The “D” Word

I was waiting for the last bullet in the Central Banks’ guns to be fired: a concerted rate cut. They did that tonight. As a result, the ES gyrated up and down, and the 30-Year Bonds tanked. For the first time, I am starting to feel that the word recession is too weak to describe the coming events.

For some time now, some commentators I respect have been suggesting we shall be entering a deflationary/stagflationary phase where stocks, commodities, and real estate drop while interest rates rise. Initially I gave the deflation scenario low probability occurrence – recession yes, deflation, unlikely.

But the FED performance has been so inept that I am starting to have second thoughts. I was looking for a repeat of the 1966 to 1982 scenario rather than the 1929 to 1936 one. Now I think the 1929 scenario is at least possible.

I think the jury is still out but I have to admit the ‘D’ phase has become more probable.  Still we still have some bright spots.

One bright spot on the horizon has been gold. If it can continue to rally, then we may just get away with a recession. The other bright spot has been the ability of Crude Oil to hold above 82 to 85. As long as the levels hold, this may still be a 12-month (yearly trend) correction.

If Gold and Crude Oil can rally, then the deflation scenario becomes less likely.

By the way, don’t you find it interesting that rates are cut and the 30-year Bonds tank? What is the bond market telling us about the prospect of inflation in the months to come?

Wither ES? 10-01-2008

Sometimes it is appropriate to take a step back just to see what the larger picture looks like. Certainly the last few days have been heady enough for most traders. I am sitting from the sidelines taking a spectator’s role. The volatility as measured by the Average True Range is still too large for my blood.

That however does not mean I am not preparing myself for a possible trade.

There are 3 chief factors influencing my thinking:

  1. The seasonal pattern that shows lows in the 2nd to 3rd week of September and 2nd to 3rd week of October. Following the October low we see a strong directional tendency terminating end December to mid-January
  2. The 12-month swing (yearly trend) has given a confirmed Upthrust Change in Trend Sell signal that projects a minimum target of 867 to 768 basis cash. (Figure 1).
  3. The 13-week swing (quarterly trend) has probably met a time and price swing target. If so we should see a 13-w line turn. Minimum price for the line turn is 133.82 but this will change week-to-week in the coming weeks.

The shorter timeframes show 3 sideways markets:

  • Figure 2 shows  two of the longer-term profiles of the sideways price action. Basis Dec, we have targets for the upmove at 1301 to 1313.
  • Figure 3 shows the sideways market that began September 17. Acceptance above 1265 projects a target to at least 1303 basis December.

When I examine the charts, I see the immediate bullish factor as being the decrease in volume on Monday’s low when compared to the low on September 17; I see the immediate bearish factor as being the rally last night that progressed on declining volume (except for the last 60-minute rally) – suggesting all we saw was a short-covering rally.

Here’s my best guess on the structure:

  1. We’ll be seeing choppy price action leading to higher prices AFTER a re-test of the 1106 lows (basis cash) as the 13-w endeavours to turn its line up. The target for this move basis December is 1300 to 1328. I expect to see a 12-m probe above 1290 but not see acceptance above it – certainly I would not expect to see monthly bar acceptance above 1328.
  2. I expect to see these targets meet near the end of December 2008.
  3. I expect volatility to shrink as the market heads north in December.
  4. Acceptance below 1106 would suggest the seasonal tendencies are absent this year – such acceptance would paint a very bearish picture. I’d expect volatility to remain the same as the present one or increase on such acceptance.


Figure 1 12-M Swing S&P Cash


Figure 2 Market Profile Daily S&P Cash


Figure 3 Market Profile 30-minutes Sept 17 to Date

Bailout, Sub-prime et Al

I received a few e-mails asking if I could explain in layman’s language:

  • what this crisis is all about and
  • my stance.

I can certainly explain my stance; the first part of the question may be a little more difficult. Sure, I have my views, but like the Elliott Wave, if we put a number of practitioners in a room, they all will have different ideas about ‘what the crisis is all about”. OK, then, here comes my reply – ready or not:

This problem began with over-leveraged, poorly managed risk among some larger US financial institutions, It then very rapidly became a world wide problem. To understand why, we need to trace three factors:

  1. The bursting bubble in the housing and credit markets
  2. The role of the Internet in the creation and demise of the bubble; and its role in the world crisis
  3. Globalization of world markets.

I won’t go into why the bubbles occurred – there is little argument that they did happen. But in Wall Street’s drive to secure greater profit, they created securitization of debt. The good news about this is  it enabled successful start-ups that normally would not have a look-in at a bank loan, that could obtain financing. But the problem is this:

these loans lack transparency, few understand their intricacies and they divorce the lender from the risk of lending.

