|The Real Estate Bubble||The Markets Straight Line Decline|
|The August 07' Market Crash||The Truth about the System|
|The Tech Stock Debacle||The 2007 Year-End Bust|
|The Stock Market Disaster of 2008||The Explosion in the Volatility Index|
The HGX (Housing Stock Index) is teetering on the edge of a cliff. I have a confirmed top into July 2005 and I expect the HGX to plunge to its weekly model magnet at the185 level. My weekly model shows the HGX trading down into 2011 and I expect a round-trip in the index with an eventual low at the 100 level or below.
When we wrote a piece in 2005 about the housing bubble--calling it the biggest bubble in the history of mankind--we based that statement on our thesis that the availability of liquidity driven leverage in combination with society’s willingness to use that leverage is what creates monster bubbles. The demand for an asset, whether it be a tulip, or stock, or art, or a house, or a baseball card, or a beanie-baby, is irrelevant as far as we can tell. If leverage is extended to the masses and if the masses are in a psychological mindset conducive to accepting elevated levels of risk through greater and greater amounts of leverage, the leverage itself is enough to create the bubble because the leverage will eventually be dumped into whatever the “hot” investment of the day happens to be. The proof in this assertion, we believe, is that once a huge bubble bursts and people are wiped out, the desire to use leverage seems to disappear for a couple of generations and that’s what makes the downturns so brutal. If you don’t believe me just think about how survivors of the Great Depression focused on paying off their homes as soon as was humanly possible and how, after seventy years, they still lean down to pick up a penny off the street and are reluctant to leave a scrap of food on their plates. Cycles of gambling and risk taking come and go and with lotteries and casinos sprouting up like tulips, it’s pretty easy to see which part of the cycle we’re in now and what will come next. The deceiving part about the current bubbles is that the housing bulls think prices cannot decline, because they assume that people will be more reluctant to sell a house than they were to sell a tulip or stock, or beanie-baby. The problem, we believe, is that sooner or later, they’ll be forced to sell. And as for the other bubbles, we also believe that when the various carry trades unwind, the coincident short-covering of foreign currencies will also result in “forced selling” in other markets.
-Last week’s report focused on the idea that the busted US housing bubble is unraveling like falling dominos, as the carnage rolls through group after group… I’ve already reco’d getting short banks and brokers.
-Based on studies of the past, including a “fakeout” inversion into the top in 1929 and 1987, I doubt that I’ll witness another period in my lifetime where my big picture view of the US stock market is as bearish… 9>
-The more we learn about various Carry Trades around the world, the more we think an unwinding of one or more of them could trigger a liquidity crisis in markets all over the world… If investors are using the same strategy (arb or otherwise) to provide the liquidity needed to enter into diverse investments, that strategy is no longer “diversified.” An unwinding of the “carry” from which the liquidity originates could potentially act as a large enough catalyst to unwind each and every one of the other positions entered into. Mechanical unwinding would likely take place on a scale not seen before and we would have to just hope that another group of geniuses aren’t on the wrong side of a 32-1 leveraged bet gone bad.
-As you can see, the four most important models—monthly, weekly, daily, and hourly—have all reached a completed topping sequence and are all telling me that the current move to new highs in stocks is a “false” move which will be “quickly and completely retraced.”
-We believe, as highlighted in chart #1 below (The popping of a bubble), that the BKX will be the next “shoe to drop” in the US mortgage/housing debacle.
One of the most followed rules of investing is to cut losses quickly and to let your winners run. Another even more important rule is to not exacerbate your problems by throwing good money after bad in an attempt to bail yourself out of a losing position. But what if you had no choice?
What if you were holding a largely, if not completely, illiquid investment in a market that had already imploded--despite the fact that the market was unwilling or unable to reflect mark-to-market pricing reflecting the enormity of that implosion? And what if, like a cluster of nuclear weapons daisy chained together, that investment was levered five, ten, twenty, even thirty times your original capital?
