WavePredictor™ AlertsOur most current market outlook, forecasts, and action.

THEN:  In early 2000, after the world survived Y2K, the crowd rationalized the extreme valuations of P/E’s of 100+ on companies WITH earnings (the ones losing money were even more overvalued) by believing in the mantra: “It’s Different This Time”. Mutual fund managers put their last pennies into the overbaked markets of the dot com, semiconductor, biotech sectors et al and ignored the NASDAQ’s charge up to 4 standard deviations above its long term moving average price level.  It felt uncomfortable at the time, but the party was raging and no one wanted to leave.  BAD DECISION!  Within two years, the NASDAQ had fallen 80%, and the fun of the last few weeks’/months’ worth of bubblemania was a distant memory. 

Fast forward to 2005, 2006, and 2007 when the real estate, credit, and “no income needed, just sign here” party was in full swing.  Again, most folks had queasy feelings about how “right” it was to buy things they couldn’t afford, but went along with it because “everyone else was doing it”. BAD DECISION!  Within two years, most had lost boats, homes, cars, and businesses they couldn’t afford, and jobs their companies couldn’t afford to maintain.  Some of the biggest financial firms on earth imploded, and the global financial system came within hours of collapsing.  The US Treasury Department went into money printing mania and TRILLIONS OF DOLLARS were created out of thin air to flood unprecedented liquidity into the system to keep it from locking up. 

The greatest Ponzi scheme in history is not the $65 billion Madoff mess; rather, it’s the Ponzi-fication of Wall Street, which has been building for years, and is about to be revealed in the upcoming selling wave, called WAVE C.   Whatever you thought you knew about how markets work was blown away during the WAVE A market crash from Dow 14,200 to 6,500.  The WAVE B rally from Dow 6,500 to the 10,700 January peak was created to do a few things we’ve been told is nothing but a conspiracy theory. 

We documented well in advance of the Dow’s break of 12,000 that closing below this number would be followed by  “Shock And Awe” selling that would leave no stock untouched (see our comment:  http://www.613capital.com/2008/07/30/shock-and-awe-selling-imminentno-stock-will-be-spared/ ).  

At what looked like the market’s low near Dow 7,900 in late 2008, we further documented that the pendulum of crowd sentiment, which reached its manic extreme at Dow 14,200 in October 2007, had not yet reached its depressed extreme.  Even after the swift rally from 7,900 to near 9,000 in only a few weeks had most reporters, economists, and market mavens “certain” that the worst was over, we documented our forecast that a break of Dow 7,000 was needed to finish the initial selling wave of the Great Bear Market (see our comment: http://www.613capital.com/2009/02/25/dow-break-under-7000-imminentuse-it-or-lose-it/). 

In anticipation of that upcoming temporary market low, we suggested in late ‘08/early ’09 to our followers that they exit their short positions, and hold any remaining longs they’d stubbornly held throughout the crash, as the time for selling was morphing into the time for buying.  We suggested our strategy for returning to 1/3rds, 2/3rds, and finally fully long the market.  In addition, we wrote that the rally we were expecting would be the biggest upward move since the decline began from 14,200.   Even more importantly, we wrote that this “head fake” rally would serve to erase the fear of market risk that had become prevalent in late ‘08/early ’09.  We went out on a limb and warned that at the top of the upcoming WAVE B peak, bullishness would likely match or exceed the extremes of the all time highs.  Our targets were Dow 9,500-10,500 for price, and October-December 2009 for the time for the rally’s end.  As of today, we missed the price high by 200 points, and the time by three weeks.  Considering we made our forecast at a time of international financial crisis, and 4,000 Dow points lower, and 10 months in advance, we’re not being too hard on ourselves.  How’d YOU do?

NOW:  Beware the Ides of March (March 15^th in Roman times).  This prescient warning was delivered to Julius Caesar in 44 BC by a gifted soothsayer, who, like us, paid attention to the sentiment of the crowd, rather than the governmental line.  Unfortunately for Caesar, he must have been paying too much attention to the CNBC of the day, and met his demise, despite having been cautioned. 

