WEEKEND REPORT (11/23/08)
I like to try and distance myself from the day to day movements of the markets, because they mean little to me. The only thing I can get from the daily movement is a potential warning sign. Ten years ago I decided that I would no longer chase the daily ups and downs of the market. My priorities shifted toward identifying the beginning of a primary trend in a bull/bear market as early in the movement as possible. Once I've done that, I take an initial position and then just sit tight, adding on occasionally on the way up/down. Also, I made a conscious decision to sit through the secondary movements regardless of how uncomfortable it made me feel. As part of the package, I decided that daily movements were not something I wanted to focus a lot of attention on. I have used this philosophy and it has served me well. I bought into gold and silver in 2003 I am still there, and looking to buy more. I was long commodities from 2004 until July of this year without interruption and I was short the US dollar from 2002 until July of this year. Finally, I identified the top in the Dow more than a year ago, and have been short ever since.
Sitting through secondary/tertiary reactions is difficult at best, especially in today's manipulated markets. When I watched the Dow on Friday wanting to sell off all day long, and then at 3:05 pm EST we begin to rally 500 points out of nowhere, it puts a strain on your desire to sit tight. What allows me to do it though is the knowledge that no one has ever been able to change the primary trend of a market by manipulation, and the folks in the Treasury and Federal Reserve won't be the first to do so. In the end they are fighting the tape and the tape always wins. Manipulation is a dangerous thing because it brings with it all sorts of unintended consequences, and these in turn end up prolonging the primary trend instead of changing it.
When I was a kid I used to love fast cars and the faster the better. I was never satisfied with the motor and always looked for ways to alter the performance, i.e. getting more out of the motor than it was designed to produce. One day, one of my classmates told me he worked part time at the airport and my mind immediately wondered what high octane jet fuel in the tank would do for me. He was able to get me in, I bought the fuel, and it dramatically increased the operation of the car. Unfortunately it put too much of a strain on the motor and several of the pistons ended up punching holes in the valve cover! It was an expensive lesson and it seems to me the Fed is doing the very same thing. It wants the economy to run hard and fast forever, and the pistons are now coming out through the valve cover. In the case of the Fed, their "jet fuel" is fiat currency and credit. In a car, once the pistons overheat, they expand and no longer fit into the block and the motor seizes up. Once you seize the motor, you can pump jet fuel into the tank until hell freezes over and you still won't go anywhere. That's where we are right now: the economy has seized up and we are going nowhere but down.
Every day we see Paulson or some other top ranking official discussing the measures taken as well as future plans, and saying they saved the economy from collapse and everything will work out now. Then we shift over to president-elect Obama and the super-cabinet he is forming, and the implication is that once he takes office things will improve. We simply have to wait until the third week in January. Sadly, none of this makes any difference. The stock market is a barometer of what the economy will look like in nine months, and everything we see and hear today is already cooked into the mix. I'm sorry to say the barometer is telling us that the future is going to be dark and dismal for quite some time.
It is a real shame that one year ago no one in power had the capability to look ahead and see what was coming down the road. It is almost laughable that Bernanke was brought in as the world's greatest expert on deflation and the Great Depression, because that is precisely what he let loose on the world. If he had half a brain he would have realized that the US was hopelessly in debt, he was out of bubbles, and he had two choices: very high inflation, or deflation and depression. He should have known that a deflation, combined with US $600 trillion in mostly worthless and unregulated derivatives, was not the way to go. Yet the Deflation Master took his foot off of the monetary peddle, or failed to press down hard enough, and we have deflation. Some folks think that he'll be able to print large amount of money and swing the economy back to inflation or even hyperinflation, but I disagree. Japan resorted to the printing press and they are still suffering fallout from the deflation fifteen years later. Some folks think we are experiencing stagflation, a shrinking economy with rising prices, but I again disagree. I don't see rising prices. Housing, consumption, stocks, commodities, company earnings, and wages are all headed in the same direction: down! For the life of me, I don't know what is rising, except defaults and bad debt.
