Tag Archives: technicals

A rerun washout?

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Once again, fasten your seat belts. We still need a washout to set us up for a lasting thaw. Adam at goldversuspaper noticed the striking similarity between the pattern of the last few months with that of the 1937-1938 “second dip” crash in the Great Depression:

At first I did a double take and thought I was looking at recent history (with a projection of the next few months).

Just read his post for all of the technical reasons for this prognosis. He does a great job covering them. Basically, we are looking for a bottom of the wave 1 of C that started in July or October 2007. This should be the largest bottom to date in the bear market, yet we have not yet had the panic conditions necessary to scare away the premature bottom feeders and permabulls. Watch the volatility index (VIX) and the put/call ratio. When they spike, we are nearing an important bottom.

My candidate for the meaningless but newsworthy explaination/catalyst for this phase of panic is the trouble that western european banks have created for themselves with eastern european debt. I actually just returned from a visit to Kiev this week, where all of the restaurants and cafes suddenly became empty just a few weeks ago. Steel production is down by half this year, and apartment prices are down by 40% in just six months. Things have come to a standstill, the people are talking about revolution, and there is even the fear of another major war, but all is still calm for now. As elsewhere in eastern europe, the currency has crashed, but the housing, auto and credit card debt is denominated in euros or swiss francs. Ugly.

**Note: This post originaly stated that housing prices and steel production were each down by 2/3. A friend in the Ukraine sent me references for the revised figures.

Sailors be warned

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Red sky at night, sailor’s delight

Red sky at morn, sailors be warned.

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Technical musings

In recent trading days we have seen various indicators reach levels that, had they occurred together during another set of social and economic conditions, would have warranted an aggressive bullish stance. As they have arisen during the greatest depression and stock market collapse in any living person’s memory (geezers included), traders should perceive an elevated risk of a swift revival of market panic.

If we are going to start back towards the November lows sometime in the first half of the year, the next few days are as good a time as any. Optimism, or at least the abatement of fear, peaked around the first week of the year. At that time, most bulls and bears alike seemed to be counting on a BIG bounce, and that consensus view was manifested as as the top of a relatively anemic corrective rally.

Stocks then sold off solidly for two weeks, as the volatility index (VIX) ran from 38 to 58, a level that until last fall hadn’t been seen since a brief moment in 1987. Even 38 would have been indicated panic conditions until the world was turned upside down. In this environment, it indicates calm. Here is a six-month view:

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The bond market also indicated relief this month, as a rally for the history books finally broke when the 30-year Treasury bond yielded just 2.5%. Yesterday it yielded 3.41%, another level that until a few weeks ago had not been seen for decades (in this case, six of them). In this crash, 3.41% means complacency and even optimism. 30-year bond yield, 6-month view, courtesy of Yahoo! Finance:

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One more indication that the correction is exhausting itself has been the revival of animal spirits in commodities stocks, a popular ‘risk’ sector. XAU, the Philadelpia Gold and Silver Index, more than doubled from its crash lows. I am guessing that these stocks made their post-crash top yesterday, coinciding with bullion’s three-month high, because both are solidly overbought. This top in risk preference has occurred alongside the last few days’ rebound in the broader stocks indexes. Risk assets are the last to participate in rallies and the hardest hit in crashes.

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Now, with the exception of gold stocks and bullion, none of the above markets are particularly overextended at the moment. Bonds today made either a solid correction of their sell-off (corrective itself), or started a fresh leg up. The broad stock indexes are not overbought, which is the easiest time to identify shorting opportunities, so tread lightly if you are thinking about that route. I have been heavily long-term short for 18 months now, so if I am wrong on these little twists and turns it doesn’t bother me.

I would not be surprised by a loss of several percent in the Dow by next week, but neither am I counting on it. This market has been choppy and full of contradictions since December. Stocks went up with Treasury bonds last month, and this month the dollar has rallied with gold. Go figure. In cases like this, it is best to not have too strong an opinion on the market’s short-term moves. In recent days I have even covered several long-standing short positions as stocks such as Microsoft, Harley Davidson, Burlington Northern, and Union Pacific have pushed to new lows.

Keep in mind that we still could re-enact the November 1929 to April 1930 post-crash rally, in which the Dow rose 48% before the mood turned back down and stocks fell another 80% in two years. See A massive rally is straight out of the 1929 playbook.