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Our indicators are blowing our ears off with warnings of extreme bullishness and historic danger.  One of the most significant pieces of this sentiment puzzle has finally surfaced in the data, even though we have hinted at it for the past year: sideline money.  If we use the historic cash-to-asset ratio at mutual funds as our indicator of bullishness or bearishness, we see that in December, this ratio moved to the lowest amount of funds’ cash on hand in history, except during the initial July 2007 test of Dow 14,000.  If you knew then that the greatest bear market in a century was three months from beginning, would you have acted differently with your portfolio?  Obviously, yes.  If you told yourself you would NEVER ignore a similar opportunity to exit the market, voila – here it is!  EXCEPT FOR THAT ONE INSTANCE, a few weeks before the greatest market exit point in history, MUTUAL FUND MANAGERS ARE CURRENTLY AT THEIR MOST EXTREME LEVEL OF BULLISHNESS IN THE PAST 50 YEARS, when this data series began.  A couple other similar extremes coincided with the start of the historic bear markets of 1973-74 and 2000-2002.  We don’t know if this extreme will surpass that of 2007 over the next few weeks or months.  In the chart above, notice the monthly stochastic in the bottom pane.  It’s at the same overbought extreme as it was into the 2007 peak.  The daily stochastic (not shown) is a shorter term measure of the same crowd sentiment extreme, and is overbought too.  In fact, the last time the daily stochastic was this overbought was during the days leading up to the 10,722 January peak, just prior to a 900 point Dow slide.  If you are feeling particularly lucky, try staying fully invested and send us a postcard in a couple years, if you can still afford the postage. 

We’ve also illustrated three potential paths in the Dow chart above.  At the right side of the chart, you’ll see orange, blue, and white vectors representing the most probable short term paths (weeks/months), but they all have the same intermediate term (quarters/years) resolution…MUCH, MUCH, LOWER! 

Apparently, the Fed has a talent in raising short term interest rates just before big stock market declines.  Take 1929, 1987, and 2000 for example.  The mid-February, surprise, after-market Discount Rate hike from .50 to .75 basis points may seem inconsequential, but it serves to “change” the Fed’s long-standing policy of easing, regardless if they say it was only for “technical” reasons, and not to signal a change in policy.  The media immediately picked up the Ponzi-fication ball and printed headlines suggesting the Fed move was signaling an extended recovery was beginning. 

Economists surveyed by the National Assoc. of Business Economists are in agreement about the recovery being “firmly on track”.  In fact, they forecast the S&P 500 will be 23% higher in the next two years.  Interesting that this forecast, which has little chance of happening, per our work, would still leave the S&P 15% below the 2007 highs.   Unfortunately, this is one of the many groups that failed to see trouble in 2007, until the markets had plunged 50%, then failed to sound the all clear buy signal in early 2009, when we did.  So, why do we track a worthless indicator like economist surveys?  Because they provide a wonderful contrarian sentiment indicator of what “IS NOT” the right thing to believe.

The New York Times reports today that the Wall Street bailouts of big banks may have softened the recession for New York City.  The article says the things never got as bad for New York City as they did in prior recessions, and the City is poised to recover with the country.  Our work warns that New Yorkers shouldn’t get too optimistic too soon, as the worst is yet to come.  In fact, New York State (California, too) has begun withholding state payments to local municipalities in an attempt to conserve cash.  As many municipalities declare bankruptcy in the coming months and years, recent optimism won’t last long. 

Municipal bond prices are becoming correlated with bond prices of sovereign debt, but are not yet generating the same headlines (emphasis on the ‘yet’).  The interest rate spike we’ve been predicting for months may come as muni price declines begin to effect cities and states, as sovereign debt declines begin to effect foreign governments. 

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The Rockefeller Institute of Government confirms that state revenues fell through the first three quarters of 2009, in the largest drop in nearly 50 years.  Last week’s release of Q4 data shows sharp declines in tax collection, extending the income shortfall to a record five straight quarters. 

Deflationary pressures are negating former assumptions of revenue streams and credit access that were made in the past.  Since these assumptions have come into question, so will the implied safety.   This “recognition”, as Elliott called it, will be evident only after most of the price damage has taken place in muni portfolios.  The controller of Harrisburg, PA has come public in stating, “bankruptcy is inevitable”.  The chairman of the National Governors Association warns that, “from a fiscal standpoint, the worst is yet to come”.  The head of the Civic Federation, a prominent watchdog group, said, “Doomsday is here for the state of Illinois”, referring to their inventory of unpaid bills.  FOR MUNICIPAL BOND HOLDERS ACROSS THE COUNTRY, NOW MAY BE THE LAST, BEST CHANCE TO CLEAR MUNI’S FROM PORTFOLIOS AT REASONABLE PRICES.  When it becomes obvious that it’s bad, the bids will drop to unthinkable levels. 

The point is to be aware of information other than what is being told to us by those with conflicts of interest.  Don’t be lulled into believing that the economy is fixed and all is well, when you see with your own eyes daily that it isn’t better, perhaps even worse than a year ago.  If you didn’t like the rollercoaster ride in your portfolio went through in the past 3, 5, or even 10 years, change your investment plan.  Don’t make the mistake that most Americans did in early 1930 and just watch while their quality of life changed in front of their eyes.  DON’T BE FOOLED!

