The study below originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, February 7th, 2006.

The following is another installment of 'top watch', where we scour the financial landscape in search of clues to tell us when one should expect a profound directional trend change from up to down in the stock markets (equities) of the world. In further qualification of this study, it should be noted this author believes that all stocks markets of the world are rising in tandem on a sea of fiat currency (money supply) liquidity, and that we are entering the latter stages of a slow motion hyperinflation that may or may not accelerate considerably from here. Therein, because savings rates are so low, and indebtedness is so high amongst the general population, along with the fact such a broad range of asset classes are being pushed higher in tandem via this liquidity like never seen before in history, it's questionable both asset prices and / or general price levels, which are heavily influenced by commodity prices, will 'blow-off' as with other hyperinflationary sequences witnessed throughout history. That is to say for all intents and purposes, if it were not for Greenspan keeping the 'pedal to the metal' in terms of proliferating the credit bubble, perhaps the late 90's explosion in tech stocks would have marked the top of a more 'narrow' modern day South Sea Bubble, which as with England at the time, signaled the beginning of the end in terms of its financial dominance in the world.

Further to this, it should be noted we believe both instances did mark the initial stages of global Grand Super Cycle turns, where at present we are now witnessing the finishing touches of a very broad (assets) and far reaching (geography) hyperinflation that because of its breadth and stealth nature (debt acts as quasi-money supply) will not produce further singular instances of extreme asset / price bubbles past what has already been witnessed. That is to say it should be understood that for all intents and purposes it should be understood the current hyperinflationary sequence kicked in as a result of Nixon closing the external gold window in 1971, where not too long afterward money supply growth rates have reached into the double digits at times. Here, the point I am attempting to make you see is that we are well into the 'grand' inflationary process, and that recent mechanism changes mark 'the beginning of the end' for current organizational frameworks. The only notable exceptions we consider possible for further significant bubblization in this regard are the energy and precious metals groups, where it's likely broad measures of commodities will continue to rise further for years to come if our larger degree cycle work has any value, but that no other singular measures will stand out like these two. Now watch the grains blow this theory right out of the water. $10,000 loaves of bread anyone. Or how about a million? Where's my wheelbarrow?

Of course it is this risk of inflation that necessitates one own select 'real assets' that still represent 'good value', preferably as early in their respective inflation cycles as possible. Here, it can be strongly argued select small / micro-cap precious metals / energy related opportunities, several of which we have listed in our Portfolios, still offer good value in relation to anticipated pricing a year or two down the road. Of course there are no guarantees this is this regard, as the current set-up is beginning to look increasingly like the late twenties, where no matter what kind of equity you are talking about, once liquidity trends reverse, all categories are anticipated to take a hit. And as you likely know, where we will repeat our opening remarks once again, it is this risk that keeps us constantly searching for clues as to when the party will be over in this regard, and that this is why we pay so much attention to the 'credit cycle'.

Why is this? As you will see below, history has taught us credit cycle trends are 'the key' to establishing likely peaks in economic activity, with the rate(s) at which margin debt is employed the single best indicator in marking stock market tops bar none. Thus, it is on this basis it makes a great deal of sense to us a comparative analysis of the current Primary Degree / Cycle Degree Wave extensions in markets of import are performed to see exactly where we stand in the current sequence. Further to this, and for all practical purposes, where as you may know based on a wider view of the equity universe, we are currently just topping in the current Grand Super Cycle sequence, and that the market capitalization weighted index tops seen in 2000 were simply a precursor to a broader top in coming years, it is important to recognize these broader measures are already extending fifth waves, meaning it's now only a question of how far these extensions will run. Here is a chart panel showing the market capitalization of the New York Stock Exchange (NYSE) that clearly demonstrates stocks remain poised for further gains. (See Figure 1)

Figure 1

At least this is what one must assume if you live by the adage 'the trend is your friend'. But, considering what is at stake, and not wanting to exist within such an arcane / inappropriate mindset, as mentioned, it is our opinion a study of historical credit cycles along side of equity prices should continue to serve us well in helping to identify tops of varying degrees. Here, the hope is we are able to avoid a Grand Super Cycle correction, or worse an X-Wave event, which as you may or may not know could involve asset prices falling more than 90-percent from current values in a sequence lasting generations, possibly as economies / markets turn inward as the US modeled globalization trend reverses.

Be that as it may, we can tell you recent 'extended' gains in stocks as measured by the total market capitalization of the NYSE seen above have not been accompanied by new highs in margin debt utilization, which is a first for the larger degree sequence. Furthermore, you will notice below that internal technical conditions associated with profound shifts in margin utilization are preparing to close this divergence in one way or the other, meaning credit in the market will either surge to a new 'blow-off high', or collapse in a 'fifth wave failure', marking an end to not only its own larger degree advance sequence, but also that of asset prices, and quite possibly the 'inflation' trend, as it were. As mentioned in the annotations on Figure 1 however, with gold breaking above 'key resistance' recently, which is the Cycle Degree 50-percent retracement off 1980 highs at $556 (Handy & Harman), a signal has been triggered suggesting one would be wise to reside in the bullish camp at present. (See Figure 2)

