One sell signal to rule them all.

Posted on March 14, 2010

You know the one: the 5-day trailing average equity put:call ratio:

indexindicators.com

Retail options players almost never get significantly more complacent than this, and they virtually ALWAYS get creamed within a week or two, sometimes a little, sometimes a lot. If you did nothing in the market but buy puts or vol when the 5-day CPCE got under 2 standard deviations from its mean and sell or tighten your stop (use a conditional stop with options) when it reached 1SD you’d have a very nice trading career.

Couple this with the classic RSI signal from Friday, and I’d place the odds of a 2% further rise here at under 10%, and the odds of a 5% decline at over 80%. To be very conservative, wait a couple of days to confirm that the rise is broken, and use a stop against the highs, but I bet stocks stall here for no more than a week then fall hard. Maybe this is Oct 2007 redux. Sure smells like a big top circus. The latest EWI publication points out that the AAII survey is again at record lows — this is not as precise a timing indicator as 5-day CPCE, but it puts it in perspective: we’re looking for a major top, so any minor top like this could be the one.

A long-term glance at modern bubbles.

Posted on March 7, 2010

I’m attending a convention from now through Wednesday, so expect a lot less activity here than has been the norm lately.

Regarding the markets, it is still my strong belief that we are in the process of making a top to last for many years, on a weekly as well as yearly and even decadal scale, since the prices of financial assets prices are still stretched far above levels that could be justified by expected returns. History is not kind to buyers of stock markets yielding 2% or real estate yielding a gross of 5%.

Society used to go through these episodes of financial mania briefly and locally. The South Seas bubble in England lasted a couple of years:

Close-up of 1720:

The earlier tulip affair in the Netherlands started in the fall and was over by spring:

In modern times, perhaps due to the ease of access that technology has brought to the markets and the emergence of a large middle class (though actually those explanations sound like feeble professorial BS), or possibly because of longer human lifespans (this I find more probable, as people need to collectively forget past experience in order to repeat it), we have the phenomenon of giant, recurring financial bubbles to accompany the credit/Kondratieff cycle.

One also has to note that the first such modern super-bubble began just a decade after the founding of a highly inflationary central bank, and that there has been no hard money nor hard-nosed policy since soon thereafter. After all, inflation is the expansion of money and credit, which always begets bubbles that are necessarily followed by crashes. These all-encompassing bubbles in everything are not healthy — they misdirect assets, squander wealth and shorten the time preference, which is no small thing. The young and already rotting cities of 20th-century-built North America are tawdry in comparison to those of Europe constructed in an age when real wealth was being accumulated at a blazing pace (yet inflation was non-existent or negative). People looked and planned further ahead, and built for yield and posterity, not to flip.

Here is a 200 year view of stocks priced in gold (DJIA for the last 100 years — approximation prior):

Marketoracle.co.uk

Isn’t that an interesting pattern? Looks like we’ve been in a huge megaphone since about the time of the Great War. The target for this leg is a Dow:Gold ratio of about 0.75. Dow 600, gold $800? Dow 11,000, gold $260 would have seemed pretty crazy in 1980, wouldn’t it?

Strikes and nonsense from Greek unions.

Posted on March 5, 2010

From Bloomberg:

Striking Greek workers shut down transport and tried to storm parliament as lawmakers passed 4.8 billion euros ($6.5 billion) in budget cuts, including wage reductions, needed to trim the region’s biggest budget deficit.

Police with riot shields fired tear gas at demonstrators outside parliament in Athens today as lawmakers approved the measures, which Finance Minister George Papaconstantinou said will show European Union allies and investors that Greece is making good on its deficit pledges. Socialist Prime Minister George Papandreou has a 10-seat majority in the legislature.

“We didn’t create this crisis but now we have to pay for it,” said Manthos Adamakis, who was protesting with other catering workers outside the five-star Grande Bretagne Hotel on Syntagma Square in downtown Athens.

