Global Downside Breakout
Well, I don't know about you, but I know I will sleep a lot better tonight having tuned in for Mr. Bernanke's semi-annual ‘pearls of wisdom.' According to Uncle Ben, who testified today in front of the Senate Banking Committee, "there is a reasonable prospect that the recession will end this year," provided that the credit markets and financial markets operate "normally." I know I feel better already, don't you? Of course, if we go back and look at some of Uncle Ben's prior comments, well, maybe we might not feel so confident. Let's see, I guess it was June of 2008 when he addressed the International Monetary Conference in Barcelona, Spain. Back then, Bernanke summarized his outlook stating,
With this broader perspective as background, I turn now to a brief discussion of the current situation and outlook. Broadly speaking, the functioning of financial markets has improved of late, but conditions remain strained and some key funding and securitization markets have shown only tentative signs of recovery. Some borrowers, such as highly-rated corporations, retain good access to credit, but credit conditions generally remain restrictive in areas related to residential or commercial real estate. Residential construction continues to contract, and the overhang of unsold new homes remains large, although it has declined some in absolute terms. Consumer spending has thus far held up a bit better than expected, but households continue to face significant headwinds, including falling house prices, a softer job market, tighter credit, and higher energy prices, and consumer sentiment has declined sharply since the fall. Businesses are also facing challenges, including rapidly escalating costs of raw materials and weaker domestic demand. However, the strength of foreign demand for U.S. goods and services has offset, to some extent, the slowing of domestic sales. Overall economic growth was quite slow but apparently positive in both the fourth quarter of 2007 and the first quarter of this year. Activity during the current quarter is also likely to be relatively weak. We may see somewhat better economic conditions during the second half of 2008, reflecting the effects of monetary and fiscal stimulus, reduced drag from residential construction, further progress in the repair of financial and credit markets, and still solid demand from abroad. This baseline forecast is consistent with our recently released projections, which also see growth picking up further in 2009. However, until the housing market, and particularly house prices, shows clearer signs of stabilization, growth risks will remain to the downside. Recent increases in oil prices pose additional downside risks to growth. Our decisive policy actions were premised on the view that a more gradual reduction in short-term rates could well have failed to contain the financial and economic problems confronting us. For now, policy seems well positioned to promote moderate growth and price stability over time."
As we re-read his comments from only a few months ago, we see a relatively perfectly well balanced, carefully crafted, very "close to the vest" analysis. Yes, it is true that the analysis touched on many salient points both PRO and CON, accurately noting the deterioration in housing and the slow down in consumer spending. However, in reading and re-reading many of the speeches by many Fed members, not just Bernanke, it is always in the conclusions where things go wildly to pieces. In concluding that "we may see somewhat better economic conditions during the second half of 2008," and "growth picking up in 2009," "moderate growth and price stability" ...What? How about the potential for a heart-stopping recession, or did that thought ever cross your mind? I guess not, as the Federal Reserve has been wrapped up in its own grandiose view of its dominion over the world economy. As new readers should understand, prior to six months ago, recessions had been officially outlawed by the Fed and consigned to the trash bin of history. Well, with the entire Western world sinking into nothing less than a global DEPRESSION six months later, one can only look back and wonder what the heck the Fed was collectively smoking, starting with Greenspan and ending with Bernanke.
These are not the guys who are going to get us out of this, and unfortunately, nothing coming out of Washington of late is going to do anything else but the make the situation that much worse down the road. As many highly qualified writers have noted on Financial Sense, you cannot borrow your way into prosperity and the hope of Keynesian Deficit Spending as the magic elixir is at the moment, badly misplaced. We seriously doubt that the Bernanke recovery forecast is much more than a ‘feel good' roborant lacking any sound underpinning from the message of the markets or the economic data.
Speaking of the financial markets, the message emanating loud and clear from most corners of the world is that of two words, "downside continuation." That's right, rather than a warm and cozy dose of ‘chicken soup for the soul,' the downside confirmation coming from both US and Foreign Stock Indices is more akin to the markets choking on a ‘chicken bone in the throat."
Note on the chart below that as the Dow Jones Industrial Average has broken below the 2002-2003 market lows, the Dow Jones Transportation Average is making fresh new lows in lockstep. While the Trasnportation Average performed better during the last bull cycle as a result of strength in the Railroad stocks, over the last few weeks the Transports have been a lot weaker than the Dow. Over the last eight trading sessions dating back to the intra day high on February 9th, the DJIA peaked at 8376.56 with the DJTA at 3250.18. Since then, both indices have tumbled for the balance of the last eight days (prior to today's bear bounce) with the DJIA hitting a low last Friday at 7226.29, and the DJTA hitting a low of 2607.48. Over the eight day stretch, the Transports fell 19.77% while the Industrials fell 13.73%, Transports in the lead on the downside. What's more, on a year-to-date basis, the DJIA is down 18.47% from its January 2nd peak of 9034.69, while the Transports are down an amazing 27.39% from their equivalent January high.
In my view, not only is there a freshly minted Dow Theory downside confirmation signal, but the fact that deeply cyclical Transportation Average is acting so poorly tells us that the odds of recovery are low indeed. Of course, we would not, even for a second, want to understate just how important it is that the Industrial Average has now broken down new multi year lows. In my view, this is the ultimate downside continuation signal as the Industrial Average is being well confirmed by markets and other indices worldwide. In the case of the perhaps more important (cap weighted) S&P 500, the breakdown below the 2002-2003 lows at 780 to 800 is being confirmed by a MACD that remains deeply ensconced at levels well below the zero line. While some may join the ‘clutching at straws committee' pointing at a minor divergence with prices, in my experience the fact that MACD had virtually no bounce over the last few months and has now reversed to the downside once again in deeply negative territory is just about as negative a technical signal as I could imagine. Simply put, it implies a market getting ready to move a great deal lower in the weeks and months ahead.