Here some recent observations that are being dismissed:  single family home sales -11.2% in January and prices back to 2003 levels; pending home sales -7.6% for January; consumer confidence lowest since April 2009; mortgage demand lowest since 1997; construction spending lowest since June 2003; and the FDIC is technically bankrupt with a $21 billion deficit.  Initial Jobless Claims came in at a huge 469,000 in the latest reporting week.  THIS ECONOMY IS NOT IMPROVING, NO MATTER HOW HARD THE FINANCIAL MEDIA PROPAGANDA MACHINE TRIES TO SPIN THE NEWS!

Our analysis of the past two centuries of data suggests the crowd is making the same critical mistakes by assuming the worst of the economic and market hardship is over as was made 80 years ago.   Making this mistake in 1930, after the market crashed in 1929 proved to be catastrophic.  The market fell 51% in the three-month 1929 crash in WAVE A down.  It rose 55% from the initial WAVE A low in November ’29 to the top of WAVE B in April ’30.  From this peak, at which time the crowd thought they’d survived the worst of the “correction”, the real damage occurred in the following two years.  That WAVE C was far worse and led to much wider and deeper destruction than the shorter, sharper Great Crash of ’29, their WAVE A.  By the end of WAVE C in 1932, the Dow had fallen 90%, and the over-the-counter market (the Russell and NASDAQ of the day) were nowhere to be found…completely wiped off the face of the planet.  The economy then spent the rest of the decade stuck in the throes of the Great Depression, only to be pulled out by the onset of WWII in the early 1940’s. 

NEXT:  Let’s also look at some interesting historicals to see what may be coming in the near future.  If we observe all years ending in “0” for the past century from 1900 to 2000, they ALL include declines from high price of year to low price of year, and the average decline of these 11 “0” years is 21%.  4 of the 11 were higher at the end of the year than the beginning, but 3 of these 4 were up only an average of 6%.  To summarize, 91% of the “0” years of the past century were not great for stocks, and 7 of the 11 had average declines sometime during the year of 21%. 

Historically, 2010 should be bad year for stocks, and include a couple mini crashes, with the potential for a very serious “selling event” later this Fall.  The fact that the SEC is considering new curbs on short selling hints that they know something that they are afraid of, and they want to get out in front of it this time.

In addition, for the past ten years, 9 of the months of March (remember my Ides of March reference above) have seen significant trend turns in the S&P 500.  Only 2006 didn’t see a significant turn in March.  It took until May 9^th that year for the “Ides” to show up.  Is it just random that proximate to the Spring Equinox of each of the past 10 March’s, the S&P has seen dramatic crowd direction changes?  Statistically, this is an impossible coincidence. 

The topping process of this rally from the March ’09 low is taking on classic form.  The Russell 2000 rose above its January top, creating an inter-market Bearish divergence as neither the Industrials, S&P 500, Wilshire 5000, NDX, nor Trannies have accomplished that.  Intermarket Bearish divergences are often seen at major tops. Trannies are close to rising above their January top, but the Industrials are not. The Industrials have retraced 71 percent of the decline from January 19^th through February 5^th.  Interestingly, at the October 2007 significant top, after prices fell in their initial down-leg from that top, the retracement of that initial drop was 72.7 percent, almost identical to the current retracement. The Initial October 2007 drop was 11 percent, and the initial drop from January 19^th, 2010 was 8.3 percent. The point here is, there is similar stock market price behavior now as there was back in October 2007, when this Bear Market started. This suggests the third leg of this Bear Market, and the second major down-leg may have started on January 19^th, , 2010.  While other scenarios are possible, and all the averages could still decide to exceed their January 19^th highs, at this time it does not look like that is going to happen. The daily and monthly stochastics are topping, supporting the view a major top is occurring now.

Shorter term, 24 of the past 27 Mondays have been up days for stock indices.  That’s right, 89%.  Even if you are a habitual gambler, lottery player, or oil well driller, you can’t possibly believe that this is a coincidence.  THIS IS CALLED MANIPULATION!  The big money uses the public’s “desire” to participate in rally to sell into these manipulated Monday rallies.  They’ll continue to sell to the public during the coming 1000-1500 point Dow decline over the next few 6-12 weeks.  When we see a series of lower Mondays, rather than higher Mondays, the next selling wave will be nearing an end, likely near Dow 9,000 +/-200 and S&P 1,000 +/-20.  Another sign of manipulation is that on each market rally since the March ’09 bottom, volume (public participation) decreases, while on each market decline, volume increases.  It’s a merchandising operation to clear inventory, like when the super market moves slow moving products from the back of the store to the spot near the check out line.