Figure 2

Further to this, and turning our focus to the market capitalization S&P 500 (SPX) now in an effort to aid us in ascertaining an understanding of where we currently stand in the credit cycle as it pertains to margin debt, here one should notice that even with the increasing rates of monetary largesse on the part of authorities over the past few years, these efforts have been insufficient to do the 'heavy lifting' required to send large capitalization stocks that populate this measure back to previous highs. Again, as you will see below, it's not that money has been shifting out of stocks, which is confirmed by a maintenance of rising margin debt, instead it appears we are talking about other areas garnering greater investor attention (a new mania), where it should be of no surprise to anyone we are referring to the housing market. Of course rising commodity prices and interest in resource related equities also account for some of the divergence between broader measures of stocks and the still heavily technology weighted market capitalization indexes, as well. (See Figure 3)

Figure 3

Now, in relation to the potentially popped housing bubble, and the binge of refinancing that went along with it, some of you may be thinking the reason margin debt has not been rising is because investors might have been taking fixed rate equity based loans against their homes and investing the proceeds into the stock market. And in a review of the pertinent figures attached, where mortgage debt appears to have been the only source of increasing consumer debt that experience vibrant growth over the past few years, this would appear to be a possibility. But, just based on the large gains housing prices experienced over the same timeframe however, in what will undoubtedly be looked back on as the greatest bubble of it's kind in history, one would be wise in not jumping to this conclusion in our estimation. That is to say, if refi money was not spent on consumption, the outsized gains seen in house prices of late suggests it was plowed back into real estate. (See Figure 9 in attached figures above.)

Further to this, for our purposes, we will not ignore the obvious, and avoid speculating contrary to the observation made above that in spite of increasing and new high measures of money supply being injected into the US economy, margin growth rates have stalled. And that although broader measures of stocks encompassing smaller capitalization and specialized issues are seeing new highs, there is in fact insufficient pressure in the 'collective pipe' to lift all boats. Again, and more specifically, we are referring to the 'big boats' here, which by virtue of the bubbles in tech and the financials, involve mega-capitalization stocks like Microsoft and GE. If a picture is worth a thousand words, then in terms of dollars, this one should be worth trillions as it clearly demonstrates that unless the US consumer / debtor / investor is willing to take on increasing amounts of margin debt, market capitalization indexes are not going anywhere. (See Figure 4)

Figure 4

Does that mean the stock market is doomed from here? Actually, for the observant, the answer to this question is a resounding no. How can this be, with the consumer apparently tapped, and our most reliable indicators signaling storm clouds on the horizon? The answer to this question is simple, as the maestro left us no alternative, which is to remain optimistic, and when that doesn't work, inflate the hell of everything through monetization when nobody is looking. Here, since the more immediate shine has likely left real estate at this point, undoubtedly the hope would be loose headed individuals would head back to the stock market, and in turn, margin thresholds will begin rising once again. One thing is for sure, we are definitely approaching decision time in this regard, as if the Rate Of Change (ROC) in margin debt growth rates associated with stocks in the SPX do not bounce soon, values will plunge into negative territory, and you know what that means. (See Figure 5)

Figure 5

The thing is though, if history is any guide, there should still be one more surge in margin debt utilization rates to complete the current sequence, where some degree of a parabolic move is seen before prices begin to retreat once again in earnest. For example, back in the late 90's, margin debt utilization shot higher for a short time in late 1999 until early 2000 to mark the tech top, where this occurrence was so brief the ROC for the SPX did not even sputter. (See Figure 6)

Figure 6

Furthermore, it should be noticed prices have been rising while margin has actually declined of late, meaning increasingly, trades are not being financed. The last time this happened, albeit on a much larger scale, was in the early to mid-90's, as seen above in Figure 6, and we all know what happened after that. Therein, let's say the Fed is pulling back on the feedbag right now in an attempt to show the market there will be nothing to worry about once M3 and repos are no longer reported after March 20th. The idea is they are saying 'look over here, you see, we are not debasing our currency at an accelerating rate, so no worries once you can't observe these numbers anymore'.

We of course will know if this is not the case by observing other variables, and it just so happens margin use is one of them. Thus, we will be watching for a brief surge in this variable set against the monthly SPX ROC remaining constant to signal an end to the current advance of stocks in general, because as you know from our work above, when / if the large capitalization stocks begin to move impulsively, brief as this may be, an end to the larger degree sequence is likely not far off. (See Figure 7)

Figure 7

You know what, that is all we wish to say on this topic for today. There is much to consider and review in the above, which is exactly what we will be doing, so don't be surprised to see some modifications to our thoughts along the way. Other than that however, because liquidity is being reigned in at present, expect to see weakness in stocks continue, but where losses should be buffered by the support outsized bets against such an outcome provides.

Furthermore, since participants in the precious metals sector are very charged up right now, and betting that way, it should be expected that weakness here would be more profound. If I had to guess, monetary authorities are timing elections again, where it appears they are allowing pressure to leak out of the pipe right now with the intension of blowing up new balloons as November approaches. I wonder if they know gold and its related equities, along with the energy complex, will literally explode higher if successful.

In leaving you now, we invite you to visit our site and discover more about how an enlightened approach to market analysis and investing could potentially aid you in protecting your finances and family life into the future. And of course if you have any questions or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.