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This educational report falls outside the four part series I have planned for TraderKingdom readers. Because the stock market has moved so far, so fast off its March 2009 low, it is once again perplexing many traders and investors so a review is in order.
Recently, I have been asked how would I gauge the probability of the secular bear market resuming from a high in Q4 2009. Even though other pundits such as Bill Gross are seeing red in Q4 09, I gave it a very low probability. Why? To answer that, I thought it would be timely to take a step back from the market, and look at the big picture, the Really Big Picture that provides perspective that only 100 years of Dow Jones price history can provide. For sometimes, when we stand too close to the market, all we can see are trees. We lose sight of the forest in which we are surrounded. Stepping back from the trees is all about gaining perspective of the forest/market.
What follows is some background, perspective and color on my thoughts as to the exact position of this particular bear mkt rally in equities. Duration and pattern, along with political backdrop of rescue operations are overweighted in this assessment, price itself is underweighted.
Monetary, fiscal, political, legal, and accounting machinations have both buffeted and buoyed our stock market this past year, as the plunge protection team steps in the clean up the mess they helped allow Wall Street to make. For the moment, the rescue is working to save riskier asset classes like the stock market. The plunge protection team will run out of bullets at some point at which time their policies, for better or worse, will be found wanting, and pushing on a string. One strong reason that their policies will eventually fail is because after a credit bust, there will be no multiplier effect from this rescue operation in the form of bank lending. Even if policymakers do not make any further mistakes in policy, when no multiplier effect emerges in the private sector, the stock market will be at risk of resuming its secular bear market personality. If policymakers do make a mistake in policy, that will only hasten the onset of the next bear mkt leg.
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Stock Market rescues are nothing new. In the days of old, even though it was not his explicit intent, JP Morgan single handedly orchestrated stock market rescues as he did with the Rich Man’s Panic in 1907. But, tired of bank runs, and a desire to create a central bank to promote stability, low inflation, full employment and end bank runs, the Federal Reserve was created in 1913. Between 1906 to 1921, the stock market was in a secular bear market roller-coastering from highs just above 100 to lows in the 50’s and 60’s. Note that each save occurred after roughly a 50% decline in the stock market and that after each save, the stock market moved higher in a V-Shape recovery for roughly 24 months or two years or more. The real economy did not necessarily follow during 1906-1921. For perspective, the 2009 rescue rally is only 7 months old.
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In 1929, we had a stock market peak followed by a credit bust and debt deflation cycle, not unlike today. The stock market bottomed in July 1932, but really did not get any traction until FDR closed the banking system for 2 weeks, cleaned it up, and then enacted his April 1933 Gold Confiscation Act to end hoarding.
It was “An Act to provide relief in the existing national emergency in banking.” Banks needed to be recapped and the best way FDR saw to do that was to expropriate the gold holdings from his constituents to increase gold reserves in the banking system. Essentially, the Act was a transfer of wealth to save the “top” of the food chain, much like the transfer of wealth that has occurred to save the top of the food chain today. As galling as it may be to the American public, a form of expropriation is just the way politics gets played out in the US, and the Constitution itself is largely thrown out the window.
Regardless, what we want to observe is that the stock market more than doubled between Feb 1933 and Feb 1934. The cycle of bear market recovery was 19 months old off the July 1932 low and 12 months off the 1933 low. It only paused for 5 months into July 1934, before taking off to its next leg up into March 1937. It took another 3 years for a major top to form following the Feb 1934 high and almost 5 years from the July 1932 low. For perspective, the 2009 rescue operation is only 7 months old.
It took fiscal and monetary mistakes in 1937 to re-engage the secular bear market that began in 1929. Now, what is most intriguing on the 1932-1942 chart is the 62% 32 wk or 7 month rally from March 1938 to Nov 1938. It intrigues because the Dow Jones has just rallied 56% in 33 wks. It intrigues only from the perspective that both started from a March low, and rallied about the same amount in the same time span. Beyond that, the correlation breaks down, because policy mistakes since “Saving the Top” have yet to be introduced, nor has the “save the top” policies been removed, the safety nets are still drawn up as high as they can be, and the safety nets such as access to capital at zero cost to profit from the yield curve is insanely high and will be left there indefinitely, most likely until the slack in labor resources is absorbed.
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During the 1970s, the Federal Reserve had been politically captured by Washington with the election of Nixon. The first big secular bear mkt rally began in May 1970. There were two stages to that rally, The first stage was 11 months long, and the second leg was 14 months long. The second leg was buoyed by the Smithsonian agreement which effectively devalued the dollar as FDR did in 1933 when he confiscated gold. The effect of the agreement made it easier to export cheaper goods abroad, so drove our multinationals to record highs by Jan 1973. Nixon had the Feb prime the pump in Q4 1972 according to Edson Gould, to ensure a second term. That explains why you see that rocket ship rally in Q4 1972. The whole secular bear mkt rally was 31 months.
