ES 09-15-2008

I find it interesting that markets are so driven by fear nowadays. I am, of course, speaking of the response of Lehman Brothers applying for Chapter 11. Perhaps this will be the event that will cause the US Stock Market to break down below the congestion range low at 1200.

The 2% to 4% world-wide sell-off surprised me. Lehman’s failure was, after all, not unexpected. The rumour mill has been working overtime proclaiming Lehman to be the next corporate victim. In his ‘Thinking Outside the Box”, John Mauldin published a piece entitiled: “Dead Men Walking”. That piece provided a model for identifying how a ‘good bank’ goes from a ‘good bank’ to a ‘Dead Man Walking’. The author, Bennett Sedecca, described Lehman Brothers as the ‘poster child’ for this sort of behaviour.

Since the Chapter 11 application can hardly be said to be an Act of God i.e. a bolt from the blue, it is either:

  1. the culmination of an unexpected event becoming visible or an
  2. over-reaction that may mark a temporary bottom.

There is a great deal of difference between the two; and I expect the first 60 minutes to 90 minutes to be the key to distinguishing between the two. If the event is (1), we’ll probably see an early rally but muted rally shortly after the open. By muted I mean a rally covering no more than 40% of the open-gap and preferably no more than 33%. Should the market not produce even a rally covering 25% of the gap, we’ll be seeing an even greater probability of (1) being the event.

If we are in (1), we’ll see after the first 90 minutes, a break of the lows on strong volume. Here Market Delta will prove invaluable. The rest of the day will be in trend mode down and we’ll see the ES down at 65 to 80 points (5% to 6%).

If (2) is the event, we can expect a rally covering at least 50% of the open gap in the first 60 minutes to 90 minutes. Following this period we’ll see the market make an attempt to form a reversal day. Given the size of the gap down, it is unlikely we’d see a close above Friday’s high but we ought to see a close above Friday’s close.

The readers of this blog will know that I lean towards (1) being the event in question. In all my public appearances, I have described my ideal scenario as being one where 1300 to 1328 is reached; this is followed by a test of 1200 to 1214 which gives way. A close with conviction below 1172 will confirm the start of the bear leg.

Take it easy out there and best of luck with your trading. Remember to plan the trade and trade the plan.


The Soybeans and Crude Oil have been behaving in text book fashion. Tonight’s blog will take the form of a video – see the link below.

In the video I did forget to show you the 13W Maximum Extension. I have attached it here.


Soybeans 13W

One point I want to stress to NOT users. In the event of a clash between the Hart and Barros Swings, I follow the Barros Swings – see video for an example of a clash.

Fannie and Freddie

When Paulson announced the possible intervention, he said it was unlikely that the bailout (read ‘nationalisation’) would be needed. At the time I thought: “Hmm, yeah sure! It’s a question of ‘when not if’.

Well, the ‘when’ has occurred and Wall Street has rallied in its night market.

I used the opportunity to take short positions in the BPJY, Gold and QM which also rallied. To understand why, you need to be aware that the technical position in each case had the following characteristics:

  1. A downtrend in the 18-day swing (my trader’s timeframe).
  2. The instrument had reached a zone
  3. The instrument had provided an entry pattern and
  4. The stats and the Ray Wave showed there was more downside potential with an acceptable risk of more upside.

In this case however, the context of the technicals is just as important.

The announcement of the bailout I view as a surprise event i.e. some unexpected news hits the market and a correction ensues. Usually it’s some Black Swan happening. But in this case, it was an event that ought to have been seen as bordering on inevitable – not the type of event that is likely to lead to a change in trend.

For about a year, I have been saying here and elsewhere that after the elections we can expect the FED chickens to come home to roost. Actually, we are now starting to see them straggle in – it’s just that the traders aren’t paying any attention.

Austrian economics argues that there is a direct relationship between the money supply and inflation. In mid-2006, M3 started an exponential rise that peaked at 17% from 9%. Recently M3 has dropped to 14% (I see this drop as a correction in an uptrend). This bailout has the potential for causing even more of a rise in M3.

By the way, the rise in M3 to 17% has already had an effect on the CPI.

Two months ago we had the worst rise in 6 years. Last month we had a greater rise than expected. In the meantime, the US growth figures are slowing alarmingly. Official unemployment stands at 6%; ShadowStats shows the figure to be at around 15%. A more important difference in my view is the fact that the ShadowStats figure broke above the 2003/2004 peak while the Official number has double-topped with the 2003/2004 peak – important because ShadowStats shows a confirmed breakout with a target of an unemployment rate of 18%. This translate to 8% on the official figures.