When Bear Sterns recently threw good money after bad, I had to wonder if they were breaking a very basic investment rule out of lack of discipline or simply executing a strategic decision based purely on necessity. My guess is that it’s the later and I think they understand all too well the ticking time bomb they, as well as others, are sitting on. I also think the BAM stock model will prove correct in its prediction that a decline over the coming months will send the market spinning into a black hole with investor psychology switching from optimistic to pessimistic in the blink of an eye. Bear’s decision to do what they did only reinforces the model’s idea of a severe plunge because when they finally admit that the subprime market is not going to recover quickly enough to stave off additional margin calls, they’ll be forced to capitulate which will create a domino effect of capitulation from others trapped in similar positions.
-We are more convinced than ever before that we are about to drop like a stone starting next week.
-I want to reiterate that the BAM model has a current set-up calling for a tremendous straight-line decline. The reason I’ve been so adamant about the nature of this decline off the top (straight-line as opposed to a rounding top) is that never before in my work have I seen such a large number of sell signals (in a variety of time frame models) all ready to trigger simultaneously. A straight-line decline is very rare coming directly off a new all-time high but that’s exactly what I’m calling for.
-I have no idea if the quant models are feeding the portfolio managers certain price velocity parameters based on historical studies, but my money says they’ve got it wrong again and that some heavy-footed hot-shot (in addition to Bear Sterns) is about to wrap their portfolio around a tree.
-Months back, in our report covering food based inflation, we guessed that the corn based ethanol boom could create a huge increase in world-wide food prices and that, if that were the case, the results might be tragic with both class-related uprisings against governments as well as an increase in starvation in poor nations.
The BAM model is showing a very good probability that, during the next 8 months or so, we could give-back all of the gains made since the August 2004 lows... in the case of the INDU and SPX, we’re talking about the 9700 and 1060 level respectively.
The massive amount of easy money that’s been fueling private equity deals is obviously generating tons of revenue for certain players in the XBD. Why then--even prior to the Bear Sterns hedge fund blow-ups—is the XBD lagging the general market? Not a day goes by that I don’t hear someone talking about how “undervalued” the financials are yet they’re leading us down as they break to fresh lows ahead of the general averages. The XBD, in our work, looks as bad up here as the HGX index looked at its summer peak in 2005. Back then, we called for a multi-year collapse in the HGX even though the analysts were talking about a bright future (and moving estimates higher) and now we’re calling for a multi-year collapse in the XBD even though they’re (analysts) calling for a continuation in large fees generated by private equity deals and a booming stock market.
In our July 16th report titled Hello and Goodbye to DOW 14,000,” our opening line highlighted in red said, “we are more convinced than ever before that we are about to drop like a stone starting next week.” Also, in our July 23rd report we said, “I want to reiterate that the BAM model has a current set-up calling for a tremendous straight-line decline. The reason I’ve been so adamant about the nature of this decline off the top (straight-line as opposed to a rounding top) is that never before in my work have I seen such a large number of sell signals (in a variety of time frame models) all ready to trigger simultaneously. A straight-line decline is very rare coming directly off a new all-time high but that’s exactly what I’m calling for. (Look back at the February decline and double it in brutality if you want to get an idea of what I’m expecting to kick off this bear trend.)”
One of the most interesting and appealing features of the BAM model (for me at least) is its apparent ability to predict sea-change events in markets. These turning points--whether related to shifts related to nature or human mass psychology--produce major tops or bottoms and are, at times, very surprising given an otherwise contrary consensus fundamental view. But, with its benefits, it also at times, gives me an uneasy feeling about what might lie ahead if its predictions do indeed come to fruition. At times its predictions seem harmless in relation to our everyday lives, as in the case of its very unlikely call during May of 2004 that OJ would end its fourteen year bear market. That call turned out to be correct and although it was, in retrospect, mainly due to the string of hurricanes that would batter Florida later that summer--along with the death of the Atkins low-carb diet craze--the fundamentals that drove the move were fairly harmless. At other times though—and I’m speaking specifically about the current predictions regarding the US stock and bond markets—the predictions are much more ominous with respect to the fundamental fall-out that might result from its call being correct.
Here’s what we said about the market over the past several months:
April 2 Report- “All I can say is that I am certain of what the model is saying about the current set up and once it breaks—even if that occurs after another higher high—we will most likely witness something that none of us have witnessed before in real time. I hope I’m completely wrong about what I think we’re facing because it looks to be more than a normal bear market.”