The next major secular bear market rally began in Dec 1974. This two had to major legs to it. The first leg was 8 months long before a pause, and the whole secular bear market rally was 21 months long, and the market advanced 80% in a V-shape recovery before secular bear mkt resumed. Mind you, this was only the stock market experiencing a v-shape recovery, not the real economy. The next secular bear market rally began in March 1980, and lasted 13 months, the shortest of them all. Fed Chairman Paul Volcker took over to save the economy from the runaway inflation that the policies of the 1960s and 1970s stoked, and that choked the stock market until August 1982. We have had inflationary policies once again since the 1990s, but real inflation has yet to arrive on the scene. I expect the labor mkt will have to up and running again before the next inflation cycle arrives on the scene, or otherwise will require a policy maneuver to force an acceleration of the dollar devaluation. But devaluation would not necessarily be bearish equities, whereas inflation would be.
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Yes, the Dow Jones and other indices have come along way in a short period of time. The Dow is up 56% in 33 weeks or seven months. The SP500 and other indices are up even more than that in the same time span. So, yes, in terms of price, we have come a long way baby, but not so much so in time. As we have seen in the secular bear markets of 1906-1921, 1966 to 1982 and 2000 to whenever, secular bear market rallies tend to be at least 11-13 months long. In my way of thinking, I have a great deal of difficulty with any idea that this bear market rally can’t last roughly 17-18 months or longer.
There are a great many reasons for this. First, as I have taken effort to point out, though this rally may see long in the tooth based on price, this bear mkt rally is relatively young in time. The rescue is very young. And the stimulus, which is far greater than the LTCM rescue operations that the administration is bringing to the market, is only about half way spent. And traders for the banks and primary dealers would have to be idiots not to lever up yield curve with access to capital at roughly zero cost.
Second, earnings troughed in Q4 2008 and Q1 2009. Earnings comps y-o-y will show good growth rates into Q2 2010 or July 2010. Fiscal stimulus helped accelerate the mfg sector and productivity in Q3 2009, this will flatten out by Q3 2010 earnings in Oct 2010. Moreover, if earnings comps are good through July, this will provide the stock market a margin of safety into 2H 2010 just ahead of the very important mid-term elections.
Every politician’s job is on the line right now after bailing out banks only to see the banks award them record bonuses in 2008-2009 on taxpayer dollars. Politicians are strongly and very self-interested in saving the market into mid-term elections. They will offer up any “pretend and extend” excuse they can to keep the stock mkt up into 2H 2010. We can’t underestimate the chicanery of politicians, from the Treasury and administration, to Barney Frank ad infinitum of almost every other congressperson down the line.
But because big banks are hoarding and aren’t lending, as and when it is revealed that the private sector can’t expand on its own by 2H 2010, the real impetus to end the secular bear mkt rally will begin to emerge. The green shoots optimism for a V-shape recovery in the economy will be found wanting, and disappointment will be the result. Then it is a matter of discerning when the effects of fiscal and monetary policies will wane and be pushing on a string. When evidence appears that their policies no longer produce green shoot miracles that accelerate mfg and productivity, that is precisely when capital flows into riskier asset classes slow down or comes to a halt. Short of a policy blunder that offsets or removes stimulus from the mkt, capital flows on balance will move into riskier trades for the foreseeable future or “extended duration,” to borrow from a recent FOMC phrase.
To a large degree, in my analysis, I am not weighting too strongly how high the stock market might go off the March 2009 low. But, I see it as important to note the rate of change off the 2009 rescue low is far stronger than the rate of change of the rally off the LTCM rescue low. This is a function of policymakers throwing a 1000 times more stimulus to the market than 1998. LTCM was only about a 4 billion rescue. This operation is in the trillions. Consider the weight of that. This alone tells you not to be surprised that the bear market rally off the 2009 low is far greater than anything we have seen since well really 1932.
The Dow sits at 10,000 today. Just to do a similar price move to the rally off the 1998 low by Q3 2010, the Dow would be expected to climb to 10750, the Feb 2004 high. Interestingly, the 2004 high was the first major crest after the mfg recovery began to accelerate in Q3 2003. But given the rate of change is so much stronger in 2009 than 1998, the risks are to the upside unless something comes along from our policymakers to upset the apple cart to throw the market a curve ball. Our policymakers are decent students of history and the Great Depression, and I for one am not going to underestimate them only 7 months into a financial system/stock mkt rescue operation. I am not willing to bet that policymakers will throw the stock market under a bus just yet.