Anyone sense a change in the air?

For the bigger picture, all you have to do is glance at a newspaper. From a non-technical perspective, the trend is clear: things are getting worse, much worse. Earnings will continue to surprise to the downside, to an extent that few can imagine. Firings and bankruptcies are just getting rolling. As the illusion of prosperity wilts away, we are going to discover that our productive capacity has been hollowed out by the distortions of the credit bubble and regulations, and that a drastically reduced standard of living awaits. Needless to say, stock prices will be proportionate.

Impatient Treasury shorts toasted.

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The 30-year yield closed at 3.91% today, in a massive compression of the yield curve, a movement that has a lot of room left to run. Way back on August 8th (day 4 of this blog), I wrote the following in “That crazy, crazy bond market: a call for sub-3% long bonds”:

I predict that the dollar rally will strengthen the compression of Treasury yields at all ends of the curb, as the market perceives a lower currency risk. This is a sign of deflation: an increasing preference for cash. With the banking system on the verge of a collapse worse than the ’30s, people will have no choice but to buy Treasuries. These promises of an insolvent and unrepentant debtor are safer than cash in the bank (because its not really in the bank!).

This flight to safety will send short-term yields back under 1% (as they were in March), and traders will move out the yield curve to get ahead of the compression, driving long bonds to historic lows, likely well under 3%. …

So it may seem crazy, but it is entirely possible (and given the banking crisis, likely) that long Treasury yields will fall to 60 year records in the face of horrible fundamentals. But once they get there, I expect them to turn up and keep going, as the government starts to default by Fed printing.

To all those who feel that the US debt just DESERVES to be shorted, I say wait. It will get more deserving.

That post is worth another look, if only for the charts of the last top in Treasuries, the 1940s, when long yields hovered under 3% while inflation breached 10%.

There has been a lot of talk of a widening yield curve lately, and more than a couple of people have mentioned to me that they were thinking of shorting TLT or buying a short Treasury ETF. This actually furthered my conviction that despite the HUGE deficits that the US gov’t has started to run, that bonds were still a buy, or at least not yet a short, as no market tops out in room full of bears. Well, the premature shorts had another rough day, as we all were reminded again that this is a deflationary panic, and that Treasuries are the only things that go up in these little episodes.

Markets don’t have to make fundamental sense. They only sometimes do, in the sense that a stopped clock is right twice a day.

What a close. Down 473 points in 15 minutes.

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I have built up a position in DIA Nov. 08 puts on rallies over the past couple of weeks, and with the Dow up 300 at 3:30 today, I couldn’t resist adding a few more than I would ordinarily be comfortable with. I intended to part with the extra contracts maybe tomorrow or the next day in the inevitable correction after such an awesome rally (1,208 points, 14.8%). As it turned out, the Dow proceeded to drop 473 points in about 15 minutes, and I unloaded the contracts at the close for the fastest money I’ve ever made (as regular readers know, I’m more fond of buying LEAPs to capture the big, multi-month moves).

From Bigcharts.com, here’s the 1-day chart (1 minute):

Click image for sharper view.

As I count the Elliott Waves, this pattern has the A-B-C shape characteristic of a countertrend move, so it doesn’t change my expectation for new index lows in the coming days or couple of weeks. The mini-crash at the close looks like waves 1, 2, 3 and 4 of an impulse wave, which would resolve with another drop below the wave 4 low near the open tomorrow. Impulse waves move in the direction of the one-larger degree trend, as opposed to A-B-C moves.

Today’s chart also illustrates another textbook pattern: the contracting zig-zag from 2:40 to 3:15 resolved in the direction of the previous trend — up, way up. The 1-month pattern is still a very large contracting zig-zag, which, should it stay true to form, would resolve downwards, perhaps to Dow 7000, though a push above the October 14th high first is also possible:

Click for sharper view.

All of this near-term wave counting and trading is really just a hobby for me. I don’t use big money in it, but just enough to keep my attention so that I learn something. My real money is in T-bills, gold and still a boatload of 2010 puts that I accumulated over the last 15 months (see disclaimer), though I have been paring that position in the crash. If I hadn’t been selling, it would be about 85% of my portfolio by now.

