innovation that includes a greening of American industry. Given the history of the Warmists trying to impose onerous regulations and taxes on industry, it may instead be that "Green Jobs" is used as a rationale for even more impositions and constraints. Rather than foster innovation, "sustainability" could become an assault on economic progress. 

If you think this is over the top, consider the economic suicide mission that Kevin Rudd, prime minister of Australia, is on at the Copenhagen conference. As the ever-colorful Andrew Bolt puts it in his column in a major Australian newspaper:

is Rudd really going to approve a draft treaty that could force Australia to hand over an astonishing $7 billion a year to a new and unelected global authority?

Yes, that’s $7 billion, or about $330 from every man, woman and child. Every year. To be passed on to countries such as China and Bangladesh, and the sticky-fingered in-between.

What makes this worse is, in the details of various climate treaties, the West have been trying to impose burdens on the Rest, especially the BRIC countries, including border tariffs on imports with excessive carbon footprints. Energy Secy Chu has been boldly pushing border tariffs to 'level the playing field' since early in the Obama administration. 

Now, Kevin Rudd's Australia has become very dependent on China sucking out natural resources. A climate scheme which sucks wealth out of Australia into uncontrolled waste by third world countries, plus puts a huge damper on China's imports of Australian resources, is economic suicide. 

Rudd must be affected with a form of madness. Jared Diamond in his recent book Collapse supplies a clue to how a peculiar form of madness can grip a people and lead to economic demise. He looks at the wasteland that used to be Easter Island, with those forlorn heads staring into the abyss, and asks: what idiot chopped down the last tree, in order to move those heads to their resting places?  

Yes indeed, what idiot will pull down the pillars of prosperity to chase a fraudulent crisis called Global Warming ClimateChange  Sustainability? It seems to Take a Village to pull this off! A global village of idiots, a ship (of state) of fools blithely sailing off the edge, for ... what, exactly? Even the West's own calculations show that the drop in carbon emissions will have almost no impact on global climate, since the Rest will happily burn those fossil fuels faster to catch up. 

The implication for investors is not just to rotate out of investments reliant on government subsidies and carbon taxes based on Global Warming, but be prepared to rotate out of the AUD if Rudd persists in getting his treaty passed. The good news is it looks hopeless. The BRIC countries will take the A$7B handout, thank you very much, without lifting a finger to fall into the Easter Island madness  economic suicide of border tariffs and *forced* reductions in carbon emissions. 

The Dollar Dog Didn't Bark: We Are Now On Sea Change Watch

The Dollar Dump did not come last night, and the Monday Stock Surge evaporated as well. We are seeing the footsteps of a sea change in markets, but it won't be sudden or straightforward. 

Case in point: Gold has dropped very sharply, enough that Neely seems prepared to call the top in, although shortly after his morning newsletters Bernanke tried to diss expectations of a pending rate increase, and gold promptly shot back up (see chart), but is still down for the session. Equities fell sharply after digesting Ben's statements, then have recovered a bit. 

The Japanese Prime Minister's speech was a non event - he hasn't figured out what to do yet. 

More interesting is that the Euro has been trading below a key level of $1.4872 (and below its 50DMA). This can raise predictions of a drop towards $1.44, but Mother Market likes to fool, and Neely's wave count allows one more jink back up. Again, this revolution won't be televised, but will sneak up in a few false breaks before it hits. We seem to be close. 

The currency duo to watch is the AUD/USD. The AUD is a big beneficiary of the USD carry trade, and its fall (when it occurs) is a great signal of the sea change in positions globally. I will post later on a possible cause of its demise coming from the Prime Minister's policies at the Copenhagen conference. Simply put, they embody economic suicide for Australia. Likely the markets do not believe they will ever be put in place, but we shall see if something happens this week. If the AUD breaks below 90c (specifically 89.50), the next level down is around 83c. 

The Game to Watch Tonight is Not On TV

It is on the Forex screens. Turn off NBC or Fox and tune to FX. Will there be a Dollar Dump tonight? Or is a Dollar short squeeze on? 

A few days ago I speculated:

Throughout November we have seen overnight selling of the USD Sunday, and a sharp spike up in equities Monday; then a fade through the rest of the week. Given Thanksgiving and Dubai, the pattern reversed into a sharp overnight drop in equities; but the pattern returned on the last day of the month, with overnight dumping of the Dollar on Monday night and a sharp rise [in equities] to greet the new month.

Why this play? A number of Asian Tigers publicly announced that they would intervene to debase their currency (or at least stop it rising so fast against the USD) in order to remain price competitive with China. China stayed out, Japan is tapped out, and the US stayed mum. If you were George Soros, who had called a bluff of the Bank of England and won, what would you do? Sell into them, let them drive it back up, and do it again! In the meantime hedge via buying into US equities. I cannot confirm the play, but it is pretty clever.

The overnight Dollar Dump begins Monday morning in Sydney, and then spreads towards Europe with the rising sun. Australian markets are open, and the AUD has fluctuated, being slightly higher right now. Japan just opened, and the Yen is also slightly higher (vs the USD). The US Dollar Index is fading right now, down a little. Hard to extrapolate so far. We have to see what Europe begats.

The choice of Dump vs Squeeze will have a huge impact. The denouement may not happen tonight, but tonight will give us a clue. There is an estimated $1T in the Dollar Carry Trade, meaning (simplified) borrowing in USD and lending (buying bonds) in another currency. The darling right now is the AUD, since the Oz government has been increasing rates. Borrow in Dollars at 0.25% and buy the AUD bonds at 3.25%. Nice spread, especially if the USD continues to fall and the borrowing can be paid back with cheaper Dollars. 

But what happens if the USD spikes up? Those near-zero interest-rate debts have to be covered with more expensive Dollars, creating a potential loss that dwarfs the rate spread. If you don't have the inventory of USD accounts to cover, you have to race into the market. Banks of course have all sorts of swaps between currencies, but swaps have time limits (like CDs) and other limitations that still require covering at a higher cost.

There are several events that argue for a reversal of this pattern:

• The sharp spike up in the USD Friday bespokes a short squeeze
• We hit record lows on 2-yr Treasuries after Dubai, and although have eased off this, it suggests a return to risk aversion could happen quickly
• The Japanese may be tapped out - there is a story that Japan may stop buying Treasuries. See chart. A major speech is expected today in Tokyo, tonight in the US. 
• The $1T carry trade would suffer huge losses with a Dollar spike, and need to move quickly to cover their short positions (short the USD) if it occurs

 

My take is that the Draconian scenarios like Japan backing out of Treasuries are not an immediate policy change. We might find out differently tonight! Yet absent a crisis these changes tend to ease in and the market rolls over, not spikes. 

Think like a carry-trade bank or hedge fund: would you back down your play over a vague set of statements out of Japan and a one-hour pike in the USD? You have $1T in play, and can probably quickly add another $0.5T. This magnitude dwarfs the currency intervention of the smaller countries; no need to fear them. The US has signaled as clearly as it can that the Fed is not prepared to intervene to support the USD; indeed US policy is to allow a controlled fade to support low interest rates. Is Japan really about to intervene at scale to drive the Yen down? Well, maybe, but let's wait and see if they actually do it first. 

If I were playing currency poker, I might back off a week and see what happens, then hammer the trade again next week. But it has worked so well so far despite jawboning, why not continue pressing? 

At some point the Fed will have to support its currency. The US is under huge pressure from Europe and Asia to stop their reckless monetary policy. The FOMC now seems to have dissenters of Bernanke's policies, and Bernanke is having to fight for re-appointment.The well-respected economist David Malpass put forth his case for raising rates over the weekend. David's comments are priceless:

The irony of the zero-rate policy, coupled with Washington's preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home. ...

According to International Monetary Fund data, U.S. GDP has fallen to 24% of world GDP from 32% in 2001. And as U.S. capital escapes the weak dollar and high tax rates, the U.S. share of world equity market capitalization has fallen to 30% from 45%. This leaves the U.S. alone with Japan at the bottom of the monetary heap, with rate expectations so low they repel investment. ...

The fed-funds rate can stay near zero for a while longer, but the Fed can't keep promising "exceptionally low rates for an extended period," as it did last month. 

David thinks a change of policy may come at the Dec16 FOMC meeting. The apparent peak in unemployment gives political air cover for the Fed to shift. He expects Wall Street to throw a tantrum (ie equities to drop) if this occurs, but it will do more for righting the global economic situation than a steady drop in the USD. So perhaps the fun is not tonight, but in two weeks. 

Seasonal Adjustments Ratchet Unemployment

Today's 10% unemployment number sparked a rally at the open. News like this can ratchet a market momentarily, but then the sober analysis follows. As I write this, the market already has largely faded the pop. Neely put out a bulletin this morning to that point, suggesting the rally be shorted. 

In my recent post Is Unemployment Sending the Wrong Signals? I noted that last month's 10.2% rate was spurious - unemployment was essentially flat, but seasonal adjustments made it look worse. The primary adjustment this time of year is for temp workers in retail, and since we have many fewer retail outlets, the adjustments will overstate unemployment.

Similarly, this report is can be misinterpreted, as the market did at the open. Mish has provided a good table showing unadjusted and seasonally-adjusted numbers. Looking at U3, we see that the raw number last month was 9.5%, before seasonal adjustments took it to 10.2%. This morning's raw number is 9.4% before adjustment to 10%. Even that raw number has data massaging in it. We actually lost about 69K jobs, with temporary retail and healthcare jobs ameliorating a larger decline for a net 11K loss. 

Jesse notes how the Labor Dept. has a running birth/death adjustment (for companies not people) that also may ratchet these numbers after the holiday retail season. 

Overall, however, this report has good news in it: the job drop may be bottoming. Karl Denninger runs this chart showing the change of trend on a YoY basis:

Calculated Risk has more on this theme. As you can see in comparisons with prior recessions, our current one is long and deep, but appears to be bottoming, albeit slowly. What to watch: what happens in the January report (which comes ou t in Feb) ater the temp workers for retail roll off.

The most interesting take on this: the Fed Funds futures have "come to life", possibly due to a better jobs picture in 2010. Better jobs = rate rise = bearish for stocks. So it goes n the twisted logic of Wall Street. 

Will The Yen Steal Christmas? A Look At The Seasonal Pattern

The Yen hit a high against the Dollar not seen since 1995, and the Japanese are taking action, including a new stimulus. While the stimulus looks modest in size, the intervention that should follow to debase the Yen should have a much larger impact. Over at ZH Yves presented a chart that shows a change of trend in the Yen. Over in Europe, the ECB has pre-announced a withdrawal of monetary stimulus, timing uncertain. The ECB head, Trichet, is in a tricky position as he wants to stem to rise of the Euro against the Dollar but at the same time is worried monetary easing will spark inflation. It appears by his actions that he will intervene to keep the Euro below $1.50. 

Since the Dollar Index is heavily weighted against the Yen and Euro, a significant fall of the Yen combined with a stable or falling Euro will drive the DX up. 

If these major currencies begin debasing against the Dollar, the DX will finally bottom. A Dollar reversal up is likely to accompany a Dow reversal down. Will this happen in the near term, and steal away the Santa Rally? 

It seems unlikely. As the chart shows, the seasonal forces this time of year are quite strong. This chart is a summation of a number of years to show the average moves across the year. The seasonal strong period from Nov to May is quite pronounced. As Sy Harding has been touting for years, Buy in Nov and Sell in May is the best market timing strategy, at least most years. 

An even simpler approach is buy in the week before Thanksgiving and hold into the first week of January; those eight weeks can be 40% of the rise all year. Or, wait out the two flat weeks after Thanksgiving, and join the Santa Rally, which on average can cover 25% of the whole year's advance. The Santa Rally is quite real.  

But the two weeks between Thanksgiving and the Santa Rally kickoff have tended to be flat. We are there now, and perhaps it will deter potential bulls. The Wall of Worry seems higher during a pause. 

These seasonal tendencies are just that, tendencies. While the Santa Rally is quite real on average, it isn't always there. We are going through a fairly ahistorical time, and the standard patterns cannot be expected to be there. 

On the other hand, the wave count says we are in a small wave 4 (or B) sideways period, which should end tomorrow or early next week. Although counts can be constructed to show the wave 5 that follows has already occurred, it would have been a wimpy one. making this a low odds count. The more likely counts have a wave 5 or wave C to follow before the end - and they would be consistent with the size and duration of the last few waves (3 and 4) to run through the Santa Rally period, if not all the way onto Feb. 

