Not much between here and Dow 8500

Many of the world’s stock markets have already retraced large portions of the entire rally from the 2009 lows, but US equities have a long way to go before they give traders a scare. Judging from the sanguine attitudes expressed by various managers on Bloomberg TV, the majority remains firmly convinced that the lows are in and that any sell-off is just a healthy correction on the way to new all-time highs. This is exactly the same attitude expressed from late 2007 to mid-2008 before the crash got underway in force.

Since we are still in the early phase of the credit deflation and most people remain unconvinced of its magnitude and implications, this next decline in asset prices could be very swift and deep, driven by the panic of recognition. Technical support has already been taken out, and dip buyers will be less eager, since they have seen that stocks can indeed crash. We could see an unrelenting slide like the two years from April 1930 to July 1932.

There won’t be another bounce of the magnitude we’ve just seen until real value is restored by attractive dividend yields. A 7% yield on today’s dividends would put the S&P 500 at 350 or the Dow under 4000, but this assumes dividends won’t be cut and that the recent years of extreme overvaluation won’t be matched by an era of extremely low valuations as the culture of financial speculation dies off.

What is it about Thursdays? In ’29, ’08 & ’10: giant intraday plunges w/ recoveries.

Here’s a close-up of the Dow in October ’29. Black Thursday, the start of the heaviest phase of the crash, saw an 11% intraday loss, then a close down just 2%:

TD Ameritrade

In 2008, October 10th saw the same type of action: an 8% intraday loss, then a barely negative close. In this case, the day marked an interim exhaustive bottom, since unlike in ’29 and this week, we’d had very heavy declines already:

TD Ameritrade

Here is yesterday in the Dow:

TD Ameritrade

I’m not making any calls here, other than to say that the market remains treacherous. Few have been converted to the bear camp, with the general consensus being that yesterday was a technical aberation. It should serve as a warning about how ephemeral equity prices can be, and how buyers can just disappear in a panic when there is no fundamental support for thousands of Dow points under the market.

The crash of ’87 happened from much lower valuations than today, and also coming off a top, though not from nearly as close to the top as yesterday. The market was overbought and overvalued on high bullishness, then buyers just disappeared. It also had a nasty Thursday from which stocks never looked back:

TD Ameritrade

What is particularly worrisome about yesterday’s crash is that it happened right off a top that registered some of the most extreme bullish complacency readings in history, and that few are truly worried about further declines. It has happened during a depression, at extreme overvaluation (1.7% dividend yield), with waning market momentum after a giant bounce off a bottom (March ’09) that had none of the classic signs of a lasting low (yields were just 3.5% at best, and the low was not tested).

Keep out of this market. Hedge any long exposure you can’t get rid of.


I didn’t mention anything about computers here, which any discussion of yesterday should have. So yes, computer stop-loss orders kicked in and buy orders were pulled, but this is just what would happen with humans. Every market in the world has experienced some kind of crash this week. It’s not the machines – they basically just do what people do, but faster.

However, you can probably blame computers if you got screwed out of something during a split-second 50-99% drop — that would probably be less likely to happen in a market with human specialists to absorb order flow with their brokerage’s books.  But that’s not the cause of the crash, just something that happens during a crash — buyers pull out and stop-losses kick in. In ’29 you also had solid companies selling for a buck for a few trades. That’s just the way the cookie crumbles, and one of the myriad risks of the equity market.

(BTW, breaking those trades was likely a bad decision on the part of the exchanges. If they had let them sit, those kinds of ridiculous plunges to a penny would be less likely to happen again, as everyone today would be coding away to program their bots to snap up “bargains” during the next swoon. If they could just turn around and cancel the trades, who’s going to take that risk, since you might end up short a stock trading at $20 the next day that you’d bought for $10 and sold for $15?  Doesn’t anyone believe in markets anymore? Not even people who run the stock markets? Just let them be, and participants will naturally seize opportunities and add efficiency to the market.)

The cause of this crash is just an overbought, overbullish, overvalued market during a depression (9.9% headline unemployment again, 17% real).

Blame the computers? Bah humbug.

Did the computers drive the Dow down 25% in a week in May 1940 (no, there was no major war news that would have justified such a move):

TD Ameritrade

Here’s the Dow for the duration of the last depression. Quite a few crashes in there:

TD Ameritrade

The fact is, markets just fall out of bed sometimes. It’s normal, and they don’t need the kind of reasons you can read about in the paper. Greece had nothing to do with it.

A move like this off a top does not mark the end. If we had plunged hard and reversed like this after we were already reading oversold on sentiment and momentum gauges, it could mark a bottom, but not right off the top — that is what should scare people today. This was not like Black Monday ’87 — it’s more like the Black Thursdays of ’29 and ’08 (huge intraday crashes with recoveries, followed the next week by the real crashes), or the Friday before the ’87 crash (down 5%). It’s likely a kickoff to more downside. New highs are possible, but looking less and less likely, and we doomsayers might be right after all these months…

You can’t predict a crash, but you can tell probabilities, and the probability of a decline was high as of last week. We had an extremely, extremely depressed put:call ratio, momentum was rolling over, mutual funds were all-in, and just about every measure of sentiment showed that complacency and bullishness were off the charts.