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Sorry for the paucity of posts lately. I’m in the middle of a trans-oceanic move, ditching a ridiculous Latin American country for a central European one known for staying sane while the rest of the world goes nuts.

The Gold:XAU ratio is off the charts. How will it correct?

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A ratio of the gold price to the XAU gold stock index of greater than 4 is traditionally considered a buy signal for gold stocks, with 5 a strong buy. Today the ratio is an unheard-of (to my knowledge) 10.65.

Are gold stocks a screaming buy or could this mean that gold has much further to fall? Mining stocks and other metals are down from 50% to 80%, so gold bullion stands alone with roughly a 30% decline. It is money, so it should fall less than other assets in deflation, but these ratios may be a bit extreme.

I considered GDX calls today as a short-term trade but thought better of it. This deflation is powerful stuff, and I want to stay out of its way for now.

On Black Thursday, 1929, the Dow closed down 2%.

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A little remembered fact of stock market history is that on the first momentous day of the Crash of ’29, Black Thursday, October 24, the Dow closed down just 2%.

The previous day it had dropped 6.3%, the steepest decline to date after a more orderly swoon of 20% over 7 weeks. In the first hour of trading on Black Thursday it plunged on record volume from 305.85 to an intraday low of 272.32 (down 11%), then swung to a high of 312.76 that afternoon, and closed at 299.47. That was a 13.2% intraday move, with a barely negative close.

Sound familiar? In the 6 weeks before today, we were down 26%. Yesterday the market closed down 7%, and today it plunged 8% at the open on record volume, then swung 11.9%, touching positive territory, and closed down 1.5%.

In the Great Crash, Friday the 25th was the pause that refreshes, with a swing of only 3% and a flat close. But then came Black Monday and Black Tuesday, the 28th and 29th, with losses of 13% and 12%, respectively. The next two days brought a 32% rally (measured intraday from Black Tuesday to Thursday the 31st), which still closed well beneath the intraday low of Black Thursday. That rally of course failed spectacularly, leading to the 1929 bottom of 198 on November 13.

So are we close to the end of the Crash of ’08? Probably, but the worst could lie directly ahead.

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Yahoo! Finance carries this intraday data back to 1928, but their date function seems to currently be stuck on 1969, so you have to find the days yourself.

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.

Unfinished business: Financials, REITs, small-caps.

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These three categories have only begun to really break down in this plunge. Let’s look at some charts. In a crash like this, you want to see deep new lows in all the vulnerable sectors before you can consider things complete.

Here are financials. These stocks are just revisiting July’s lows, yet to make a solid break to lower levels. XLF is our proxy:

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Next, REITs are finally breaking down, but they have a long ways to go, considering that an honest accounting of real estate prices would probably reveal that many of them have negative equity. IYR is a REIT-laden real estate ETF:

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For small-caps, we’ll switch to a 10-year shot of the Russell 2000 to show the magnitude of the bubble in crappy stocks since 2003. The Russell is making new 3-year lows, but like REITs, it has defied gravity since last year so there is a lot of air underneath these levels. (PEs on the Russell are infinite, by the way, just like the Dow.)

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May as well throw in an update on Wal-Mart for good measure. I shorted them a few weeks ago, not because they were horribly overvalued (they are, but less so than most junk out there), but because they have been boosted by a nifty-fifty “defensive stock” mania, and therefore the puts were dirt cheap. 2-year view:

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The fact that these laggards are just now breaking down, along with the lack of a meaningful bounce today, suggests to me that this plunge is not out of steam.

The Jaws of Death

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Today’s word to the wise comes from John Hussman’s weekly market comment:

Years ago, Larry Williams used to look for a situation he called the “Jaws of Death” – noting that when bond prices were weakening but stock prices were strengthening, the two differing trends opened a set of “jaws” that tended to snap shut, usually due to abrupt weakness in stocks. On that note, Bill Hester sent a chart over the weekend noting “I thought this was an interesting graph. The blue line is the 5-Yr Swap Spread, and the red line is the VIX. Credit investors are getting very nervous while equity investors are mostly whistling Dixie. It looks like a variation on the jaws of death that you’ve mentioned to me before….” Nothing like a good picture to complete the story (thanks Bill).

As Hussman notes, a compressed VIX in the face of rising Treasuries and an overbought market that has still not acknowledged the recession signals choppy waters ahead.