Niall Ferguson Nails the Deficit Dilemma

"My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar." - Paul Krugman, 2003

Niall Ferguson in Newsweek:  On average," write Carmen Reinhart and Kenneth Rogoff in their new book, This Time Is Different, "government debt rises by 86 percent during the three years following a banking crisis." In the wake of these debt explosions, one of two things can happen: either a default, usually when the debt is in a foreign currency, or a bout of high inflation that catches the creditors out.

Now, default is extremely unlikely and infationary forces are not visible. So what happens? Niall goes on to nail it (emphasis added):

Yet from where I am sitting, inflation is a pretty remote prospect. ...

So here's another scenario—which in many ways is worse than the inflation scenario. What happens is that we get a rise in the real interest rate, which is the actual interest rate minus inflation. ... [S]ignificant increases in the debt-to-GDP ratio tend to increase the real interest rate.

Today's Keynesians deny that this can happen. But the historical evidence is against them. There are a number of past cases (e.g., France in the 1930s) when nominal rates have risen even at a time of deflation. What's more, it seems to be happening in Japan right now.

It's not inconceivable that something similar could happen to the United States. Foreign investors might ask for a higher nominal return on U.S. Treasuries to compensate them for the weakening dollar.

Unlike the last time we ran huge and persistent deficits (WWII), this time it is not being financed by US citizens. Instead, the Fed is buying, feeding on its own tail so to speak, and we still have foreign buyers. This can continue for a while, but he predicts a huge shortfall next year of around $600B with no clear buyer on the horizon. 

Hmm, what does this mean for bonds? Right now we have seen no recent problems with Treasuries; if anything, after Dubai, we should expect Treasury rates to continue to drop. Yves' scenario is intact. Niall's scenario comes into play late next year, when the shortfall begins to emerge.

Peak Stimulus is Right Now

There is talk in the air of a second stimulus. Actually, it would be the third since Bush passed one before he left us. Thanks, W, and good riddance!

Comments to my post on Embracing the W show some continued confusion over the timing of the Stimulus, so let me update everyone.

The specific stimulus bill counted out at $787B. I suppose you could include the unspent TARP as well, and the earmarks that got TARP passed ($180B?). Plus we had a $300B real estate bailout passed under W during the election summer of 2008.  So we are at well north of $1T of stimulii.

For a good resource, download PeakStimulus. This first chart is from that report. The second chart is from Goldman Sachs and includes inventory rebuilding. They both show that the peak of stimulus is right now.

 You can also read my take on this from prior posts, here and here. My preliminary conclusion in late August was that gimmicks - what I call Cash4GDP - have had a bigger impact than the stimulus itself. At least, easier to measure.

This isn't to say that the Stimulus isn't helping to buoy up GDP. It is. But the peak impact is now. It is downhill from here. A year from now, 70% of it will have been spent, and the remainder will be so stretched as to be lost in the noise. We actual risk the remainder having a negative impact, particularly if we try to reduce the short term deficit.

This may sound paradoxical, but take a look at the third chart. Since we have already be running high government spending (for years), the change in spending is what has a stimulative impact. If we reduce spending, as is inevitable without a second third stimulus, it has a negative effect, at least to the extent that government spending has much effect at all.

 This isn't to cheerlead for a new stimulus. Quite the opposite. The way out of our mess is to fix the financial sector and get the private economy on its feet. The many stimulii simply kick the can forward of that fix and put the economy on life support. Necessary adjustments are postponed. We are turning Japanese, indeed!

The silver lining in this leaden approach to our golden economy is that these stimulii don't do much, so the negative impact may not be that impactful, just as the third stimulus won't do much in the short run. In the long run the excessive debt, malinvestment and waste from the stimulii eat into our national wealth and impoverish us. Also, the long run may not be that far out.

Now, as to the Stimulus itself.

A big chunk of it (35%) has been tax credits to lower income (or no income) people, and that is being paid out weekly as we speak. Ford did that in 1975, to no effect. His failure got studied and it was realized that temporary changes to income are squirreled away in quick savings (not investments) or used to pay down debt. As such they act as a black hole in terms of stimulus. Bush did it twice, the second time in 2008. No impact. Christina Romer of Obama's Council of Economic Advisors studied these rebates and concluded a permanent tax cut has a 3x stimulus effect whereas these one-time rebates are inconsequential at best if not politically expedient and economically wasteful. (So why were they put into the Porkulus? Maybe because Obama cared more at that time about "social justice." meaning redistribution of wealth, than fixing the economy. Now his mistake is becoming apparent, even to him inside his bubble.)

Of the rest about $100B or 12% is well-designed to have an impact (according to the WSJ). The leftover balance is obscure in its impact. For example, a chunk goes to K12. I have a company selling into K12 and have visibility into how some of the stimulus money is being handled. Confusion reigns, and almost no jobs have been created. Why? No school district wants to hire with a one-time stimulus, and then fire when the government life support goes away. Instead they are trying to figure out what to do with it. In this way a chunk of the obscure part of the stimulus may be out of the Feds and into the school districts where is is hung up in a type of indecision purgatory.

Around $200B is considered direct aid, much of it to State governments or State construction projects. How is that being spent? There is a brewing scandal in California because the state unions are plundering the budget. More jobs? No, saved featherbedding jobs, more benefits and retroactive pay increases! An Orange Count firefighter makes $175K. Yes, you heard that right. Shocking, to say the least. Maybe they are using the vig they are collecting to buy cash4clunker cars, who knows.

In any event the schedule of flows of these funds peaked in Q3. To the extent it is still hung up in the hands of some "czar", or has left the Feds and gone into "indecision purgatory" before it is actually spent, the peak spending is in Q4 with slop-over into Q1. Right now. This is as good as it gets.

Embracing the W - the Double-Dip Recovery

“Obama, Pelosi and Reid are drafting a new stimulus bill that White House says could have twice the number of non-existent jobs as the last jobs bill.” - Jay Leno

Mother Market has built in a sharp V-shaped recovery (to justify current price levels, the P/Es need robust earnings in 2010). In the Great Depression we never had negative earnings across the whole index, but we did last year. US industry has now cut costs enough that in Q3 earnings have exceeded expecations on lousy revenues. To keep this up, we now need growth. The amount of growth requires a V shaped recovery - a sharp rise next year of at least 5%. 

Today's downgrade of Q3 GDP from 3.5% annualized to 2.8% raises the spectre of a slower U-shaped or a jobless L-shaped recovery, yet the market barely reacted.

The NYT ran a piece on the recovery, and provided this first chart showing projections of some economics firms. Of course, this sort of thing has about the same predictiveness of the embarrassing unemployment projections of Obama with and without the stimulus. I assume the NYT dropped this in as part of a broader campaign to justify a new stimulus, since it is supposed to show how much worse we would be if there had been no stimulus. After the JobsGate scandal of ludicrous claims of how many jobs were saved or created by the stimulus, a new stimulus will need better support than this. (How much we should accept Moody's analysis is also unclear, given how badly they did their ratings job during the bubble. This may be another example of feeding results to an audience that will pay for positive predictions.) Nonetheless it supports the conventional wisdom, which has been summarized on Bloomberg TV as "70% expect a V."

When I scan the pundit-sphere, I grow concerned of a confirmatory bias in their predictions. Those who bash Obama see the U; those who gush see the V. More perverse, those who want a big jobs bill push the L to justify more stimulus (Krugman? Krugman?).

Yet it seems Mother Market still sees a V, at least in the short run. It could just as well become a W, a double-dip, in the long run. Let's see if we can support the V, and estimate when it becomes a W.

Some economic news shows recovery. Global trade has ticked up (see chart). The much watched Baltic Dry has shown a rise in rates (possibly because so much container capacity has been mothballed). Trucking fell slightly in Oct, but has been on an uptick. Rail data shows a bottoming but hasn't ticked up much yet.

Charts of US GDP show a V, even with the reduction to 2.8% annualized, from a bad Q1 at -5.7% (this is a revision up from prior reports). Although holiday shopping surveys say watch out for Q4, they also suggest a flat to slightly up season, year on year. So far this week has started up, boding well for Black Friday. Surveys also indicate that this season will be late and value-driven, meaning people will wait for sales, so there may be upside surprise come the day after Xmas.

Some data is mixed. These four charts show various US indicators (as of Sept.) that are bottoming or have bottomed. The LEI has been in a V up for months, and continued up in October. ECRI also expects continued recovery despite a weekly blip down last week. Of most interest is industrial production, which is ticking up. Unfortunately, the Oct results were poor, with industrial production growth slowing to 0.1%, a four month low increase, and housing starts a six-month low. The industrial production flatness is lively a hangover of cash4clunkers plus prior inventory rebuilding, hence more likely a pause before an increase, not a change of trend.

One of the odd side consequences of C4C was an increase in imports of autos. The GDP revision down was partly due to this (more imports lowers GDP). Northern Trust expects a drop of such imports in Q4, which will lift GDP.

My conclusion is that Q4 will beat expectations, and will beat Q3, perhaps even get to 4%. After the revision today, expectations faded from a 3.3% range down to a piss poor L shaped pace:

Economists see the economy growing at a pace just above its long-term trend. They expect GDP to grow 2.5% in the fourth quarter, 3% in the first quarter of 2010 and 3.5% in the second quarter. That's a far cry from the 6% growth seen in typical V-shaped recoveries, but it's better than a poke in the eye with a sharp stick.

These expectations will likely meander upwards as retail data comes in, albeit it will largely be later than past history and driven by promotions and discounts. This should not surprise, since we are in a New Normal where past patterns do not predict behavior; yet it will likely fool the pundits and forecasters until the data pikes in. 

Hence I expect a V-like recovery for several quarters out.

The problem is what happens after. This recovery is largely an artifact of government stimulus and gimmicks like C4C and the first time home buyer credit. We need to see the real economy begin to emerge. On this score things are troubling. 

Real estate normally leads out of a recession. Not existing home sales, but new home construction, which drives growth across many sectors of the economy (new house, new appliances, new furnishings, etc.). Despite the big Oct jump in existing home sales, new home sales are in the dumpster. This chart from CalculatedRisk shows how dramatic the gap is. A slight uptrend over the summer is now fading in the winter.

It may be too much to expect a large shift to new homes until the massive overhang of existing homes is worked off. The second chart compares vacancy rates to new home sales. Another huge gap. 

Private Investment is a second driver of growth, and is reflected in bank lending to business. There are lots of charts showing a simple reality: banks are still cutting back on loans to business. Until that changes the private economy will be moribund and the V will be largely a concoction of government stimulus. 

Stimulus will turn relatively negative late next year, and worse in 2011 when the expiration of the Bush tax cuts turns into a large tax increase.  The impact of real estate and private investment does not seem likely to change appreciably in the first half of 2010. Hence we may see the start of the W in 2H10.

The negative effects of diminished stimulus can be seen in this Goldman Sachs analysis of why we won't have a V, at least not past the first half of 2010:

Despite the sharp pickup in real GDP growth since the dark days of early 2009, we estimate that real final demand—net of the boost from fiscal policy—is still contracting at an annual rate of around 1% in the second half of 2009.  Although we expect a moderate recovery of around 2% by the second half of 2010, such a 3-percentage-point improvement would be insufficient to offset the loss of 4-5 percentage points of stimulus from fiscal policy and the inventory cycle.  Hence, real GDP growth is likely to slow anew to a below-trend pace

Their chart shows we were in Peak Stimulus in Q3, a point I made several months ago, and with inventory rebuilding adding to a peak overall stimulus in Q4. 

Hooverism may be the ironic response of Obama. He has already proffered a dangerous thought, that deficits could cause a double dip recession. (Krugman's response: "What? Huh?") He may push for accelerating the end of Bush tax cuts, replicating one of the huge mistakes of Hoover, to push for a tax increase in 1932 to help balance the budget. We had been coming out of the Depression, and promptly sunk back in. Something similar happened again in 1937.

The first rule of Recession Club is: you don't raise taxes in a recession

Obama has also begun the siren song of yet another stimulus, now a "jobs bill," a belated recognition of how awful his Porkulus first Stimulus was. I suppose if he were to retarget existing stimulus and the remaining TARP money and avoid increasing the deficit, he might be able to help extend the period of government life support to prop up the economy and push off the W.

All of this will be tragically ironic, because he will be hoist by the petard of Keynesian economic revisionism: that Hoover was laisse faire and did nothing, and FDR did something to get us out of the Depression. The victors rewrite history, and the post-war economic writers like Samuelson sure did a number on Hoover.