What happens in securitization is lenders placed their investment assets into a group. They then sub-divide the package into multiple income streams and sell each stream as an asset-backed security.

When the US housing boom ended, the invalid (pie-in-the- sky) assumptions underlining the sub-prime mortgages caused above normal defaults and foreclosures. This caused larger than greater normal losses firstly with hedge funds and then with banks. These institutions were not only US based but were located world-wide.

Securitized sub-prime loans have been aptly described as ‘toxic waste’. Now here’s why the problem grew exponentially – no one knew who had how much of the ‘toxic waste’ and how to value the ‘waste’.

As a result two things occurred:

  1. Investors started to withdraw from any institution that ‘smelt’ like having ‘toxic waste’ exposure. This caused the share prices to fall, thereby affecting the ability of the institution to borrow money. This was a crisis of cash.
  2. The problem grew so large that banks were reluctant to lend whether or not the counter-party was tainted. This was a crisis not of cash but of confidence.

This is where the problem stands at the moment.

The US bailout is an attempt to solve the problem of cash – but like many short-term solutions, the US authorities, like Wall Street in the bubble years, are ignoring the consequences of their actions: the spurt of growth in M3, a growth divorced from productivity, will cause massive inflation. This rise will start being reflected in the inflation numbers in the next 3 to 18 months.

At that point, the FED will ultimately be forced to raise rates or face hyperinflation. You can use your imagination what would happen to an already fragile US economy when that happens.

Here’s the sad part. It’s not clear that solving the cash problem will solve the confidence dilemma. As I write, the Asian markets have reacted positively to the bailout but I’ll reserve judgment about its effectiveness to restore confidence until end of trading today.

In any event, whether or not, the bailout will help confidence in the short-term, I take the view that in the longer-term other measures are necessary i.e. greater transparency on securitized assets and some means of valuing the ‘toxic waste’.

In ‘The World is Curved’, David Smick said (page 45):

“..securitization, even though essential to wealth creation, is so arcane that few people can understand its workings…..the industrialized world has surrendered control of its financial system to a tiny group of five thousand or so technical market specialists….These insiders are the rare few who know how the securitization process works..And even they at times are dubious that the securitized assets reflect the value stated. But you want a scarier thought? Picture the US Congress trying to effectively legislate the regulation of something as complicated as the securitization process” (without causing even more financial carnage).


This Time It’s Different

First off my apologies for failing to make the pre-open comment on the ES as promised in my blog yesterday. Something came up that prevented it.

Here are my thoughts for today.

I was watching CNBC the other day and someone was congratulating the FED for acting more effectively and promptly than the Japanese Central Bank did when the Japanese crisis first broke. He also said that ‘the US experience was different this time’.

It’s always different – humans have a tendency to substitute fact for wishful thinking. Remember Dow 36,000? So what are the facts regarding the Japansese and current crises?

In Volume 4, Issue 47, John Mauldin’s ‘Outside the Box‘, the guest author, ‘The Absolute Return Letter’ provides some facts.

  1. This crisis began with housing and will not end until housing prices return to the mean of housing prices relative to the disposable income. Currently in the US, prices are 2 standard deviations away from their mean. For this to happen, we need to see housing prices fall precipitously or remain flat for around 4 years; and the excess supply of housing must be eliminated. There is a 10 months supply overhanging the market, the greatest it has been since 1984.
  2. All countries of the world face inflationary pressures – the emerging countries – Russia, India, China etc more so than the developing ones.
  3. US housing prices in 2006 rose more than the housing prices in Japan in the 1980s and the Japanese decreased the cost of money more quickly than the FED has done.  
  4. The US advice to the Japanese was ‘let the weak banks fail’. I quote the observation about the US practice today: “(The US ) are now at risk of making exactly the same mistake as the Japanese. A number of U.S. banks have capitulated over the past year, and both Fannie Mae and Freddie Mac are in pretty serious trouble at the moment. What do the Americans do? They spend tax payers’ money to try and fix something which is unfixable, not at all dissimilar to the policy mistakes made in Japan 10-15 years ago. This could have quite severe implications for U.S. GDP growth for years to come”

 If this is so, the FED remedial action is little different to that of the failed policies of the 1980s to 2000. It didn’t work then and it won’t work now. So, guys and gals, gird your loins for a bumpy 2009 and beyond.

ES 09-26-2008

The ES is now at the crossroads. You will recall that in the ES 09-22-2008 video, I articulated the view that I was looking for a 13-week line change (i.e. a correction of a quarterly trend magnitude). I also said that because I considered the low of October 18 to be a ‘spike’ low, I believed the retest to be one that would hold above 1157.

