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December 07, 2008

Bottoming Process Continues
by David Chapman

The first few days of a month tend to be greeted by a somewhat positive market. The record since 1953 is that the first day of the month is an up day roughly 56 per cent of the time, though Mondays tend to be mixed, with gains only about 47 per cent of the time. And in bear markets Mondays are up only about 40 per cent of the time. The first day of December also tends to bring us an up day in the market.

Well this past week we had the first day of the month of December, in a bear market, and it was also a Monday. The markets were pummelled. The Dow Jones Industrials dropped 680 points or 7.7 per cent, the S&P 500 fell 80 points or 8.9 per cent and the TSX fell an astounding 864 points or 9.3 per cent. So much for history.

But unlike the collapse back in October, the market rose the next day and held together for the rest of the week. Then came Friday and the employment numbers. The official report showed the US losing 533,000 jobs - the worst month since 1974. The unemployment rate leaped to 6.7 per cent, the highest since 1993. If you include workers who have given up because there are no jobs, the unemployment rates jumps to 9.8 per cent. A total of 1.9 million jobs have been lost since December 2007.

Canada lost 71,000 jobs, equivalent to over 600,000 in the US. It was the most in 26 years. The unemployment rate rose to 6.3 per cent. The province of Ontario was hit the hardest, losing almost 61,000 jobs. It has been a long time since we recall the Canadian unemployment rate below that of the US. And Canada's unemployment rate includes discouraged workers.

The bad news didn't end with the headline numbers. October and September were both revised down. October was revised to a fall of 320,000 jobs against the previously reported 240,000, and September was revised to a drop of 403,000 from 284,000. Service industries alone shed 370,000 jobs in November following the demise of the consumers' shopping spree. Retail sales have been relentlessly falling, and despite the headlines of a Wal-Mart associates being trampled to death and a gunfight over toys resulting in deaths at Toy's R Us, only Wal-Mart showed a 3.4 per cent gain in sales from the previous year.

Other numbers and stories were also bleak.

Factory orders fell 5.1 per cent in October.
Commodity prices are at their lowest in years. Oil prices have fallen back to their lowest levels since 2005. The major zone of support is $40, the place of the lows of 2004, the highs of 2002, 1980 (the Iranian hostage crisis) and 1990 (Iraq's invasion of Kuwait). Forecasts abound of falls to $25, $20 and even $10, mimicking the opposite calls of a rise to $200 and higher seen a mere four months ago.
Bankruptcies continue to run at record levels and are rising sharply in Canada as well.
The housing crisis continues unabated. Here in Toronto, housing sales are down 50 per cent and the average price for homes is down 10 per cent from a year ago.
US foreclosures rose to record levels. It is estimated that another 2.2 million homes will go into foreclosure in 2009.
The share of loans in foreclosure rose to 2.97 per cent from 2.75 per cent in the previous quarter and 1.69 per cent a year ago. The nine worst-hit states, all well above the national average, are Nevada, California, Arizona, Florida, Michigan, Rhode Island, Illinois, Indiana and Ohio.
The Big Three auto manufacturers (GM, Ford and Chrysler) are threatening to become the Big One or even the Big None. In the US the Big Three have 70 per cent of the car dealerships. With all of them teetering, that means that GMAC, Ford Credit and Chrysler Credit are also teetering.
In Canada the share of Big Three dealerships is not as high but there are still a high number. Walking past one of them the other day, the price reductions on the used car lot were routinely in excess of 12 per cent. Yet nothing is moving as consumers are reluctant to buy a car from someone who might not be around six months from now. Warranties are hanging in mid-air.

The collapse in commodity prices brought on a sharp rise in the US dollar. Hedge funds and others had made huge bets on commodity prices, betting that while North America may flounder, the economies of China, India and others would continue to boom. Now they have slowed as well. As the hedge funds and others sold their foreign holdings they brought the proceeds back into the USA converting to US$ creating a higher demand then normal for the currency. As well there has been a mad global rush into US Treasury securities pushing yields on short dated instruments to virtually zero and dropping even long dated Treasuries sharply below the rate of inflation.

The commodity market topped out in July a mere five months ago. The subsequent collapse has turned into a disaster, falling so fast that it made the high technology/dot-com bust of 2000-02 look like it happened in slow motion. Unlike the broad market that has been falling now since October 2007 the collapse in commodity prices looks more like a crash having characteristics more in tune with October 1987 then the financial panic collapse of 1937-1938. Commodity prices also collapsed in that famous panic but we will discuss that more in detail in another "Scoop".

We have been writing for years about the potential for a debt and financial collapse. History shows that as debt builds up, the potential for a financial collapse rises proportionally. All financial collapses are about debt collapse. In the good times debt and leverage rises, but when the bubble pops the collapse is rapid. Fighting history is pointless, as we are sure that at least 80 per cent of the population including the elites, the media, the politicians and the captains of industry, all got it wrong. The reality was probably an even higher number. The trouble with calling it is getting the timing right - that's always the hard part.

As time went on and the collapse didn't happen, the perma-bears came under increasing criticism or were laughed at or dismissed as pariahs. But in the end even bears (mea culpa) got caught in the resulting meltdown.

One reader said that "after reading your write-ups I wanted to go home and slit my throat". People want upbeat reports, not perma-bear stuff. Brokerage firms are famous for constantly releasing generally upbeat reports on companies and even economic forecasts. In an industry that is dependent on buyers, the word "sell" is not popular. So it is no surprise that brokerages are suffering hugely in this meltdown. Many stockbrokers will no longer be brokers a year from now. Some firms have already gone under, with the biggest name thus far being Lehman Brothers. But firms that were not highly leveraged and followed prudent business practices will be fine, even if they are suffering the ill-effects of the meltdown.

