June 5, 2010
The market is the best predictor of future economic activity than any Economist
A horrendous jobs report on Friday cut the bounce I was expecting short and threw the market in a tailspin. Of the 431,000 new jobs added in May (versus 290,000 in April), 410,000 were temporarily recruited for the census. In essence, if we back out the census workers and net new jobs come in at 21,000. The total unemployment dropped to 9.7 due to those who quit looking for work from disillusionment.
Regardless of what appears to be happening in the economy, its lagging indicators, and even current news events, the stock market is the best predictor of future economic activity. It discounts the future six months to a year ahead better than any economist or group of economists. Make no mistake what you are seeing is the Prelude to the biggest Crash in 300 years.
The combined price estimates of more than 2000 forecasters tracked by Bloomberg show the S&P 500 is expected to rise by 27% in the next year. Of course in order for the Bear Market to squeeze out the excess of the previous boom, investors must be lured to pile in right at the top, otherwise the Bear Market could not fulfill its purpose. Pay no mind to these estimates...like economists they are all wrong, and most lack both experience and perspective.
On Friday the jobs scare cut short the upside bounce, we must now drop with a small bounce on to ~1075, followed by the completion of wave 1 down below S&P 1040 (the wave iii of Diag II low, barring a failure). Only then comes the wave 2 dead-cat bounce, likely near the top with a minimum upside of 1180. This last Diag II has lengthened wave 1 considerably, multiplying the indications of both the severity and violence of the subsequent wave 3 plunge.
Below is the hourly chart so you can see the detail.
As in nature, everything is proportional. From the high of wave 2 the length of wave 1 gets multiplied by the Fibonacci ratio of the second or third degree minimum (2.618 or 3.618) in the length of wave 3. The point of recognition is far into the midpoint of wave 3, where a gap in the chart typically occurs, when the “Scheiße” hits the fan, a replay of the flash crash on a mammoth scale, at which point there will be no exit.
The Vix jumped 21% on Friday to 35.65.
To complete the Diag II however it should drop back below 20 before the really big spike. Below is the Weekly chart revised. Just like in preparation for the big spike up a Diag II is being traced out. Notice that after wave iv it shoots up again. This being wave (3) it should exceed wave (1) to the upside.
13 to 24 more years of Bear Market
Supercycle wave 3 lasted 68 years from the 1932 low to the March 2000 dotcom bubble bust. If a Bear Market typically lasts 1/3 to half as long, we can expect this Bear to last between 13 and 24 more years. There is no way a 68-year Bull Market can be corrected in 10 years. Since Supercycle wave 4 typically retraces to the low of the previous 4th of one lesser (cycle) degree, we are looking at a trough for this entire Bear Market of 572 on the Dow, marked by e on the chart below. As you see in the chart below, we will most likely climb back to an all-time high after this Crash before the final Crash. Multiple crashes are the norm at Supercycle degree.
Recovery remains an illusion
For the dead cat bounce to occur, a rising risk appetite is required which would also mean less safe haven demand for the Dollar, which has peaked and about to tank right along with stocks.
In the chart below a Diag > near the end means a dramatic reversal is just about to occur, this being the second Diag > in addition to one very large and another smaller Diag II which cumulatively will make this a very violent reversal. Just one more day of upside is required to complete the move.
Still retail sales remain lackluster, with discounters faring best, yet even some these fell below analyst expectations. Last week Chinese manufacturing expanded less than expected in May and property sales plummeted sparking a sell-off in Asian equities. In the Eurozone unemployment hit a 12-year high.
High hopes for manufacturing exports bound to disappoint
In the US the Institute for Supply Management's manufacturing survey index fell less than expected to 59.7 in May, just off the six-year high of 60.4 reached in April. A fragile economy nevertheless persists as companies are reluctant to hire new workers. While manufacturing has played a critical role in “recovery” job creation, it is unlikely to be able to fulfill expectations. One reason is an increase in productivity - at an annual rate of 3.6% in the 1stQ. Those working want to keep their jobs, so companies can squeeze quite a bit of output from a small increase in overtime. Both Boeing and Caterpillar are shedding workers while expanding production. Manufacturing's recent strengths come from export sales. 59% of total exports come from manufacturing and ¼ of manufacturing employment is supported by exports. However now that European demand is contracting, China is in a slowdown and stimulus spending is near exhausted, both growth and job creation in manufacturing are bound to disappoint. Without renewed consumer spending there is no recovery, and there is no spending without jobs. Ergo, recovery is just an illusion.
Declining demand rather than constrained loan supply
In the US non-financial businesses shrank by $326 billion last year, not from lack of supply for loans, but rather their shrinking demand. In a poll taken by the Atlanta Fed in April, only 11% of respondents cited unwillingness by banks to lend as an obstacle to obtaining credit. Far outweighing these were weak sales, existing large debts or poor credit scores. But if construction and real estate are excluded, almost half of those 311 small enterprises polled saw no obstacles to obtaining credit. We are in a bust, and the loans from the boom continue to weigh heavy on today's consumption.