In last night’s trading the market came to my ideal level for the retest and provided a contraction setup:

  • 1-day swing (5-period 80 minutes swing) shows possible spring change in trend to the upside.
  • The 1173 to 1178 range falls within the ideal statistical time and price window for a buy.
  • There is MIDAS support coming through. The maximum retracement for MIDAS comes in at 1171.
  • There are price ratios coming it at 1183 to 1174.
  • The statistical time window has support from Jeff Greenblatt’s Fibonacci and Lucas time counts.
  • In Figure 1, the Delta Chart, note the decrease in total volume for today but increase in buying Delta volume – this is bullish provided we see follow-through buying today.
  • Figure 1 also shows the Market Profile. We have a Neutral Day closing in the middle quadrant. Known as a test day, a break above the high of the day will augur a short-term uptrend; a break below the low of September 24 will augur a short-term downtrend.

Given the above, we have zones and setups for the 1-day swing timeframe trader(my trader’s timeframe trend is still down, so I’ll pass on this long trade) buy signal. I’ll follow-up with a comment just before tonight’s open.

If the market accepts below September 18 low, I expect a directional downmove to begin and the seasonal pattern to invert.


FIGURE 1 Market Delta & Market Profile

It’s OK, We Are Here to Help (??)

I ‘love’ governments. They cause the problem, then wring their hands because ‘you caused it’ and then come up with a cure that is worse than the disease.

Let’s look at the current US financial quagmire.

  1. First Greenspan expanded the M3 to the extent that it not only assisted in the creation of a stock market bubble but led to a real estate bubble as well as a credit bubble. When the ‘s… hit the fan’,
  2. The FED first denied there was a long-term problem – remember that it first denied a sub-prime crisis,
  3. then from Bear Stearns and subsequent crises, it kept assuring us that the problem was contained.
  4. It solved the problem by throwing more and more money at it – reported to be 1.6T to date (and growing? since no firm final figure can be arrived at).
  5. This increase in the M3 will cause the CPI and inflation number to rise exponentially. I expect the first rise to occur in 2008 while ShadowStats says 2009.
  6. Let’s not mention the total ban on Short Selling on about 799 stocks. Like lemons the other countries have fallen into line. I wonder if the CFTC is contemplating a ban on short selling of futures?

Of course the FED is only trying to help (??). With help like that from my ‘friend’ I don’t need any enemies.

There were 3 interesting pieces along the lines I have written:

All are interesting reads.

ES 09-22-2008

Given the dramatic events of the previous week, I videoed my comments for the ES today. The Aussie and Singapore Stock Markets, I’ll do tomorrow.

Here’s the link:

I received quite a few ‘thank you’ e-mails.

Guys and Gals, I do not want to appear churlish – I appreciate your thanks and I rejoice in the fact you made tons of money. But if you continue to trade in this fashion, the market will hand you your head on a silver platter.

Let’s look at some facts.

Currently, I happen to be in a flow state – the Nature of Trends material (Barros Swings etc) – happen to fit the current condition of the market and I am doing little wrong. That can change tomorrow. Instead of moving up each time I call that, the market will move down (and vice-versa)!

Trading is all about risk management, consistent execution of your plan and learning from your mistakes – what I call the Habits of Success. Following tips from any blog is a likely path to the poorhouse.

Better is for you to either learn to trade or follow a paid investment advisory newsletter. This blog is merely a personal reflection and forms part of a range of methods to share my knowledge. It is not intended to be a tipping sheet. If you haven’t mastered Risk Management and Winning Psychology, there are a number of great educational packages around. Of course I think my Habits of Success is among one of the best; at US$350, it is certainly one of the best values in town.

If you want a trading method (plan with an edge) and to learn how to make it your own, the 6-week webinar is an option. More expensive than Habits because it represents 30 years of blood, sweat and tears. Also, there are other great courses to choose from e.g.Pride Educators.

The point I am endeavouring to get across is you won’t find success from following this blog – it’s not intended to be an advisory tool and it scares me to think some of you are treating it as such.

Take care out there.

Market Volatility

I have received quite a few e-mails asking how to handle the current volatility; some e-mails also asked how I assessed the increase from 30% to 45% in the ‘ES 09-15-2008 III‘ piece.

Let’s take the first question. I have a rule which says that when we see ATR increases for 2 consecutive days (sometimes 3 depending on context) beyond mean + 2 standard deviations (stdev), and I don’t have a position, I am to stay out of the market. If I do have a position, I manage the trade in accordance with my rules which call for a reduction in size usually about 50%. These are the general guidelines. I may change them if the context demands.

