Today's Market WrapUp 02.04.2009 Mon Tue Wed Thu Fri Goldberg Archive
Economic Woes Start with Stock Market
BY MARTIN
GOLDBERG, CMT
Healthy economies begin with healthy investments. Sick economies begin with sick investments. Sick investments are made by sick investors. Speculative markets breed sick investors which breed sick economies which breed sick investments. The process accelerates to produce economic bubbles which eventually pop. But with enough government intervention, popped bubbles do breed new bubbles which breed new sick investors while making whole, the existing sick investors. This government intervention also destroys the government's balance sheet while the new bubble cycle accelerates until those bubbles pop and the government (with its damaged balance sheet) intervenes again. When those bubbles pop, the economy enters uncharted territory.
And that is where we are now - in uncharted territory. This condition was entered during the last administrations. The government is now intervening in unprecidented magnitudes in spite of its unprecedented poor balance sheet. While it appears to many intelligent folks that what the government is doing is the wrong thing, it may be best to give the Obama administration some slack because they inherited this predicament from past administrations. While many folks think our economic situation can be cured with the application of the free market, one must consider that this philosophy may be misguided too. The key point here is that we are in uncharted territory -- no one knows for sure how to solve this predicament and how and who should be saved. In such a situation, it is best to look to analysts displaying the quality of humbleness and shy away from those who are the most sure of themselves. In times like these a good rule of thumb is that one's useful knowledge is in inverse proportion to how sure of the person is of himself.
Are there some important observations that can be gleaned from technical analysis of the markets? I think there are. One such observation is that bear markets end in one of two ways. One way is a capitulation bottom which is a sharp bottom occurring with climatic volume where traders all throw in the towel at once. This would be similar to the action which occurred in the '02/'03 market bottom. The other type of major bottom is that of a long duration capitulation bottom, which is characterized by most traders and the public leaving the market and therefore the bottom occurs with relatively low trading volume. Such events signal "revulsion." It is during these times where it is totally uncool to discuss the financial markets at parties. It is my view that the end to this bear market will be characterized by a long duration low volume event where traders and (especially) the public become repulsed by the stock market. As you can see in the chart below, the '02/'03 bottom exhibited increased volume and was accompanied by a short sharp bottom. The high volume bottom was indicative of increased speculation and was not a revulsion event. For those who think that the market is bottoming now, they would have to subscribe to the belief that this bottom will be similar to the last one - that is a high volume relatively short duration market bottom. While this is certainly a potential scenario, it contradicts the "tendency of variation." This "tendency of variation" says that markets tend to vary in their action. That is a short sharp bottom tends to be followed by a bottom of long duration. Similarly, a high volume bottom tends to be followed by a low volume bottom.
It is also relevant to note the importance of 800 as a technical support level for the S&P 500. One would think that a decisive break below this level would severely damage a significant amount of the public (even more than they have been recently), and trigger the type of revulsion that would be necessary to make an important bottom. I'm thinking that the current "bottom" level is not the final bottom because it hasn't triggered any serious changes in behavior from the recent past. Most institutions with say are still telling their clients to just be in it for the long term. This doesn't represent a change of behavior. Trading volumes are higher, signaling even higher levels of speculation at the present. While the mass media has changed from the stock market bottom that was formed from the Great Depression, it is curious that the "stock personalities" are still those that existed at the last market bottom. Again, this doesn't represent the change in behavior that I think would characterize the next major stock market bottom. It is my view that the next important market bottom will be formed in the absence of any stock personalities.
Will long term interest rates rise, or will they fall? The chart below depicts the entire multi-decade bull market in the 30-year T-Bond (and bear market in its yield). We see that after 27 years of a bull market that was largely linear, we had a parabolic move in the direction of the 27 year trend. Such action tends to indicate the top of a bubble or at least a major top. The top was signaled with a concurrent short term interest rate cut to near zero (0) percent.
The bond market can be summed up by the following observations:
- A 27 year bull market.
- A parabolic (bubble) move in the direction of the trend.
- Completion of a reversal pattern.
- A reduction of short term rates to near zero.
- Bullish news (the Fed is going to buy treasuries.), without resulting bullish action.
- The relationship of the bond and stock market no longer is applying on a day to day basis. (Bonds no longer are bought when stocks are sold.)
The preponderance of the evidence suggests that a break of this neckline to the downside would be another strong piece of evidence to support the conclusion that there is a new bear market in US Treasuries. Perhaps there needs to be one more cincher. Observe the 7 to 10 year Treasury Note ETF (IEF). A desisive break of the neckline would cinch the end of the 27 year bull and beginning of a bond bear market in my view.
Which will it be? Inflation or deflation? If gold were to proceed to new highs from where it is now that would be a great confirmation for the inflationists. This is because in so doing, the gold chart would have violated numerous technical analysis principles. The most important of these principles is that large moves come off of large bases. In the case of gold, there is no base. Rising to new highs from here would be quite a trick, but the short term odds don't favor this in my view because the chart looks too sloppy for such a move from these levels. This is a short term view. In the long term, I'm expecting the action in gold to "base out" before eventually moving higher.
Martin Goldberg
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