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March 17, 2007

Stock Market Swoon Announces the Next Recession
by Robert McHugh

We continue to keep a watchful eye on the this pattern, as it bears a striking resemblance to some rather famous historic tops. The set-up pattern looks complete, with point e's top at February 20th, 2007's 12,795.93. The recent mini-crash comes just when it was expected, around March 2007, and is the predictable price action subsequent to completion of this pattern. If history is a predictor, the Dow Industrials will plunge much further. The next sharp thrust lower could start around mid-March 2007 if the cycle analysis work shown in previous weekend issues is going to be an accurate predictor. The stock market represents the collective view of everyone who knows anything about the state of the economy. It is therefore useful as a predictor of booms and busts. Sharp market declines warn of coming economic upheaval. This pattern is a way to identify when the stock market is likely to announce the next recession -- soon.

The Broadening Top formation is a Bearish pattern. Thomas Bulkowski, in his Encyclopedia of Chart Patterns, suggests this pattern has only a 9 percent failure rate after a breakout. He mentions the average decline is 18 percent, with the highest probability decline being 10 percent. A rule of thumb for measuring a downside target is to use half the formation's height. That measuring stick has a 91 percent success rate.

This pattern appeared in the multi-year period from 1998 through 2000, just before the 1987 stock market crash, in 1986, just before the 1972-73's 26.5 percent one-year plunge, just before the 1966 plunge, before the 1957 crash, and just before the 1929 crash. The start of the 2007 decline has already involved a mini-crash. More could come. This is a risk factor for those invested heavily in the stock market.

A 10 percent decline -- the most likely result according to Bulkowski -- would take the Dow Industrials back down to the 11,500ish area. More decline is possible. Using the rule of thumb of half the formation's height would target the 10,400ish area. The examples shown on the subsequent pages show declines were at least to the bottom boundary, which would target at least 8,000ish, but at lower probability. You have to think the PPT would buy markets long before that level. Any significant decline here will be a forecast of an imminent economic recession. We believe one has already started, one that won't be acknowledged by the Master Planners until it is over.

Mortgage Applications rose last week, according to the Mortgage Bankers Association. Applications are one thing; approvals are another. Collateral values are dropping and Bank Regulators have just been loosed from their cages. Here's how it works: Real Estate loans go bad. Politicians call Bank Regulators in on the carpet, demanding to know how this happened. Bank Regulators dance while their feet get shot at, hat in hand, then return to their fiefdoms unable to sit like they used to be able to. They decide they don't like that experience, feel they have a mandate to catch and stop bad loans, and instantly become overzealous. They schedule more frequent exams, tighten arbitrary standards, and rate good loans as substandard, and substandard loans as doubtful, and force writeoffs all over the banking world. Bank earnings take a hit -- not from actual bad loan losses, but from subjective downgrading by bank examiners which requires transferring earnings into provisions for possible loan losses expense. Fearful any good loan has too high a chance of being rated as a bad loan by a bank examiner, banks put the brakes on lending. This causes a credit crunch, and sends an already weakening economy into the tank. Once the recession is publicized, public outcry demands solutions from politicians. Politicians then tell regulators to back off, after it is too late, demanding they let money flow again through the bank lending function. Where we are now, is the start of a coming credit crunch. First the subprime lenders are getting hit. Next will be all lenders. The problem is one of values. Real Estate stopped going up. The ponzi home mortgage ATM scheme of Artificial Economics has stopped. As long as values increased, everything was fine. The house of cards is now crumbling.

The solution will be to devalue the dollar through massive hyperinflation. There is a debt repayment crisis coming. The Master Planners either have to goose the housing inflation game again, or hand out trillions of dollars to American Households to pay off their debts, in effect monetize our debt at the expense of a 50 percent devaluation of the dollar. The Master Planners do not realize this yet, of course, as delusion reigns for the moment. Mortgage Late Payments rose to a 3.5 year high at 4.95 percent, and new Foreclosures hit a new all-time high of 0.54 percent, according to the Mortgage Bankers Association. A soft landing here is wishful thinking.

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"Now at that time Michael, the great prince who stands
guard over the sons of your people, will arise.
And there will be a time of distress such as never occurred since
there was a nation until that time; and at that time your people,
everyone who is found written in the book, will be rescued.
And many of those who sleep in the dust of the ground will awake,
these to everlasting life, but others to disgrace and everlasting contempt.
And those who have insight will shine brightly like the brightness
of the expanse of heaven, and those who lead the many
to righteousness, like the stars forever and ever.
But as for you Daniel, conceal these words and seal up the book until the
end of time; many will go back and forth, and knowledge will increase."
Daniel 12:1-4

If you are a trader, we offer market timing signals. If you are a conservative long-term investor, we manage our Conservative Balanced Investment Portfolio, and publish our transactions on a regular basis.

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

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