All this in the face of a depression. Yes, we are still in a depression — that’s what steady 17% unemployment is. Obama and friends conjured up some positive GDP by abusing the Treasury market’s generosity, and that spending is counted as “product,” but tax revenue, real estate prices, rental property vacancies, and unemployment tell the real story: this is a fragile environment. Dow 1500 is still on the table.

And how about gold? I gave up shorting it and suspected a rally after it failed to follow through on that drop from $1200 and sentiment got really bleak. Maybe real money will win sooner than I thought, or maybe this is a 2008 replay and gold will turn once the waterfall gets underway. Anyway, it gives me some hope that the companies in my mining stock database might not all go broke.

Take this week’s equity drop seriously.

Longs are playing with fire here. This market is at least as dangerous as 2007 or 2000. What happens when this multi-decadal asset mania fizzles out, like they all do? The last 12 months show that it won’t give up the ghost without a fight, but it is very long in the tooth, as is this huge rally. Also, the short-term action of smooth rallies followed by sudden drops is uncannily similar to 2007.

Stocks left the atmosphere in 1995, but since 2000 gravity has been re-asserting itself. After extreme overvaluation comes extreme undervaluation. On today’s earnings and dividends, even average or “fair” multiples would put the Dow near 4000, right back to 1995.


Charts from

A note on gold and the dollar:

I suspected a few weeks ago that gold had a rally coming, and now that we’ve seen it I’d be careful to use stops and not get too confident.

I still like gold for preservation of purchasing power through this secular bear market in real estate and stocks, but when financial markets turn down again in earnest it won’t be spared. Remember, it kept going to new highs in late 2007 and early 2008 after stocks had peaked, but then tanked with everything else when panic hit. Cash is still king, especially in US dollars and Treasury bonds. We may have only seen the start of this deflation.

Still 2007

Yahoo! Finance

I can’t draw on this chart, but you can clearly see the similarities in price, RSI and MACD between the last 6 months and the period leading up to final top of the even bigger bear market rally of 2003-2007. Will we levitate up here for a year like we did back then? I doubt it, since this is a smaller degree wave and the time scale is more compressed. It appears to be running out of steam after 12 months, not 4 years.

Since summer, the bears have been demoralized by time, not price — we’re only 1000 pts higher than last August. The bullish complacency and dejected state of the bear camp is what you need for a final top.

RSI and put:call signals like we have right now are what you need for a smaller-degree top. One of these smaller degree tops will turn out to be the big top. This is not the time to give up on shorting.

The power of technical analysis. (repost from 3.3.10)

(First published 3.3.10, 1:27PM EST)

I’ve noticed lately how well the 60-min RSI (relative strength index — a measure of oomph in price movement) has been doing, so today I decided to quantify it. The result is simply spectacular, even with a mechanical buy/sell decision that always had you in the market either long or short.

Here is a 60-day chart of the Dow, by 60-min bar. The circles are negative RSI crosses (red arrows on the bottom) and the boxes are positive crosses (green arrows). The numbers are the Dow points one might achieve by riding Dow futures from the previous signal using the signals alone, with no stop-losses. Additional signals do not add to the position, and the trade is reversed on the next opposing signal.


I tried to be conservative with those point totals (not buying or selling top or bottom tick), and some of those moves may have been missed due to opening gaps (where the price has already moved so far by the time of the opening bell), but you get the idea. It comes out to 1425 Dow points, even having been short for the whole 500 point drop in late January, which a stop-loss could have prevented. A single mini-dow futures contract, symbol YM, requires a margin of $6825 and is worth $5 per Dow point.

Now, this is hardly a perfect reflection of actual trading, but just mechanically trading a simple signal is infinitely superior to trying to outguess the crowd based on mumbo-jumbo like the Greek situation, Barney Frank, Obama this or that, oil prices, GDP, consumer data, or any other nonsense.

Now, I don’t have to tell explain any further why I think the market will probably fall by early next week.


Since Graphite senses some parallels here, I thought I’d throw up a chart of the run-up to the crash of ’87:

I was just a kid, but I remember watching the news that evening. Upon hearing that the market had crashed 22% in a day, I thought to myself, “that doesn’t sound so bad – people still have most of what they had yesterday.”

Pre-open Dow futures

It would be very predictable if stocks just rolled back over and had a very bad day:

Interactive Brokers

The caveat of course is that yesterday was a powerful move up, hinting that there could be more to come. That’s what stops are for, and we’ve got plenty of clear ones here.