Figure 1 shows the ATR and stdev for this structure, 23 ATR with a stdev of 10. In fact the ATR has remained consistently around 25 with a stdev of 10. On Monday Oct 15, we had a range of 58 just beyond mean +2 stdev; on Tuesday, we had a range of 46, below mean +2 stdev; on Wednesday we had 55 and yesterday we had 77.

Even though the market did not technically have two consecutive days with ranges greater than mean +2 stdev, the context persuaded me to exit all shorts. Apart from the volatility, we had a key reversal day off the 12-monthly swing 50% retracement and other price targets. This suggested a bounce of at least 13-week swing proportions and given the volatility I had seen, I was unwilling to hold any shorts.

Let’s now turn to the second question. The first part of the answer lies in the stats we have for reversal bars at 13-week swing and 18-day swing target zones. The stats suggest that if we see a reversal bar, there is 67% probability of correction; this goes up to over 80% , when we have a close beyond the Primary Zones.

In this case, the breakdown on Monday 15 caused me some concern. The move took place in the last 30 minutes and I believed we needed to see confirmation of the breakout, especially since the Market Profile showed a rotational day. I interpreted that to mean that there was buying support from which to base a reversal.

Instead of confirmation of the down move, we saw a reversal bar. However, before concluding a sustained bounce would ensue, I needed to decide on the amount of buying conviction the reversal bar exhibited. Given Monday’s range and volume, Tuesday’s range and volume were great. In addition we had not seen a buying conviction close above 1215, my first benchmark. Accordingly I concluded that I need to downgrade the significance of the Tuesday’s reversal bar: I did increase the probability for a bounce after Tuesday to 45% from Monday’s 30%. But note that this assessment is below the 67% called for by our research on reversal bars.

Yesterday’s bar on the other hand showed all the signs of a bear market bottom:

  • Climactic Volume & range and
  • A frenzied and fearful psychological environment
  • A Key Reversal Day

So, I’d rate yesterday’s bar as a 67% probability that a bear-market bottom that may hold well into the end of the year. The key will be the re-test of 1133 . If 1133 Primary Buy Zone can hold, we have seen a temporary bottom in place.


Figure 1 ATR Range and Std

Figure 2 shows the 18-day targets for this rally: I have drawn the rectangle around the zones.


Figure 2 18-day Targets

ES 09-15-2008 III

Well I got the knee-jerk reaction I was looking for and the retest of the breakout at 1200 to 1215 zone basis cash…BUT the prices that launched the bounce were at price and time levels. This raises the probability of a short-term bottom from 30% to 45%.

Note that for the charts below all figures are basis cash.

Figure 1 shows the target levels reached by the price action last night.


FIGURE 1 S&P Levels

In Figure 2, the black lines represent the quarterly trend. If there is a quarterly line turn, the minimum price will be the line turn price, currently at, 1326.23. Figure 2 shows that there are 2 high probability targets for the bounce:

  1. 1326 to 1335. This has a time target for Oct 30 2008. And
  2. 1371 t0 1384

If a rally gets underway, I’ll be able to estimate which of the two is more likely to occur.


Figure 2 S&P Retracement 60-day swing

Figure 3 shows  the three benchmarks for the rally: we need to see acceptance above 1215, 1251 and 1268. Another way of saying this is these are the levels where the downtrend may resume. Of course acceptance below 1168 will signal confirmation of the resumption of the downtrend.


FIGURE 3 S&P Rally Benchmarks

Interesting times. For me, I settle back and let the market play out any rally; the quality of the rally will dictate where I will next take a position.

ES 09-15-2008 II

Well, the market didn’t quite do what I envisaged. I was looking for a one-timeframe in either direction; instead we had a rotational day until 1:00 PM EST. From that time onwards, a directional move down ensued. The cash S&P closed 1192.70 on very strong bear volume on Market Delta’s footprint charts.

In this blog, I’d like to consider what last night’s action means for the US stock market.

  • The close alone is equivocal. It closed a mere 7.5 points below the swing low at 1200. A conviction bull bar close above 1215 would raise the probability of a low being in place till at least after Xmas.
  • The volume and bearish candlestick suggest that the above scenario is unlikely. Instead of a rally, we should see a continuation of the down move.
  • There is one more item muddying the waters. The FOMC decision is due at 2:15 EST. According to the Fed Fund Rate, there is an 80% probability of a rate cut of the Fed Fund Rate. I doubt that will happen but the FED may do something else ‘to try to save us from Armageddon’.
  • One thing is clear, each intervention needs greater and greater effort from the FED to generate a positive response. Will tonight be the night where FED intervention fails?

My best guess is that the FED action will generate a knee-jerk reaction that will cause a retest of 1200. This retest will succeed, and we’ll see the market start a full-fledge bear market. This assumes that 1215 will remain intact on a closing basis.