April 30 Report- “The chart draws a nice clear picture of falling domino’s and although the outcome of this (housing) bubble seemed as predictable as anything I’ve ever watched, the shorts were “chased away” in each and every group unless they had a strong enough conviction to either stand their ground or add to their shorts as others gave up and “went away.” I have to believe that we’re seeing a similar move now in certain banks and/or brokers. Common sense says there’s got to be another “shoe to drop” related to the ridiculous loans that were written (maybe a few more pairs of shoes in fact) so it might be a good time to dig a little deeper in order to determine where the garbage was dumped.”
May 14 Report- “Something is out of whack and price will eventually provide the answer but my hunch, based on the model’s forecast, is that the NDX is correct in its pricing while the rest of the market averages—led by bubble-like advances in energy, financials and the possibility of further LBO’s--have it wrong up here. In other words, we believe the investment environment is about to change so drastically that the major averages will be viewed as wildly over valued as opposed to technology being viewed as wildly undervalued. We mentioned this idea months ago and we’re now starting to hear others echo our sentiments. The big-boys are piling into LBO’s, using private equity financing, at as hectic a pace as individuals were piling into the real estate market using subprime financing two years ago and we believe both will meet the same demise because it doesn’t matter how smart they are, if you give human beings a long enough rope, (enough leverage) they’ll hang themselves every time.”
June 11 Report- “We experienced a rare “capitulation sell signal” in the XBD hourly model last week and this is a very important development because I had always assumed we were going to make a bull market top followed by a correction followed by new highs a few years from now but I’m beginning to believe that we are witnessing a top of epic proportions.”
June 11 Report- “Again, the fact that the housing market has crashed with rates barely wiggling higher and the fact that they’re (investors, commentators etc.) even focusing on the possibility of a 5% or 6% or even 7% yield creating problems for the US stock market confirms our thesis that once again everyone is massively overleveraged. Let’s face it, this is a gambling generation and somebody somewhere is making a ridiculously large bet that will eventually take the market out by its knees because the only difference between an individual making a monumentally bad decision at exactly the worst time and a hedge fund making a monumentally bad decision at exactly the wrong time is purely in the size of the bet. Human nature doesn’t change and the only difference in a harmlessly bad decision and a tragically bad decision is the level of leverage backing the bad decision.”
June 11 Report- “Human behavioral cycles are so cruel it’s amazing. Just think about where we’ve come from in the current cycle and where it will likely lead us. Low interest rates and exotic mortgage instruments allowed an increase in risk appetite at precisely the wrong time. The housing bubble--fueled by no-money down, interest only ARMS’s and endorsed by Alan Greenspan at the exact moment 30YR fixed rates were at an all-time low—is now facing new, more strict, lending rules, higher rates and plunging prices.”
June 18 Report- “I have to wonder about recent news concerning sub prime mortgage exposure. I wonder if there are a few funds feeling the same way that I felt on that ice years ago. They probably know the ice is getting thin and they probably know the illiquid nature of their holdings, if the ice ever breaks, will carry them straight to the bottom.”
June 18 Report-
June 18 Report- “One of the reasons I believe we’ll see another push higher is that the move off the top I’m expecting should be a straight-line cascading decline without a big bounce like the one we saw late last week. If I’m correct, that means that the next decline will be even worse than the one we just saw off the highs. This would be very unusual (a multi hundred point decline straight off a new all time high) but it has happened before and this cluster of sell signals we’re triggering up here call for a tremendous straight-line decline so we have to believe that we’re about to see a rare anomaly.”
This is strictly a guess, but I think many of the current quant fund problems and their all-to-simple excuses about markets not acting “normally” are akin to a group of poker players trying to hide a losing hand. The real problem, I’m guessing, was created by a massive margin-driven liquidity squeeze that forced trade executions having nothing to do with the buy or sell triggers built into their quant models in the first place. The decline seems too shallow to warrant excuses about not expecting “a correction” or markets not acting “normally” especially given the fact that this decline, so far, has been historically shallow and the VIX has only registered an intraday high of (29.84)! Take a look at how that stacks up against VIX spikes during other periods of panic and you can see that we’re way too early in this decline to be blaming things on the computers.