I have lived in countries with hyperinflation, stagflation, and deflation and the current situation definitely feels like deflation. No one is consuming, or they're consuming the minimum possible, people are now trying to scrimp and save. There is massive debt everywhere in the world. The US accumulated massive debt consuming beyond their means, while the rest of the world went into debt trying to expand production in order to meet the increasing demand from American consumers. Everyone thought the consumption tree would grow to the sky, and now they seem dismayed when it all falls apart. Bernanke reminds me of the Captain of the Titanic; too busy admiring the beauty of his stateroom to notice that people were drowning in the compartments below. Then there is Paulson! I don't even know where to begin with him, other than to say that he was put there in order to bailout certain privileged parties at the expense of everyone else. Mission accomplished!
In order to stem the deflationary tide, both the Treasury as well as the Fed have discharged trillions of dollars in liquidity. Below you have the M-2 money supply chart from the St Louis Federal Reserve and you can see it's
a perfect example of the application of "jet fuel" throughout the Greenspan era. Then, on the far right you see a small horizontal period corresponding to Bernanke and then a vertical surge. That horizontal movement is an "oops" and should never have happened, as it opened the deflationary Pandora's Box. In a debt-ridden world, that box cannot be closed until deflation is through ravaging the world economy. Japan has suffered from deflation for more than a decade and they are a creditor nation, so I would not look for a cessation to the downward spiral any time soon. Unemployment is just now beginning to rise, and yes, the figures are mani-
pulated, and it will exceed the 1981 stagflation highs before it is all said and done.
When you turn on the financial news networks everyone asks the following question: if we are in a recession, when will it end? Then they go on to ask if it will end in the first half of 2009 or last a bit longer. The stupidity of such a line of questioning is beyond comprehension. As I mentioned to you, the Dow is a barometer for the future prospects of the economy and it looks terrible. It is telling anyone with any intelligence that things will be bad well into 2009. Now, if you are a student of the market, you can take this a bit further. We had a bull market for stocks that began back in July 1982 with the Dow at 776.92 and it lasted until October 2007 when that same Dow topped out at 14,164. That is an unprecedented twenty-seven year bull market, and if you think you're going to offset it with a thirteen month reaction, you'd better think again. I don't care how violent the reaction has been, a twenty-seven year bull market will require a minimum of 12.5% of that time period, that's 3.37 years, in order for a correction to run its course. That's a best case scenario. Under normal circumstances a correction could run 38.1% or 10.28 years! If you don't believe me, just go to Japan and ask anyone who invested in the Nikkei back in the 80's.
Since the bull market topped out, the Dow has made a series of significant lower highs and lower lows, most of which were confirmed by the Transportation Index. The latest such series occurred on Wednesday and then again on Thursday, before we saw a late day rally of 494 points on Friday, where the Dow closed out the week at 8,046. Every time we get one of these "one day wonders" the networks bring out the usual chorus of cheerleaders, with the usual crop of stupid comments. The last time we had a bounce a number of gurus called a bottom, but there was none of that yesterday. When I look at how the week developed, I see that the Dow was
Finally able to break and close below what had been strong support at 8,146. This occurred on the third attempt after more than a month of trading in a range, and Friday's close was the second consecutive close below that level, making it the real deal.
As I mentioned previously, the bull market in the Dow began at 776.92 and ran until 14,164.53 for a gain of 13,387.61 points. On Thursday the cash Dow closed at a new bear market low of 7,552.30 and that is just above support from the 50% retracement of the entire bull market coming in at 7,470. It is also a couple hundred points above the 2002 closing low of 7,286. Many folks see this as a good test of the 50% retracement, but I do not. You may recall that we had this same discussion when the Dow came within 100 points of the 10,725 support, some months back. Many took it as a test and a bounce, but I insisted that was not the case. Well, there is no difference here. We have not seen a bottom yet and the low is not in. Despite the last minute rally on Friday, there were two new highs and 1,245 new lows and there was no substantial increase in volume. What's more, Lowry's selling pressure hit a record high on Thursday, while buying pressure hit a record low, indicating that there are still plenty of sellers out there. Finally, if you look at RSI, MACD, and the histogram, they are all headed down, but the market is not oversold. In my opinion, Friday was just an expected bounce after two consecutive 90% down days and it would not be unusual to see a run back up to 8,146 after taking so long to break down through it. We've seen that countless times before.