Tram, rail, subway and bus services shut in Athens and other cities as employees rallied against cuts to bonuses and holiday payments. A walk out by air-traffic controllers forced the cancellation of all 58 flights to and from Athens International Airport between midday and 4 p.m. and the rescheduling of another 135, according to a spokeswoman.

“We didn’t create this crisis but now we have to pay for it,” the union member says! Of course they created it, by striking and threatening strikes to demand raise after raise with ever greater benefits. Unions are paying for none of it — their fellow citizens are. And how screwy is the Greek economy that the government sets the wages of hotel caterers, if that is indeed the case?

Most Greeks oppose plans to cut wages and increase value- added tax, according to the first opinion poll published since the austerity moves were announced on March 3.

Seventy-two percent of 530 people surveyed by Public Issue for Skai Television said they disagreed with a drop in bonus- vacation payments, while 68 percent opposed a value-added tax increase. Sixty-two percent said Greece will see social unrest in the next year, according to the poll broadcast yesterday.

The additional budget cuts aim to save 1.7 billion euros through a 30 percent reduction to three bonus-salary payments to civil servants, a 7 percent overall decrease in wages at wider public-sector companies and a pension freeze. The reductions are accompanied by an increase to 21 percent from 19 percent in the main VAT tax as well as in alcohol and tobacco duties.

Further Strikes

Teachers are also striking, closing some schools, and workers at the Public Power Corp SA, the country’s biggest electricity company and controlled by the state, have also called a 24-hour strike today.

ADEDY, which has already held two 24-hour strikes this year after the government backtracked on pledges to grant civil servants a wage increase, is considering holding another 24-hour strike next week.

It seems like everyone in Greece is on the dole, but I believe only 20% of employment is government work.

Where are the taxpayer protests telling these extortionists to go to hell and demanding that parliament repudiate the debt? Majority or minority, the victims in this racket sure are silent. It’s as if they think the money grows on trees (or as if Greece still can print Drachmas!).

The “austerity measures” and tax hikes are sure to fail. The debt is simply unpayable, so default is the only option if Germany is not willing to bail out Greece, Italy, Spain, Portugal, Ireland and maybe even France. What are the odds of that? What happens in those volitile, socialist, economically ignorant countries if the government gravy train dries up? We haven’t seen anything yet.

VIX cycles

Posted on March 4, 2010

No strong conclusions here, just some food for thought:

Prophet.net

You can also see a possible 30-day pattern: 30 days down, then a ramp. Let’s put this in perspective. Here’s a 5-year weekly chart. All I can note here is a divergence on the RSI over the last few months:

I’ve also noticed how Treasury bonds have resembled the VIX for some time (I put in those RSI buy/sell signals just for fun — not as effective here as in the 60-min chart of Dow futures, but not bad either):

Just goes to show, when you think you’re trading US stocks, Chinese stocks, commodities, bonds and options, you’re really just trading global patterns of fear and greed. It doesn’t matter what market you choose these days. They’re all the same.

Some thoughts on government debt during deflation

Posted on February 27, 2010

A question of Keynes vs. Kondratieff

Until recently, the sovereign debt of nearly all governments would rally during panic episodes as stocks and commodities fell. This makes sense, as strong sovereign debt is cash for big boys, and investors are forced to reach further and further out for yield as short-rates are driven to zero or negative. However, starting with Greece, this pattern may change, as bonds are likely putting in a secular top in the 2008-2016 window. Their last bottom of course was the early 1980s, and their last top was 1946-47. The indebtedness and unabashed Keynesianism of all of the world’s governments seem to virtually guarantee higher interest rates in the coming years, even though US, German and Japanese bonds are still finding a bid during panics.

We have already seen the beginnings of this development in municipal bonds and the crappiest sovereign debt, but the market may slowly realize that it is all crap, beyond the short-term credit of the strongest governments.