August of 2002 (45.08)
September of 2001 (43.74)
October of 1998 (45.74)
October of 1997 (38.20)
NOTE: We think the VIX will spike to at least 36.00-37 over the coming weeks.
Contrary to popular belief, Market crashes DO NOT happen out of the blue. They are events that only occur after the proper emotional set up is created and that set-up normally takes several months or weeks to form. The fact most people miss—even some technical analysts I’ve heard speak—is that crashes, although rare, can occur off the highest high within an uptrend as opposed to the more common crash which occurs off a failing rally high within the early stages of a downtrend.
When RSI is setting up for a potential crash it acts in a very specific manner. Remember, crash set-ups NEVER predict that the crash will happen, they only warn us that conditions are proper for the crash to take place and that if the market is “pushed off the cliff” the fall will be fast and deep as opposed to fast and shallow. Markets can always get whacked to the downside under almost any configuration of RSI but without the proper configuration they cannot crash. (It’s simply a mathematical impossibility) The easiest way to understand it is to think of the market (any market) as always walking along a ledge but whereas most of the time the ledge is only 5 feet above the ground, a crash set up warns us that the ledge is temporarily 50 feet above the ground and that if the market were to slip off the ledge, the fall would be very painful—if you’re long.
FACT: The most bullish moves occur after a market becomes “overbought” and the most bearish moves occur after a market becomes “oversold.” I always cringe when the talking heads speak in terms of overbought or oversold, because what they fail to understand is that those terms are worthless—in fact they’re very dangerous—unless you understand where market price lies with relation to the overbought or oversold reading.
Extreme overbought RSI readings, when they’re reversing off a period of sustained decline, are actually very bullish whereas extreme overbought readings moving into a high after a sustained advance are (immediately or eventually) bearish. The same is true when moving in the other direction, in other words extreme oversold RSI readings, when they’re reversing off a period of sustained advance—as is the case currently--are actually very BEARISH whereas extreme oversold readings moving into a low after a sustained decline are bullish.
But the most bearish of all (I’ll speak in terms of bearish set-ups only for purposes of helping you understand why I’m so bearish currently) is when a market declines sharply in price with the RSI holding near the 35-38 level—as opposed to getting hammered down to or through the 30 level— then rebounding to the 40-51 level before reversing again below 35-38. That set-up is the kiss of death because the slight blip up to the 50 level after the first trip down allows the market to gather even more downside momentum for the next leg down. In real-life terms the bounce that allows the RSI to lift to the 40-50 level is a signal that shorts are covering and that bottom fishing is taking place which in turn leaves a new group of potential sellers down near the lows.
As far as determining whether you’re in a sustained advance or a sustained decline, that’s something specific to each time frame we track and the model’s topping and bottoming counts answer that question very nicely for us. Today’s set up however, is very obvious since we’ve been in a sustained advance since the 2002 lows which means the current RSI set-up is coming off a top. Again, this is very bearish.
I know this sounds over-confident but the advantage I have here is in following the BAM model’s dynamic of “fractal” market movements, meaning that markets act in the exact same manner whether you’re studying a 1min, 5min, hourly, daily, weekly or monthly price bar along with its RSI movement. What this means, is that I’ve seen and studied every type of emotional set-up you can imagine as they unfold in intraday set-ups 10’s and 100’s of times each and every week. In other words I have, in essence, studied thousands of year’s worth of daily and weekly market movements through my study of 1 minute, 5 minute, and hourly bars. A one minute bar is equal to a one year bar…so you can do the math. Anyway, today’s current RSI configuration is potentially very bearish (read crash bearish) so we’ll be keeping a close eye on it for all of you.
Ehrich Weiss, better know as Harry Houdini, was looked upon as the greatest “escapologist” the world had ever known. Handcuffed and shackled, he would wiggle and contort—sometimes dislocating his shoulders in the process—until finally he would free himself. But after escaping from jails, handcuffs, chains, ropes and straightjackets became mundane; he eventually transitioned to more and more difficult tricks like the “Water-Filled Milk Can” and his coup de gras--the “Chinese Water Torture Cell.”