Our last point on how perfect the timing of a trend reversal lines up for March, Tuesday March 2^nd was a full moon, and Tuesday March 30 is another full moon, called a Blue Moon because it’s the second full moon in a calendar month.  Crowd emotionality often changes within a day on either side of a new or full moon.  Here’s the rub, this year, we are having a double Blue Moon, when both January and March have two full moons.  The last time this happened was 1961, and before that was 1885.  After this current month, the next double Blue Moon will be in 2018, then 2037.  Let’s just say, they are rare.  When we overlay our crowd psychology pendulum showing extreme bullishness, mutual fund cash to assets ratio at a record low cash level, waning volume on rallies and expanding volume on declines, extremely low VIX (indicating the crowd not fearful of market surprise), weekly and daily stochastics pegged to overbought extremes, to name just a few, we are on red alert for THE IDES OF MARCH to have special meaning this particular year.

If you are looking for safe havens, remember our month-early forecast in November ’09 of the imminent low in the dollar.  Since our presentation at that November Investment Advisors conference, the dollar has bottomed and had its steepest rally since July 2008, which was the initial wave of a 25%, four-month rally. 

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There is so much to say about the dollar, bu suffice it to say: the globe is no longer hating it.  In fact, the world is beginning to focus its love/hate relationship on the Euro.  Over the next few years, we believe the Euro will break below its October ’08 low near 1.2300, but the real fireworks (or C-4) will really come when it breaks its ’05 low near 1.1700.  By the time this happens, there will be no Euro, as the Union will have disbanded.  If you doubt this, check out the current riots in Germany and Greece, and imagine another year or two of the “haves” supporting the “have-nots”.  The global village concepts that floated in the glory days of the last century are quickly falling to earth, where ego, power, mine vs. yours, hatred, segregation, separation, blame, etc. all thrive.  Eat what you kill…if you can’t kill, don’t expect to eat mine!  In the very short term, the Euro is about to make a swift dive toward 1.3100-1.3400 in a 5^th wave decline from the 1.5100 peak in November.  This will be the end of the initial downward waterfall, which will eventually cause Euro implosion in the coming few years.  From the upcoming low as just targeted, we expect a multi week/month rally, back up towards the low 1.4000’s.  THAT WILL BE THE BEST TIME TO SELL EUROS BEFORE THE MELT DOWN in that house of cards, and the BEST TIME TO BUY DOLLARS since the November low.  Things will happen quickly from these inflection points, so get prepared in advance.

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Gold, you say?  Well, maybe.  But, with the Soros hedge fund doubling its gold exposure in Q4, and the central banks of China and India, and the China Investment Corp increasing theirs strongly as well, one has to wonder if this is the time to join in on this very crowded trade.  Bullion has strong resistance approaching $1,200, and should be sold into that level, or on any break of support surrounding $1,088.  Initial targeting suggests $950, but $885 is better justified.  We will view $600-$750 as the best buying opportunity since the ’08 probe under $700.  And, $500 or lower as a “back up the truck” opportunity, prior to the shiny metals eventual safe haven push towards the $2,000-$3,000 area, with more bullish potential higher.  That being said, we view any move above the November $1,225 high as a reason to add to positions for another advance into the $1,325-$1,450 range.   ACTION:  Our final chart is the VIX Index, or the “fear” index.  When this index is high, there is a lot of fear in the market, like in late ‘08, when the market was crashing.  When it’s low, there is little fear, like the period leading up to the ‘07 peak, and NOW.  Notice the extremely oversold stochastic, last seen at this level in 2002 and 2003.  Now, compare the actual price currently vs. the past decade.  See how the crowd is more bearish on the sentiment stochastic than when the actual price was lower in 2004, 2005, and 2006.  This is called a bullish divergence, and forecasts a turn higher in crowd fear.  When the crowd becomes fearful, it sells assets that have risk.  The more fearful it becomes, the more selling there is. 

We would be using this window of UNUSUALLY low fear to exit any assets you are nervous about.  This should happen before you hear or see actual evidence that there is reason to be more fearful. 

Conservative investors should stay in or move to cash or 90 day T-bills until this fear index moves above 90.  Aggressive investors and traders should stay in or move to short stock positions, adding to them if the Dow moves into the 10,800-11,300 area, which we doubt will happen at this time, but it’s possible.

For what it’s worth,

Ken

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We've been deluged in the past few weeks with emails about the market rally and the economic recovery. More so than when the economic toilet was flushing last Dec - March, and most people's money was circling the drain. Back then, folks were asking us if they should sell their "buy and hold" portfolio, since they could no longer take the financial strain, and were unable to stomach the sleepless nights and emotional roller coaster of the market. At that time, we had been long and short several times from late '07 through early '09, but did so from the stance of avoiding the extreme market risk that we had forecast. In summary, we had been "leaning" short for many months, even though our strategy allowed us to take many long opportunities along the way.

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