Tag Archives: dead cat bounce

Rosenberg concurs: 400 point rallies are bearish

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From Tea with Dave (free sign-up here):

The obvious question is: how can the bull market possibly be over considering that we enjoyed that amazing 405-point rally on the Dow just three days ago (Monday, May 10)? Wasn’t that an exclamation mark that the bull is alive and well?

Far from it. There have been no fewer than 16 such rallies of 400 points or more in the past, and 12 of them occurred during the brutal burst of the credit bubble and the other four took place around the tech wreck a decade ago. See Chart 2 below.

Tour des charts

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All the world’s a short…

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Charts below are 5-year views.

NASDAQ biotech index:

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[email protected] WK Internet Index:

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Value Line Arithmetic (where’s the value?):

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Philadelphia Gold and SIlver Index (XAU), back at ’06-’08 commodities bubble levels:

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Mexico Bolsa:

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Venezuela:

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Argentina’s Merval Index:

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Pakistan’s Karachi 100 (look at the flat line where the govt suspended trading last fall — worked wonders, didn’t it? This market is up a lot less than most others — maybe people don’t trust it as much anymore, since they can’t be sure they’ll be able to sell when they want):

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Bet you didn’t know Mongolia had a stock market. Looks like a one hit wonder:

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Singapore Straits Times:

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Indonesia’s Jakarta Composite:

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Taiwan Taiex:

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All images above from Bloomberg’s stock index pages

Some thoughts on the bear market.

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This post started as an email that got way too long. I added some charts and put it up here:

The rally has not surprised me (on March 31 I expressed the opinion that we would hit 900 or higher by summer:

…more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).

That said, I was leaning closer towards 900 than 1050:

I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight (slopeofhope.com) seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.

Though I saw this rally coming a mile away, I have traded it very poorly. First, I put too much emphasis on picking the absolute bottom for a buy-in.  Back in Feb and March I got out of most of my shorts by the time we were under 700, and I entered a bunch of limit orders to put over 1/2 of my net worth in SPY on the long side. Unfortunately, those orders started at 620, and we bottomed at 666. So I missed the bounce, and not only that, starting in April I began to short the junk stocks that were flying the highest and have been the real driver of this market. That was way too soon, and they kept on going, to the surprise of many a long-short fund as well. The outperformance of junk was a surprise, but the overall bounce has not been. When you have mood as compressed as it was back in March and you reach an exhaustion point after 18 months of a strong bear trend, you get a big reversal, which can then generate the extremes of optimism needed to set up the next plunge.

I’ve been buying long-term puts on the S&P and Nasdaq again since late March (way too soon, considering that I expected the rally to continue). I bought a bunch more yesterday, by the way. I view it as extremely unlikely that this market doesn’t decline to the point where solid value offers support — that would be a sub-10 PE and dividend yield of over 5% on dividends that have to fall by 50% or more from here to around $12 for the S&P. That would be the 240 level, but it should take at least a couple more years to get there (or below), if not four or five.

What has always worried me as a short in this market is not a 5-8 month rally, but a 12-18 month affair  like some of those that Japan has experienced in its long bear market since 1989:

Source: Yahoo! finance

That said, Japan’s financial sector was deflating while exports were improving, families had savings and the rest of the world was growing. Today’s situation is much, much more severe of course, and we can only find a parallel in the Great Depression for so many of the economic trends we are seeing. The longest bounce in that bear market was 5 months, and it was of similar magnitude (48% from Nov. ’29 to April ’30; we’re up 47% in the 4.5 months since March 6).

This is the Dow from 1928 to 1931:

Source: Yahoo! finance

And here’s how that bounce looked from 1933:

Source: Yahoo! finance

The S&P500 is now the most overvalued in history by PE (infinite as of this quarter’s running 12 month total, or a dot-com-esque 32 times current annualized earnings levels, about $7.50 per quarter). The dividend yield is about 2.5%, but dividends are nearly as high as earnings right now, which is completely unsustainable (they should be less than half of earnings). On a sustainable basis, the yield is 1.0 – 1.25%.

Here is the S&P PE ratio (TTM data through 12.31.08) going back to 1936. (the dates read right to left, since I can’t figure out how to reverse them in Excel). Data through 6.30.09 would be off the chart:

Real (U-6) unemployment is approaching 17% and climbing, and that is if you exclude the likely 6 million illegal immigrants who are out of work now (who used to take home $100 per day as construction cleanup boys or dishwashers). Throw them in, as we would have in the 1930s, and you get a solidly depressionary 20%.


Credit is still being withdrawn everywhere you look, whether in home equity, credit cards or small business loans. There has been a bounce in the corporate bond market, but that is due to the same technical forces that are driving the stock market, and the big bankruptcies are just beginning. Only the very weakest have gone under so far, like the car companies.