Personally, in the chart above, I find 11750 to be a very compelling price magnet or energy spot for the Dow Jones to be attracted to during this bear market rally. That was the 2000 year high, the Jan 2008 yr low and the August 2008 high, just before the collapse of the financial system. You bet your bippy this is a high energy spot for the Dow Jones to be attracted to. And if you check the notes in the charts above, you will find that a rally to 11750 in the Dow Jones off the 2009 low would be 81%, which is roughly the same as the 80% rally off the Dec 1974 low when fiscal and monetary policies performed another rescue operation. My final remarks will focus on George Lindsay’s Three Peaks and a Domed House pattern. This pattern is a huge structural consideration for market participants to put in their scenario planning. These patterns are long term intermediate patterns that take more than a year to play out, typically 18 months to 5 years.
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The Lindsay pattern is a 28 point pattern, with 23 points to form the 1st and 2nd floor and reach the Domed House, then 5 points down to reach the bottom of the pattern. Constructed above you will see that because of the gradual and careful removal of monetary stimulus in 2004-2006, it took 5 years to complete the 23 point pattern to the “domed house” and 17 months to finish the pattern to its point 28 final low. This does not mean the secular bear mkt is over, it just means that we have to count to 23 to get to the next domed house before the next leg in the secular bear market begins. I have also shown an Ewave model in the chart above that allows for an ABC correction to take place off the March 2009 low. We can imagine that this bear market rally can be illustrated either as a Domed House or an Ewave ABC bear market correction to the Oct 2007 high.
The ABC Ewave model gives us some rough idea of a price target that you can’t derive from a Domed House model per se. Using symmetry as a guide, C = A just north of 11000, just above the 2005 yr high and below the 2000 yr high. Now, we don’t have enough info with regard to Wave C quite yet, and how it subdivides. And when it comes to subdividing waves, the George Lindsay pattern is more precise in wave count. Not only is the count more precise, but Lindsay’s pattern respects time duration much more solidly than Elliott Wave theory.
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I find curiously enough that the intermediate term Domed house that put in the 2000 high off the 1998 LTCM rescue operation low is a good analog so far for the Domed House pattern I believe is setting up off the 2009 rescue operation low. If you project forward 173 trading days off the LTCM rescue low, you find the Dow rallied 50% before pausing. If you look at the rally off the March 2009 rescue low, we find the Dow has rallied 56% in the first 163 days. Patternwise, you can see the point 3 high labeled after 173 days off the LTCM rescue low. It is possible to suggest that off the March 2009 rescue low that the point 3 high has not yet even been reached. But we won’t go there for now. We want to look at the fastest counts I can give this pattern for the time being, as this should be more fruitful.
The fastest count I can give on this pattern is to label the Sept 23 high as a point 7 high, because of the complex ABC correction into Oct 2, this allows me to place an 8-9-10 points onto the Lindsay count. But my feeling is that labeling might be “too tight” or too compressed in time. Still, the fastest count could be a valid count for reasons I discuss below.
The second fastest count I can give it is that the Oct 21 high set a point 7 high, but to do that, I would need another complex ABC correction to place 8-9-10 points onto the Lindsay count. Now, if the former count is the more accurate, the market will just move to new highs with relative ease. If this latter count is more accurate, a secondary high will have to form under the Oct high next week so that I can label it a point 9 high, and then head south to set a point 10 low.
We have discussed the scenario for a further correction off the October high. In this scenario, a secondary high would form under the Oct high next week, and then set another lower low below the October high. The basic premise is that the riskier asset classes for further digestion off the October high is that riskier asset classes may not be ready to rally to new move highs based on the UE rate shooting above 10% in October, and using crude oil and other outside markets as a leading indicator for short term confirmations. Watching outside market behavior near term will be a big tell as to whether a larger correction ensues off the October high. A lower low in the near term would give the market a point 10 low.
Now to be truthful, we get a little bit lost placing too much emphasis on Ewave or Lindsay counts, and discussions about where we are in counts is largely The discussion is largely academic. It’s an art, and we infer largely based on feel and experience, and what we know from using other tools in our kit. Worse yet, we have to adjust counts slightly as the market reveals more of its personality and behavior to us. The Lindsay counts are generally respect time duration far better than Ewave counts and are generally more precise, and the attributions of each point high and low have certain characteristics to them.