Contrary to popular belief though, Houdini’s death--widely thought to have occurred while attempting to free himself from the Chinese Water Torture Cell--was actually the result of a blow to the mid-section by a less-than-hulking college student. The trick gone wrong--performed many times during his long career--was a simple show of strength and thought to be immeasurably safer than any of his other under water escapes. But unfortunately, even a master escapologist—given to the human frailty of overconfidence—is vulnerable to making the most obvious of mistakes.
Here’s what happened.
Houdini claimed he could walk away unharmed after withstanding any blow to the stomach. But after a show on the evening of October 22, 1926, a young man by the name of J. Gordon Whitehead struck Houdini before he had time to “lock in” his abdominal muscles, and the results proved tragic. Within hours, Houdini was running a very high fever—later understood to have been a result of his ruptured appendix—and within nine days the master escapologist was pronounced dead.
For decades now, the US financial market geniuses have, like Houdini, moved to ever more complex “tricks” as they invented and passed around scraps of paper in what may later be labeled the most reckless financial engineering experiment of all time. Like Houdini, they became overconfident. After all, the tricks--their egos convinced them--would perform within their “defined” risk parameters…just as planned.
Their critics on the other hand, continued waving red flags and talked incessantly about the scraps of paper and the chaos they would later spawn. The “tricks” as far as the critics were concerned, represented the worst kind of financial engineering--the kind that was meant to magically mimic any desired hedge while allowing its borrower to sleep tight at night. The list of tricks is long and we’ve all heard it many times before so I’ll skip it. But like Houdini, the US financial markets have, for years, pulled off trick after trick—many of them at the hand of the once beloved illusionist--Greenspanian—only to come out on the other end almost completely unscathed.
-Two weeks ago we said our model suggested a spike to 36-37 on the VIX and last week’s high was 37.50.
-The model is suggesting that the XBD is positioned similarly to the HGX in 2005. Brokers look to be down 50% into Q2 2008!
-I talked about the idea that a housing bubble the size of the one we’re unwinding would not normally be expected to spare anyone, including the richest of the rich. The problem with the reasoning, according to most I spoke with, was that the rich had so much money now that it seemed impossible for anything to hurt them enough (financially) to shut down the massive liquidity driving the real estate investment bubble at the high-end. After seeing an article about a hedge fund manager dumping his 150 ft. yacht and his new helicopter I think I have convincing proof that the high end of the real estate market can implode just as quickly as any other.
- BKX as good a long term short between 2007 and 2008 as HGX was 2005-2006!
-SHLD is now back below where we sold it and we continue to hold to our target of 67.67 into January 2007 through February 2008! We told everyone that it was an “EPIC” short in our work and they all said the person who runs the business is a genius and that it was a tough call. Remember though, that even geniuses make mistakes. In fact, we recall a Wall Street Journal article talking about his use of extremely complex investment vehicles and the outstanding returns he was achieving through leverage. We think the model is telling us that some of those may have backfired at the same time that his retail business and the real estate portfolio (always thought to be a huge positive) will all be “repriced” moving forward.
-Look at the HGX and stocks like CFC. They’re all unwinding 100% of their gains from the 2002-2003 lows because the advance into 2005-2006 was based on bogus funny-money. The only people who don’t get it yet are home owners. Home prices are going to follow with a disastrous 20-60% decline the people who refied and pulled equity are going to feel worse than they did after the dot.com blow-up. Our parents and grandparents paid down their mortgages religiously and this generation stripped out equity religiously. This is a disaster for the consumer and the US economy and the FOMC is not going to be able to help. They may be able to bail out a few big banks etc, but the deflationary spiral is set in stone and bailing out the banks will only add to our national debt and create a boycott on new purchases of our government bonds by foreigners.
-The way we see it, this market has nothing to do with earnings, nothing to do with the economy, nothing to do with geopolitics as a matter of fact we don’t think it has anything to do with anything going on currently. But what this market has everything to do with is the past. Mistakes made in the past must be paid for in the future and as far as the housing bubble, stock market LBO bubble and hedge fund bubble, the future has arrived.
