The following is part of Pivotal Events that was published for our subscribers March 17, 2011.
Signs of the Times:
"The Fix for High Oil Prices? Regulate the Speculators" ~ Daily Finance, March 4, 2011
What about central bankers and their speculative theories about currency depreciation?
"Economic optimism growing among brokers" ~ Schwab survey of 1300 independent brokers, March 8, 2011
"Bill Gross: Tax The Wealthy And Corporations A Lot More" ~ Business Insider, March 8, 2011
Is Pimco short corporate bonds?
The Bubble Seems To Have Reached Its Gossamer Limit
Independent of the disaster in Japan, the last few weeks' animated spirits in the financial markets have changed from robust confidence to uncertainty.
After soaring nicely, Consumer Confidence, on the latest report by the University of Michigan, plunged from 77.5 to 68.2. This was reported as a "stunning reversal" and the survey pre-dated the earthquake.
We have been thinking that financial speculation and consumer confidence would top within the time window as targeted by our Momentum Peak Forecaster. With fascinating implications, perhaps interventionist economics has peaked as well.
To be serious, a strong surge into around March has been essential to set the reversal to the down side. And the turn began well before the catastrophic earthquake close to Japan.
The focus, then, is the financial markets rather than repercussions from natural disasters. Ross reviewed stock market action subsequent to non-financial disasters and for traders the initial objective is a Downside Exhaustion. A relief rally for the still popular sectors would follow. It could be brief and should be considered as a technical test of exuberance.
Part of the exuberance is focused on the likelihood of the Fed being successful in its desperation to depreciate the dollar. This week's emergency, according to alarmists, will drive the rate of inflation to exceptional levels. Usually, just what the inflation will be in seems not to be specific.
Since the panic ended in March 2009 there has been outstanding price inflation in, for example, base metal price mining stocks that soared 800 percent. Silver prices have inflated by 325 percent. Junk bond prices have also enjoyed an outstanding price gain.
The Shadow Government Statistics reading on consumer price inflation is up to 9 percent, which compares to the blow-out high of 14.7 percent in 1981. The more contrived reading is at 2 percent, but that is rigged by the relentless improvement in computer efficiency. The CPI should be limited to a basket of groceries, gasoline and the cost of a home.
Conventional wisdom expects this CPI surge to exceed the old highs.
History suggests that this is unlikely.
Inflation And Our Momentum Peak Forecaster
"Wholesale food prices rise 1.6% due to the biggest jump in food costs in more than 36 years" ~ AP, March 16, 2011
More specifically, it is the most sensational move since the early 1970s when the CPI jumped from 2.7% in 1972 to 12.3% in 1974.
As with that example, the current surge is almost over.
Why do we think this?
Our Forecaster peaked in November 1973 and commodities peaked three months later. The recession started in that fateful November and the CPI rate of inflation reached 12.3% in 1974 and then declined to 4.8% at the end of 1976.
It was a relentless bull market for CPI inflation and the establishment invented "inflation expectations" as the cause of rising prices. This translates to rising prices were causing rising prices, which indicated too many graduates in tautology. They also confused things by going on about accounting for inventory as either FIFO or something else.
All the while the Fed was claiming innocence in depreciating the dollar and blamed that upon the "Gnomes of Zurich". These were private Swiss bankers when Swiss banking was the epitome of fiduciary responsibility. They wisely redeemed dollars for gold.
The bull market for CPI inflation resumed and soared to 14.7% in March 1980. The number is the same for the BLS chart or the Shadow Government Statistics and set a huge double top.
Our Forecaster peaked in November 1979 and the buying frenzy in precious metals climaxed in January 1980. That recession started in January and CPI went into a long decline.
We had yet to develop the Forecaster, but our historical work prompted our 1981 conclusion that "No matter how much the Fed prints, stocks will outperform commodities". The concept that inflation in financial assets would be the next big game was controversial. By 2007 it was no longer controversial, but was embraced with considerable enthusiasm.
The bear market for the CPI took it down to a low of -1.9% (absurd BLS number) in August 2009. The typical post-bubble crash dropped the Shadow number to 5.4% for the same month.
The jump to 13.7% in July 2008 is interesting as it appears to be the third attempt at a major high that was interrupted by an inconvenient crash in commodities.
Even central bankers can see that the CPI goes up and down with commodities. And the Forecaster's record on the two earlier commodity highs and lead to the CPI highs will likely be effective this time around.
By way of review, the Forecaster gave the signal at the end of the year and the CRB was likely to set a cyclical high around March. What appears to be an excited high has been accomplished earlier in the month and it could take a number of weeks to build the top. In which case CPI inflation could peak by mid-year.
Commodity prices have soared to what could be an important high and have become volatile. Valuations on commodities seem beyond normal financial analysis. As an aside, valuation determination on equities has been elusive over the past decade.
One commodity valuation is the number of working hours needed to buy a unit of the CRB. This has soared from 19 with the crash to 35 on the February posting. The 2008 thrust made it to 33 so this surge seems to be testing that high. Also, there is overhead resistance at 35.
Valuation, momentum and sentiment have reached levels usually seen at important highs - within the expected time window. It will be interesting to watch the roll over.
The action to an important top roughly followed our expectations. Initially it was agricultural stocks leading the high in agricultural commodities. The GKX (agricultural) has broken down.
Much the same worked for base metal and crude oil prices, but these have yet to break down. Seasonal forces for both could be favourable for a few more weeks.
Obviously, uranium has suffered a hit - for exceptional reasons. The media whip-up of superstitions about "nuclear" has reached hysterical levels which will have lasting implications. The industry has been handicapped by intentionally slow permitting. The process could become impossible.
Revealing yet another mystery of the market's free hand, natural gas is becoming available in huge amounts - just when it is really needed.
On the February pause in asset speculation in the bond showed that it can rally in jumping from 115 to 121. The correction was to a little above 116 early in the month. The high was 123.16 yesterday, which makes for an interesting uptrend.
A correction as assets test their highs could run for a couple of weeks.
We like the action, but it is for nimble traders.
Municipals have enjoyed a nice rally out of the universal trashing with headline stories. Ross flagged this shortly after the low and the NPI has rallied from the low of 11.79 in mid January to 12.91 on March 8.
The rebound has accomplished a big increase in the RSI at overhead resistance. Perhaps enough to end the move.
The risk has very little to do with credit analysis, but a lot to do with a profound political struggle. The unions have monopolistic powers on employee dues and that funds election of friendly Democratic governments. Who in turn cater to union demands. An evil circle of corruption.
Union intransigence and above-market benefits will eventually by quelled by city bankruptcy.
Over in subprime-land, chart action for the best of the worst has quickly ended a year-long uptrend. Price-level lows dating back to October have been taken out. Further decline will begin to suggest that the Fed is stuck with all that toxic waste.
After a sensational year, corporate bond prices have declined a little, but have not reversed the trend. However, spreads for junk and high grade have reversed trend. This is only over the past five weeks but we consider that any extension of the trend would mark the end of a fabulously reckless reach for yield.
There is no memory of the crash in lower-grade bonds from the reversal to spread-widening in May-June 2007.
The Dollar Index has accomplished enough of an oversold to end the decline. The other important item was that it remain low through last week - enough to accomplish the Sequential Buy pattern.
The dollar would likely set an important low as the speculative surge in hot assets completed around March. It could take a few weeks to set the uptrend.
Link to March 18, 2011 'Bob and Phil Show' on Howestreet.com: http://talkdigitalnetwork.com/2011/03/test-exuberance