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Global Credit Contagion On the Verge Again

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, January 25th, 2011.


Apparent disparities and idiosyncrasies between Western economies and China (at center of the emerging market model) continue to grow more profound, which will eventually end badly by popping the larger global credit bubble for good this time. This is of course not to say that our ambitious and greedy bankers and their crony politicians will disappear overnight, however if the serial bubbles in stocks, bonds, and anything that moves are popped, they will definitely have a great deal less currency to work with moving forward. So, hang onto your hats, because starting sometime in the first quarter here, or not long afterwards, we are likely to see increasing volatility begin to spread across the larger equity complex as a building contagion in debt markets continues to intensify and spread. And the thing about this that's most amazing is more people don't see it, which means you ain't seen nothing yet. (Thank you Randy Bachman)

What do I mean by this? Well, for one thing, as with the first bout of contagion back in 2008, if Iceland is leading the way once again, then, arrests of it's central bankers made last week might be a harbinger for Benny and the Jets sooner than later considering he is now steering the U$$ titanic directly into an iceberg. We will call what is happening there right now the Icelandic Model, where they have thrown out their trouble making bankers, right sized their economy, and returned to organic economic growth. Now all we need is for Ireland to follow, and perhaps central bankers and their bureaucracies around the world will finally be on the road to facing the music for all their misdeeds. They had better hope the remedies are not medieval, no? Although at least a few of them should probably lose their balls, no?

Be that as it may, as the sheep populating America today have gone over the top in denial and complacency for too long now, so the lunacy could last longer, again, as per above the bubble popping we have to worry about is not in the US, it's the Chinese real estate market, and it's on the edge as we speak. The thing is however, it's being extended by Chinese monetary authorities and greedy politicos who continue to throttle a corrupt fed back loop that is being sanctioned by the upper-ups because it's been keeping the population occupied. Now however, with food prices (which make up 40% of an average disposable income) rising at an accelerating rate in China, and with recent wage increases worrying investors about more to come, Chinese monetary authorities will be forced to tighten policy again and again until this trend is halted, with the big risk being a possible domino effect that spills over to other economies. In this respect it's the West that's the big worry, because whether the inflation bulls like it or not, if China's biggest customers outside their own markets stop buying, their Ponzi economy will come down too. And you don't need to be a rocket scientist to know what that means; as such a development would be quite profound, undoubtedly spanning the entire globe in short order.

In putting the pieces of the puzzle together for you then, one must understand investors are worried monetary authorities in China are going to make a mistake like the Fed did back in 1929 by tightening too much, which popped the larger credit bubble of the day. That's the bubble that cannot be popped if the global elite's fiat currency economy(s) is to remain in tact. You can have all the other bubble you want pop, from tech stocks to real estate to Chinese stocks, just don't pop the larger credit bubble, which is why Chinese monetary authorities are tightening right now in an attempt to save the real estate market, which is the largest supply of new loans into the larger credit bubble. So you see if the real estate bubble in China pops, it's all over for the larger credit bubble on a global basis (the globalization model would be kaput), which is why all else will be sacrificed to preserve it. This all for naught of course, because it's already popped essentially, and Murphy's Law (think crashing bond market) will naturally kick in at some point (think very soon), but in the meantime money printing is hiding this fact for now. (i.e. but not for much longer as Keynes is now almost dead - finally.)

At some point this fact will be exposed however, and we will know this is the case when the Dow / TSX (Toronto Stock Exchange) Ratio breaks out higher, signaling the commodities bubble has also been popped. To remind you, the TSX is viewed as the premier commodities market in the world, with the totality of it's companies (including tertiary services - banks, etc.) a reflection on global demand for inputs. So, if it makes a fundamental / high degree turn into deflation mode, which is what a breakout in the Dow / TSX Ratio would signal, this in turn would signal the Chinese real estate bubble is in trouble, along with the global credit bubble. This, ladies and gentlemen is why watching the Dow / TSX Ratio is so important, especially since in closed on key trend-line resistance on Friday, given it's a bit overbought on the daily chart, meaning a pullback might be in order. (i.e. enter the Fed Meeting this week as they attempt to screw with every market on the planet.)

What that means is incredibly, and in spite of options expiration Friday removing this support mechanism, stocks might not roll over just yet, especially with the NASDAQ 100 (NDX) / Dow Ratio already sold down. Combine all this with a continued generous POMO schedule, and who knows, the bureaucracy's price managers might just get a good looking close for stocks on the month yet. You know they will be pulling out all the stops in this regard. The only thing is however, from a sentiment / gambler attitude perspective, such an outcome would likely be the worst thing that could happen from intermediate to long-term prospective for stocks because this would leave surface dwelling speculators little reason to keep buying / hedging using puts, which could bring index open interest put / call ratios down on a sustained basis. The idea here is a strong January close would lead to increasing numbers (likely a consensus) of speculators saying to themselves 'as January goes, so goes the rest of the year', which in stead of having have buying puts on every rally they would be buying calls on all the dips, keeping both put / call ratios and prices depressed for an extended period of time.