-On an unrelated note, a women in my neighborhood recently announced that her veterinarian prescribed Prozac for her dog. Just a heads up that things ain’t quite right out there…in case you haven’t noticed.
-The Carry Trade unwind has started and it is ugly. Just ask Australia.
-So if the stock market’s 10% slide was simply a “correction”—as most of the talking heads seem to think—and if the subprime problem is “contained”—as most talking heads seem to contend, one has to wonder why the heck the FOMC felt compelled to step in at all...unless of course they know something that we don’t, or even worse, they don’t know what they don’t know!
The two most notorious liquidity bottlenecks of the past 100 years took place during the 1929-1931 period in the United States and again during the 1990-19--? period in Japan. In both cases the liquidity bottlenecks were preceded by a huge surge of liquidity which subsequently created a huge boom in asset prices of all types—driven of course by investors’ use of too much leverage--and in both cases the inevitable bust was just as dramatic. The reason we think it’s so likely that we’re on the verge of the third great liquidity bottleneck is threefold. Number one, our model says it will happen, number two, the “backdrop” is correct, i.e. casinos, lotteries, art, real estate, and hedge fund billionaires etc. and number three…complacency is ripe with so many “experts” telling us it’s impossible.
Bubbles are funny. Most smart people realize that they’re in one as it unfolds but I guess their greed and ego must keep them involved right to the bitter end. Maybe they think that as long as they’re positioned close to the exit door they’ll have enough time to slip out with their sack of dough before everything crashes. Unfortunately for the less astute, the fact that the smartest of the group are always so near the exit means that many of them will actually get out the door—with their sack of dough in tow—and that fact only adds to the rapidity of the swing from optimism to pessimism which in turn accelerates the crash. The other sad fact—and it adds considerably to the debilitating length of the liquidity bottleneck—is that even the smart money tends to lose a decent portion of their wealth and, as the primary “middleman” and bubble facilitator, their lack of funds combined with a stubborn resolve in waiting for perceived value to re-appear, often act to prolong the cycle even further.
-The destructive forces, swirling behind arguably the most monstrous real estate bubble in history, are becoming more evident as each day passes and like hurricane trackers watching their computer models, the FOMC seems to finally understand that what they had originally forecasted as a CAT 2 hurricane has now intensified to a full-blown CAT 5.
Unfortunately, stock market bulls—lured out of their storm shelters by what they perceive to be a bail-out from the FED—are, according to the BAM model, about to discover that the blue skies above are strictly temporary (like those associated with the passing of the “eye” of a hurricane) and that the most dangerous portion of the storm—the eye wall—is about to strike.
We think Bernanke knows just enough to understand that he doesn’t know much about what the full repercussions of this housing bubble fall-out are going to be. And more importantly, he doesn’t know what the public’s reaction to the fall-out news is going to be. Proof of this, we think, is the fact that people have been so quick to make runs on banks. This is an odd phenomenon considering the fact that we’re so close to an all-time high in markets around the world and considering the fact that the general economy, if we’re to believe government stats, is in decent shape. Given this backdrop, a bank run is simply NOT normal and we think this might be indicative of the idea that the public at large knows better than the Central Bankers that the foundation of the housing bubble—no money down and funny money no-doc loans—is even weaker than the levies surrounding New Orleans were as Katrina approached.
-The model says stocks are about to TANK, led by the NDX and the XBD.
-Sell signals are of the “EPIC” category up here and we think the FOMC actually made the problem worse than it was before because we had record short interest going into the July/August decline (which meant we were likely to find solid support within another 5%-8% even if they had not stepped in) but now, because of all the rate cut related short covering, we probably saw a significant number of shorts “go away.” This means the FOMC actually REMOVED the protective cushion we had in place. Bottom line is that we’re now ready to fall even faster and farther than before their intervention.
-The market wasn’t even down 12%. That’s like watching a guy drink three light beers and then carrying him into a room for an “intervention.” Let’s just say “preemptive” is an understatement.