So with this backdrop, I don’t expect this summer’s good feelings to last into the holidays. The markets should start to roll over again soon, since the big-money value investors needed for a sustained advance can find no reason to buy in, and the little guy has been burned too many times to chase this market very far. Volume is very thin, and an unusually large fraction of trading is taking place between automated programs.

When the data to back up the green shoots theory fails to show up after another few weeks or months, and even official unemployment is solidly into the double digits and climbing, while another huge wave of mortgage resets hits the middle class, there will be no hope at all left to support this market, and it will slide to levels not seen since George Bush Sr. was in office.

It will then still not be a safe long-term buy. For that, considering all of the obstacles that the government has created to profit-making, we need to get back to Reagan-era levels, somewhere under the bottom of the 1987 crash.

S&P500:

Source: Google finance

Most of the way there.

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The bounce has been faster and more comprehensive than I expected. I was thinking that we would top around these levels, but by summer or fall, not early May. I have continued to scale into distant-expiry SPY and QQQQ puts, favoring ITM and ATM, and have now deployed about 1/3 of the money I am willing to allocate to shorts. I also have a smidgen of shorter-term positions in certain ridiculously high-flying restaurant and other consumer stocks.

The bond sell-off and commodities rally indicate that inflation fears now have the upper hand, as most people still believe deflation will be a short-lived phenomenon. The aforementioned movements are setting up nicely for long and short replays, respectively.

Notwithstanding a long-overdue correction, I suspect that stocks have further to run, and am no longer such a skeptic of certain Elliott wavers’ target of S&P 1050. Bullishness is now at 80%, up from 2% in March, but judging from attitudes on TV, there is still a great deal of skepticism to be overcome before we can call a top. That said, the speed and evenness of the advance leads me to expect much more choppiness for the remainder.

Shorting precious metals has been frustrating, and I suspect that we are repeating the pattern of last spring, when we had to work our way through several months of chop after receding from manic levels (1030 gold that time, vs 1007 in February).

It is important to keep in mind the real situation, not just the current market mood (though you can’t trade on fundamentals alone). We can’t work off the greatest credit bubble in history in 18 months and just a 57% loss in the stock market. The real (private, productive) economy is not going to stop shedding jobs, let alone add them, for years, and people are so indebted that they cannot be enticed to reflate the asset bubble or return to previous levels of wasteful spending. It will take a generation to work through our debt and lifestyle delusions.

It bears repeating that today’s official headline unemployment number (8.9%) cannot be compared to numbers from before the 1990s, when the Clinton administration changed the reporting methodology to exclude large segments of unemployed. A more useful measure for historical comparisons is U-6 unemployment, which now stands at 15.8% for April. Today on Bloomberg I heard Christina Romer say that things were nothing like the Great Depression, as she compared apples to oranges. In reality, we are at solidly depressionary levels already.

Also bear in mind that stock valuations remain at bubble levels. This is easy to see when you remember that stocks have no intrinsic value other than marked to market book value and heavily discounted future earnings. The major indexes’ trailing PE’s on net earnings will be under 10 by the time this is over. We still need to work off the bubble that was blown in the 1990s, which didn’t finish deflating in 2003 because of the easing of credit. Every kind of credit is tightening now, unless of course you are a bank holding company.

Trading sardines vs. eating sardines

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I have no strong opinion on near term market direction. I was prepared for this little downward correction, as for the larger bounce off 666 on the S&P500, but am highly ambivalent about where we go from this juncture.

Has this been a four month flat correction?

A case can be made that the entirety of market action since November has been one giant zig-zag correction that terminated last week, in which case we are now about to plunge to 550 among the kind of panic conditions that were so lacking at the latest lows. In support of this scenario we have the death-defying performance of a great number of tech and consumer stocks that have failed to even re-approach their November lows, as well as some of the most extreme readings on retail bullishness since the start of the bear market (Rydex bull/bear fund assets, put/call ratio, NYSE Tick). Remember, the ’29-’32 market corrected from its initial crash with a 48% rally from November ’29 to April ’30. If this is the Greater Depression (and by the looks of the latest trade and manufacturing numbers, let alone the scale of the debt saturation that caused this situation, it is), perhaps a big zig-zag is all the enthusiasm society can muster this time.

Or was it actually a washout?

That said, more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).

I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight (slopeofhope.com) seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.

Feel like a depression yet?

Though the current bear market is half over in terms of price (three weeks ago we hit -57% and you can’t lose more than 100%), we are still early in the game as far as the economy goes. Official (read: bullshit) unemployment is still just a tad over 8%, and while the old measure (U-6) is reading 14%, we are headed for 25% in a hurry. Baring a catalyzing event, Obama’s approval rating has nowhere to go but down — in terms of historical context his term is positioned like that of Hoover, not FDR, who took office after the market had bottomed and already doubled.