Whatever the true figure may be, what is essential to notice is that the economy is in poor shape. So what will the FED do when CPI figures start going through the roof in consecutive months? Raise rates? Whether or not they raise rates, what do you think the ES will do under those conditions?

In my book, we can expect the start of the strong directional move south – when the penny finally drops. How far can the ES drop? At the very least we’ll see the 12-month Primary Buy Zone 867 to 768.

ESF & FX intervention



ESF & dollar intervention

Cross ref

August 21, 2008 – 12:00 am

So few of us are aware of the ESF – the Exchange Stabilization Fund of the US Treasury. In fact, all major central banks or nations have a similar facility.

I thought it may be good follow up on the post touching on Shadow Statistics at:

The ESF was started in 1934 in response to perceived prior dollar manipulation by the Bank of England and others earlier in the decade.

Simply put, the ESF can deal in foreign currencies as well as in gold and “other instruments of credit and securities”, totally legally. The ESF can also serve a valid purpose in helping to stabilize the value of the dollar,too.

So, what have we on the nitty gritty details on the recent dollar intervention?

Officially, all we really know is that about $7 billion dollars has been placed and directed into something called “other foreign currency assets invested through reverse repurchase agreements” which is a fancy name for a loan.

That may be in Euro based repos, but since the classifications are not specific, we do know that governments have not always been transparent and above board about what they’re doing.

The actual timing and dollar details of the recent intervention are as follows:

  1. As of the reporting weeks ending June 13 & June 20 2008, $6.381 billion dollars were sold by the ESF in Euros (Euros were sold, dollars were bought). The ESF maintains the account balances in dollars, but the money is actually in Euros .
  2. During that first week, the value of the dollar index moved from 72.39 to 74.15 and then back to 73.43 the following week.
  3. The reporting of the ESF actions from the weeks ending June 13 & June 20 was not made public until July 14 2008.
  4. The dollar index closed at 71.87 on July 15 2008, which was the recent low.

In actual fact, the ESF intervention preceded any other significant factor to the dollar move.

Currency intervention can be done in both directions. This quote is key in understanding interventions in general: dollar holdings of foreign governments and central banks rose by $41 billion in 1986 and kept rising this year; that represents their intervention in currency markets. Hence, at the exchange rates that prevailed last year, private capital inflows to the United States were not enough to finance its current-account deficit. “Without official intervention,” Mr. Perry said, “the dollar would have fallen even further than it has.” — New York Times, 1987

As an aside about the ESF is this : 70% of its $2.8 billion initial funding in 1934 came from proceeds of F.D.R.’s confiscation of gold and its subsequent revaluation from $20 to $35/oz.

So we have to take all official releases of economic data with a pinch of salt!


Ag Moderator

The CPI and M3

First off today I want to thank Ana who stepped in to fill the gap when I had to fly to Sydney urgently. Thanks Ana – heaps!

In this blog, I want to continue with Friday’s theme: that the exponential increase in M3 must eventually be reflected in the CPI figures. I say this based on the foundation of Austrian economics; but theory is one thing,as a trader still needs to see the ideas reflected in hard data.

Fortunately, the hard data is not hard to come by. Last month the US CPI had its highest rise in 26 years; this month, the CPI rose in excess of consensus.

ShadowStats has graciously consented to let me reproduce part of the CPI report it sent to its subscribers. I have attached the excerpt to this. But for me the key section is: Adjusted to pre-Clinton (1990) methodology, annual CPI growth rose to roughly 8.6% in July from 8.3% in June, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to a 28-year high of roughly 13.4% in July, up from 12.6% in June. The alternate numbers are not adjusted for any near-term manipulations of the data”.

Note that the real inflation is around 13% as compared to the official 8.6%. After the elections, there will be some ‘catch-up’. The national statistical agencies know that they need to keep some connection to reality or their work will fall into disrepute. So we can expect some ‘shocking’ numbers.

Notice that traders have chosen to ignore the facts that are there for all to see. You’d think that a high inflation number coupled with a less than robust economy would send warning sirens; instead the stock indices remain flat to bullish. This is akin to the reaction of sub-prime problem. This ‘ostrich’ reaction is well illustrated in this accounting.

I was having a conversation in late March 2007 with a couple of brokers (I shall keep their firms anonymous to save red faces). I said:

  • Me: “Don’t you think there is a crisis in the making with the sub-prime loans? If interest rates rise or for any reason, the borrowers start to default, you have a real problem in the making.”
  • Broker 1: “These are ‘AAA’ loans, default is not an issue.
  • Broker 2: “Anyway, there is such a flood of paper, the US Treasury will bail out the problem and it won’t affect us or the stock market”.