Look at the chart of Federal spending vs GDP. Hoover ramped it up, and FDR sustained that level until WWII. It was Hoover who first tried a massive stimulus to boost the economy, running up spending to 20% of GDP in his final two budgets (FY32 and FY33). FDR did not do a Krugman-like stimulus beyond what Hoover had already done, and indeed when he met Keynes in 1936, it was reported as a poor meeting. Rather than follow Keynes, one could say FDR followed Hoover. Heresy I know, but historically closer to the truth. How will history rank Obama, who so far has largely followed the path Bush first set?

Obama would do better to postpone his progressive causes (climate change, healthcare reform and social justice) and first fix the financial sector (real estate, business loans, consumer credit) to get the private economy back on its feet. But it appears he would rather drive us off a cliff, albeit inadvertently through his apparent economic illiteracy.

All of this is why I say to embrace the W. Expect the V over the next few quarters, and watch how misguided government policies throw us back down again.

Is Unemployment Sending the Wrong Signals?

The market is watching unemployment as an indicator of when the Fed will raise rates. In prior recessions the Fed has waited until unemployment has peaked before raising. The first chart shows the beginnings of a plateau over the summer, but the October numbers shot us back up again. 

Before the October report, expectations were for a peak in Feb, at 10.2% - which we just hit. After, expectations have shifted out at least Mar. See the third chart. Of course, these are the same guys who thought it wouldn't get worse than 9%, and advised Obama on those embarrassing projections with/without stimulus in the first chart. 

More relevant is that the Fed has much more pessimistic projections. And history says the Fed will wait a year or more after that peak to raise rates. See the second chart, from Calculated Risk. This puts us in a low rate environment for at least 18 months. 

Before we get too gloomy, let me argue that this spike may be an artifact, not a trend. 

These stats have scads of adjustments. The unemployment rate is unemployed-still-seeking over available-workforce. I have earlier noted the problems with the denominator in that it is adjusted by birth-death estimates that seem too light, making the workforce count larger. This doesn't specifically affect the unemployment rate but does skew related labor reporting of the government (Mish explains here.) Also the reported rate of unemployed loses those who stop looking. (Not to make too much of a point of this, but about 1M workers will fall off unemployment at the end of this year.) The much higher U6 count (at 17.5%) captures them. So the reported rate has probably been too low. 

This time the rate may have spiked too high. The prime seasonal adjustment on October is ramping up temp workers for the holiday sales season. Given all the retail outlets that have been closed, even with a reasonably strong Xmas, and hiring on a per-store basis, the overall number of temp workers would be much lower than expected due to fewer storefronts. In fact, prior to adjustment, unemployment held constant at 9.5%, and the number of jobs actually rose by 80K. 

My conclusion is unemployment is worse than the official stats show (at least the most reported U3 rate), but the trend may not be not as bad as this report suggests. For purposes of estimating when the Fed begins to tighten, the trend is more important than the rate. 

Right now we cannot tell if the trend is flattening. We can say the downward trend, when compared with all other post-war recessions, is making this the longest and soon the deepest fall since the Great Depression. Worse, the percent of long-term unemployed (15 weeks or more) at 5.7% is much higher than in prior post-war recessions. The NYT has a good chart showing this. 

The spike up in October, however, has spooked a lot of commentators, and may be driving some poor policy decisions. Here are examples:

1. Bernanke was noticably downbeat in his remarks last week. He singled out "the labor situation" along with bank lending as the two worrisome factors. 
2. Dallas Fed President Fisher commented that he thought Q3 GDP would be reduced from 3.5% to 2.5%. (We will find out tomorrow.) Bernanke believes that growth of 2.5% is too slow to bend the unemployment curve. 
3. Keynesian economist Brad deLong now thinks there is a chance of falling into a Great Depression. He has pushed for a new stimulus, along with Krugman.
4. Speaker Pelosi claimed the Stimulus created or saved over a million jobs. This spurred investigations of her claims, and instead found 700 (!!) phantom districts, faux claims, and few jobs. Today even the left-leaning SF Chronicle reported Errors Riddle Accounts of Stimulus Spending. They had a hard time finding any jobs created or saved, but they did find the claims had created non-existent districts in California. Future virtual voters with virtual Congressmen?
5. Obama remarked how more deficit could throw us into a double-dip. This is so at odds with the advice he has been following from Krugman et al. it makes you pause to wonder what is up. Most likely he is maneuvering to push a jobs bill that largely retargets the remaining TARP funds and some of the unspent Porkulus Stimulus. 

How to make sense of this? Mish has done a series of analyses on how bad this could get, and how long it could last. He started with this gloomy chart from a recent WSJ article, which shows how long it will be to get back the jobs lost already. 

Mish went on to estimate peak unemployment across different scenarios. He took Bernanke's recent remarks to heart, and created a Scenario B which has unemployment peaking about a year out then sliding. Mish's conclusion:

 "unemployment will still be above 10% at the end of 2014 and will not dip below 8% until the end of 2020."

He isn't the only gloomy one. Former Merrill Lynch analyst David Rosenberg, whom I think has done a great job assessing the economy, believes we get to 12% or higher, and will continue to creep up for at least a year after the recession ends.  One of his key insights is that many of the jobs created post-2000 were credit bubble related, that is, not tied to any real increase in the productive side of our economy, but an illusion created by excess borrowing. They cannot come back until the economy catches up again to the ilusory level of the bubble. This will take a while. 

One of my favorite economics bloggers, Edward Harrison at Credit Writedown, sees us in structural high unemployment: even if we are slowly recovering, the many unemployed will be left bereft of employment for a long time. And of course new workers are coming into the workforce all the time as well, compounding the problem. 

John Mauldin has been on this theme for a while. beginning with his New Normal article in Sept. He commented on Mish's scenarios and Rosenberg's analysis in If This Is a Recovery ... He has become a believer in the double-dip scenario, Scenario 3 (see last chart), which puts unemployment over 13% and staying above 10% for eight years (!!). Gloomy indeed. 

Yves Projects Unemployment Based on High-Yield Default Rates

Yves does some intriguing homework to come up with a predictive model for the peak in unemployment. Around that peak we should see the Fed finally raising rates. We can all hope that a real private-economy recovery is underway, since otherwise the Fed will have a hard time exiting the box they are in. I will comment further on unemployment stats in a later post, and consider this a good companion piece as to the investor implications. Enjoy!  

-------------

Most participants these days should take the “thinking outside the box” more seriously. With this in mind, I have studied the behavior of default rates and high yield spreads. In doing so, I also discovered that the general YoY growth in the GDP was mainly going down. The resulting effect on unemployment should then be obvious. 

I show in the first graph the result of higher debt having a diminishing effect on labor. You notice that like a weaker GDP trend would suggest, the rate in unemployment shows higher peaks from the 1950’s onward. It would not be surprising that we exceed the 1985 peak close to 11%. The graph of unemployment with the default rates is meant to show that the rate of unemployment will continue upward for some time once default rates have peaked. You will see this in the 1980-1984 period, the 1990-1994 period and lastly the period of 2000-2004. These are times very similar in each start of decades, coincidence? 

The basic assumption generated with this study results in a rate of ascent in the rate of unemployment once high yield default rates peaks. 

I will have applied an average of these three periods discussed going forward in our three base cases. 

This rate of ascent is shown in the graph with the subsequent higher unemployment rate. It does carry upward for some time and will lag the turning point of the high yield default rate peak.

Lastly we provide an overview of my unemployment projections based on three scenarios.

The base case number one takes the view that high yield default rates are peaking and will start to drop from this level now. The rate of unemployment ranges from 10% to 11.5% with this given scenario. 

In the base case number two, I am using a composite of both peaks in 1991 and 2002 to suggest that default rates may carry upward one percent more. The resulting effect on unemployment targets will range from 11% to 13.5%.

In our final analysis, base case number 3, we use the peak at 13% in default rates established in 1991. Unemployment rates in this scenario show a range of 12.5% to 15% before peaking.

In exploring various theses, I seldom have a psychological prejudice. I suggest people doing pseudo-finance do the same.

 Yves Lamoureux, Investment Advisor, Blackmont Capital inc.

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

Run on the Dollar?

Bernanke made dolorous comments today about a slow recovery and added: "economic conditions, ... are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Karl Denninger at The Market Ticker captures the moment (see attached chart): 

The market took about 10 minutes to discern that Bernanke's "concern" was BS, and now has pushed in the chips - "all in" - breaking key support below 75 - and still going.

The carry traders have redoubled their bets and obviously intend to force Bernanke to either put up or shut up.  ...  It appears the FX market intends to force Bernanke (and Geithner) to either defend the dollar or allow it to collapse. 

Just look at the drop and the volume. After hours we saw a bit of a bounce but it has faded. The DX got down to 74.68, lower than Karl's chart indicates. 

The Forex view is well captured here: China scolding Obama prior to his visit shows that China is not about to be pressured by the US to let the RMB really rise. Instead they are pressuring the US to support its currency. Hence Bernanke's remarks could be read as a reply in the negative, and now the FX market is delighted to play chicken with the US Peso. Who will blink?

Although the prior trading day was Friday the 13th, today was a bit spooky in that the Euro and the S&P topped almost on the New Moon (2:14p ET), an odd moment highlighted in tonight's STU. I see it as mere coincidence to Bernanke's remarks. 

It is nonetheless an oddity that markets have a two week cycle in tune with the Moon. We are not the rational Enlightenment creatures we make ourselves out to be. 

More to the point, the wave structure is following what I outlined in Rally Scenario last Thursday: a wave 4, which has broken as a "spiky" flat, seems to have completed today. A final wave 5 rally awaits over the next two days, if this view holds. For those waiting on the STU to opine, their prime count is that wave 5 completed today; and their alt count is a flat wave 4 completed today with a wave 5 to go. It seems that the STU was influenced by the New Moon too, and wants a nicely wrapped story that we peaked on the New Moon. 

Astrological lunacy aside, it seems more likely we have play out the game of Dollar Chicken over the next few days, and stand aside for the Counter-Dollar rally in equities. The US Peso will wane while the Dow will wax. The Dow seems determined to get to 10500, a level I thought it would reach when I went bullish last November, although I thought it would happen faster (by the end of summer). The S&P will likely then reach its 50% retrace at Sp1121. 

What happens after that depends on the Forex market and Dollar Chicken. The US Peso has become the Hot Tamale, with FX players knocking it around in a game of pol(l)o  

Calm Before the Coming News Storm

Market is beginning another sideways move, most likely to digest a flurry of economic news this week, including the FOMC meeting Wed. Both the USD and Dow have similar patterns - a flat correction before the next sharp move. This can be counted a number of ways - the easiest is that after a sharp wave 1 drop, wave 2 is breaking as a flat that should take it to the Sp1061 +/- 5 pt range tomorrow or Wed.

This chart of the VIX (courtesy today's STU) shows how dramatically the the investor climate has changed to "global warming" from a mild cooling of risk and volatility. The VIX measures volatility which represents itself as a higher premium for options. The risk premium had been steadily dropping ever since the start of the Obama Hope Rally, and now has spiked two standard deviations the other way, breaking the trendline of the downslope. Fear is coming back.

It is an interesting question as to how much news moves the market. The trader's aphorism is "buy on rumor, sell on news." Prechter is fairly adamant that news does not move the market except as a short term jink. Neely is more sanguine and thinks news affects the market all the time, but the impact is incorporated in the wave pattern.

To Prechter's point, you always have examples like 9/11, where the market was falling hard before the event and when markets re-opened after a sharp reaction down, rose after almost back to the all-time highs of two years early in May 2002. But most of the time news is not some attack out of the dark, but can be anticipated as a policy change or economic transformation. Doesn't that pendency of change affect the wave structure?

My own experience is that the wave pattern begins to change in anticipation of news - not the shots out of the blue like 9/11 but the policy changes and economic news that one sees brewing. One example is the E leg of a triangle, which EWI often describes as being jinked by news. Thinking of a triangle starting as a flat ABC then breaking into a new wave; but a news comes and jinks the market briefly in the opposite direction before settling back into the direction of the break. After the fact we designate the intial break as Leg D and the momentary jink as Leg E. 

A more interesting example is the ending diagonal, or contracting terminal in Neely parlance. It is as if an impulse has been foreshortened by expectations of some policy change. The growing need for a policy decision causes the market to enter a different structure, the change occurs, and off the market goes in the other direction. We had ending diagonals last year at the Bear Stearns moment in Mar08 and at the bank bailout moment in Oct08.