As I've told clients all week, I do not know where the Dow will bottom, but I do know that we haven't seen the bottom yet. My guess is that the support at 7,470 and then down at 7,286 will not hold, but that is just a guess. If it fails to hold support this range, the next good level can be found at 5,890. What's more, you need to focus for a second on what a break and close below 7,470 would mean; using the 50% Principal it would imply a run down to the 1982 low was now in play! In any event, there will be a boot, whether at 7,470 or at 5,890, or somewhere in the middle, and that will be followed by a sixty to one hundred and twenty day rally, which should be a buyable rally. The counter trend move will convince a lot of folks the bear market is over and could run as high as 9,913. Once the reaction is over, we'll begin an even nastier leg down that may not stop until the Dow hits 2,450. That should open a few eyes!
So, what does one do in a world where everything seems to be deflating? A lot of money is seeking shelter in the bond market, but I think that is a momentary thing. Others think the US dollar is the place to be, but I disagree. I know a long dollar position was the place to be, but I now believe that game is over and it may very well be time to jump back on the short side. Sometimes the end of a trend goes unperceived and that could very well be the case here as the US Dollar Index might very well have put
an end to the secondary reaction by simply moving sideways out of its recent uptrend. What's more, notice that the last two marginally higher highs were not confirmed by RSI, MACD, or the histogram (red arrows) and all three are headed down. Finally, it is worth remembering that the dollar is still firmly in the grips of a bear market, and with price being compressed as it is, the odds clearly favor a move down. You cannot create trillions of dollars of worthless paper and expect the world to just soak it all up and say thank you very much. Debt service drove the dollar up, but there are downward pressures beside the printing press. Don't forget that most commodities are priced in dollars, and the demand for these products has fallen through the floor. I am utterly convinced the dollar is an accident looking for a place to happen.
On the other side of the coin we have gold. For the last month or so it has had few friends and even fewer buyers, and that is almost always a sign of a bottom. I told you on Thursday night that I was extremely bullish gold, it
was close to a breakout, and it should be bought. On Friday we saw a significant breakout to the upside, as it moved past strong resistance at 772.80 and never looked back, with the December gold futures contract closing at 800.20. The CNN's of the world are attributing the move to a flight to safety, whereas I would say that people are now searching out a true store of value. Deflation can no longer be swept under the rug, even with the Fed presidents coming out and denying its existence.
From a technical point of view, gold looks better every day. You have RSI, MACD, and the histogram all headed up, and declines are being bought into almost immediately. Gold was up considerably every morning this week, sold into, came right back for more the next morning, and if you are bullish that is what you want to see. When you look at gold's P & F chart,
you'll see a bullish price target of 825.00 so we still have upside potential. I obviously see much more upside potential than that, but there will be points of resistance as you can see below:
It would not surprise me to see gold fall back to where it broke out from at 772.80 before it works its way higher, but I believe we will go higher. Much higher! The next decent test of resistance is at 820.80 and should occur within the next seven sessions. Finally, I also like silver a lot, but the chart is not nearly as bullish as gold's. I have been buying gold and will continue to buy as it surpasses resistance levels.
In conclusion, the world has now entered a long deflationary period that will change the political, economic, and moral landscape of our globe. I am pessimistic about the outcome. Americans in particular are going to have to learn to live with a lot less and that is unfamiliar territory. Unemployment will continue to skyrocket and wages will decline as companies continue to cut back. Unfortunately, most of the cuts will be in the bottom half of the pay scale, instead of the top half. The gap between the "have's" and the "have not's" will widen considerably, and that will lead to civil unrest. Sooner or later, Americans will realize they gave away their freedom and their future, as well as that of their children and grandchildren, and they'll try to reclaim what was lost. There are well entrenched powers in the US that will not go quietly into the night and you may very well see US soldiers trying to keep the peace on American streets, and I will be very interested to see if they can shoot their brothers, cousins, and neighbors if so ordered. I believe it could very well come down to that. There are a lot of things I don't know, but I do know that 2009 will be an interesting year.
[This week is Thanksgiving in the US so there are no markets to speak of Thursday and Friday so I will take time out to cook a turkey and catch up on some reading and a little football. My last report will be Tuesday night and then nothing until Sunday night.]
ebo@dtanalysis.com
Dow Theory Analysis SAC
November 22, 2008
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