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Wednesday, November 30, 2011

The World's Biggest Pawn Shop, Part 2

Perhaps a better title would be:  Whadda you lookin' at!?!

In a replay of September 15, the Fed has essentially offered to swap out US dollars for all the crappy collateral the rest of the world can throw our way.  Below, in its entirety, is my analysis from the last time.  Turn off CNBC and read; I promise it's worth the 10 minutes.

Nothing has changed except the numbers, which are much bigger this time.  The punchline?  These things boost markets for a couple days, then look out below.  These are the interventions I found last go 'round:

                                                                         SPX              DX

                       December 12, 2007                 1512              75.92
                       low/high next 3 days               1445              77.49
                       low/high next 35 days             1270              77.85

                        May 9, 2010                            1164              83.07
                        low/high next 3 day                1156              85.57
                        low/high next 30 days             1011              88.91

                        Aug 24, 2011                          1208              73.72
                        low/high next 3 day                1121              74.55
                        low/high next 35 days             1121              78.30
                                  (so far)

When the September 15 intervention occurred, I concluded that "today's rally isn't justified."  Sure enough, the 21 points we gained that day (and 11 the next) were followed by a 1-wk 100-pt plunge.  Twelve sessions later, we had lost 146 points to the 1074 low.

The lesson here is that if things are so bad that the Fed needs to resort to these measures, then things are very bad indeed (duh!)  And, it's probably just a matter of days (Friday is day 150) before the rest of the world gets it.



The World's Biggest Pawn Shop 

Sept 15, 2011

On a day when Marketwatch warns...

...the Federal Reserve goes out of its way to increase US exposure to Europe's debt crisis.

The good news is they'll be able to pay us back the money they owe us.   The bad news is, they need to borrow $500,000,000,000 from us in order to do it. 

This puts the "pawn" in Ponzi.

We first started this back on December 12, 2007.  From the NY Fed's research publication Current Issues in Economics and Finance, Apr 23, 2010:

We took Euros and Swiss Francs and Japanese Yen and NZ Dollars that no one wanted and gave them US Dollars in exchange.  These central banks could loan these valuable greenbacks to their financial institutions who would (theoretically) lend them out to (theoretically) worthy borrowers -- keeping liquidity alive and jumpstarting the economy.  It would also (theoretically) put a floor under the foreign currencies' values and keep them viable in the global finance marketplace. 

Back then, financing had dried up because several large banks, investment banks and a hedge fund in insurance company clothing (AIG) had failed or were in the process of failing.  They were failing because of a newly developed but widely circulated idea that loans ought to be backed by adequate collateral.  Those that weren't probably weren't worth all that much.

Today, financing in the Euro zone has dried up because the Euro zone, itself, is in the process of failing.  Some foreign and Euro-based investors are convinced that making loans there is throwing good money after bad.  As I blogged a few days ago:
Deposits by financial institutions in Germany off 12% since Jan '10, 24% since Sep '08.  France, oddly, not as bad at 6% and 14%.  Italy off 1% in retail dep's (serious money's already gone), 13% ($100B) by financial insitutions.  In other words, banks don't trust each other.

Fitch says US Money Market funds cut lending to Euro banks 20% in last 3 months (Germany-42%, French-18%, Spain and Italy 97%.)  At $1.5 Trillion, MMF's are a vital source of funding. 

The ECB can't make up for all that, but it's trying.  Italy - EUR 85B in three months; Greek and Ireland - EUR 100B each in August; Portugal - EUR 46B in July; Spain - EUR 52B in July.  Total lending so far = 7X Euro zone central banks' combined capital.

Total exposure in loans from other Euro countries to PIGS: $1.7 Trillion.  Lots more in guarantees and derivatives.  
Total swaps outstanding under the 2007 program peaked at $580 billion in December 2008.  At the time, this represented about 25% of the Fed's total assets.  The program was officially terminated in February, 2010.  As the April 23 Fed article points out, market conditions had improved and financial strains had abated.

Two weeks later, on May 9, the Fed announced...

Apparently the system wasn't quite ready to stop sucking the liquidity teat.  The ECB immediately drew down $5.5B, bumping that to $500B in both August and October 2010 and finally zeroing it out in March 2011.

All was fine until last month, when the Swiss National Bank unexpectedly drew down $200B.  It was followed the next week (Aug 24) by the ECB and another $500B.

Then, today's news, and a 20-point SPX rally.  Is this really that great a development?  Let's look at how both the dollar and the stock market performed following previous manipulations.