Then, you throw in the observation margin debt is back at extremely elevated levels, and that this condition has created a negative net-worth situation for participants that has refused to improve since the 2008 implosion, and again, as per above, it becomes apparent we have a recipe for a credit crunch once more. At least that's what history would suggest, where as alluded to in our opening, some nasty divergences exist today that will need to be closed at some point. Like Mark Lundeen, in his latest attached here, while nobody knows when the next shoe will drop (which will trigger the next phase of the credit crisis that never went away), at some point over the next few years such an outcome is sure to come, because you can fool some of the people some of the time, but you can't fool all of the people all of the time. (i.e. at some point the Fed's own insolvency will be exposed via uncontrollable rising rates.) And while more tricks like a one-time tax holiday to corporations that would see some $1 trillion come home will be employed along the way to avoid such a destiny, it won't matter in the end, you can rest assured of that. This is when the divergence between the post crash Dow pattern and that of the tech wreck (NASDAQ) will be closed at some point, which will bring stocks crashing down once again. (See Figure 1)

Figure 1 - Click Chart For Sharper Image

Larger Image

Source: The Chart Store

And they will bailout the States and Municipalities. And the dollar ($) would get killed with just a hint they indeed are going to bailout the States and Municipalities, not to mention an official acknowledgement (it's announced the Fed will no longer pay the Treasury interest) of the Fed's insolvency. Further discussion on this topic is for another day however, as our price managing bureaucracy is likely saving such moves (which would support the equity complex) for down the road when they are even more desperate (if that's possible considering they print money every day now), which would be the case if stocks were to tank moving forward. To think the bureaucracy / establishment continue to attempt steering / goading people into the stock market while knowing themselves it's a house of cards just goes to show you what they think of the average village idiot. And it's this brand of thinking that will eventually see equities tank when it's realized they themselves are not rocket scientists either, and that with the public bankrupted it's going to be a lonely road attempting to buy up all those stocks when the NASDAQ is vexing 1,000 again, threatening to break lower. (See Figure 2)

Figure 2 - Click Chart For Sharper Image

Larger Image

Source: The Chart Store

Impossible? Well, as you can see above, not only does the post crash pattern in the Nikki (see Figure 1) point to the probability the divergence in the same patter of the NASDAQ is closed one day; but also, as you can see in Figure 2, in comparing the post mania pattern in Dow a la the '29 bubble, again, if history is to repeat stocks should be topping soon here, and the apparent divergence closed. Here, the important thing to remember is throughout the ages human behavior does not change, it simply gets more desperate, which is why the bubbles / tops of today are so grand in nature. Life is still good for most today in spite of increasing hardship, and people are becoming increasingly nervous about losing their lifestyles, which accounts for their incessant desire to keep on buying puts right into the face of the most blatant money printing episode of a global reserve currency in history. According to the larger degree cycles (time-lines) denoted on the S&P 500 (SPX) Supercycle Fibonacci grid plot seen below however, this desire should end soon, which will allow stocks to fall along with US index open interest put / call ratios. (See Figure 3)

Figure 3
$SPX Index

What could cause such a crash if the Fed will inflate / monetize until the cows come home and inflation is guaranteed? Besides the fact one must worry when a consensus the likes of the present inflation becomes widespread, on top of this there's always that unseen boggy out there, and right now the primary source of surprise I see can be found in prospects for rising interest rates. And as you can see below, just one more minor degree wave up in the TNX will have it counting higher in fives, which of course would mean that after a correction, more gains should be expected. Further to this, this is also why one should expect more strength in the larger equity complex moving forward as well, because it's not likely the count would be able to be completed unless stocks continue higher, which would keep the inflation trade in tact even though precious metals and commodities are under attack. (i.e. most peoples savings are in stocks, which accounts for this thinking.) (See Figure 4)

Figure 4

So don't be surprised if we finish the month on a positive note, because apparently this is probable from a statistical perspective. In doing so no other outcome would likely prove more bearish however, as again, bearish speculators will have little to hang their hats on afterwards (a positive January has been a buy signal for the entire year historically), which would remove options (put) related support from equities. Why would this occur? Because the bears will finally be out of excuses to buy puts, which should drop the index and ETF open interest put / call ratios that have been providing the other key element to increasing liquidity this low volume slow motion short squeeze has been feeding on.

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 web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. Along these lines, you should know your subscription to Treasure Chests would include daily commentary from either the myself or Dave Petch. As you may know, I cover macro-conditions, sector timing, and value oriented stock selection, while Dave covers the HUI, XOI, USD, SPX, and TNX technically each week. Mr. Petch is a world class Elliott Wave Theory technician.

In addition to this, you would have access to all archived commentaries, the Chart Room, exhibiting 100 annotated charts of the precious metals and stock markets, along with stock selection and sector outlook pages. 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.

And if you are interested in finding out more about how our advisory service would have kept you on the right side of the equity and precious metals markets these past years, please take some time to review a publicly available and extensive archive located here, where you will find our track record speaks for itself.

Naturally 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 and best of the season all.


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