Platinum and Palladium point the way for gold
In May Palladium plunged more than European banks, the Euro or even BP stock. With investment demand shrinking fast by the smart money, only retail investors and industrial demand remain to support prices. In two days palladium plunged 16.6% and platinum 9.5%. The level of exuberance in metals is gone. ETFs hold 1 million ounces of platinum and 1.8 million ounces of palladium, equal to 1/6 and ¼ of annual production respectively. Last month's drop came mostly from hedge funds rather than ETFs. While these ETFs could become instant sources of supply, demand form a recovering automobile industry is but a short-term blip. Gold is next. From a high of $850 in 1980 it dropped to $250 over the next 20 years. It is most likely we see repeat of that move in the next several years as deflation rather than inflation fills self-fulfilling expectations.
In the Daily inverse gold chart below we see the identical pattern as in stocks showing a bit more downside likely to the area of 13 before a reversal up to wave ii with a min upside of 17.75.
Corporate Bonds are dead, soon to plunge
Bond markets are dead in both Europe and the US as market volatility scared off issuers and raised the premium over the risk-free government rate. While May is usually one of the busiest months for corporate bonds, issuance was weak all around with financial groups managed 1/3 of their 10-year average. Since the health of the primary debt market is a gauge of corporate confidence and investor appetite, investors are watching the interbank borrowing rates soar as signs of strain. June is usually another busy month, but so far there has not been a pick up.
In bonds we are in wave ii of 5, which is followed by the next big plunge in wave iii. We own the inverse bonds for which the count is identical, but in green to denote the profit upside. Rather than attempting to trade the bonds, I intend to let them ride until the minimum upside of 66 for TMV, (which corresponds with the red dashed line at 86.75 below) before we begin scaling out.
Euro – to maintain purchasing power
The single currency is gathering momentum as the latest auction of dollars by the European Central bank attracted no bidders. Given the expected loss of purchasing power in the dollar ahead, it would seem wise to use this fund as a money market alternate.
Until May, the no-brainer carry trade this year was short the Euro, long Asian or Latin American Currencies and long Emerging Market equities. That was until European debt concerns spread around the globe sending growth-oriented currencies such as the Australian dollar tumbling in the last three weeks. Now hedge funds are licking their wounds from heavy losses in the Australian dollar, the Yen and the Swiss Franc. As fear of contagion spread, they all attempted to cut risk in Emerging Market equities at once, sending them tumbling as well. High volatility and recent market turmoil will undoubtedly affect the global economy and in turn the risk trade. While funding carry trades with the Euro are likely out, soon the dollar which has climbed 17% since November's low, will become the favored short.
Breaking the Circuit
In the aftermath of the “flash crash” on May 6 when 55 S&P 500 stocks experienced price moments of 10% or more from a sale in a preceding 5-minute period between 2:41 and 2:50 PM, and shares of Procter & Gamble briefly fell 35%. The new circuit breakers halt trading based on where a stock was trading in the previous 5-minute period. In essence stocks can drop 9.9% each 5-minutes without being halted. What's most important to note from the “flash crash” is that it doesn't take much to cause these markets to crumble. It is highly unlikely that these new circuit breakers will prevent another flash crash and more likely they could exacerbate them. What this now results in fast computers backing off a stock when it approaches the limit could cause it to occur faster. Although ETFs are not included yet, they likely will soon although with wider bands supposedly. Besides the circuit breakers apply only to trading between 9:45am and 3:35pm, watch for the opening and closing to become much more volatile.
Below is Friday’s scorecard
On Monday it is highly likely we have a small pull back after Friday’s surge, before we continue higher…
In all these the Diag II is likely at which point we would likely buy back the half we sold on Friday.
In all of these the a-b transition ends in the black candle, while it normally would have dropped below the 7.
A pull back to 51 is likely on Monday, if so we will buy back. The upside minimum in all of these is just beyond the high of wave iii of the Diag II which is 64 on this chart.
Likewise a pullback likely before we continue higher.
In FXP I have labeled the a-b-b, again a pullback is highly likely
In HGD we will buy back near the wave ii low
SCO did not trace out a Diag II as expected since wave iv did not overlap wave i
Again a likely pullback on Mon
In the inverse bonds we bought back the half previously sold near 47, from here it should be mostly upside to 66
The tech chart is hardest to read because of the flash crash…it is no longer safe to have stops, as the volatility will mean selling your shares at the lowest possible price just before they bounce back….otherwise this chart is just like the others, on the way up to complete wave 1 as the market falls further into wave 1 to the downside.
Many more thrills and windfall profits in the coming weeks.
Best regards,
Eduardo Mirahyes
Exceptional Bear.com