                                                                         SPX              DX

                       December 12, 2007                 1512              75.92
                       low/high next 3 days               1445              77.49
                       low/high next 35 days             1270              77.85

                        May 9, 2010                            1164              83.07
                        low/high next 3 day                1156              85.57
                        low/high next 30 days             1011              88.91

                        Aug 24, 2011                          1208              73.72
                        low/high next 3 day                1121              74.55
                        low/high next 35 days             1121              78.30
                                  (so far)

Bottom line, each intervention did diddly squat for stock investors.  Today's rally isn't justified.

But, more importantly, we need to consider the more serious implications.  The Euro zone is obviously on life support.  The entire scheme is hanging by a thread, and we've been brought in to stitch it back together.  We, who just last month were in danger of defaulting on our own debt.

The Fed's balance sheet, only $885 billion in Dec 2007, has ballooned to nearly $3 trillion.  And, every time we bail out another entity, whether it be Bank of America, General Motors or the ECB, we minimize the effect markets have on lending and borrowing and saving.  We impose a rationale which, in the long run, not only delays the inevitable but exponentially raises the stakes.

And, what happens when one of these sterling borrowers goes under?  The Fed article goes to great lengths to explain that we're not taking crappy foreign loans as collateral.  No, we're simply taking the currency backed by lenders who make the crappy foreign loans -- loans that no lender in his right mind would make.  So much better, no?


The Fed Reserve article (published when the Fed thought the worst was behind us) details what happened the last time we did this. 

Picking up Pennies -- November 30, 2011

 UPDATE:  3:30 PM
We headed back up and are testing this morning's high of 1239.99.  I would typically expect some negative divergence to set up before calling this the top.  Profit taking wouldn't be a terrible idea,  especially as much of the action has been in the overnight futures lately.  On the other hand, I think there's at least some more short covering to come.

UPDATE:  2:50 PM

We successfully broke through the red trend line, confirming the bounce off the longer-term yellow line.  This was followed by a backtest of both.   Market should return to 1238-9 and retest the day's highs.

UPDATE:  2:00 PM

We've reached a decision point, as illustrated on the 5-min chart's RSI trend lines.  The bottom yellow line has stopped 5 declines in a row.  If it's to be 6, the market will have to rally through the red trend line.

UPDATE:  9:45 AM

Not sure I've ever seen a falling wedge break out quite this strongly...

It seems pretty likely, in hindsight, that the ISEE Sentiment Index spike I mentioned below was probably the result of all the financial system insiders who were privy to the central bank news doing a little insider trading.

To bulls, this announcement is mother's milk.  It's the ultimate solution to too much debt -- create more debt!  Time, now, to analyze the deal, see how much oomph it really packs.  Who would be surprised if it was like so many past announcements -- all hat and no cattle?

The RSI trend lines I discussed last night are playing out nicely.  RSI has blown through the lesser thin red line (Point 2) and is making a bee line toward the longer-term purple TL at Point 1.  The next test is whether it stops there, setting up a lower high, or it has the strength to bust through.

As we approach it, the trick is to shift to the 5, 15, and 60-minute charts for a sneak peek.  In the meantime, 1241 is the next logical rally target.  As discussed the past few days, it represents the .236 Fib level, a TL off the recent highs, one of our parallel channel lines.  And, it's only 3 points beyond our Inverse Head & Shoulders target of 1238.

More later.


"Picking up pennies in front of a steam roller" is the expression, meaning here pursuing small profits at the risk of being creamed by a larger trend.

We've spent a lot of this past week talking about potential upside targets -- whether we might rebound to 1215, 1241, 1265, 1307, etc. before getting on with a rather nasty downside scenario.  But, let's be clear that the potential 100 points of upside is nothing compared to the downdraft to come.

There are some very good arguments for a little higher bounce this week:  the gap to fill at 1209.43, room to run in the daily RSI, EW 2nd/4th wave alternation, the inverse head and shoulders pattern, a better-formed harmonic (Gartley) pattern.

There is also a perfectly good case to be made for the downturn to start right here, right now: the underlying economics, Europe, the bank downgrades, Fitch's negative outlook, the 2008 analog, a competing negative RSI trend line, etc.

Those who wish to squeeze the very last nickel out of this rally might be rewarded by being patient a few more days.  Otherwise, it's time to start considering short entry points.  Here are a few of the charts I'm watching.


First up, the IHS target which coincides with a TL off the recent highs, one of our parallel channels and the 23.6 Fib at around 1241.

Here's the same target, shown as small Point B on the daily chart.  Small Point A shows the gap fill at 1209.43 -- also the .382 Fib level.

The trend lines on the RSI chart have done an excellent job of signalling reversals.  Look at the chart below.  When the purple RSI TL was recently broken, it signaled the beginning of the 7-da7, 100+ point decline.  

Frequently, when a major TL is broken, the market attempts a back test.  Yesterday was a strong start towards that back test, but today's action deflected its upward trajectory.  In fact, the market failed to clear a lesser TL extending off the peak associated with the 1292 high (the thin, red line.)