With so much gloomy news out there, we guess many would be surprised to learn that we are now turning bullish. Maybe it is the natural contrarian in us, or maybe we are just contrary. Our turning bullish, as we have stated before, is not because we believe we have hit the bottom but that we are in the vicinity of a bottom. The Great Depression had numerous ups and downs. The major collapse was 1929-32. What followed was a four-year bull market (1933-37). Then came the financial panic of 1937-38. 1938 was the eighth year of the Great Depression.

Just as we saw during the Great Depression, we had a bear market from 2000 to 2002. A bull market followed from 2003 to 2007. And corresponding to the Great Depression we have had a financial panic in 2007-08.

The 1933-37 bull market gained 381 per cent from the lows of July 1932. In 2003-07 the bull market gained 99 per cent (all measured by the DJI). The subsequent 1937-38 panic saw a collapse of 50 per cent. The panic of 2007-08 (to November 20) has seen a collapse of 48 per cent.

We were struck on Friday by the fact that the loss of 533,000 jobs was the largest for 34 years. We note that 34 is a Fibonacci number. This is a sequence of numbers starting with 0 and 1, where each subsequent number is the sum of the two previous numbers (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, etc). Fibonacci numbers are used extensively in technical analysis.

The worst monthly job loss in 1974 was in December, and the low of the 1973-74 bear market occurred on December 9, 1974. That bear market lost 46.6 per cent from the highs of January 1973. Come Tuesday we will be exactly 34 years from the lows of 1974. In 1974 the market made its initial low in October and its final low in December. This time around we made our initial low in October and quite possibly our final low in November. The low in December thus far is a higher low.

We show the 1972-75 market below. We can't help but note that 1974 was also the 8th year of the long bear market of 1966-1982. The number 8 (also a Fibonacci) has been consistent in all three bear markets (Great Depression and War 1929-1949 and the Inflation years and War 1966-1982). Note the clear lows seen in October and December of 1974. It was followed in 1975 by an impressive rally, despite the fact that unemployment continued to rise into 1975. The stock market often precedes both falls and rises in the economy.

Despite all the gloomy news on Friday of this past week, by the time we got to the close the market was up on the day after being down earlier. This is a bullish development. When markets can't break down against the backdrop of extremely gloomy news, then the sellers are losing their control of the market and the bulls will slowly regain the upper hand. There is a lot of cash sitting on the sidelines looking for a sign that the market is in the bottoming process.

We show the current market below. Note that the collapse brought us to our momentum low in October, followed by a lower low in November. Thus far the low made in December is a higher low. This is potentially positive.

The massive inflow of liquidity into the markets could be helping. In fact it just keeps getting larger. The most recent numbers we have seen say we are now up to $8.3 trillion. Based on articles we saw in the San Francisco Chronicle (Government Bailout hits $8.5 trillion - Kathleen Pender) and Bloomberg News, the bailout is now 60 per cent of US GDP, an astounding number. It was only a short while ago that the numbers being reported were $2.2 trillion, then $4.3 trillion. The breakdown is as follows.

As one can see, the total program has thus far only been tapped for 37.6 per cent of the funds. And there are more funds coming if one listens to the bailout plans of president-elect Barack Obama. The massive infusion is having some impact as the high spreads over US Treasuries that most instruments were trading at are at least levelling out.

Even though 10-year Treasuries have fallen under 3.0 per cent and short dated instruments have fallen to virtually zero, 30-year mortgages as an example had remained around 6.0 per cent. They have now moved down a little, even if only by 20 basis points or so. The Fed apparently amongst other things has been buying mortgage-backed securities. Seems that home owners will now be making their payments to the Fed even if they don't know it.

The Japan of the 1990s actually had negative inflation (deflation). This gave the BOJ room to move its policy rate to zero per cent. Today the Fed is down to 1.0 per cent but the inflation rate is still 3.7 per cent (though it may go lower over the coming months). So a major difference is that corporate bonds in Japan traded at a mere 16 points over comparable Japanese Treasuries. Not so for US corporate bonds that are around 260 basis points higher for Aaa bonds and over 600 basis points higher for Baa bonds. Japan had a deflation and investment problem, the US it seems has a default and illiquidity problem (The Economist - Plan C, November 29, 2008).

On the other hand, credit conditions have eased somewhat at the short end. Our chart of the Ted Spread (three-month Euro Libor less three-month T Bills) and three-month commercial paper less three-month T Bills, shows that the TED has fallen from near 500 bp over to the current 222 bp over. CP is down to 235 bp over from 440 bp over. Still this is a long way from normalcy of 20 bp over.

Bankers it seems are afraid of the market even as their fear is subsiding a little bit. Oddly enough with Freddie and Fannie becoming effectively the mortgage lenders of America the banks themselves are not lending any funds. This effectively means that bad borrowers (who will get their money from Freddie and Fannie) will now crowd out good borrowers as the banks freeze out credit worthy borrowers except at high spreads.

There are signs of improvement out there, despite the parade of gloomy numbers over the past week. And buoying our spirits was the ability of the market to close up Friday despite the huge job loss. The seasonals are also slowly shifting in our favour. Maybe there will be Santa Claus after all this season. Bear market rallies can prove to be more lasting and go higher than anyone expects. Just don't get the idea that it actually means the crisis is over. It isn't and won't be for years. But it may just prove to be a tonic even if temporary. This is a trading market not an investing market. When the rally ends (usually unexpectedly) the bear will return. But in the interim a bottoming process is underway.

Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.