A great example is the Iraqi War Triangle of May02-Mar03. After the rise off 9/11, we fell hard to a low in Jul02, then bounced far back in Aug02, then fell again into Oct02. But we weren't done - the fever pitch of noise around the pending Iraqi invasion caused a further up/down move.  We didn't end the pattern until we started the invasion. Looking back the whole pattern looks like a large triangle with bottoms around the same level in Jul, Oct and Mar. A triple bottom. Of course, orthodox wave counting would put the end at Oct02 and make the next up/down a wave 1-2; but an alternative that is where Neely and Zoran came out is to see the move as a terminal pattern like an ending diagonal, a large triangle of indecision while the policy decision (to invade) was pending. 

Similarly, we just had a interesting news item - higher than expected GDP - and a spiky bounce down/up/down and now somewhat up surrounding it. The GDP report has an intriguing aspect that I have not seen picked up in the broader financial news: if global GDP is now on the rise, the demand for Dollars should increase. Maybe the drop in the Dollar was influenced by a lowered need for it as global commerce dropped. Hence a rise in economic activity would be bullish for the Dollar.

This week we have a slight risk of another major change in the assumptions of the current situation. There has been a huge short interest in the Dollar, brought on in part by turning the mighty Dollar into a carry-trade currency like the Yen (borrow Dollars at low rates, lend at high rates in other currencies). If the Fed at the FOMC were to raise rates (surprise!) or signal a coming change of policy beyond the vague hints of recent meetings, it could cause a massive short-squeeze in the Dollar as carry-trade players scramble to cover their short positions. Odds are low but impact is high. Hence a pause to assess two sets of data this week:

• change of Fed policy on rates
• insight into whether a global recovery is real or is but government life support

This type of pause would be reflected in sideways patterns, such as flats with spiky ups and downs, and triangles. As we are having. So stand aside for the next few days.

Cash4GDP Updated

Market reaction to better-than-expected GDP report (3.5% vs 3.3% consensus) is the expected retest of yesterday's break of key trendlines. A common technical pattern is to close a gap down; today the S&P e-mini at 1159 (at the time of this posting) is getting close to covering a gap at 1161. The Naz has a bit more to rebound to close its equivalent gap at 2116, so watch for continued strength today. It was bit surprising that markets were down yesterday before the GDP report, as more typical behavior is to rally into the news and fade it after.  It shows the strength of the four-day down-move 

 

We remain with clear signals of bifurcation yesterday in all but the Dow, which confirms the trend change: Dollar up, everything else down.

The strongish GDP report was based on gimmicks: Cash4Clunkers and the first-time buyer's credit. Edmund's noted that the C4C payments of $4k per car are really much higher at $24K per car when the trendline for sales without C4C is compared with the incremental sales from it. (They also note today that there are clear signs of a recovery in car sales from the October data.) A similar analysis of the $8K housing credit would estimate a $43K actual cost for incremental sales. Whatever the validity of those methods, they raise the question of whether this GDP bump will sustain. We should see estimates for Q4 be adjusted upwards as economists tends to extrapolate the present, probably from a pre-report range of 2.5% to a past report range of 4%. 

In past history the GDP turnaround following a bad patch - and we have been in the worst patch since the 1930s - would be much more robust. We grew well over 10% a year in 1934-36 coming out of the first phase of the Great Depression: 17%, 11% and 14%.  Today's annualized GDP reading at 3.5 and a Q4 performance at 4% are quite disappointing in comparison.

Updates: a number of sites have done a deeper dive this morning:

1. Almost the whole increase is due to government stimulus and gimmicks. Karl Denninger adds the auto component of 1.66% to the increase in government spending of 2.4% (the 7.9% increase times the 30% share of GDP from government) to show that the 3.5% would turn into -0.5% if those are removed.  Now, not all the auto component was due to C4C so his calculation is a bit aggressive, but the point is sound that absent stimulus we would likely have been flat or negative GDP again.
2. The consumer component is worsening. From Karl and also Mish, personal income decreased in Q3 when it had increased in Q2; taxes increased in Q3 when they had decreased in Q2; and most concerning disposable income dropped in Q3 (and dropped a lot in constant-Dollar terms) whereas it had risen in Q2. Ouch.
3. Savings dropped in Q3 vs Q2 even though disposable income dropped more; this is probably the result of C4C gimmicks, and is likely to reverse in Q1 if not Q4 due to Holiday spending.

The next report to watch is unemployment. We might crest 10%. Jobless recovery is an oxymoron, but note that unemployment is a lagging indicator. The key indicator to watch is real estate - it almost always leads out of a recession. The Case-Shiller report has good news - a fairly widespread price uptick. Whether this is mostly due to the another government gimmick, the first-time buyer credit, will be more clear when that program lapses.

Dollar Gets to YE$. Fed Gets in a Box

Today the YE$ currency (Yen Euro $Dollar as the reserve basket) hit a milestone: the past three months have seen the Yen/Euro get 63% of new reserves vs the Dollar at 31%, or below even one-third among the three. The US Peso is now down to its lowest level as a reserve currency since the break with gold in 1971 at 62%. While this is not quite the fancy headline "Dollar Loses Reserve Status" it does show that pressure is building on Bernanke to raise rates to support the Dollar. 

The Fed's conundrum can be simply explained (this is a quote from John Mauldin from Mish's site today):

You cannot continue to run deficits significantly larger than nominal GDP for too long without risking the demise of the economic system. But we are in a deflationary environment, so the Fed can monetize the debt far more than any of us suppose without risking immediate and spiraling inflation.

The mistake we are running is to have huge fiscal stimulus (deficits) alongside huge monetary stimulus. 

The concept of monetary stimulus to avoid serious deflation and ease the write-down of excessive debt comes from Irving Fisher's seminal Debt-Deflation Theory of the Great Depression paper of 1933. He gave a cogent explanation of the events that led to the debacle, and discussed how Hoover almost got it right in the summer of 1932 when he began reflating the currency - we began to emerge from the Depression between May32 and Sep32 - then lost heart during the election and let it come tumbling down. At the time Fisher was the pre-eminent US economist, the Keynes of the US so to speak. 

His work is required reading, even with recent revisions. He explained as simply as I have seen why the Depressions of 1929, 1873 and 1837 were different in kind from deep Recessions in 1921, 1893, 1859 and 1820 (and 1981): the Recessions were due to over-production, while the Depressions were due to over-indebtedness. As now.

His remedy is now accepted wisdom: massive liquidity from the central bank is needed to ameliorate deflation and prevent money from being hoarded. Back in the 1930s people may have stuffed bills into mattresses, but today we stuff them into short-term Treasuries. Same effect - the money is not spent nor is it invested (which is also then spent, on new plants and new hires). Hence plopping savings in short-term low-interest notes is the same as taking it out of GDP and stuffing it in mattresses. As now.

Bernanke's Fed reacted too slowly, and drove US consumers to pay down debt and plunk their savings in safe instruments; but has heroically pumped liquidity since. The dilemma comes not from Bernanke but Obama: the massive Federal deficits to finance stimulus are creating a terribly negative dynamic. I have previously discussed the impotence of fiscal stimulus: rather than reinvigorate the private economy, it acts as short-run life-support. 

The worse position to be in is where the deficit grows faster than GDP. This creates a dynamic where the government simply digs a deeper and deeper hole. Right now economic projections even in the V-Shaped recovery have us growing the deficit faster than GDP. Only Obama's optimistic projections suggest otherwise, and they are not taken seriously. From Judy Shelton in a WSJ op-ed today: 

Even with the optimistic economic assumptions implicit in the Obama administration's budget, it's a mathematical impossibility to reduce debt if you continue to spend more than you take in. Mr. Obama promises to lower the deficit from its current 9.9% of gross domestic product to an average 4.8% of GDP for the years 2010-2014, and an average 4% of GDP for the years 2015-2019. All of this presupposes no unforeseen expenditures such as a second "stimulus" package or additional costs related to health-care reform. But even if the deficit shrinks as a percentage of GDP, it's still a deficit. ...

The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio ... .

Sadly, due to our fiscal quagmire, the Federal Reserve may be forced to raise interest rates as a sop to attract foreign capital even if it hurts our domestic economy. Unfortunately, that's the price of having already succumbed to symbiotic fiscal and monetary policy. If we could forge a genuine commitment to private-sector economic growth by reducing taxes, and at the same time significantly cut future spending, it might be possible to turn things around.

Worse, the maturity of Treasury debts is decreasing, from 6 years in 2000 to 4 years today, and dropping towards 2 years. As Karl Denninger comments, this places Treasury in an untenable position: it has to roll over the whole deficit every four years PLUS tack on new debt to cover the deficit. Why would the maturities decrease? Maybe that is all our trading partners will take, since they are rolling out of the Dollar into the YE$ basket. By reducing their exposure to long-term Treasuries they better prepare to get out if the US Peso continues to fall. 

When something cannot go on, it doesn't. Expect something to break, and soon, and the USD to begin to rise again.  

The Dollar as the Hot Potato

The Long Bond is way up in the past few days, with yields shooting from 3.95% on Oct2 to 4.2% Friday. The yield curve had been flattening, but is now going the other way. See chart from StockTiming. Bond markets are closed today for Columbus Day Fall Weekend Day. Tomorrow should be interesting. Does this sharp change in bond yields reflect local turmoil last week in forex markets, meaning it will settle back down this week, or is it presaging a trend change in the Dollar?  

Treasury had a surprisingly poor auction on Friday. Perhaps the CBO long term analyses are causing concern, since they point to fiscal doomsday. Curiously, despite last week's sneak attack on the Dollar, it came back on Friday. The Dollar is down today except for a collection of Asian Tigers who have been intervening to devalue their currencies (including Japan). My experience with bond markets is they don't look out that far; instead are driven by the trading environment. That may be about to worsen.

First, central banks are worried over holding the hot potato: too many Dollar holdings when the bottom drops out of it. While central banks are not decreasing USD holdings, they are shifting proportionately away. In effect, central banks are shorting the Dollar. Why?

No one wants to be caught holding too many dollars, and this rising reluctance is increasing pressure on the USD. This is an obvious USD negative, but it is also means that the ECB and the EUR are caught between a rock and a hard place. The capital flows into the EUR have very little to do with any euro area cyclical dynamism.. 

Second, we seem to be in a swirl of events that may soon change the current market dynamic. Besides Latvia having a failed auction and potentially defaulting, now Romania may collapse tomorrow. Fear of fiscal dominoes is bullish on the Dollar as a safer haven.

Third, the other shoe to soon drop may be China. The Shanghai exchange had been closed for over a week, opened strong Friday and faded today. Nw a report is out that lending in China hit a new low in September. From the report: "Yet the September decline was doubly ominous, as it comes in a time when banks traditionally let the spigot on full blast." 

Spiky Dike Broken, Now Where To?

The divergences yesterday resolved to the downside. The top is in. Question is how much of a top, and how serious this drop will be.

The S&P joined the Dow in breaking Friday's low (Sp1041) and the Aug28 intraday high (Sp1039). The Naz has broken Friday but so far has only gotten within 10 pts from the Aug28 level (Naz2060). The Aug28 level is critical in that it represents the top of wave i in the count which would have allowed a final wave v up; but once we break into the range of wave i, this is no longer a wave iv and the top is in. 

Let's see how the next two trading days settle before picking a direction, but here are the main options:

1. The bullish count (yes there is one) is that we are in wave 4 off the Mar6 bottom. The correction from Jun11 to Jul8 is wave 2. That broke as a zigzag, so this one should be a triangle or flat - essentially a trading range not a serious drop. Now, it is very difficult to count the Mar9-Jun11 move as impulsive (5 waves); it counts quite easily as a zigzag (3 waves). So I think this count is a misdirection. But the move off Mar03 initially fooled a lot of ewavers, so keep your eyes open to this possibility.
2. The bear-rally count is that this is a second X wave, the first being Jun11-Jul8. The move so far is a double zigzag tied together by that X wave; it could certainly morph into a triple zigzag. If so, this X may look like that X - about a month long and relatively steep down. Then up we go in a third zigzag. The Obama Hope Rally lives!
3. The retest count is that we drop to retest at least the Nov08 lows if not the Mar6 lows, then bounce. The continuation is a long rolling wave into summer of 2010, and then another serious drop towards a major bottom in 2011. 
4. The P3 count is we crush through the Mar lows and head towards Sp400/Dow4K. If so this break should be a hope-crushing steady decline with occasional sharp and short rallies - like 1931.  