This all spells a continuing deterioration in mood, possibly even at an accelerated pace, but because the market is not efficient and couldn’t care less about the economic fundamentals, an aggressively bearish trading stance is still only warranted when the market is highly overbought in multiple time-frames. Right now, we are only mildly overbought on a week-by-week scale (on Friday we were very overbought on this scale), while of course oversold on a daily scale and still somewhat oversold to neutral on a monthly scale (picture a 1-year chart). It is the 3-10 year chart that makes me nervous about being too quick to load up on shorts again. All things being equal, does this look like a good spot to go short?

3-year view here from bigcharts.com:

To deal with this situation I have lately been slowly accumulating December 2011 OTM puts on the S&P, scaling up purchases as the market rises. These positions are for keeps. I do not intend to part with them until the market has fallen well below 600 if not 500 (32 months should be more than enough time for that to happen, no matter how things girate in the interim). For trading the twists and turns along the way, December 2010 and even 2009 puts do very nicely. They are highly liquid and responsive to the market’s daily moves.

I am still bearish on the precious metals from a trading standpoint, and exercise this opinion mainly through the silver futures market and various equity puts (that said, if you don’t already have a nice pile of physical gold, get some and you’ll sleep better). Here and there investors are still losing their minds over certain stocks (ahem, Best Buy), and I always stand ready to short such silliness.

Quick opinions:

S&P earnings: Analysts still have their heads in the clouds and the I-banks are still getting away with talking about “expected operating earnings.” NET NET NET trailing report earnings are all that matters, and those will fall under $20 and stay there for many months before they start to grow again. Put a PE of 8 on that Jackson for your stock market bottom.

US bonds: bearish but not shorting

US dollar: bullish

Euro and Swiss Franc: bearish

Yen: neutral

Oil: neutral but prepared to start shorting at 60

Base metals: neutral to bearish (will short again if higher)

Grains: still waiting to buy

US real estate: wait until 2012 and figure on a cash market, but maybe buy in late 2010 if you can still get a low fixed rate loan.

NYC real estate: wait a year longer than the rest of the US — amazingly, denial still runs deeper there.

Guns ‘n ammo: good to own, but worthless if you don’t learn how to use them intelligently.

Obama: To appease and distract the masses, will he be crucified like Nixon?

A massive rally is straight out of the 1929 playbook.

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Below is a table of highs, lows and closes from October 23rd to November 14th, 1929, courtesy of Yahoo!. (Unfortunately, their date function is stuck in 1969, so you have to count up from the bottom.)

Key dates:

  • September 2nd. Pre-crash high water mark: Dow 381.
  • October 25th, Black Thursday. From the previous close of 305, down 11% in early trading, a swing into the black, and a close down 2%. (eerily similar to last Friday).
  • October 28th, Black Monday. Down 14.7% intraday, 13.5% at the close.
  • October 29th, Black Tuesday. Down 18.5% intraday, 11.7% at the close.
  • October 30th and 31st: Huge two-day rally, 19%.
  • November 13th: Bottom for 1929: Dow closed at 198, down 48% in 10 weeks. It then rallied to 294 by late April, before declining to 41 by July 5, 1932.

Here’s a visual aid (wider time frame):

Source: sharelynx.com

Look at the rally from the 29th, Black Tuesday, to the 31st: 19% by closing values, and 33% intraday. So far in the Panic of ’08, we are up 11% from the close and 21% intraday from last (Black) Friday.

The rally in ’29 was a wave four bounce within wave three, and it failed spectacularly. I’m not saying this wave four of three bounce will end in exactly the same way, but I think we have yet to see the lows for this fall:

My gut squirmed today.

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For the first time in this crash, I looked at the Dow down 600 and felt dread, not excitement. I took it as a signal and bought a few short-term calls (with about 1/200th as much as I have in long-term puts). Maybe this is what a capitulation feels like in this kind of a market, although darker thoughts inside of me say we’re not there yet. Too bad nobody trading today was on the floor in 1929.

We are now down exactly 40% in exactly 12 months, and 26% in three weeks.  In 1929 the Dow fell 48% in 2 months and 1 week. It really started to crash after October 11, and dropped from 352 to 230, 34%, in 18 days. It then embarked on what must still be the most furious rally of all time. From the close on Black Tuesday, October 29th to Thursday, October 31, the Dow gained 19% in two days (32% intraday). That blistering move shows up here as the zig-zag in the drop from 381 to 198:

Source: Yahoo! Finance. Click image for sharper view of terror.

Of course, after peaking at 273, the Dow dropped right back to the area of the previous lows, contemplated the situation, and plunged again until November 13, the bottom of the Great Crash of ’29. Then after rallying all that winter, it resumed a more orderly decline the rest of the way down to 37 (intraday — the close was 41) on July 5, 1932.

