Credit Crunch Contagion

By: Captain Hook | Mon, Dec 10, 2007
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The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, November 20th, 2007.

Make no mistake about it, the credit crunch is still spreading and contagious, and will remain that way until all debt that needs to be purged from the system has been expunged. Unfortunately for all concerned, with conditions in key factors displaying signs of Super-Cycle Degree tops, such as in demographic trends for example, this process could take longer than the current batch of bankers would prefer, and in fact likely scuttle the present day credit-based monetary system as a result. This is why one should not be surprised to see blank check policy and / or monetization rates continue accelerating moving forward, along with falling interest rates in bringing real yields down in an effort to support a faltering Western banking model. And because this is a global affair expect to see competitive devaluations begin to occur more frequently soon as well, which in total will continue to benefit precious metals in both relative and nominal measure as an increasingly stressed populations search for safe means to save wealth once again. In this sense, an entire era of speculation in paper assets is quickly turning the corner at present.

Of course at first glance based on the above one would think such conditions are a 'natural' in terms of a bullish outcome for gold moving forward, serving as tangible 'real' money for thousands of years now. And you know what - you would be correct in this respect if the recent surge in interest is any indication. What's more, this trend should begin to become increasingly obvious to greater numbers as time marches on, where factors like constricting supply will help to fuel higher prices as the lights go on for those currently in the dark. In this respect so far our price fixing bureaucracies have been able to hide the effects of their inflation quite well to the extent the general population is not concerned as of yet. But just wait a while, as this will all change as monetary inflation rates (and corresponding price gains) must rise even further to counter a loss of confidence in the American economy, and its ability to service its debt. It should be noted this is already occurring in key high-level debt markets and could quickly spread to the currency in effect. It's all quite contagious you see.

Oh and we can go on in this vein of thinking, where although they don't want to hear about it on bubble-vision or newspapers, there can be little doubt the US economy is in recession. With all this said however, Christmas is coming, so it must be time for a round of seasonal strength in the equity markets right, especially with respect to the Decennial Pattern and the Presidential Cycle. And let's not forget price managers will pull all the stops in making sure stock markets rebound into Thanks Giving Day weekend coming up, the busiest time for shoppers of the year in preparing for a Joel Noel. And just so you know, this coming week has a high historical tendency to be strong in this regard not only for the reasons already mentioned, but also because the shortened week and lower volumes due to holidays make it easier for both the bulls and price managers to get their way. So, short sellers beware.

Past this however, and especially if holiday shopping numbers come in disappointing next week, I expect any strength in the stock market here to be quite fleeting, lasting into next week or so, and that's all. And although it could be quite violent in nature, much like the 40-point short covering rally in the S&P 500 (SPX) experienced last week to test the break of the 200-day moving average, what we should see here moving into the weekend is much the same, where I would be surprised to see prices get back above this resistance. This hypothesis is supported not only by the count and select internal readings on the broads now, but also increasing long-term trend line breaks in sector indices as well, where just last week the Retail Index ($GSPMS) has now joined the Bank Index ($BKX) in this regard. Further to this, I will be posting a simplified count on the SPX tomorrow to this effect along with a few other charts that support the bearish case moving forward. The bulls will label yesterday's low in stocks a corrective zigzag, but they are wrong based on internal market and sentiment conditions which will also be elaborated on further as well.

In the meantime, I have a whole bunch of other charts to be presented today that also support the bearish case moving forward, the first of which captures the entire echo-bubble bounces experienced in US stocks for both the 1930's and post 2000 'tech wreck' aftermath juxtaposed on the same plot. Here, one should notice the almost 'perfect' similarity between the two, where it should be remembered that past this point if history is a good guide, stocks could fall 50-percent into the first quarter of next year. (See Figure 1)

Figure 1

Source: The Chart Store

How could these charts be so similar? Are we not 'better' than our forefathers and masters of our own destinies through technology these days? In answering both of these questions only one basic understanding need be gleaned, that being psychologically there is no difference between the way human beings of today react to certain stimuli compared to previous generations, which is born out in the close matches seen both above and below. And technology - all technology has allowed us to do is make the same mistakes as our forefathers except in larger numbers (in racing to our own demise), where in fact now we've taken these number so high the larger population is subject to environmental risks even Orwell could not imagine in his day - biblical in nature (disease, pestilence, war, etc.) for sure. That being said, here is a close-up snapshot of the above that shows the similarities discussed above in greater detail. (See Figure 2)

Figure 2

Source: The Chart Store

And then here is the same snapshot only this time comparing the SPX to Dow of the 30's in showing you the pattern similarities are simply to striking to ignore in the 'big picture'. So, in further answering whether we are 'different' or 'better' than out predecessors in matters of basic psychology it should be plain to see the answer to such folly is - hardly. (See Figure 3)