Let's look at the psychology of two periods to give guidance: the next two quarters, and next summer. Right now we are in a Grand Experiment (yes it deserves capital letters) to see whether massive global stimulation can get us out of the deflationary depression that inevitably follows a credit bubble. Greenspan successfully made this magic work in 2002-4 to create the Greenspan Indian Summer, a reflation that put off Kondratieff Winter but led to an even worse bubble than 2000. Indeed, it could be said Greenspan postponed Winter for 20 years, since 1987. Yet since 2007 the psychology has broken and the Bernanke Reflation is not working, at least not to change behavior in the private sector. At least not yet. It might change. As more green shoots pop up, the psychology could flip. Hence it has been rationale for market participants to push up on hope, and stay emboldened as more green shoots appear.

Over the next two quarters we should se a positive Q3 report (3% or so) and a somewhat positive Q4. Consequently the market could quite reasonably watch as economic news comes out, and stay buoyant hoping for upside surprise in Q4 and Q1. After all, economic growth often has the same starts and stops as market patterns. Hence option (2) above is quite reasonable. Some negative tea leaves recently have spooked the market; if more positive news begins to appear about the Xmas selling season, we could zip back up. This is not the market watching news so much as extrapolating future earnings.

Over the longer run a different psychology comes into play. In Hope and Disillusionment in Obama I described how he will inevitably disappoint his supporters who have dumped too broad a range of hope into his lap. Now, he has pushed hard for a more radical agenda than independents hoped, so he has already lost them. Next summer he is likely to lose his more radical supporters as he fails to get much more of his agenda passed. (Change freezes in an election year.) The dynamic of the election of 2010 is highly anti-Obama today, and while this could change (as they say, a year is a long time in politics), I expect the politic dynamic to ratchet the market dynamic. Hence scenario (3) is also quite likely.

I am not in the P3 camp. Serious economic chickens will come home to roost over the next two years, but not right away. Sure, option ARMs and HELOCs will be reset over the next two years - see chart. Various steps may be taken to delay this, but it is too large to put off. Also, the Fed needs to unwind its financial support for commercial paper, mortgages, and so on, and this will happen over the same period, but gradually. Hence it seems more likely markets meander for the next two years rather than drop precipitously.

In the short run, watch for whether we have a trading range off a shallow drop, or a sharp but relatively short month-long drop. Once past that we can see whether we stay in the relatively bullish scenarios (1) and (2) or the more bearish (3) and (4). 

The Japan 1989 Analogy

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

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

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

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

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

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

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

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

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

Cash4Clunker Hangover

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

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

Is The Stimulus Working?

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

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

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

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

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

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

Sigh. Oh for a better economic discourse! 

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

He does state his economic view near the end:

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

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

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

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

Fed Repairing Its Balance Sheet: Not Inflationary

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

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

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

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

Treasury Yield Dive Signals "Barbell" Market

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Last Chance to Get Out?

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

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

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

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

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

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

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

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

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

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

Play Global Remembi: Dollar, Gold, Treasuries

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

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

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

Doug Short on the 1938 Comparison

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

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

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

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

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

Which one sounds like today?  

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

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

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

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

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

Yves on Presidential Approval Rankings and Stocks: Are They Linked? UPDATED CHARTS

This is an interesting take on the sinking poll ratings for Obama, as compared with other Presidents. The backdrop is a revolution in macroeconomic thinking that is underway, towards the Behavioralist View, that social mood and behavior drive the macro world, not the machine-like parameters that make up the myriad of macroeconomic models.  Man is not a perfect economic being who responds to Aggregate Demand and Money Supply, but a fairly irascible actor which, en masse, drives the macro world.  Just as Einstein never really leapt beyond the Classical View of physics, even though his Nobel came from his Quantum paper (on light as a particle not a wave), so too Keynes and Friedman never really left Classical Economics, constantly seeking Equilibrium in their great works.  But how is a market efficient in any macro sense, when on one day in Sept 2008 it can be high and the next day fall precipitously?  Or, as it did in 1987, seem to plummet out of the blue?  Where is or was the Equilibrium, and where did it suddenly go?

Yves explores whether the same underlying social mood is somehow driving both the equity markets and Presidential polls.  Enjoy his analysis.  

Dollar Rocks UPDATED

Huge move in the Dollar Index today signals a major Dollar bottom. Also a huge move in Treasury rates up after two bad auctions this week. Half a $Trillion to be auctioned over the next two weeks - heretofore that would have been over a whole year, and an exceptionally bad year of deficits at that. S&P hit the 38% retrace, and Dow came close enough. Dumb money coming into stocks. I still expect a run to Dow10K by end of summer. Market has not had the expected pullback but watch for it next week. Unemployment dropped slightly although I expect the market to realize that if it weren't for the long unemployed dropping off unemployment it would meandered up to 9.7%.  

UPDATE 8/10: This chart gives a good perspective, courtesy EconomiPic.  Unemployment got worse by 250k jobs, yet as a percent the unemployment rate got slightly better.  How come?  Because the total labor pool shrunk more than jobs, causing a net gain. As explained in The Big Picture, the chart shows that the total labor pool as a percent of population has been falling since the 2000 peak, meaning people are stopping looking for jobs since the dot-com bubble peak, and more so now as benefits run out and they disappear from the reported stats.

UPDATE 8/8: Friday's STU has pulled back from any targets for the potential B wave pullback, but does expect it to be sharp and quick.  The Market Ticker has a good look inside the unemployment numbers.  Simply put, the total US employment continued to drop, so any apparent downtick in unemployment is not due to fewer unemployed, but fewer reporting for benefits as they drop off the extended time period.  Zerohedge has a good analysis (and great comments) on why the Fed will soon end Quantative Easing (QE).  Bernanke has signaled that in the last month with his 'I have an exit' speeches and OpEd's. He traded the high quality reserves last fall for bank junk, and will likely justify his QE as primarily to repair the quality of the Fed's reserves. Next week we may see this signaled in the FOMC meeting.  If so, the USD should run to Dollar Index 90 as rates of the 10 yr crest 4%

Newsweek Declares Recession Over!

This rash call from Newsweek will probably make the future headlines, like the 1948 Chicago Tribune's "Dewey Beats Truman!" or the 1980 Boston Globe's "More Mush From the Wimp!" leaked internal headline on a Carter editorial.  After the dead cat bounce off the 1929 crash, the punditry from the President on down declared that recession over, too.  Yet before we declare the top in (ie Newsweek as a contrary indicator), we might wait to wait for Obama to make a "Mission Accomplished!" speech.

What the indicators Newsweek is counting on might be signaling is a W shaped drop.  We have had the first down wave of the W, and might have a slight uptick in Q4 or Q1 where GDP goes positive before we have the second down wave.  This would not be due to a sustained reversal but the stimulus payments kicking in and putting the economy momentarily on life support.  It would fit a stock market drop off an Aug or Sept high, than a seasonal rally from Nov to May riding the rising trend to GDP reports from Q3 and Q4; but then a sinking slide after a Summer of Disillusionment in 2010 as the realization kicks in that we are still in a sinking economy. 

Why China Cannot Lead Us Out of the Great Recession

John Mauldin picks up on the China Bubble thread that I have been on for the past two weeks. He quickly dismisses China as being able to drive the West out of our Greater Recession Depression, since "China is just 7% of global GDP. Even if they grow at 8%, that only adds 0.5% to global growth, and it is likely that we will see global GDP shrink by 2.7% in 2009."  See chart.  He adds: "China is roughly as big as the other three of the BRICs (Brazil, Russia, and India) combined. Russia and Brazil are in recessions. Also, note that it will be decades before China's economy is as big as that of the US, even with growth of 5-6% a year more than that of the US." 

He notes that China's stimulus is 1/3 of GDP, equivalent to a new Porkulus bill of $4.5T by the US.  (This is still paltry compared with Japan's stimulus in the '90s, of $6.5T, more than their GDP; it did not work but saddled Japan with stifling levels of debt.)  The Chinese stimulus is going out as bank debt.  Mauldin quotes from Vitaliy Katsenelson's recent Foreign Policy magazine essay:

"This growth will result in a huge pile of bad debt -- as forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple: There is no miracle in the Chinese miracle growth, and China will pay a price. The only question is when and how much."

Simon Hunt adds that:

"Money is cheap with loans and credit freely available, so much so that China risks developing new bubbles in the stock and commodity markets and real estate. Speculation is based on the simple premise that prices must rise. Foreigners as well as domestic participants are feeding this frenzy, especially in metal markets.

"The frenzied loan and credit growth is unlikely to be cut back until the fourth quarter at the earliest. It is not this year or next which worries us, but post 2010. What will China do when the world economy gets hit with its next big leg down?"

He sees a staggering amount of copper (as one example) being stockpiled.  Mauldin describes it as China engaged in hiding the Old Maid (the USD) by stockpiling and dumping their USD reserves on other countries, Australia in particular.  In the card game, whoever ends up with it loses.

The Problem With Breaking the June 11 High

There is a lot of commentary on the prior few posts about Neely having to change his count if the Jun11 high is exceeded.  Here is what he had to say about it this morning (emphasis added):

It’s amazing the number of emails I’ve received lately trying to talk me out of my bearish scenario or asking what it means if June’s high is exceeded (which means they think I’m wrong). That alone favors my preferred scenario, but a move above June’s high is not a good thing, it’s a horrible thing. It means the bear market will last for years and economic conditions will get much worse than originally thought. 

This would put him in more alignment with Prechter's view, of a bottom in 2014 (+/- a year or so, with 2012 at the earliest); or if the government continues to intervene like FDR did in the '30s, this might stretch even longer, to 2017 - 2020.  Currently Neely expects a rapid drop to the long term bottom, maybe as early as Jan 2010 (six months!). 

As an historical note, the last three deflationary depressions that followed a credit bubble all ended their first phase down in around 3 - 4 years: 1837-1841, 1873-1875, 1929-1932.  Hence 2007- 2010/11 would have been consistent.  This reflects the rapidity which a market can adapt to changing realities.  A lot of ink has been spilled over why the 1930s lasted so long; but it was clear that by the time FDR took over in 1933 a recovery was in progress, and a quite strong one (given how far we had fallen).  The policy question is why we went back down. 

• Keynesians such as Krugman continue to argue that we did not stimulate enough, and that while FDR caused the recovery due to deficits, an attempt to go back to normal in 1937 (due to the apparent recovery) by lowering the deficit sent us back down.  This argument is relatively easy to disprove, since the last two Hoover budgets (FY32 and 33) got us to around a 5% deficit per year, and FDR's first three budgets continued at around that level.  In what respect were Hoover's stimulus insufficient and FDR's heroic?  And even in 1937 spending continued to go up, albeit at a lower pace.  More likely something else was going on, and a recent UCLA study found it in the ill-guided attempts by both Hoover and FDR to keep wages and prices high in the face of deflation.  This prevented the market from clearing; high wages kept unemployment high, and high prices kept capacity underutilized.  In any event, the record of massive stimulus is that it does not work and may deepen the problem if done poorly; just look at Japan twenty years after their credit collapse in 1989. 
• Monetarists such as Bernanke continue to argue that the Fed failed to provided sufficient liquidity.   This comes out of Milton Friedman's trenchant work that blamed the prolonged and deep fall in the '30s on failures of the Fed.  Yet in the heart of the recent crisis, Friedman's co-author criticized the policy reaction as fighting the wrong war: the problem back then may have been liquidity, but the problem today is bank insolvency.  Liquidity helps avoid bank runs; but does not repair insolvency, which is due to overleverage and bad loans.  At 30:1 leverage, a mere 3.3% of bad loans means you go insolvent.  In this case, as asset values collapsed (real estate in particular), banks found they had insufficient collateral for their loans.  The problem is much worse in Europe than here: while our bank assets (loans) are around 2:1 of GDP, according to John Mauldin it is 4:1 in the Eurozone, 5:1 in the UK and an incredible 7:1 in Switzerland.  We clucked at the "zombie banks" in Japan after their 1989 collapse, and yet have left our money center banks in the land of the living dead. 

Yves popped over some thoughts which he might prepare in a guestblog later this week.  He notes that markets outside the US are not confirming this rally, nor are currency or bond markets. 

Regardless, if we break the SP956 pivot point, look for an enthusiastic piling on and a sharp rally.  We almost hit it today.  Potential turn dates for a summer peak center around the second week of August, after the coming lunar eclipse in the first week of August that follows an Asian solar eclipse this week.   That eclipse cuts across a huge swath of people - around half the world population - and may cause superstitious panic across India and China. A prediction of doom by an astrologer in Myamar (Burmese) may compound the normal skittishness that comes with such an unusual and rare event.  This will be a fairly long total eclipse that starts at sunrise in India, runs across Shanghai and southern Japan, and continues out into the Pacific. 