It leaves us with a virtual fork in the road.  If we fail to clear the thin red TL at Point 2, the market heads back down.  If we do break through, we could complete the back test of the purple line -- thus allowing for a higher rally.  A logical point for the back test is Point 1, which is the intersection of the purple TL with the primary overhead TL (since Jan 11) that's signaled all the important tops in 2011.

The 5-minute chart shows a similar approaching decision point.  The longer term TL supporting a move up is about to intersect with a slightly shorter-term TL supporting a move down.  These "triangles" always signal a break out, one way or the other, and bear watching at every time frame intra-day.

Another chart I'm watching is the VIX.  It broke down from a symmetrical triangle Monday, back tested the triangle, and fell throughout the day today.  Its RSI TL's reflect the "coiling" action of the triangle and the recent drop through support.

Last, an interesting data point.  I try to keep an eye on sentiment, and was surprised to see today that the ISEE Sentiment Index set a new high for 2011.  Today's spike to 187 eclipsed the old 2011 high of 182 set on July 20 -- two days before the start of the 250-point plunge to 1101.

The ISEE Sentiment Index is unique in that it measures only opening long positions -- a clear signal of bearishness or bullishness if there ever was one.  I can only view this reading as a sign that we're very close to the next plunge.

Tonight's action in the futures tends to signal the same, although we could be seeing a B wave, given that ES is also carving out a falling wedge.

A reminder: Friday marks the 150th trading session since the May 2 high.  In 2008, day 150 was the beginning of the end.  GLTA.

Tuesday, November 29, 2011

Charts I'm Watching: November 29, 2011

UPDATE:  4:00 PM

Well, that was exciting.  Not!  Everything mentioned at 1:05 is still the case and, at this rate, will be the case for weeks to come.  I believe it was just too much to ask the market to maintain the strength of this morning's rally in the face of the negative economic news, the American Airlines BK, conflicting soundbites from Fed members and Euro-gnomes, and incendiary iPhones.

VIX continued to slip, having yesterday completed its backtest of its triangle.

To me, DX continues to look like it's backtesting the rising wedge it fell from yesterday.  Although, EUR/USD appears to be back in its falling wedge.  Hmmm....  Possibly just a divergence, a distortion the normal relationship between these two.

Last, a quick peek at NDX shows it's working on its own IHS pattern.  Six points to the upside would complete, and possibly add another 3%/75 points of payoff.

UPDATE:  1:05 PM

Backtesting the neckline here...

...and, note the RSI trendline -- should offer support for the next leg up.


The Inverse H&S I mentioned yesterday just completed.  The upside is 40 points or so, making it 1238.

There are a couple of obvious targets for the termination of this wave.

Point A is 1215, the Nov 1 low that fits most of the EW counts I've seen.  Point B would create EW "problems" but fits from the standpoint of the channels that have guided much of the past nine months as well as a TL off the recent highs.

If we count the 1292 high as A of wave 2 instead of the completion of wave 2, it opens up lots of higher possibilities which I have discussed at length over the past week or two.  We'll revisit these if/when they come into play, but the highest point I can see making a lot of sense is the 1307-1313 range.

Remember, anything above 1292 would merely be completing a wave 2 -- not a bull market resumption.  The trend is still down, and I see nothing on the horizon to change that.

Note that Friday's low completed a .618 Fib retrace of the 1074 - 1292 run, meaning it's a very likely candidate for a Point B in a Gartley pattern.  A typical Gartley would put in a Point C somewhere between here and 1292 (points A or B from the top chart would do nicely) then drop to the .786 Fib level at 1121 before reversing again.  We'll keep an eye on it.

Monday, November 28, 2011

Charts I'm Watching: November 28, 2011

UPDATE:  1:30 PM

Rally showing great breadth, could go quite a ways before erasing the recent oversold technicals.   Spit-balling here, but the potential inverse H&S pattern setting up could be good for 40 points or so.  It would intersect with a TL off the 1292 top as well as one of our channel lines and the .618 Fib retracement of the 1292 to 1158 decline.  We'll call the target 1241 for now.

The bullish Bat pattern we've been watching on AAPL is playing out nicely.

UPDATE:  1:10 PM

VIX, well off its lows of the day, appears to be backtesting the triangle it's been in for about a month.  Looking back to August, VIX has established a sloppy downward sloping channel of sorts.  The bottom of the channel might act as a magnet if this rally were to gain steam.


Interesting stopping point for this morning's bounce.