Figure 3

Source: The Chart Store

Of course there are those who will not hear of it - and for those people we have the following chart that shows based in the same amount of human intercourse within the market as measured in trading days one more meager impulse higher into the first quarter lies ahead for US stocks. To these people, all I can say is good luck wishing on a star, because the internals simply do not support this view, which in my opinion reflects the poor pattern match seen below. (See Figure 4)

Figure 4

Source: The Chart Store

What about the record high short positions - are they not a very important part of the internal backdrop for the stock market? Answer: Definitely - and they will provide the fuel for short squeezes along the way, which is an integral part of maintaining an appropriate psychology for a meaningful decline in stocks, where currently it would not be a bit surprising to see a 'ramp job' as high as 1480 on the SPX forced on short sellers in testing their resolve. In a larger sense it should be remembered however what has happened here is reality has finally caught up to fiction (the propaganda machine), where no matter how many fairy tales are told on a daily basis now, the fact of the matter is the public at large simply can no longer finance the dream, not only soon to be reflected in crashing margin thresholds if history is a good guide, but also in the fact US trading partners are becoming more reluctant in this regard as well.

And then there are the hedge funds, where based on a marked shift away from market protection insurance reflected in a 'big drop' in Open Interest (OI) on the CBOE Volatility Index (VIX) (just type in VIX here and click the Submit button) for the November series, where we went from a whopping 1.625 million contracts to a scant 468,000 contracts for December, either a sentiment change associated with the factors discussed above (Presidential Cycle, etc.) has officially kicked in, or these guys are just plain exhausted. Perhaps all the credit market troubles are rubbing off on the generalist funds partaking in both debt and equity markets, where these guys are now running from risk. Either way, implied here is any way one chooses to read this, whether this radical change is attributed to either investor optimism or exhaustion (in terms of buying structured risk insurance) it doesn't matter. The fact of the matter is a very important support mechanism for the stock market is gone, not that it had a meaningful impact last month in paying the majority of calls.

What's more, all this has tremendous bearish implications of course, especially if market participants also continue to either close out put positions against the indexes and / or drop put / call ratios via the purchase of calls. As mentioned above, it doesn't matter why this is happening with reference to sentiment, only that it's happening, and the changes are coming fast. If I had to pick a reason for why hedge funds appetite for risk appears to be waning when pressed then, I would have to go with that mentioned above, that being the looses associated with the credit crisis currently gripping macro-conditions has contagiously moved into the stock markets now (as per the title of this commentary), where quite simply so many of these guys are having their heads handed to them on a daily basis now, whether it be voluntary or now, they are shutting down, where after Christmas we could witness quite the exodus in this regard as seasonals apply even more pressure in the larger equation.

Certainly, it's not difficult coming to this conclusion in viewing the emerging bull market in the Yen, where you will remember from our thoughts on the subject presented last week that once a breakout from the larger triangular currently confining trade is executed, a strong argument can be rendered the global credit boom will be 'kaput' with the demise of the Yen Carry Trade. And for those who have come to recognize this is without a doubt the single most important factor influencing macro-conditions today, it should then not be surprising you that both debt (rates may need rise in the States to stabilize the currency) and equity markets will be negatively impacted when (not if) this breakout occurs, and that in fact the trading pattern of the stock market can be explained in terms of movements in the Yen. Below, because of the positive correlation it has to the Yen, one can see both it and the VIX (with reverse pricing to stocks) remain poised to break higher at present. (See Figure 5)

Figure 5

And once such moves transpire then, which should correspond to further deterioration in stocks from the bounce we witness this week (i.e. a bounce in the 1470 to1480 range followed by a test of the August lows soon afterward), even the recovery off a test of the August lows can be explained in these terms, where both the Yen and VIX (as per significant Fibonacci related breakouts on the monthly plot) will themselves test their own breakouts, which in the case of the SPX should involve a bounce back up into the 1500 area once again in December. Again, I will cover the anticipated sequencing in greater detail tomorrow. Until then in this regard, where the following is only one of a myriad of bearish indicators to support our thoughts we could present here, please notice that the Rydex Ratio has now broken out above both the Trend Definer (155-day exponential moving average) and 200-day moving average, where any corrective price action should simply test these metrics before values vault higher. If such a sequence were to develop of course, one could ascribe a crash signature to such an outcome, meaning the decline in stocks is just getting underway. (See Figure 6)

Figure 6

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. However, if the above is an indication of the type of analysis you are looking for, we invite you to visit our newly improved web site and discover more about how our service can help you in not only this regard, but on higher level aid you in achieving your financial goals. For your information, our newly reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. 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.

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Good investing all.

 


 

Captain Hook

Author: Captain Hook

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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