I do not expect bank failures or if you like the second wave of the crisis that quickly, but as the next wave of real estate problems begin hitting - option ARMs repricing, HELOCs and other second mortgages coming due, commercial real estate collapsing - we should see an eclipse of banks beginning in Europe and moving around the world.  Ironically it might start in Austria, which is over-invested in Eastern Europe, where bank problem first began in earnest in April 1931.  Austria as a country defaulted, which was hugely embarrassing to the former head of a major empire.  Others followed, including England going off gold in September, also hugely disruptive since they had managed the reserve currency for the world for over 100 years.  Germany repudiated their war reparations, and the dominoes fell rapidly after that.  The US to its credit (literally) held out the longest before FDR devalued 40% when he repriced gold from $20 to $35/oz.

If we ponder the US response to the crisis, it is not that compelling.  Banks remain zombies.  Various attempts to deal with bad loans have foundered: the initial mortgage relief in the summer of 2008 has had no apparent impact; the original TARP was changed quickly as it failed to buy out any toxic assets; the recent PPIP proposal is a null set so far. The major initiatives of Obama - healthcare, global warming and education - are orthogonal to the financial crisis and should make it much worse due to incurring massive new debt and new taxes.  The Fed seems to have hit the wall in new initiatives.  And overall we seem to be in a high level of denial over the problems, seeing green shoots where none exist and jawboning to increase consumer confidence.  We have even spent for billboards to attempt to argue that the recession is soon to be over, as if touting the fantasy will make it a reality!  Shades of President Ford's hapless Whip Inflation Now! buttons of 1975. 

At the moment we see upside surprise in earnings, which may fuel the sharp summer rally.  This appears to be due to rapid cost reduction not improving business conditions; or in the case of Intel, due to the China bubble echo driving more chip sales. TI reported a 56% slump, although painted a rosy outlook for Q3.  And so it goes this week with more reports tumbling in and showing optimism amidst severe results. 

We night even see a blip in GDP to positive in Q4 or Q1, especially if stimulus spending gets released.  (Other than tax credits to poor folk, it has been largely held up or entangled in red tape.) 

Neither of these positive indicators are suggestive of a trend change.  Instead, they will be the calm before the second wave of the storm.

Yves on Starving The Bull

Yves will be on Bloomberg Radio at 1500 ET today. 

Why a Second Stimulus Means Lower Stocks

“Starving the beast” and starving the bull might have some similarities.  Republican credo believes that starving the “beast” of government from revenues will effect change in public spending. It will lower spending thus making the government smaller.

I am of the school that the economy is actually worse than imagined. That a second stimulus is strongly desired but can only be attained under stress conditions. A retest of the March’s low in stocks would probably be one of those requirements.  It is for that reason that I show the repos recent drop to attest that the invisible hand is being removed from the market.

I also show a different view of my count on the Dow.  It is filtered to remove some of the manipulation at works behind the curtains.  You arrived to it by a summation of many markets. In the bush administration, money was spent like it was going out of style. It now looks that this administration is on track for outdoing the Republicans. To balance this large tax increases are coming your way?

Deficits do matter and the bull knows this.

Yves Lamoureux, Investment Advisor, Blackmont Capital Inc.

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

Yves Goes Short after Two Repeated Sell Signals in His Liquidity Index

Yves comments that "The short position is very rare for me, but follows two repeated sell signals on my liquidity index.  We had in late June 2007 the first sell signal in the liquidity  index, but it stayed on sell on the bounce back up to 14,000.   Then the second sell signal came on the 3rd of October.  More recently we had the first sell around early February 2009.  The market dropped on cue but my index stayed on sell on the rebound, just like in 2007;  but recently generated a sell again in late June.   Usually that’s good enough for me to go short."  Here is his analysis behind his sell signals:

Why you should get ready to be marked (down) to market ….

Slowly but surely this administration is realizing that they will need a second stimulus plan.

The government is now facing criticism that they acted too slowly. I do not believe that they will make this mistake again. I therefore subscribe to the idea of a second stimulus plan to be announced before year end. High frequency traders have given us hope of a fast recovery. However there is so much that the plunge protection team can offer. It is with this in mind that one can appreciate the recent acceleration in repurchase agreements. These are loans originated from the Fed and used by big investment banks to buy and sell stocks. The invisible hand so to speak started to buy massively around the month of February. Combined repos jumped from about 9.8Billion to a recent high of over 1.4Trillion. Rarely have we seen such an enormous injection of borrowed money in such a short lapse of time. The fascinating relationship held at over .86 correlated until the recent crash. They dropped the ball so to speak because the pressure at the gate was too strong. We have started to see a removal of loans and the uprate had become unsustainable by any standard. It confirms our view of a downtrend for stocks.

We have initiated short positions since the 29th of June at around 8530 on the Dow. We believed then that it was a wave 2 in this developing move. We also indicated that we prefer to short the secondary top.

The talk of inflation has us disagreeing since we are solidly in the deflation camp since early 2007. The money supply is actually shrinking. The stocks are behaving as they should and the 30’s are a perfect example of flows and its impact on the stock market. We are following this with interest since the turn up will signify a bull advance. Banks are however not lending being in repair and survival mode. Once free to lend who says borrowers will borrow?

The new normal seems to be toward savings. But really who are those folks in the media/government trying to fool? The new normal is all about paying back your ridiculous amount of debt. You end up with little or no savings. This process will continue and has to effectively render balance sheets clean of leverage.

The government is doing the exact opposite of this trend:  it is taking on more leverage. At this juncture it was perhaps out of necessity to save the patient. The next injection /stimulus are expected in my opinion to have a lesser impact for each dollar spent. That would also be true for a tentative third stimulus. It all seems so clear that we are heading toward big cuts in spending and increase in taxes at a time where assets are still deflating.

One look at the recent new drop of the Baltic dry and you realise that China will not bail us out. On the contrary, I think China will see riots emerging.

The administration is fighting every market forces to let price discovery dictate the economic direction. Taking fast pain would really open the doors to a faster recovery. Let capitalism win in a capitalist society.

Yves Lamoureux, Investment Advisor, Blackmont Capital Inc.

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

Yves on the Greenshoot-Fed Sacred Fed Bull Died Fat and Happy

Or, how wave 4 is rolling over…

 
The obvious sometimes stands clearly. You face it and prepare for the outcome.  We stand at a juncture that would have you believe  in the coming outcome. But wait - lets take a quick journey into what seems to dominate my observations and you can determine the best course of action for yourself.

We have continually watched monetary aggregates and they are contracting. You will notice from the M2 chart divided by the monetary base a drop. This is significant and comparable to the 1930’s. The complaint would be the same as to banks sitting on a monstruous pile of cash but not lending it. The tradional behavior of the consumer to start saving instead of buying also compounds this problem. M2 decceleration cannot lead to inflation. The Fed cannot force the banks to lend and monetizing bonds will continue to aggravate the only asset  that people have en masse their household. An inflationary outcome is tantamount to financial hara kiri. The bonds vigilante will strike hard and mortgages will keep rising, killing any stabilization that is in process. The impact of the recent rates hike will be felt in the stock market in the next few months.

Given the choice to protect housing or stocks, the Fed will surely realise to go the real estate way. A liquidity trap as such is deflationary. The money base also doubled in Japan after the stock bubble collapsed and to no avail the economy kept contracting.

Are bonds finishing the C wave or are they in complete fast and furious 3rd wave?  This is the question we did pose in the article May 2nd. If the Fed gets it, they stop buying and monetizing the debt then it is a C wave.  

On the next graph, the spread of the discount rate to the rate of the long Treasury has never been so wide.If you had bought on a few occasions where the spread was wide as 4% between both, the resulting trade would be a winning one on most occasions.

Unless you are suggesting the Fed raises rates by about 2% over the next 24 months then buying treasuries would not be a great investment. On the other hand if you believe that there is little room for the Fed to move, then long bonds are an even better bet. There is a fine line that the Fed is walking and a slight tilt of strategy can undo with great dammage what they have built so far.Mild deflation is the preferred outcome and necessary one.

We have sold all of our inflation hedges that we owned for the last 2 months.We are turning to deflation trades or unwind. Possibly the greatest misunderstanding in the lift off of all markets singularly correlated is a function of investment demand and not real changes from supply/demand. Realise that all markets cannot possibly beat to the same rhythm for a prolonged time. Those correlations will unwind and support real bull market where there is cause for that.

We have held for a while our position of a rare 4th wave at this juncture. The last move up does look impulsive but is part of an ABC ABC 12345 pattern. The pattern still holds to the rules established. The implication is for a 5th finishing wave that will complete a bigger A wave down. The general area of the March low is the objective. It could be truncated or extended. I will be looking for an equivalent 3 standard deviation in sentiment measures to call the bottom if that was to occur. We are looking to short the market on the wave 2 of 5 and not before since window dressing could still be part of present activity.

The bull market ate too many greenshoots and died of natural causes.  Often bull markets roll over from their own weight.

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

Bernanke's Operation Twist II Has Failed

Last Dec the Fed hinted at Quantitative Easing (QE), where among other actions the Fed would print money by buying bonds in the open market (creating money by putting fresh Dollars into the seller's bank accounts without any offset somewhere else).  Last Mar the Fed Chmn Bernanke announced a specific plan of $1.2B of open market purchases, of which $300B would be Treasuries (later clarified as $1.25B of mortgage-backed securities and $300B of Treasuries).  His stated intention was to lower interest rates by paying above market prices for the bonds (higher bond price results in lower interest rate).  He is about half-way through with this plan, and yet interest rates have risen quite a bit, with 30-yr mortage rates now around 5.8%, much higher than Bernanke's 4% target.  The WSJ will report tomorrow that the Fed is reconsidering this method of QE.  As the article notes: 

Yields on 10-year Treasury notes fell Thursday to 3.862%, after Wednesday's brush with 4%. But they remain sharply higher than March's 2.5% ... If government-bond rates rise too much too fast, they could short-circuit a recovery by choking off consumer and business borrowing and spending.

What is interesting about the rest of the article is how confused the punditry is.  Are rates rising due to inflation fears?  Or a recovering economy?  Or foreign buyers swapping down to short-term bonds?  (In an interesting juxtaposition, a recent WSJ columnist recommended bying shorter term CDs to manage the uncertainty of inflation vs recovery risk).  Or is it due to the bond market calling Bernanke's bluff?  If the latter, Bernanke is about to blink. 

I find the confused rationale for rates rising a bit much.  The Fed watchers need only look at history to see the limits of the Fed's ability to manage rates in this fashion.  I have written before on Operation Twist, an ill-fated attempt by the Fed to use the same QE technique to keep rates low.  It flopped - rates rose during the whole time of Operation Twist - and it left a horrific legacy: the Great Inflation of 1966-1982. 

So why are they really confused?  Prechter put out one of his better EWT's tonight, laying out why the fears of inflation and the hope of recovery are all about to be washed away in the coming events.  Worth a close read.  The current circumstance is an example of where his Socioeconomic viewpoint is helpful to cut through the confusion.  Man is a herd animal and the herding instinct is strong, but split into two cmaps: inflation vs recovery. The stock market counter-trend rally has emboldened the bulls, and sentiment is rising to expect a recovery just around the corner.  Same sort of psychology marked 1930.  Hence the confusion is really over which herd to join: the ones fearing inflation, or the ones expecting recovery?  It is NOT over the soundness of QE, which has failed when attempted previously, by the Fed and others (such as Bank of Japan.)  And now is another example of the Fed's impotence. 

A Cluster of Historic Firsts Presage a Final Stock Surge

Monday should be a fun day.  Consider this cluster of events:

1) GM is the first Dow stock to go bankrupt.  As Friday's STU begins:

"Monday will be a historic day for the Dow Jones Industrial Average. It will mark the first time in history that a Dow component declares bankruptcy, which is what is purportedly scheduled to occur with respect to General Motors. The impending bankruptcy declaration shouldn’t be a surprise to EWFF subscribers who’ve been reading us for awhile.

[They have been predicting this since 2002] ...

"GM stock has been in the DJIA for nearly 84 years, second only the General Electric. But come Monday, Dow Jones and Company, the keeper of the venerable index, will have to remove the stock, if it does in fact declare bankruptcy. Will it be the only change and what will replace it, or others? We obviously don’t know but some astute analysts think that since the Dow is price-weighted, and since GM is less than $1 (having a negligible impact on the index’s daily change), whatever replaces it will create a more volatile stock index. We shall soon see."

2) The Treasury Yield Curve got steeper than any other time on record. 