Elsewhere around the world, we still see a large number of markets that continue to act quite poorly. In the case of the European Stock Markets, back in June of 2008 I wrote about some of the so called "Club Med" markets which in my view had great downside potential.
In a 6/24/08 article entitled, "Trouble Ahead for the The Four Horsemen and Europe's Not So Sunny Side" I wrote about the Italian Stock Market stating:
"In the case of the Italian stock market, the MBI Index last quoted at 23,879 is likely to break support at 23,000 and could then decline rapidly toward the 17,000 to 18,000 price level in the months just ahead. These patterns agree with other charts we have featured in this column showing Hong Kong and Paris in recent weeks. The message in our view is universal: global equity markets of all stripes are in for a lot of difficulty as 2008 wears on and investors should be looking to sidestep what appears to be an approaching decline of very large proportions.
Since then, the MBI Index has plunged from a 6/24/08 reading of 22,873 to a close last Friday of 12,804, a striking decline of 10,069 index points or 44.02%. So far in 2009, the MBI Index is already down 20.46% from a January peak of 16,099 to a recent quote near 12,804. Downside momentum has never abated and the index is falling on high downside momentum with no signs of a positive divergence or a well formed bottom.
BEFORE AND AFTER:
THEN back on 6/24/08 we showed the chart above of the Milan MBI Index about to break down into another extended decline. We targeted a move down to below 17,000, and as can be seen in the chart that follows, our forecast was actually too conservative.
In fact, as can be seen in the chart above, over the last few weeks the MBI Index has thoroughly collapsed below the 2002-2003 lows which I believe will end up as a good leading gauge for other markets. In my view, one important element in focusing on the action in the European stock markets has to do with the actions of the ECB. So far the ECB has been, at least in tone, the most hawkish central bank, refusing to lower short term interest rates as rapidly as most other central banks. While it is true that ECB is doing a great deal of money printing just like the Fed, because the ECB reacted a lot later to the down turn, most European countries are feeling the heavy dose of deflation to a very intense degree. As a result, the stock markets of some of the more debt laden, export dependent European countries are often breaking down in advance of other markets with countries like Italy, Greece and Spain leading the way. In my view, the MBI Index appears likely to continue its decline in the coming months with the next Fibonacci downside target the 8,500 to 9,000 zone on the MBI (see dashed line).
In Spain, the IBEX 35 has also plunged to new multi-year lows with the index closing below its October and November 2008 lows and the 7,700 mark over the last few weeks. Back in June of 2008, I noted that with the IBEX then trading at the 12,132 mark, that: "The Elliott Wave structure for the Spanish and Italian stock markets agree with the bearish chart formations, wherein for the Spanish stock market, a decline toward the 9,300 to 9,600 range – a major third wave decline looks to be dead ahead.
BEFORE: From Financial Sense Article 6/24/08 I have the chart reproduced of the Spanish stock market coming out of a broadening top and heading into a likely massive third wave decline. Watch out below!
AFTER: the IBEX Market today, now plunging to new lows below 7,700 with a close last week near 7,601.
Like the price action of the Italian stock market, the Spanish IBEX has also collapsed in recent months with the violent third wave down carrying prices below 8,000. Over the last few months, IBEX has traded between 7,700 on the low end and 9,600 on the high end, that is until the breakdown to new multi year lows over the last few weeks. From here, we see a continued decline (punctuated, of course, by the occasional fast and furious bear rallies) down to the 2002-2003 lows, which for the IBEX reside in the 5,200 to 5,300 zone. From present levels, this implies an additional 30% decline, which in my view underscores last week's notion that the worst is yet to come. Among the larger European stock markets, the DAX, the CAC and the FTSE have all broken down to new lows for the bear market over just the last few weeks. Thus far, none of these markets have yet to break their 2002-2003 lows, but in each case the momentum profile at present remains ultra bearish.
In the case of the German DAX Index, I believe that the bear market still has a long way to go on the downside with longer term Fibonacci ratios suggesting that the DAX could eventually
Decline below 2,000 toward the 1989 to 1991 levels between 1500 and 2000. That implies that remaining downside risk in German stocks could be on the order of another 50%+, with similar potential decline unfolding in both Paris and the UK.
For the Paris CAC 40 Index, a continued bear market decline could see the index blasting below the 2002 to 2003 lows and ultimately targeting a major low in the 1600 to 1700 zone perhaps early next year. With the CAC currently in the 2750 zone, once again we are looking at the prospect of still enormous downside risk on the order of 40% or more. For the London based FTSE, now in the 3900 zone, we arrive at a longer range downside objective of 2200 to 2500
(so let's call it, 2,350 +/- 150 points) for an additional decline of around 40%.
If and when these longer range targets are approached, the odds will be very high that the global bear market for equities is nearly complete and that the deflationary contraction now underway will then yield to broad scale re-inflation. For most individuals, that will mark the beginning of the real ‘hard times' as the return of consumer wholesale inflation will probably be unlike anything the world has seen in decades. For the global economy, the ‘depressionary' economic roller-coaster of the next 5 to 8 years will likely have more violent twists and turns than most of us would care to imagine. For investors, the 100% emphasis will need to be on an adaptable mindset and on market timing in lieu of ‘buy and hold' investing.
About Frank Barbera CMT
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