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July 28, 2008

Misplaced Optimism Signals Crash Potential
by Captain Hook

The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, July 8th, 2008.

As discussed in previous commentary, despite the dire realities affecting the global economy, it appears investors are not heeding the warnings. Sure, some people are paralyzed like a deer in the headlights, where you can't blame them if they are just waking up to the reality of what lies before us. However, these still appear to be the few, with most still in denial concerning future prospects for the economy and markets. This is evidenced in gold and silver's sluggish performance of late. It should be doing far better as an alternative, but again, the public does not see the need to buy it yet. Can you blame them however, with the incessant cheerleading and gaming that the media (CNBC in particular) pawns off as analysis? Exposed long enough to this kind of thing it's bound to have an effect - that's just common sense.

What effect is this having on investors? The effect this is having is to make the greater investing population, who get most of their analysis from television believe it or not, complacent, where the conditioned response 'everything is just fine' is predicated on the belief that as with all the other times it appeared the sky was falling - it didn't. What's more, if you don't capitalize on other people's weakness and buy every dip in the stock market, bubble-vision commentators endeavor to make it appear you are an idiot, and will be left behind in the dust. Combine this with the belief the bureaucracy would never let anything happen to the economy / markets in an election year, and you have a recipe for disaster in terms of sentiment, which is the primary reason(s) stocks are falling - and could fall a great deal more.

Why would stocks fall a great deal more? On the surface, which is where most minds operate on a perceptual basis, if the stock market were to 'crash', it would be attributed to a disintegrating economy, which as you know from our last meeting is the case with respect to corporate earnings. The economy is falling off the preverbal cliff hypothecated by so many for years now (which again, is why the public thinks it doesn't matter), and the quality minds in the bureaucracy appear powerless to stop it this time because they can't keep the stock market from falling. Of course the reason they can't keep stocks from falling is not because of pessimism, but again, complacency. Market participants are not buying enough puts to keep the perpetual short squeeze alive - so the stock market naturally falls.

Of course the real bad news is the stock market is an important source of asset-derived income for many (the most important next to the housing market), as was the case with home equity withdrawals. So, if this source of income is lost, an unstoppable negative spiral could ensue, possibly ushering in the unthinkable - a Depression. The bureaucracy knows this of course, which is where the inflation thingy comes into the picture. Here, as the economy gets progressively worse, central monetary authorities find the justification to print ever-increasing quantities of fiat currency to combat the slowdown, with the end result being rising prices as this inflation works its way through the (global) system to the consumer.

With all this said, it's not difficult to understand why stagflation appears to be the word right now then, because macro-conditions are undoubtedly gripped in a period of rising prices that appears to be having a visible impact on the economy. Unlike the last time we had a prolonged stagflation episode back in the 70's however, with high consumer debt rates set against low savings rates, the ultimate outcome will likely be quite different this time around. This time, with the US tapped on both a domestic and international basis, along with demographic considerations, regenerating the credit cycle will not be quite so easy, if not impossible. This is of course what is not being talked about in the mainstream media; the dire prospects that lay ahead for the larger economy.

This is because that's what it's all about you know, keeping the credit cycle growing. And this is how all economies mature through time. In the case of the US, being the centerpiece of the current global boom, the bureaucracy decided to export it's manufacturing sector(s) in favor of ever-increasing deficits and debts to extend the credit cycle, where since Nixon closed the gold window in 1971, the party has been nonstop basically. Here, manufactured imports could be had on an increasing basis in exchange for fiat currency so long as this inflation was not felt on a wholesale basis by exporting nations. As with all things however, the global nexus is maturing too now, where process has led to increasing input costs / commodity prices as an enriched labor pool in these exporting nations adds to demand.

So, let's take stock here. We have stagflation in Western (mature) economies, who in turn export their inflation to a developing world that needs to print money at break-neck speeds in order to cope with demand in their now booming economies courtesy of globalization. What's more, these countries, with the most notable example being China of course, are running huge foreign currency reserves as a result off all this, meaning too much money is chasing too few goods, which is why commodities are going through the roof. More recently however, wage gains in these economies that are necessary to keep the global credit cycle expanding have caused prices to rise too quickly - to the extent bureaucracies are having to attempt walking the fine line of slowing their own booming economies while not tipping mature economies into irreversible credit contractions. One could hypothesize we have already arrived at the station in this regard, which could permanently disrupt the entire global boom.

Enter a now complacent investing population due to years of sentiment and market manipulation, and as per the title above suggests, stock markets around the world are poised for accidents. And sure enough we are seeing exactly that, where stock markets from Asia to Europe (developing and mature economies alike) continue to plunge. And in North America the situation is no different, with the S&P 500 (SPX), the most commonly followed broad measure of stocks, taking out important channel related support at 1260 noted yesterday. Please notice the channel has been re-drawn since to allow for an extreme channel (spike low) such that yesterday's close (10-points lower) is still within the structure. Any noticeable weakness past this should be considered a channel break. (See Figure 1)

Figure 1

The question then arises, if stocks are poised to crash in coming weeks and months, how low is low? Well, for one thing you know how markets like to test round numbers and intervals. So, if 1250 on the SPX goes here, which appears probable at this point, then a quick trip down to the large round number at 1,000 comes into play in my books. Here, in addition to being important Fibonacci and trend-line support, this would be a test of the 250-point interval off the initial failure at 1500, and now 1250, as per our Progressive Interval System (PI). As can be seen below in the monthly, a break vertical support in RSI represents a large gap that needs to be filled before any price stability should be expected. The monthly SPX plot shows the potential for such a move, substantially strengthening the overall case for weakness moving forward on a break here. (See Figure 2)

Figure 2

Let's take stock here once again shall we? With the above technical analysis pointing to further weakness, not only do we have a conducive backdrop on both fundamental and internal (sentiment) bases for substantial stock market declines moving forward, we can now add the third key factor, market technicals, to the list in rounding out the trio of death. Here, anytime you have a situation where fundamentals, sentiment, and technicals are all pointing in the same direction, the chances of such a move not transpiring are low - to say the least. This is a rare configuration I can assure you, which one would be foolish not to respect. As mentioned many times of late however, this is exactly the situation - not many are expecting such a move - with sentiment mired in complacency.

Further to all this, and evident not only in crash signatures seen above, where on-balance-volume (OBV) is leading accumulation / distribution trends lower, we see the same patterning in the monthly Dow; which again, denotes extreme complacency in the trade. This is of course especially true considering long-term support for the Dow has already been broken. In the past, at junctures such as this, a healthy population of put buyers normally shows up when volatility hits the tape, which is not the case this time evidenced by falling open interest put / call ratios. No - this time traders are buying the dip, just like the talking heads on CNBC tell them to do everyday, which is scary considering trend-line support has already been penetrated. Here again, the large round number at 10,000 should act as a magnet while prices break through all degrees of Fibonacci and moving average support. (See Figure 3)

Figure 3

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our continually improved web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. For your information, our newly reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

On top of this, and in relation to identifying value based opportunities in the energy, base metals, and precious metals sectors, all of which should benefit handsomely as increasing numbers of investors recognize their present investments are not keeping pace with actual inflation, we are currently covering 70 stocks (and growing) within our portfolios. This is yet another good reason to drop by and check us out.

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And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing all.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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