Obama's grand plans are already running afoul of the bond market.  We have come out of three fairly disastrous days for Obama.  The bond market has not cooperated.  Long bonds have risen 1.4% (10-yr) this year, as foreign buyers fear hyperinflation, and have moved to the short bond.  Rising 30-year rates have pushed up mortgage rates to 5.5% and higher, killing any vain hopes for a housing recovery based on more credit.  The Fed has been buying agency paper and Treasuries in an effort to drive the mortgage rates down to 4%.  No chance of that. 

We are seeing history repeating.  In Clinton's first term 15 years ago, he tried to push through 'stimulus' bills and nationalization of healthcare, and the bond market did not cooperate.  He had to back off, and for four years (95-98) he was as good a Republican President as we have had!  Better than W turned out to be.

Will Obama see reality?  Not at all clear;  I expect him to rail against it first.  He will continue to see green shoots amidst the danger signs.  Oddly, his required optimism may jettison any second Porkulus bill, and we might see an improving GDP in Q3 (at least, not down as much as Q1 or Q2) as the first Porkulus finally begins to take some effect.  Avoiding more debt is a good thing, so we might thread a difficult needle and at least not worsen the plight.  But he should have problems in Congress with his spending schemes, including healthcare, given the difficulty of funding what he has already put into place. 

The chart from SafeHaven shows the long term trendlines of the long bond, and the spike above and now rapid fall.  if the long bond breaks the bottom trendline it will confirm a change of trend.  Rates will continue to rise.  The STU has predicted rates to exceed 4.6%, which they just broke, and now seem them rising at least to 4.8%.  But if fear of hyperinflation and avoidance of funding the Obama deficits has set in, the long bond may truly break down. 

Normally bonds do well in a Kondratieff WInter, but normally the government does not due such a large and long-term spending with huge deficits.  This time the Treasuries may have already had their low rates. 

3) The deficits are now beginning to be seen as unfundable.  We either need to raise taxes 60%, or debase the USD in half.  Both are disasters for the US economy.  Or, we could wake up and cut spending!  Most likely, we are facing hyperinflation after deflation runs its course.  John Taylor, the respected economist from Stanford, has calculated how bad an inflation will be needed to get deficits back in line:

"To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

"Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

"[An] 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating."

4) We had one bizarre spike at the end of trading on Friday, suggesting a huge short squeeze.  See chart, courtesy The Market Ticker.  

Note the volume spike in light blue.  Huge!  Karl Denninger believes someone was liquidated out of a big position, since as a trading strategy this is nuts - probably cost an extra $1.25M to buy in such a fashion.  This may portend a bull rush into the S&P, and the start of the Final Surge. 

5) Oil has spiked up even though demand has not. 

This means the oil rise is an echo of the type of speculation which marked the huge rise in 2008.  A nice set of charts from the Ellott Wave Chart Site suggest the rise is over-reaction to the drop in the USD  They expect both trends to reverse - the USD to bottom and Oil to top. 

The USD broke the important 80 level on the Dollar Index.  The STU points out how sentiment is bullish on the Pound, usually an indication of a nearing trend change (in this case, USD bottom and GBP top).  You might think with all the fear of hyperinflation in the bond market, the Dollar is toast.  But it doesn't work like that.  The hyperinflation is off several years, if it comes at all; first we have to face up to growing deflation, which is now visible in all the Euro economies as well as the US and Japan.  As all major countries try to stimulate their economies with excess debt, all major currencies will weaken, and the USD is likely to weaken the least - and hence rise!  

-----------

What is an investor to do? Perhaps surprisingly, the wave count says we are about to see the final surge of this counter-trend rally.  Several weeks ago, we had a cusp point: would the market spike up, muddle along, or fall hard?  It muddled along, and this suggests a final spike is in front of us.  In wave terms, we have a pretty good ABC 3-wave up off Mar 6, with a triangle B wave through most of April.  After the C leg, we have had a second period of a trading range for several weeks, which suggest an X wave connecting two ABC zigzags.  This is now the preferred count of the EWFF and the STU.  Their opinion is informed by sentiment readings which haven't gotten bullish enough to reflect the end of this rally.  They give a potential turn date of mid-July, which matches well with some of the pretty astute comments to my prior post.  Hence a six-week runup. 

A lot of ewavers see a triangle in this X wave.  The STU is not convinced, but it remains one of the prime wave patterns.  If so, it should end with a sharp spike upwards - and this might happen Monday, a continuation of the final trading moments on Friday. 

Neely in contrast is a bit ambiguous,  He has been on and off again about the Final Surge.  He expects a huge shorting opportunity to emerge; the key is when.  If you are interested in playing the drop, I would recommend you try out his service.  It will be a tricky thing, since it may have several false starts as this market goes through a topping process.  In any event, he leaves open the possible Final Surge in his charting.  

Hence expect a summer rally at least into July, and maybe into late August.  It might start Monday, the first day of the new month, as we saw a similar strong buying pattern at the start of May and the start of April.  The wave pattern allows a rollover (down) Monday before the Surge.  Watch, and enjoy the week.  Happy trading!

Treasury Weakness Presages Failure of Bernanke QE Policy

The US has to borrow $1T over the next four months.  And Bernanke wants to keep mortgage rates low to spur a housing recovery, hence has announced Quantitative Easing (QE), the purchase of Treasuries and other US Agency Debt by the Fed directly, which has the effect of printing money, at a premium price, which has the effect of driving rates down.  How is it working?

Well, this dog ain't hunting.  At today's Treasury auction, the yield curve got to the steepest in history.  "Benchmark 10-year notes were down over a full point and yielding 3.68 percent, up 12 basis points in just one day, having risen nearly 1.25 percentage points in just six weeks. ... As the selling deepened, the 30-year Treasury bond fell nearly a point, pushing its yields six basis points higher to 4.56 percent."

As CNBC reports: "Spreads between the 2-year and 10-year widened by over a dozen basis points on Wednesday alone.The 10-year saw its yield move above 3.70 percent, after trading at 3.55 percent the previous day." 

The Fed is being gamed by the bond market: 

The Fed, meanwhile, has been an active buyer of mortgages in an effort to keep rates lower, and until the last couple of days, selling in Treasurys did not ripple into the mortgage market.

On Wednesday, mortgage spreads widened sharply. In the last couple of days, there have been some dramatic changes.  For instance, David Ader of RBS said a Fannie Mae mortgage with a four-year duration has seen its duration extend to 5.7 years as rates moved higher in just several days.  To hedge that move, traders would sell long-dated Treasurys, forcing yields even higher.

(Mortgage bond dealers often sell Treasurys to hedge against the risk of early repayment by borrowers, which alters the overall duration of the investor's portfolio.)

The 30-Yr fixed mortgage jumped 30% to 6.5% in one day.  This should correct back down, but the moves in Treasuries and mortgages are absolutely huge.  

Speculation is that the foreign holders (including China) were buying the 2-year and selling the 10-year bonds.  

As the long rates rise, to make QE work, Bernanke may have to commit $Trillions over the next few years.  Does this make sense?  It risks hyperinflation,  Alternatively, the bond market is calling his bluff and he will be out of tools to try to keep rates low  They will have to rise to attract investors to fund our deficit. And this bodes very poorly for stocks, let alone any recovery of the economy. 

Powers That Be Declare Victory as Market Starts Fall

I am over in London, and saw several articles celebrating the recovery (in the FT, in the Euro WSJ, and so forth).  At the same time other sections asked whether stocks were now too high. A funny juxtaposition.  Dollar, Dow and other indicators all reversed today.  Tonight's STU says the rally itself is not over, but time for a major pullback.  The pause that refreshes. Others are less sanguine. 

In the meantime the secured lending field is shell-shocked over the strong-arm stunt pulled by the Obama Administration in the Chrysler bankruptcy.  Even back in the Great Depression, FDR did not get away with this.  Obama has pushed the secured lenders down below other interests.  Now what is the value of a security interest?  Financial markets continue to be stressed; why lend even with collateral to a company in the clutches of the Obama Administration?   

The means of production are being turned over to their "rightful owners," as explained by Obama himself.  In the case of Chrysler, those rightful owners are the proles in the form of UAW getting 55%, the Euro Zone in the form of Fiat getting 30%,and the Government taking the rest.  American lenders get squat.  

This bodes very poorly for any recovery from the private sector. Some of my favorite commentators are freaking out . 

Yves on the Flight To Safety in the Dollar

Interesting market in April.  All the gains were on the first two and last two days of the month.  In between it can count as a triangle, according to the STU.  Their ending diagonal is gone, but the triangle looks sound.  Typical to have a triangle in the penultimate wave (B or 4).  Suggests a final five-wave C ahead.  Other pundits saw a rising bear wedge, but if so, we should have a sharp correction.  Instead, we shot up last week.  Perhaps that is a false break; but if so we should have serious down action early this coming week.  Neely's count is a bit confused; read the many comments to the last two posts for a very good assessment of Neely.  In any event, Neely expects a sharp rise in the weeks ahead.  We still have a ways to go to hit the normal 38-50% retracement levels.  Here is a good chart in the S&P with those levels. 

Yves has also been active.  He still holds to the current wave as a running flat wave 4; but if it pops well above Dow8400 he will have to reconsider.  He was on Bloomberg Radio last week, and has a view on the US Dollar as a haven in a flight to safety.  Recent trends in the bond market suggest this may be ending.  Yves had been an early predictor of deflation and a bull on the USD, but now he says to hold Yen.  Worth reading below the fold.

Deflation is the Green Shoot Sprouting

Obama is trying to read the tea leaves and sees "green shoots of recovery" poking up.  Today Neely sent out a bulletin to note that deflation is finally showing up in the stats.  Despite the huge attempt to reflate the currency by Bernanke, and the financial stimulus, the destruction of credit continues unabated.  More on this here and here.  And Prechter of course has been saying since 2000 that the Fed will not be able to stop deflation.  I will repeat what I have written previously, due to its seminal importance: 

I reread Conquer the Crash recently, and was blown away by Chapter 13, which lays out why the Fed cannot prevent deflation.  While Prechter has provided his thinking to his subscribers, I asked him for permission to distribute Chapter 13 to my readers, and he graciously agreed.  I would urge you to download and read Chapter 13, excerpted from his book, especially when you see in the news and columns drivel like "no one could have predicted this."  They could, and they did. 

What Prechter wrote in 2000 is pretty much what has been tried for the past 18 24 months, to no avail.  How can we expect bailouts and reflation of under $2T to forestall a credit debacle of $52T?  Global credit grew $24T over the Greenspan Indian Summer period on a paltry global GDP growth of $10T, so at least $14T will come crashing down; plus we already were highly over-leveraged across the global economy in 2000. 

Once we accept that the party is over, we can begin to get serious about how to reset the economy.  A lot of it is time and taking the pain.  And we should not forget the wisdom of FDR's Treasury Secretary Henry Morgenthau, who testified in May 1939:

"We are spending more money than we have ever spent before, and it does not work. ... I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. ... I say after eight years of this administration we have just as much unemployment as when we started ... and an enormous debt, to boot."

I don't think he was any more a Keynesian. 

Yves Sees The End of an Era, The New Start

Yves Guestblog:    An ending era and a new start….

It is about time that we turn the page of this horrible episode of greed. From one bubble to the next, we had lived beyond our means.  The stock market being the great equalizer has cleaned up the slate. We will have soon to be completed a brand new start.

Perhaps fewer promises from the current administration and more decisive actions are now required.  Making the hard choices now makes us suffer less; if any lessons had been learned from the Japanese meltdown,  this is it.

Things better get in motion soon. Capital flows are fast paced and so is entrepreneurship.  (Details, recommendations and timing below the fold.) 

What We Got Here is a Failure to Communicate

Yves is back with a new signal based on the policy bets now being made by the Obama Administration.  Is the Obama Hope Rally on?  Or are we about to pay a heavy price for Obama's economic illiteracy (courtesy of Gerard Jackson's latest post on SafeHaven)?  Read on  ...  and you can hear more of Yves on Bloomberg Radio Wednesday 11th at 16:00 NYC time.

Ground Hog Market Still Spooked By Shadows

Bulls make money, Bears make money, but Pigs get led to the slaughter - market wisdom

This market is grinding both bulls, who eagerly await the Obama Hope Rally, and bears, who anxiously await the Neely 'biggest drop yet!'.  Or perhaps more precisely, is grinding the more piggish who have been in and out of positions.  The STU gives a concise summary tonight: "The current position of the stock market should be on the side of a milk carton. Still Missing; the rest of wave (5) that draws the major stock indexes to new lows (beneath the November lows)."  Their prime count is a little wave 2 of that wave (5) down, but the slow grind fits a continuation of the wave 4 from the Nov21 lows, with the market currently in leg E of a running triangle.  Both counts suggest the end is nigh.  Leg E's normally spike on news, and this next day or two should have a double bang: the Stimulus passes, and the Geithner save-the-banks plan is unveiled.  The put/call ratio is extremely optimistic - as the STU notes, at the same level of the October 2007 highs!  The herd expects the Stimulus to Save All of Us. 