-Back in July of 2005, as Hovnanian was making a new 52 week high up at 73.40 we issued a screaming sell signal along with a target of 15 dollars into 2007. At the time, analysts were issuing earnings upgrades and the real estate bubble was supposedly an unstoppable force driven by demographic change and several other fundamental arguments. But a bubble is a bubble and they all end the same way-- in a wipeout.
-Moving into the end of the day, we emailed clients warning them that the market, as it inverted to the upside, was pushing into “the most powerful sell signals of the entire year” and we then also emailed again to let clients know that we were triggering sell signals not only in the BAM model but also in our proprietary velocity model (an entirely separate tool). After the market closed we were able to update other longer-term velocity models and they too were providing the exact same picture—screaming sell signals!
The BAM-VI is a tool we developed over just the past year and it tracks what we refer to as the “path of least resistance” as well as market risk both up and down. It is also a tool that, just like our main BAM model, tracks several different time frames from monthly, weekly and daily all the way down to hourly movement. This tool, as of the close on Friday October 26, registered sell signals in its weekly, daily and hourly periods and this is the first time that this tool has done so simultaneously, all year long. Any one of these signals is enough, in and of itself, to register a sell signal and one of the three sell signals was present at each of the February, June and July tops. Bottom line, this signal is flashing a very, very strong indication that we are at or near an important high and the BAM model is also flashing it MOST POWERFUL sell signal since 2001.
As we pointed out in last week’s report, several indexes have already broken through the August low and of these four indexes, one of them (SOX) topped way back in January 2004 and is off 20%, one of them (HGX) topped in July 2005 and is down about 49%, one of them (MFX) double topped during January/February 2007 and has recently entered into a free-fall--now down 38%, and the last (BKX) topped in February and is off 19% from its highs. These indexes—some topping as early as three and a half years ago—represent important areas of the economy providing integral growth components and/or high-paying jobs in the USA. Other indexes, considered important for economic growth or general stock market health—like the RLX, TRANS, and Russell 2000—have also not yet confirmed the market’s new October highs and in the case of the RLX, it too remains dangerously close to breaking down below its recent August low.
-The stock market tracked the BAM model well last week as stocks suffered their biggest three day decline in five years with the NDX plunging in a “straight-line decline” to the 2056 magnet level just as anticipated. But now, just as investors probably think it can’t get much worse, it has.
-Lets start by reiterating the bigger-picture BAM stock market forecast which points to a brutal 58% bear market decline into 2010 with the SPX round-tripping the entire 2002-2007 bull run before finding support into the SPX 680 level.
That’s right, regardless of election year cycles, the Olympics in China, emerging market strength, a possible interest rate easing cycle etc. etc. etc. our model is unequivocally ultra-bearish over the coming few years in fact it most closely resembles the set up we had during the 1929-1932 period.
During the 1929-1932 period—to dissect it a bit for you—started with a crash followed by a large bounce followed by a variation of mini-crashes and long grinding declines. No two periods are exactly the same, but as I take a step back and look at our stock model, it has a very similar set of sell signals, future periods of weakness etc. as did the 1929-1932 period. In fact, the only real difference between the 1929 through 1932 period is that the current set up actually looks MORE bearish in our work. Maybe that’s impossible, and maybe it’s not but let’s just say I can honesty tell you all that this is the first time I’ve ever hoped our model is 100% wrong.
When we first started talking about the enormous real estate bubble in 2005, the BAM model was giving us what appeared to be absurdly low price targets for stocks like HOV, DHI, BZH, KBH, and TOL during what we thought at the time would be a huge real estate collapse into 2009. Well, those absurdly low price levels now seem believable—because we’ve already reached most of them—and we’re now ready to talk about some equally absurd price levels we think other stocks will see on either a crash leg or over time during the next several years. This is just a small very random sampling but it should serve to illustrate what we see coming.
GM-6.00, possibly even 2.50, into 2009
RIMM-48.75-crash leg, 24.00 into 2009
FSLR-120 crash leg, 52 during 2008
GS-70 into 2009
GOOG-293 into 2008
BIDU-187 into 2008
LM-23 possible on crash leg or into 2008
-No clue why we’re seeing this set up this year, and seasonality says we’ll probably be DEAD WRONG, but we have to go with the BAM model because it shows a distinct “bear cluster” into the 12-17 through 12-21 period. I have to admit that the set up defies seasonality trends (if not logic) but it’s undeniably bearish as we crunch our data and it therefore requires that we remain bearish as well.
