December 26, 2009
Economy on Crutches; the Stock Market on Steroids
Bull to Bear ratio over 3 is a highly negative indicator
Insider Transactions back to 50:1 sales
2010's best performing asset classes
After a “breather” since March, the Market continues its plunge
Emerging Markets and Bonds, especially high-yield bonds, are in a bubble
As Barron's Alan Abelson so elegantly quips, we have “a Recovery on Props of an Economy on Crutches, accompanied by a Stock Market on Steroids”. In the 30 years that I've been reading Barron's, Alan's brilliant and insightful column is one of the few things that have remained constant.
You would think Wall Street Bears were becoming an endangered species. The latest Investor's Intelligence survey of advisory sentiment was 52.2% bulls vs. 16.7% bears. Like insider transactions, back to 50:1 sales vs. buys, this is a highlydependable negative indicator. When there are this few bears, the likelihood of bull defections to the bear camp are great. Since bulls are nearly fully invested, all that's supporting the market is year-end retirement plan contributions. What's more the 10-week average of “bulls”divided by “bulls plus bears” indicates the market is overbought by 70.8%, fast approaching the July 2007 high ratio of 71.5%. We're all well aware of the painful implosion, which began shortly afterwards. Follow the timeline on the chart below for a clear picture.
In the segment labeled “a” beginning at the Bull Market Top, notetheDiag IIwhich kicked off the downdraft, had its fall broken by the Diag >. In the absence of such a Diag this time, we continue dropping to the area of 2750. In the chart below, each target marked by the red dashed horizontal lines is a lower degree wave 4, descending in stair-step fashion. (iv, 4, iv) Wave a barely exceeded the ivth of the Diag >, which began signaling the end of the Bull Market as far back as 1997. Once a move from a Diag II is completed, the chart swiftly retraces to at least where it began. On the lower left we see it began with wave i which is identical to wave iv to its right. Note the 1987 Crash, represented by the long red candle just past wave i, will likely be dwarfed by the Crash just ahead.
Since March 2009 the Market has merely “taken a breather”, to give the “buy high, sell low suckers” time to pile back in. “Steroids” above refers to the NY Fed's clandestine buying of futures, under the guise of selling “repos” through its network of government debt dealers. Although these “steroids” are no longer being administered, their carry-over effects have only recently started to wane with “trend followers” starting tobail out. Next they will “deflate” the Market back to the larger Bear trend, which began in March 2000. As you see, wave 5 must drop to at least to Dow ~5170, where it will likely bounce before continuing South to a trough near the vicinity of Dow ~2750. Dow 2,750, which corresponds with 300 on the S&P 500, will not likely timed for year-end 2010.
Our forecasts for 2010's best performing asset classes, in order of attractiveness
Inverse Emerging Markets
Inverse China
Inverse Financials
Inverse Real Estate
Inverse Technology
Inverse Small Stocks
Inverse Bonds esp. junk(although bonds, like the dollar up to now, will initially run
counter equities, they should reverse and plunge together)
Inverse Basic Materials
Inverse Crude Oil
Inverse Gold
Inverse Dollar
The World is now truly flat, there is no diversification to be had anywhere, as all assets will fall in tandem. And because of a Spike in volatility, only expertly timed inverse funds will profit in 2010.
Some naïve traders assume that once a 50% Fibonacci retracement is surpassed, a 61.8% retracement is virtually assured. Quite to the contrary, this reversal has been in progress since November. Only the “b” waves transitioning down have surpassed the 50% retracement.
In 2009 $85 billion has moved out of US Equities in favor of Emerging Markets and bond funds, both are crowded trades. When everyone invests in the same asset class, it becomes crowded, and thus sub-optimal returns and even losses are to be expected. Emerging Market Equity funds at $75 billion are at all-time highs, up 39% from 2008, 2/3 of which is attributed to multiple expansion and a weaker dollar, rather than earnings growth.
In the bond market, we have the steepest yield curve ever. With short-term rates being artificially held near zero by the Fed, borrowers looking to roll-over maturing obligations will of necessity have to bid up the price of money (interest rates). And, in the absence of any likely shocks to the financial system, we can only expect another, more severe credit crunch. With the securitization market down 90% from its pre-crisis peak, this “shadow banking system”, which previously financed everything from Mortgages to Auto loans, is moribund. What's more, over the next two years the US Government must roll-over $2.5 trillion concurrent with banks world-wide requiring an additional $7 trillion, and US Commercial Real Estate needing to roll over $0.75 trillion. That's $10,250 billion.
In Diag IIs as below, once five waves down complete there is always a bounce back to where the Diag began, marked by the green dashed line. So although long-term rates are headed down longer-term, they will be highly volatile until these bounces complete. The trajectory should first drop to a yield below 2%, followed by a bounce above 4%. Afterwards the plunge continues, following the Japanese model. In effect the 15-20% capital losses on US Treasuries this year, as a result of climbing yields, are about to reverse in the intermediate term.
Flows into high yield bond funds alone have totaled $30 billion this year. In the meantime, yield-hungry investors have bid up the prices of the riskiest, junk debt. Triple C bonds have appreciated 100% this year, for their biggest returns in history. It's not return on their money, which investors should be concerned about, but rather return of their capital at high risk. Companies in a rush to take advantage of this high-yield demand have issued $171 billion in new bonds. Distressed debt - bonds trading at less than 50 cents on the dollar - now represent just 1.1% of the high-yield market, down from 27.5% a year ago. While yields have dropped from 20% to 9%, defaults were inching higher at 12.9% at the end of the third quarter. This is another insane market bubble set up for catastrophe; another product of the Fed's easy money policy. With the Depression ahead, default rates for junk will skyrocket and the little piggies hungry for yield will be the first ones slaughtered.
Meanwhile the Dollar is forming aDiag indicating the reversal up, father down the road, once the area of 73 is reached. Once that low occurs, the dollar should swiftly exceed 99 on the dollar index before collapsing again. Essentially wave 2 is an upside correction of a predominantly downward move with much further to go. Being a monthly chart wave 2 could take 2-3 years to complete.
At this juncture this is a trader's market, with volatility picking up, either you trade or you constantly end up giving back the profit. The alternative is to earn nothing from cash, or risk receiving negative returns.
Best regards,
Eduardo Mirahyes
Exceptional Bear