Take for example point 10 lows. Generally, point 10 lows are sharp and sudden. And, just as startling, is that moves out of point 10 lows tend to be dramatic pushes to new move highs. The dramatic move off the Oct 2 low does have the characteristic of being a point 10 low on the daily charts. This suggests that the “compressed count” could be the more accurate count (even if it still not quite the right count). If the latter count is the more accurate, the stock market has already begun its move to new move highs off the Nov 2 low. No one wants to make a mistake on this. If you are betting the Dow Jones won’t set a new move high for the year in November and December, market participants should be aware that the Dow Jones is less than 1% from a new move high for the year. It won’t take much of a rally to suggest the preferred count is the compressed count.
But what if the other stock indices don’t follow the Dow in Nov, and the Dow sets new highs but other stock indices fail to do so. That would be a potential negative divergence to consider. But then again, I will remind you that the primary trend is up off the March 2009 rescue low, the rescue operations are still in high gear, and duration is a major consideration, so the benefit of the doubt should be to give the market a little room for some short term market noise. Another thing to bear in mind, as a primary bear market rally becomes more entrenched, corrections become shallower and shallower as we saw in 2003-2007. Not one 10% correction ensued in those 4 years. Likewise, we have not seen a 10% correction yet in the SP500 or Dow since March. It is a function typical of stock market behavior for market volatility to trend lower for an extended period of time as the market stabilizes after taking a beating.
So, could the secular bear market resume from here, yes it could. But the safety nets and rescue operations would have fail miserably, something would have to go terribly awry amongst policymakers. Something akin to 1937 would do the trick when both fiscal and monetary blunders were created simultaneously. But since our policymakers are keenly aware of those blunders, the chance they would commit similar blunders seems remote. These policymakers are hell-bent on reflating, monetizing, papering-over, and generally pretend to the public that the financial crisis is not irreparably flawed in its current form, it was just a bad dream ~ not to worry our little heads about.
Yeah right, the financial system in its current state is more than flawed, it is also rotten to its core, and the fiscal and monetary policies to prop up the broken financial system is also flawed. So eventually, this is going to bite them in the ass, but their only goal is to just kick the can down the road and hope the problems go away ~ if only they give the financial markets enough time to recover. Well this recovery is a bit like giving an alcoholic in recovery more alcohol so he feels better. Sure, he feels better, but he’s still an alcoholic, and so is our financial system doped up on OTC debt and derivatives.
Our policymakers are doing everything they can so these weapons of mass destruction remain in the hands of the financial terrorists who brought this last financial crisis to us. Neither the financial terrorists nor their weapons of mass destruction have been removed from the financial system. And that is because of two crucial factors. One, our elected govt officials believe that our financial terrorists are too interconnected and big to fail. True, these institutions and the derivative products they peddle are considered Too Difficult to Resolve, TDTR, but this is not an insurmountable challenge. Second, our elected gov’t officials believe they can effectively regulate weapons of mass destruction. Well I got news for you Lucy, that is some pretty messed up thinking that the govt is spinning. Do they expect the American public to buy that? Very few policymakers it seems see the light of day, and those that do are drowned out by the cacophony of fear-mongerers peddling red herrings and prescriptions that amount to little more than some very bad medicine.
These policies that save the top of the food chain carry their own set of peculiar risks, with delayed fuses to be sure that delays the day of reckoning for the next leg down in this secular bear market. A seven month bear market rally is just too short in duration from a most major rescue operation low. No matter what the precise “counts” are, all will be revealed to us in the fullness of time. And if we pay close attention, we will know it when we see it. We will also feel it.
In July 2007, I remember clearly how well I could “feel” that all the pieces of the puzzle were in place to set a major bear market rally high in the SP500, and even that turned out to be a tad early because of the Sept 18 2007 rate cut that mkt participants believed would save the financial markets and make them all better. Yeah, well that idea worked for only a few weeks. As soon as the financial started reporting losses in Q3 07 from writedowns, it was too late for the Fed to save the financial markets from their own demise and reckless behavior that included not only excess leverage, but fraud for which no one has ever been put behind bars.
Honestly, I just don’t have that July 2007 feel today, for an end to a secular bear market rally at all. If my assessments are wrong, then I will surely be missing some key vital information. I do my darnedest to make sure I hold as much vital information as possible in my head at all times. I know I can’t know everything at all times, it is unrealistic for anyone to know everything relevant at one time. The key is to be a great filter of what is irrelevant.
The points I have discussed here broadly cover, if not in detail, some of most relevant considerations. First duration of bear market rallies are more important than price. Second, the safety nets are high and in place to save the top of the food chain. These safety nets will not be coming down anytime soon, again a duration issue. Third, policies, no matter what they are, will always run into trouble at some point. These particular policies have long fuses, and are have short term goals explicitly designed to keep the chicanery of the past decade alive and well. Fourth, I am afraid it will all end badly, but that is a story I think for another day.
For more from John Bougearel, visit Structural Logic |