The rest of the evening flowed along the lines outlined above. I thought at the time that ‘Blind Freddy’ would see the looming issue; but, my friends certainly didn’t or wouldn’t. It was a prime example of what Pete Steidlmayer called ‘an unexpected event‘.

My evaluation (that some time after the elections, the increases in the CPI will force the FED to raise rates) is another such idea. The exponential rise in M3 must show up in the CPI – it’s not a question of ‘if’ but ‘when’. When that occurs, given the state of the US economy, I expect the stock indices to head south.

There are two areas where I could be wrong:

  1. The timing of the rise – we may see the FED act or be forced to act before the election; and
  2. My view of the stock market’s response to the rise in rates.

Of the two, the margin for error is greater in item (1).

Time will tell if I am right; right or wrong, you heard it here first.


The Magic of Numbers

I was introduced to Austrian Economics through the works of Ayn Rand. From the first works that I read, I knew I had encountered a school of thought that would describe the real world. I have not been disappointed.

I tell you this to answer the question that was posed to me: on what do I base my belief that the FED’s actions, since the beginning of the sub-prime crisis, will lead  to an exacerbation of the recession in the US?

Here is a simplified explanation of my reasons. If you want to have full understanding read Rothbard’s book:

Austrian Economics teaches that recessions are caused by an increase of the money supply. As a result of such expansion there is a misallocation of investment . At some point, (especially where the money supply rises much faster than productivity) the misallocation causes crises (sub-prime, Bear Stearns, Indy Mac etc) or results in an inflation rate that forces the excess funds to be mopped up (e.g. raising rates). (See America’s Great Depression by Murray Rothbard). Recessions follow if the market is allowed to correct the malinvestment; depressions follow Government intervention.

The charts below are from ShadowStats. The site does a superlative job in providing a true picture of the US Economy.

Figure 1 shows an exponential rise in M3 since mid-2006. There is a lag between the time the money supply expands or declines of 9 to 12 months. However since the end of 2007, we have seen an ever rising CPI. This is true even on the ‘official’ figures. Officially, since end 2007, the CPI has risen from 2% to 5.5 % – an increase of 175% in less than 12-months. And given the rise in M3, there is more to come in terms of CPI increase.

Figure 2 shows the CPI increase.

What this means is after the elections when the excessive fiddling with the CPI numbers ceases (if historical patterns hold true), we’ll see a sharper rise in the CPI numbers. Bernanke will have to raise rates or be faced with hyperinflation.

But as Figure 3 (Unemployment) and Figure 4 show (GDP), the US economy is still far from robust. A rise in the interest rates will depress the economy and the recession will exacerbate. If Bernanke fails to act promptly, he’ll eventually have to raise rates anyway but the later he leaves it, the greater will be the increase needed and the greater the adverse effects on the US economy.

So folks, we can expect a deepening set of economic problems in the future. Bear Markets anyone?


FIGURE 1 M3 (supplied by ShadowStats)


FIGURE 2 CPI (supplied by ShadowStats)


FIGURE 3 Unemployment (supplied by ShadowStats)


FIGURE 4 US GDP (supplied by ShadowStats)

S&P 08-11-2008

I know I am supposed to comment on the S&P, Strait Times, All Ords and Sensex. But over the weekend, I received a number of requests to do an analysis clearly identifying Nature of Trends Material (NOT), Market Profile and Ray Wave.

I am happy to oblige. The link for the video is:

There are a few points I want to make.

  1. There are no Ray Wave Counts. The RW is best used in directional markets; the Market Profile in rotational. The RW material lies in the ratios used to identify the possible resistance zone.
  2. My starting point is the theme that the massive increase in M3 will force the FED to raise rates, probably after the elections. This is a continuation of the theme that enabled me to identify the coming of the sub-prime crisis long before the crisis hit.
  3. I say in the video that the 12-m Upthrust was confirmed (by the June bar)…..This was a poor choice of words. The Upthrust will not be confirmed until we see lower lows and lower highs after acceptance below the October low at 768. What I should have said was: “The June bar increased the probability of a valid Upthrust Change In Trend pattern”.

A Review of Four Stock Indicies 07-27-2008

The numbers of visitors from Australia and India have increased dramatically in the past 2 weeks. The US and Singapore still lead but the others are catching up!

In view of this, each Monday I’ll post a chart/charts of the stock index from each of the four countries with a short commentary. The ideas behind the analysis are all contained in the Nature of Trends. Each chart contains my thoughts for the direction of the market for the next five to ten days.


Figure 1 S&P 18-D


Figure 2 S&P 18-D


Figure 3 Strait Times 18-D


Figure 4 Strait Times 18-D


Figure 5 Australian All Ords 18-D


Figure 6 India Sensex