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November 11, 2008

Pivotal Events
by Bob Hoye

The following is part of Pivotal Events that was published for our subscribers Thursday, November 6, 2008.

SIGNS OF THE TIMES:

A Year Ago:

"Exorcising Ghost if Octobers Past"

"Despite Housing Slump, Crashes Such as in 1987 Likely to Stay Memories"

- Wall Street Journal, October 15, 2007

Well, it wasn't like 1987 - it is like 1929 or 1873.

"I think the Fed has taken care of the summer's harrowing turbulence by cutting short-term rates, pumping money into the system and seeming determined to prevent a recession."

- Wall Street Journal, October 15, 2007

Conventional wisdom still seems unaware that in a post-bubble contraction treasury bill rates decline until the bear is over.

We haven't mentioned the recession for a while - there have been more interesting market opportunities to discuss. However, our view has been that the climax of a financial bubble and the peak of the business cycle have been almost coincidental. In 1929 the stock market peaked in early September and the NBER deemed that economy topped in August. In 1873, the stock market ended its speculation in September and business peaked in October.

On normal cyclical contractions the recession, as determined by the NBER, usually start a year after the stock market high and in showing a certain inability to forecast the NBER decision is typically announced a year after the date they set as the start of the recession.

For those who have waiting for the mighty decision before adjusting positions, the wait is almost over. The pattern suggests that the NBER is about to make its announcement and the recession may have started in 4Q2007.

This Year:

"These institutions [Fannie and Freddie] are fundamentally sound and strong. There is no reason for the kind of [stock market] reaction we're getting."

- Christopher Dodd, Chair, Senate Banking Committee,
Financial Post, July 12, 2008

"The United States witnessed a boat boom from 2000 to 2006 as buyers used the equity in their homes to put down payments on vessels, big and small."

- Financial Post, July 19, 2008

On the failure of yacht dealer in Ontario

"I'm trying to save the planet; I'm trying to save the planet!"

- Nancy Pelosi, House Speaker, Politico, July 29, 2008

* * * * *

Stock Markets: Using the S&P the rebound amounted to 20% in six days and is the most overbought on our "summation" thing since the rebound highs made on July 23 and May 16. The rebound from Black Friday's low added up to 25%.

This sets a series of lower highs on each rebound, which is not healthy. The action is now heading into the November "test" of the classic fall panic. The test could be slightly above or slightly below the worst of October, or maybe a perfect "Goldilocks". Which would be at the low.

Cadres of international socialists, do-gooders, meddlers, and the terminally anxious are celebrating Obama's win. While understandable, it should be kept in mind that this mob won't promote stocks, and what's worse they will force their compulsions about perfection upon the markets. It's worth noting that as a political phenomenon it seems without precedent. Perhaps it's a mania equivalent to the housing or commodity bubble.

Fortunately the Dems didn't obtain a super majority, which could constrain their ambition to merely the Captain Bligh treatment: "Floggings will continue until morale improves". Naturally they will demand more money from an economy suffering a severe contraction.

Then there is Mother Nature and Mister Margin who have shown, yet again, that they can trump even today's ambitious central planners. Indeed, more than likely, they will overwhelm policymakers appointed by the next administration.

Nevertheless, we have hopes that stock markets can muster a tradable rally into March-April.

This would be within the context of a cyclical bear market. It is worth emphasizing that Downside Capitulations on the DJIA have been rare since the index began in 1895. One in 1966 and three during the 1929 to 1932 decline. The one in October is likely the first of a potential three such panics.

Near Term: Yesterday's ChartWorks reviewed the overbought condition, which set up a

timely slide. The chart also showed the Capitulation registered in October. It is useful to have a model that works both ways.

INTEREST RATES

The Long Bond is doing the knee-jerk rally that goes with a stock slump.

However, this is within a stair-step decline since the blow-off high of 124.73 in mid September. As noted last week there is support in the 112s and it held. So far the bounce is approaching overhead resistance at 117.

The pending change in US government will not be kind to fragile capital markets, within which long treasuries are the last asset class to really get worked over.

The main direction is down in price, up in yield and as with Bill Clinton, Obama is probably innocent of knowledge about bonds. Late in 1993 when Clinton was gearing for the next election long rates were rising and he expected that they could be reduced at will. When told it couldn't be done he angrily stated that his political success should not be messed up by "f....g bond traders".

Traders have been playing the short-side and steepeners. Investors have been in the five-year maturities, that usually show a good return during a post-bubble contraction.

Credit Spreads: It is interesting that money-market spreads generally widened as the federales were injecting a growing amount of liquidity. This began in January. When the seasonal turn to widening expected in May came in, we advised that spreads could widen to dislocating conditions in the fall. This worked out as dealer commercial paper rates decreased to 262 bps in May and soared to 525 bps with the panic in mid October.

On the move, the spread over the three-month bill widened from 145 bps to 525 bps. Much has been said about Libor, but dealer commercial paper had the bigger trip and as noted in our October 23 edition this sector was beginning to ease - naturally - setting up the next stock rally.

Pressures on long corporates continue. The junk yield, that was at 11% when all was well a year ago, is now out to 29.25% yield, which represents a price-plunge from 100 to 37. Even the investment-grade BBB has increased in yield from 6% to 10.5%.

However, the price decline this week has been modest and since last week we have been expecting some relief. Just a little relief.

Currencies: The Dollar Index registered an Upside Exhaustion on October 23 and we advised that the currencies, including the euro/yen could correct for a while. This would release some rallies in the beat up stocks, commodities and the Canadian dollar.

This generally is working out and the DX could be steady for a week or so as the stock market tests the lows.

Link to the Friday, November 7 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1018

Bob Hoye
Institutional Advisors

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