Popular opinion (and my gut) has it that 1292 was the wave 2 top. However, we're keeping an eye on the 2011 v 2008 comparison.  Day 150 (since the May 2 1370 top) is Friday, December 2.  While prices have obviously diverged from the 2008 pattern, this past Friday's low (day 145) matches up to a reversal on day 144 in 2008.  Might day 150 still be significant? 

More later.

Wednesday, November 23, 2011

Donuts Good For You!


Charts I'm Watching: November 23, 2011

UPDATE:  11:30 AM

The futures held the 1.618 line of 1167 until about 20 minutes ago, while SPX's opening sliced through its 1.618 at 1177 like a hot knife through butter.  Now at 1164, is the rebound idea dead?

EUR and DX are both pushing the bounds of their respective wedges (and Gartley's).  If stocks are to rebound, we need a reversal right here, right now.   There aren't any good harmonic supports at these prices, but there are a fan line and trend line worth taking a look at.

Note the regression channel in the 2007-8 time frame.  It perfectly captures the highs and lows of that top.  I constructed some trend lines with the exact same slope and laid them over the 2011 top, connecting important highs and lows over the past year.   The slope is important, because it lends credence to the notion that these lines are legitimate, rather than the product of my bias.

The two lines have thus formed a channel, the centerline of which is drawn as the dashed line.  It's worth noting that this centerline did a number on the Mar 16 decline, but was exceeded by the wild swings we saw in August and September.

Today's plunge has paused right at the centerline, which might be significant.  It has also reached a fan line drawn off the Mar 09 lows through the Aug 9 low.  Either or both of these lines could act to arrest a further decline, but there's no reason they have to.

In short, the case for a rebound is hanging by its fingernails.  If either of these lines fail, there's not a lot of support until 1115 (horizontal), and then 1100 (fan line off the Oct 4 low and also the .886 Fib.)  Keep an eye also on the positive divergence on the 5, 15, 30 and 60 min charts.


Just completed a perfectly-formed bullish Crab pattern on the futures at the 1.618 extension of 1167.25.

Yesterday, SPX came within 4 points of completing its own Crab (1181 v 1177.)  So, it could be considered to have completed (96% of optimal AD.)

On the other hand, SPX closed at 1188 today.  If the current decline in the futures market (-13) were to hold overnight, that would result in a more precise Crab pattern completion in the 1177 area -- a gap down that immediately reverses if the pattern were to play out.

If the SPX Bat pattern plays out, the most common potential targets (depending on which Point D is valid) are:
  .618 -- 1239
1.272 -- 1305
1.618 -- 1340

As mentioned yesterday, EUR/USD is very deep into a falling wedge and DX is very deep into a rising wedge.  AUD/USD is also very deep into a falling wedge.  Combined with the above patterns, conditions are ripe for a reversal of the past week's weakness.

Does that mean the bear isn't playing out yet?  Not at all.  In my opinion, there's still at least a 50% chance that 1292 was the high and we're on our way to huge losses.  However, the flip side of that 50/50 equation is the possibility that wave 2 isn't quite done.

It's days are numbered, though.  If it's going to happen, it has to be pretty much immediately.  So, be careful.  Needless to say, a 100+ point rally between now and December 5 would trap an awful lot of bears.

Of course, if we get a garden variety .618 reversal up to 1239 or so, we'll have a very nice spot at which to add to existing shorts.  Such a move, BTW, would tag a TL off the Oct 27 (1292) and Nov 8 (1277)  highs.

Looking at the big picture, there is a possible road map taking shape on the daily chart.

The only problem is that this Harmonic pattern is neither fish nor fowl.  It reverses at the .786, which would indicate a Butterfly pattern.  That would also imply a completion at the 1.272 at 1433 or the 1.618 at 1530.  I don't consider either of those targets as even remotely possible at this juncture.

Bat patterns complete at the .886 Fibonacci, in this case 1324, which would also be in line with a trend line off the 1370 top through the Jul 7 high.  But, Bat pattern points B aren't supposed to exceed .618 of the XA distance.  The .786 we see here should disqualify the pattern.

Another way of looking at it is the place Point X at the 1370 May 2 high, which results in a Point B at a little higher than the .618 Fib -- making it a Gartley that completes at a .786 Fib -- in this case 1307.

Of course, there needn't be a harmonic pattern at play in order to identify a reversal target.  Wave 2's often retrace to the .618, .786 or .886 Fib levels.  While the .618 ship has sailed, .786 and .886 in the 1307 - 1324 range are valid targets.

It's also worth noting that the original Gartley pattern, first introduced by H.M. Gartley's Profits in the Stock Market (1935), made no reference to specific Fibonacci levels.  They've been added over the years by practitioners.  In the meantime, patterns that don't quite fit the mold, but which are based on common Fibonacci levels, can and do play out all the time.  We'll eventually find out what's going on here, but for now we'll just have to wait and wonder.