Pivotal Events

By: Bob Hoye | Mon, Nov 2, 2009
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The following is part of Pivotal Eventsthat was published for our subscribers Thursday, October 29, 2009.


Last Year:

"Not panic selling - it is forced selling by margin clerks."

- Money manager, Business New Network, October 27, 2008

In that fateful week the Dow plunged a thousand points to 10459, and a fund manager rationalization that it was not "panic" selling.

The plunge continued down to 6470 in early March, which included both panic and forced liquidation - otherwise known as crash.

And then there was the highlight from when all was well with the boom:

"Corporate executives are increasingly turning to debt for the cash they need to feed stock investors with share repurchases, dividends and empire building."

- Wall Street Journal, July 11, 2006

* * * * *

This Year:

"Right now there is sufficient stimulus to create a substantial recovery."

- Financial Times, October 21, 2009

"Deserted shopping mall bleak symbol of Fed bailout"

- Reuters, October 21, 2009

This was from the Bear Stearns fiasco. The Fed inherited a dead shopping mall in Oklahoma, but the property included a live oil well. Unfortunately, the way the contract was written - the Fed did not end up with the mineral rights.

"Pension funds will increase gold holdings to acquire 'financial insurance' ".

"I think the larger institutions like our own are realizing that we barely own any gold."

- Bloomberg, October 23, 2009

"Consumers' confidence about the U.S. Economy fell unexpectedly."

It dropped from 53.4 in September to 47.4 in October. The consensus forecast was 53.1.

- AP, October 27, 2009

"U.K. Retail sales unexpectedly stagnated."

- Bloomberg, October 22, 2009

"U.K. GDP unexpectedly dropped in the third quarter."

- Bloomberg, October 23, 2009

* * * * *


The "Conundrum" we discussed last week described the disparity between soaring asset prices in the face of a massive credit contraction. This week's downdraft seems to easing the conundrum. As it turned out, the five to six months post-crash rally provided the best count. Our work on the seasonal rebound to around May-June provided a trade.

This decline was anticipated by the turn up in gold's real price in late August, the breakout in the TED-Spread on October 10 and the increase in the gold/silver ratio since September 17. The latter became a warning on the test at 59.6 on October 9.

As we have been noting, this was similar to the beginning of the credit disaster in May 2007. An important missing item was the reversal to widening long-dated spreads. For the Sub-Prime that started last week. Corporate spreads continued to narrow until Monday when the downside reversals in High-Yield (CYE) and in Junk (JNK) signaled recent widening.

It is usually dangerous to discuss stock markets and GDP in the same paragraph. Orthodox economic numbers can be a trap as typically the cycle for share certificates leads the cycle for business activity. Some institutions have used strong GDP numbers to stay long during the initial part of a bear, and then used bad economic news to lighten up in the early stages of a bull market.

And then there is the critical behavior of both at the end of a great financial mania when speculation becomes exhausted and stocks and the economy turn down at virtually the same time. Traditional is the stock high in March 2000 and the start of that recession in March 2001.

Every great bubble has been followed by a great contraction and on this old "normal" the big bear started in early September 1873 and the recession started the next month. Much the same occurred with the 1929 peak. In our example, the stock market high was in the latter part of October 2007, and the recession started in that fateful December.

Using this argument, we expected that business activity would pick up with the stock market rebound and then rollover when the rebound completed.

The quotes above note the "unexpected" decline in a couple of U.K. economic numbers. It is not isolated as there was the "sudden" drop in Consumer Confidence and then yesterday's U.S. New Home Sales were -3.6% month/month against the consensus of a 2.6% increase. This was the first decline in six months. There could be more such reports, but these examples suggest our thesis is working out. In which case, the stock market rally since March has not been discounting a cyclical economic expansion.

The post-crash rebound in stocks and business is an important part of the path to a great contraction. So is the next and coordinated decline in both.

It is early in the potential change and it will take more data to fully make the case. In the meantime, as concluded last week, "Investors and traders can sell aggressively".

Near-term: Technically, Ross estimates that the decline could reach the 40-week EMA within some ten weeks, or some 11% to 15% below the rebound highs.

The GDP number is now history, but the lift to stock markets could run into next week.

Banks: Our Bank Trading Guide set its last low at 139 on July 10 and the high at 173 in mid September, with the highest RSI in 18 months. This was the alert, and after the first decline the test of the high made it to 168 on October 8. Usually the high for banks (BKX) is within a couple of weeks after the formal "sell" signal, and this time the BKX reached 49.2 on October 14. So far the low has been 42.7 and the failure level was at 43.5. The decline to July lows at around 34 could be reached by year end.


The post-crash rebound bubble could run for around six months and an important change in the credit markets would signal the end of the party. The short-end changed first when the TED-Spread reversed from narrowing to widening on September 10. The breakout on October 10 set the trend to widening and this could continue.

But, long-dated spreads narrowed until Monday. As noted in our Memo on Tuesday, JNK (ETF for Junk) set a downside reversal on Monday. Along with some other key reversals, the conclusion was that it was a traditional warning on a significant trend change.

This, including other hot assets, seems to be working out and corporate bond spreads are heading to dislocating conditions.

The mechanism for this will likely be similar to previous contractions. The decline in commodity prices represents declining pricing power for most business, this collapses earnings which reduces the ability to service debt. If severe - rating agencies downgrade credit ratings.

This was the case from 2008 into March of this year when the post-crash rebound started. Commodities bottomed and turned up in the latter part of February and set a high recently.

Our Gold/Commodities Index (G/C) reduces currency influences and has been a reliable proxy for "good" and "bad" turns. The bad one was in May 2007 when in turning up it was accompanied by the start of the collapse in credit. Then, in setting a top in February it signaled the start of the great financial rebound.

Of interest is that it set a technical bottom in August and the increase - think decrease in commodities - has been anticipating the resumption of the contraction.

Two weeks ago we advised getting out of all spread games - the world is on the carry-trade.

With all the conviction that a two-year trend can inspire - the world is also doing the carry on the steepening yield curve. This could also reverse, but lately the action has been trendless.

Flattening would occur as long rates increase faster than short rates.

Policy manipulators are probably noticing that a good portion of the "stimulus" went into financial speculation rather than into plant and equipment.

With the positive GDP number the Fed could get out of its panic mode and turn to its posterity. No matter how heroic these interventionists may be in their own minds, at some point the more responsible may not want to go down in history as the most reckless financial adventurers in history.

One step towards this could be an attempt to briefly tighten, or at least "talk" some tightening. If the gods of irony still prevail this could be timed with a natural turn to a flattening curve.

The long bond could rally as today's "good news" pop in stocks and commodities completes. However, as the next phase of the contraction becomes more evident - will the bond do another magnificent "safe haven" rally? For reasons to be expanded next week - too much "carry-trade" - this seems unlikely.

Link to Friday, October 30 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1452



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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