DAILY REPORT (11/17/08)
It turns out that the Republicans do not want to help the automakers. I guess Paulson doesn't have any friends in the auto industry. Most of the economic reports coming out have a decidedly negative tone, and that's the way it is with deflation as it just slowly and relentlessly grinds the economy up. The bad thing about deflation is that it feeds on itself until it becomes completely self-stoking. Consumers spend less, companies take in less, companies cut costs and reduce employment, consumers become fearful they'll lose their jobs, so they consume even less, and so on… In a normal world the government would use monetary (increased liquidity) and fiscal policy (reduced taxes) to combat deflation. Unfortunately, a loose money policy has been a way of life in the US and is responsible of the credit crisis we face today. What the Fed is trying to do now is use an even looser money policy to resolve the credit crisis, but it won't work. The credit markets have seized up, much like a motor that's been run long and hard with no oil, and no amount of credit will resolve the problem. No one wants to loan and no one wants credit. End of game.
The affects of the slowdown can be seen in the demand for raw materials and that in turn is reflected in the horrendous decline of the Baltic Dry Index:
When they finally get around to publishing the truth about the Great Depression that began in 2008, this chart will be at the forefront of any good report. I have never seen a major index look this bad! Also, keep in mind that this reflects worldwide declines in demand, and I don't think that has been fully priced into the market. All the focus has been on the US market, but the real downward pressure will come from overseas.
As things tighten up even more, two things will happen: the US will issue more bonds and more dollars. There's no way around that. The more bonds issued the more investors will perceive higher risk, and the more they'll demand a higher interest rate in order to hold bonds. Take a look at
the weekly chart for bonds and you'll see a top in January followed by a higher high in late August that was unconfirmed by RSI and MACD. That kind of technical weakness can often indicate a top of some significance is in. You might remember that we saw the same thing with the top in the Dow last year, and that worked out quite well. I think the bonds are distributing with a range, 120.00 to 112.15, and once we fall down through the bottom, the party will be over. I see critical support in bonds at 105.06 and I see this as the equivalent to 10,725 in the Dow. Once that was broken it was downhill fast.
Finally, the cash Dow has fluctuated from up 70 points to down 225 points and most of that time has been spent in negative territory. One thing is obvious to me and that is that the Dow goes down much easier than it goes up. What's more there is little or no follow through to the rallies, while the declines seem to go on forever. Many have been quick to call bottoms throughout the bear market, and they have continually error in this call. I have insisted for more than a month that the bottom was not in, given the way that selling pressure never really subsided and buying pressure never really took off to the upside. What's more, each rally was always followed by one or more 90% down days, indicating that there were still plenty of willing sellers out there. Today the December Dow has traded as low as 8,246 as we are in the midst of a third test of the crucial 8,146 support. I have to believe that the third test of the 8,146 support is not yet over and we will test the 2002 low at 7,286 this month.
Volatility will only increase until the Dow finally puts in a real bottom. Bear market declines are always more volatile than bear market secondary reactions, and this will be no exception. The VIX is used to track volatility and, as you can see in the daily chart, we are at historical highs in the index. After moving as high as 90 we saw a correction, but we still stayed at uncommonly high levels. Now RSI, MACD, and the histogram are all headed higher, and that is not a good sign. If I am right and the Dow tests 7,286, it would not surprise me to see the VIX close above 100!
ebo@dtanalysis.com
Dow Theory Analysis SAC
November 18, 2008
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