Prechter makes the point in Conquer the Crash that higher rates on risky long-dated sovereign debt are part and parcel of deflation, an increased preference for the safest cash and cash alternatives. Steepening yield curves fit right into that trend. If the long bond sells off hard, this does not mean the end of the dollar, but the opposite. All else being equal, if T-bonds fell with stocks this year, it would just mean that the US government would finally feel the same pinch as everyone else.

Now for the tricky part. We have to keep in mind that interest rates are more than just a mechanical product of fiscal deficits, savings rates and politics. They are a kind of natural social phenomenon, a reflection of forces I can’t fully understand. They are not rational: why were short-term rates in the low single digits during the second world war when the US had just abandoned the gold standard, had a debt:GDP ratio of over 100% and inflation was running at 8-12%? Why were they still double-digit in the mid-1980s when the economy was good and inflation was 3-4%? (For some charts and discussion of the long-term rate cycle, see this post). The only answers that make any sense are that it was time for rates to bottom and then it was time for them to top.

We are certainly entering what *Kondratieff described as winter, when debts are called in and defaulted upon and cash is at a premium. This is associated with low interest rates, reflecting a low demand for credit, provided that the monetary unit retains value, which it tends to do since this unit is how debts are denominated and settled. And with deflation very much a reality, low rates can provide a high real yield so long as the credit is sound. With housing and wages falling by large percentages and every consumer good on sale, what is the real yield on a 10-year note priced at 3.6%?

There is no telling how long rates will stay low or how low they will go. See Japan, 1990-

Those are the market rates on the credit of a horribly indebted nation with terrible demographics that has been trying to spend its way out of recession for 20 years. Is there a better way to explain this than Kondratieff winter?

If social forces demand that governments start to shift towards frugality and default like the rest of society (and government is a reflection of social mood), this would be very supportive of the current fiat regimes. Think about it: what would happen to the Euro if Greece defaulted (which is what they should do)? Billions in euro-denominated balances would go “poof” and the remaining euros would be worth more.

What if younger generations of Americans, the ones who most enthusiastically support Ron Paul and even phonies like the new senator from Massachusetts, start to exert pressure for the rolling back of that $70+ trillion in retirement and health-care promises? Those are contracts that the government can’t honor, so by definition, it won’t. It will try to pretend otherwise, but it won’t. In effect, much of the debt will be repudiated.

There are huge caveats to the above, such as radical socialism or expanded warfare, but there are going to be real deflationary undertones to social mood that may effect policy and prolong the current paper regimes for longer than almost anyone suspects. Kondratieff winters are not short episodes, but generational, and if the last two turning points in the interest rate cycle are a guide, there could even be another ten years to the bottom.

That is hard to believe right now, but it is possible if social forces demand default. I can’t gauge the odds very well, but I have to consider this longer-term bull case for treasury bonds and a few strong currencies. Bottom line — history has not been kind to paper money and government bonds in times of crisis, but the nature of deflation may give them a longer life than we have assumed.

If you just can’t wait to short some sovereign debt, try Japan before America. They may be a generation ahead of the west in the rate cycle, and really, how much lower could they go?

*Kondratieff waves in the US (click image to expand):

welling@weeden, 1.23.09

One thing that strikes me in the above chart is how huge the latest wave is compared to the others. At 60 years and running, it is the longest, and prices, rates and stocks have gone up so much more than during any of the previous three. Just out of proportionality, it would be perfectly fitting if rates and prices fell for another 5-10 years.

Here’s a clearer view of the Aaa corporate bond rate from 1919 to 2010:

Also see Rothbard and then Mish on Kondratieff theory. As Rothbard makes clear, winter is not necessarily an awful time to be alive, judging from the strong economic growth of the 1830s-40s and 1880s-90s. This means that prolonged unemployment and war can’t be blamed merely on the credit cycle, but that fingers must be pointed at the socialists, Keynesians and fascists who’s actions directly brought about the nightmare of 1929-1945.

Follow “sovereignspeculator”