I remain massively short long-term, but this is the most probable way-point for a rally that I have seen in the past 2 weeks. It may finally be that everyone who was going to panic in this slide has done so. They will all panic again soon, but it won’t take much relief to cause a bounce from here. There are plenty of bargain hunters and technical traders who might jump in on the first uptick tomorrow, afraid of missing out on a rally, and thereby causing one. Either that or today could have been Black Thursday to tomorrow’s Black Friday.

Short-term trades: Don’t buy gold. Prepare to go long stocks.

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When everyone has run to one side of the boat, stroll over to the other.

GLD in blue, S&P 500 in green, Nikkei red. 2-year chart:

Source: Yahoo! Finance. Click image for sharper view.

I’m not calling a bottom in stocks (I think the Dow is going below 3500), but nothing moves in a straight line, and it looks like the market is setting up for a bit of a clearing rally, although it might take a plunge below 9000 to really capitulate first. It actually feels relatively calm to me today, despite the panic conditions, so another deep plunge to finish things off wouldn’t surprise me from here.

Along the same vein, look above at the inverse correlation that gold has had with stocks during this bear market. Markets are all about mood, and lately when fear is high, stocks are down and gold is up. We are nearing the point at which everyone is already on board the panic express. From there, you can expect temporary relief. When the relief comes, gold will resume its own unfinished business of working off the manic top from 2005-2008:

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Note: I’m not going long stocks. I’m still massively short with long-term puts, so short-term rally or not, it doesn’t matter to me. I’m also long gold, but holding a few puts on GLD right now.

Keep your eye on the bouncing commodities ball

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Here’s a five day chart of my favorite commodities stock shorts:

Click for sharper view. Source: Yahoo! Finance.

I nailed the commodities short at the peak in June, and sold a lot of my puts (GLD, GDX, TCK, NUE, X…) earlier this week as the sector made what may be the first of multiple panic bottoms in a bear market. I like shorting with longer-term puts, so I didn’t close all of my positions, but I built up a bit of cash. Lots of that went into retail and REIT shorts earlier this week, but some of it is waiting for this commodity bounce to get overextended.

This group fell 30-40% over the last ten to twelve weeks, so if this was indeed a meaningful way point, it could take up to eight weeks and a 25% rise for the countervailing bout of hope to play out. If the broader market is on the verge of a strong downdraft to beneath the July and March lows, which seems likely to me, commodities could get swept up in any waterfall and resume their decline sooner rather than later. This might not even be much of a bounce at all if broader market sentiment deteriorates quickly. Crashes do arise from oversold conditions – just ask Lehman shareholders.

The commodities markets are exhibiting a bit of negative correlation with the dollar, so I am also a bit short-term bearish on the currency. Any significant retracement would be another opportunity to get out of Euros, Pounds, Aussies, Loonies or precious metals (or short them again).

It’s a beautiful day for shorting. My picks: Wal-Mart & Costco

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I wouldn’t be surprised if the market ends down on the week (maybe even the day). This morning’s little bailout* blip just offers shorts another chance to set up some trades we may have missed in the bounce since July. (*For a dissection of the bailout, here’s Mish).

Why short leading discount big-box retailers? Although they sell stuff cheaply, they have come to rely on Americans buying lots of cheap stuff. American’s have a habit of viewing low prices as an opportunity** to buy more of something, not to buy the same amount and save the difference. The aisles of these stores are packed with discretionary goods: a myriad of toys, cosmetics, housewares, sporting equipment, and all kinds of footwear and clothing. People’s homes are overflowing with decades worth of junk: enough clothing for a couple of generations, and used toys, tools and appliances galore.

These stocks are priced for perfection, as if the consumer binge will continue in perpetuity and the companies will continue to open new stores in new exurbs. Unfortunately, many of those new developments will be ghost-towns before long, and the stores will be big, empty cleanup liabilities.

Let’s take a look at the numbers:

Wal-Mart: Price: $61; P/E: 18; Dividend yield: 1.6%; Earnings growth, 2005-2007: 6.5%

Costco: Price: $70; P/E: 24; Dividend yield: 0.9%; Earnings growth, 2005-2007: 0.94%

By any Graham and Dodd style evaluation, these two are massively overpriced, Costco more so than Wal-Mart. However, I like the short odds on Wal-Mart just as much because it is so overbought and near a 52-week high in a sort of nifty-fifty bubble (hence, I picked up some puts this morning — I’ve had long-term puts on COST for a while).

Yes, same store sales may be up, but that is largely on account of groceries and gas. The profits are in discretionary items. Over the next 12 months, watch for sales to go flat and margins to shrink, before sales drop outright.

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**People don’t apply this logic to investment purchases, hence the securities and real estate markets are inefficient.