Governments tend to be the slowest to respond, the last to see the trend; and to make their moves when the need has gone or the problem is something else entirely.  I posted a companion piece on my Politick blog to summarize a very good analysis that the government moves since 2007 have been solving the wrong problem, and hence largely ineffective.  The influential economists directing the government are fighting the last war, the Great Depression, as if they want to prove their academic theories could have worked back then.  This is shadow-boxing - what about the problems of today? 

The characterization of the Stimulus as a Porkulus may be apt.  The new administration is trying to pig out to serve its political constituencies rather than head off the Greater Depression.  They may accelerate and deepen the disaster.  Expect the market to pop on news and drop on reflection.  Then expect future Porkulus bills as this one fails to be more than a blip.  The slaughter of the Porkulii will come later, in the 2010 elections and then the 2012 Presidential race. 

A Depression is Not Just a Bad Recession

A Recession is when your friend loses his job
A Depression is when you lose your job
A Great Depression is when an economist loses his job

They are different in kind not just size.  The rule of thumb that a Depression is a Recession of 10% or greater drop in GDP is more misleading than helpful.  A Recession is typically caused when the central bank RAISES rates to cool off an economy.  A Depression is caused by a banking crisis that comes from the central banking LOWERING rates, spurring a credit bubble which leads to the banking crisis. 

Hope Giving Way To Anger

Prechter likes to say that during bear markets science gives way to magic and uplifting films give way to horror.  Then I read tonight's EWT and realized I don't need to go to the movies to read a really scary script.  In his latest he lays out the unbelievable destruction of world trade that is underway.  Baltic Dry Index (ocean shipping rates) down 96%. Exports from the Asian Tigers down 27% in Japan, 30% in Korea, and 42% in Taiwan.  Toyota dropping production in Japan (!!) by half.  Japan output in Nov dropped 8% from October (which annualized is 96%).  P/E ratios in the S&P at 22 are down more than 55% but are still much higher than at market bottoms (7 in 1932, 5 in 1982) - and the P will be chasing a falling E next two years.  Little wonder his downside targets for the S&P are much lower than anyone expects, so low he has paused in printing them.  And who else expects oil to soon be back to its wave 4 level at $10/bbl?

I received a fair amount of email asking, with the new President and all the hopefulness, where is the Obama Hope Rally?  Didn't FDR just dispel fear with his inauguration speech ("The only thing we have to fear is fear itself!") in 1933?  Well, he took over after four years of a 35% drop in GDP, many times larger than anything we experienced since 1950, and much of the excess from the 1925-1929 bubble had already been worked out of the system.  Interesting, the message board at Club EWI got a similar question - their answer is here. 

A more timely question is how fast will the feelings of hope fade?  If you have watched the news, you probably saw how Iceland has already defaulted - shades of Austria in 1931 being the harbinger of a series of country defaults.  The EWT also suggests that England may be soon to follow, for the first time since the Middle Ages, due to owning $4.4T of foreign liabilities and virtually no offsetting foreign reserves.  Now we have this shocking story from The Times Online: Riots in Iceland, Latvia and Bulgaria.  They tried to shut the parliment in Iceland.  The Times opines that we may be entering a period of unrest as early as this March. Although Americans seem to feel that Europeans are looking over at our debt binge and laughing at our profligacy, the joke is really on them: European banks were even deeper into the credit bubble than US banks, and the turmoil seems to be about to rock Europe before we feel it here.  Do they expect Obama to bail out their banks?

5 Myths of the Great Depression

We have all become Keynesians again, trying to understand how policy will work this time around. When this is all over, Keynes may be put to rest, along with Milton Friedman and Monetarism.  Austrian Economics may reign supreme.  Or not, depending how we muddle through the next five years.  Here are some key myths floating around that we would be best to put to rest as they lead to bad policies.

1. The Crash Caused the Depression.  Not really.  It had an immediate impact on growth, but by Spring 1930 we were coming out.
2. The Fed Failed to Act.  Don't know what PR firm put this out, but it is patently false.  The Fed dropped rates 2 days after the initial crash, again a couple of weeks later, and a year after it had dropped from 6% to 1.5%. It is fair to say, however, that the Fed could have done more to prevent bank runs of non-member banks.
3. Hoover Failed to Act.  Hoover was the great Policy Wonk of the '20s, and he was active all the way through.  Ever wonder why the Hoover Dam is not the Roosevelt Dam?  Hoover started public works programs very quickly when unemployment began to worsen.  When bank failures began in earnest in Sep31 Hoover first created the National Credit Corp., and when that proved inadequate, the Reconstruction Finance Corp. - the TARP of the '30s.  And he drove the biggest peacetime increase of Federal spending ever before or since - 50% over his four years.
4. The Gold Standard Made It Worse.  This is a complex issue.  In 1925 Churchill put England back on the gold standard, but at the pre-war level of $4.86 not the level gold was trading at, around $3.50.  Worse, instead of the pre-war gold standard, they came up with a hybrid system that kept the US on a strict gold standard but allowed other countries to cheat (run persistent deficits and devalue their currency).  In order to help England avoid a run on its assets, the NY Fed Governor pushed US interest rates to very low levels (while England held their levels high), causing the 1925-1929 credit bubble and stock market boom.  So you could argue the English mistake caused the bubble and the collapse.  We probably would have muddled through except in Sep31 England abandoned their gold standard, throwing the world financial system into the same sort of turmoil that rocked it in Sep2008.  
5. Keynesian Policies Got Us Out, or Would Have, Had We Spent More.  In May 1939, FDR's Treasury Secretary Henry Morgenthau testified: "We are spending more money than we have ever spent before, and it does not work. ... I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. ... I say after eight years of this administration we have just as much unemployment as when we started ... and an enormous debt, to boot."

If you rerun history, you see that British machinations forced a poor international monetary scheme on the world in 1925 and made the US foot the bill.  This caused the stock market bubble and crash.  Efforts to adjust from that may have worked, but in Sep 1931 England defaulted on its obligations and dropped their own gold standard.  Hoover, smart guy that he was, was finding his policies had severe limits in the face of a global banking crisis, much as Bush and Paulson have found with TARP.  FDR was able to get a reset to the economy, and we began recovering, but overall his policies were incoherent, and some downright destructive, such as allowing firms to collude on price and propping up wages by strengthening unions, which simply made goods too expensive and wages too high.  Unemployment rose, the economy slid. 

Santa Rally Needs Poor Rudolph

We seem to already be in the holiday trading season - lighter volume and a meandering market.  Where is Rudolph!  We are lost on the fog!  A special STU tonight suggests we are on edge of losing the wave 4 triangle count, which means Santa has already come and gone and we retest the Nov21 lows.  Yet despite the size of the drop today, the volume was light, so we wait to see what tomorrow brings.  It needs to rally at the open strongly to keep the Santa Rally alive.

Instead, look elsewhere for guidance.  The Fed seems determined to turn a credit crisis into a currency crisis - check out this chart.  This may be what Gold was signaling when it went into backwardation on Dec2.  Oil has broken $38 and may just plummet to $28 due to an estimated 1.8x the demand being still held in hedge funds and other speculators, all expecting a bounce back to $100.  The market may force them out of their positions before the bounce comes. 

Deflation Emerges, Fed in Trouble

First indications that deflation is really happening: PPI down 2,8%, CPI down 1%.  NYT:  "It was the steepest single-month drop in the 61-year history of the pricing survey and raised concerns about deflation as the economy contracts and demand for goods and services plunge." November is expected to be worse. 

The Fed has been somewhat desperately monetizing debt, having doubled its reserves from $900B to $1.8T in the past two months, replacing the high quality Treasuries with a mish mash of stuff.  Bernanke may still believe he can helicopter in money to reflate, but it ain't occurring yet.  Expect a rate drop in December, and then what? 

The Hopeless Triangle UPDATED

The STU tonight thinks leg e came and ended, fast.  Not usual for leg e to be such a stub, but Prechter has previously noted that while news does not move markets, it can jink it temporarily, especially in triangles, where leg e's tend to come on news breaking the prior move momentarily.  Perhaps news can also snuff out a leg e, as the fade off yesterday's rally off SP885 turned into a rout after Paulson's testimony this morning, where he acknowledges that the bailout structure is too slow acting, and he now will instead directly recapitalize the banks - a problem & solution noted in this blog after the post-bailout market meltdown.  The MSM of course reported it all wrong, focusng on Barney Frank having his own meltdown when he realized that Paulson really is about to use the extraordinarily broad authority granted in the bill. 

UPDATE 11/13:  Thursday's STU now sees the e leg as the Fri/Mon action, what had been the b wave of leg d.  Thanks also to dlu for pointing this out in the comments. The news event that moved it would then be the Chinese bailout.  Check my Nov13 post for more. `

So, where do we stand?  If we break SP845, it confirms that leg e and the triangle are done, and we are in wave 5 down.  If we bounce above SP845, then THAT starts leg e and it should go to SP950 (Dow9200) before wave 5 begins.  More analysis below the fold. 

The (Slope of) Hope Election "Rally"

Whither the Election Rally?  Historic election, huge leap forward for confirming that America is an idea, not a race or creed. Yet the market rises into election and fades the 'certainty'.  I doubt they expected McCain to win, so why the fade?  Profit taking?  Or, perhaps they listened to the acceptance speech, where he pulled back from his campaign promises, said his mission wouldn't be done in one year, or even one term, required we all (not just the rich) sacrifice, and defined the mission as 'remaking America'.  Well, a new CEO always comes in and says "this is worse than I imagined" to give carte blanche to changing things. 

What his speech really meant was: uncertainty.  Worse, Russia already began testing him, putting up nuclear-capable missiles on NATO's border this morning.  Hmm, the last time they did this was the Cuban Missile Crisis, when the tested Kennedy after he met Khrushchev, who figured him a lightweight. Do they figure Obama to be an empty suit?  And to compund his worries, will Bush unleash Israel to strike Iran's nuclear facilities?

Bear markets slide down that Slope of Hope.  Is the sudden Wall of Worry bullish?  Maybe the pundits can help us sort this out. 

Triangulating the Election

A reply to George's question in the comments to the previous post:  yes, the STU has an alternate triangle that now appears to be the prime count.  See chart. 

This is what I relish about Prechter's service - they deal in probabilities not absolutes, and like to present the alt count along with the primary.  Sure, it can drive you nuts, but it gives better guidance to adapt to changing realities while trying not to be whipsawed by emotion.  I should add, the Neely River is even more adaptable and can guide traders rapidly if not always accurately. 

Note that both the a and c legs (today!) reflect the type of very sharp relief rallies seen in a bear market.  Futures are down right now and this dramatic pop may simply fade tomorrow.  The triangle should now accelerate to an end, likely the day after the election, unless a close one leads to litigation and delay as in 2000.  Then the Election Rally?   Given the a and c legs as sharp, expect a meander downward again to a higher low, then one more sharp relief rally (the day after the election?) before the final thrust down.  Which may be slow and grinding.  So rather than a dash, which Neely still expects, or a crash, which Prechter awaits, we might just get a mish mash. 

This triangle makes sense when we consider how it reflects the uncertainty leading into this election, especially with polls tightening, and the huge stakes of 2008, which I think is now seen as a much more serious election than any since 1980.  I have written in my companion blog on politics about how the 2004 election should have been seminal since "political realignments occur every 36 years (1824, 1896, 1968) and great ones every 72 years (1788, 1860, 1932).  One was due this [2004] election, and the Demos blew it."  Well, sometimes these important elections right shift 4 years, as in 1828, and now the 72-year the seminal election has arrived four years later, with the magnitude of 1932.  The recent disclosures of Obama's redistributionist intentions marks this as potentially changing the US as much as 1860 and 1932. 

Before 1860, we said "The United States are ...".  After 1860, we said "the United States is ...".  The federation had become a nation.  After 1932 we said "The Government is ...".  The nation had become a welfare state.  After 2008, and the rapid nationalizing of financial service firms, we might find ourselves in a very different place.  Hence, expect a continued triangle of uncertainty until the winner of 2008 is clear.  Then the Election Rally?  Well, that might depend upon who wins.