-This is much different than any other financial problem in the history of financial problems because we now have larger leverage exposure, larger derivatives exposure and larger ego exposure than at any other time-- which in turn means we’ll see more chaos finger-pointing and indecision as they attempt to uncover and track the mess that they created and exported. If you think the USA is unpopular because of Iraq, just wait until we our trading partners figure out that we left that flaming bag of crap on their doorsteps. Anyway, and we’ve been talking about this for many months now, we think the inevitable result of all of this will be a CREDIT BOTTLENECK the likes of which the world has ever seen.
-We’re going to make the commentary short this week because, as we said in the title, “the rest is up to Mr. Market.”
-I have to caution everyone that a stair-step decline with periodic INDU 200 to 600 point plunges should be considered our MOST BULLISH interpretation of what may lie ahead of us and we are in NO WAY ruling out the possibility that we’ll witness a straight-line crash to the SPX 1150.51 weekly magnet. In any event, whether we see multiple plunges of 10-30 SPX points—with an occasional 65 pointer mixed in—or a single straight line plunge to 1150.51, at the end of the day we should be facing a bearish market over the coming weeks.
-Moving into 2006 the BAM stock model correctly forecast the collapse in the homebuilding stocks and as that decline continued to play out into 2007 we then told subscribers that we expected to see a “domino effect” (weekly report “The Dominos Keep Falling” dated May 7, 2007) whereby bankers, mortgage brokers and broker/dealers would all begin to cascade lower as well.
-After that forecast proved correct (stocks in those groups tumbled sharply, some as much as 60-80%) we highlighted the next group of victims (according to our model, not our opinion) and suggested selling short REITS as well as retailers such as Sears Holding (because the model was bearish and common sense dictated that SHLD would be hit with a double whammy as sales slowed and valuations assigned to their massive real estate portfolio were marked down) and that also proved to be a correct call.
-This year, we’re expecting the domino’s to continue tumbling with commercial real estate stocks joining the ranks of 40-80% decliners and we’ve also reco’d aggressive sales/shorts of the technology high-fliers like AAPL, RIMM, FSLR Because we expect those groups to tumble 40-70% as well.
6000 during 2008 is possible but expected no later than 2009 with an important low due no later than the first quarter of 2010.
As most of you are aware, I base my forecasts 100% on the Behavioral Analysis Model, which is an emotion-driven model that tracks topping and bottoming counts within various time frames. (Think Elliott Wave Theory without the subjectivity factor)
I also use three other proprietary indicators in order to anticipate the violence of the subsequent price reversal once a top or bottom is identified, because I think the violence of a price reversal—more often referred to as “velocity”—is key to my value-add as a forecaster (especially during today’s market participants’ propensity toward excessive leverage.)
With that in mind I decided to recap the build up of negative data that led to my call for a TOP in 2007--because the only way for clients to get comfortable both selling strength and buying weakness is to revisit my thoughts and forecasts prior to periods where the model was correctly fading the 2007 market strength.
As most of you will recall, my ultra-bearish forecast looked pretty silly at times during 2007—especially given that the vast majority of advisory services were raving bullish and only focusing on “breakouts, bullish flows of private equity money, and DOW 16,000,”—but I’m hoping the stock model’s correctness (telling us to use strength as a selling opportunity 20%, 40% and even 80% above current levels) will make it a bit easier to at least entertain the thought that we might be correct in our call for a crash or at least a relentless decline to the 6606 level during 2007-2008 with an eventual decline to the 3971 level over the coming years.
The BAM report has been short crude oil for months now and although the market tracked the model off the first sell signal (with a quick 10 dollar plunge to the downside during January) the market has since come unhinged from my forecast in what looks to me like a classic “last gasp” blow-off leg.
There is nothing on a chart basis that would prevent Crude Oil from blowing-off into the 140 level short-term.
Based on the current model, I’d say the odds are HUGE that we’re at a bubble TOP in crude oil that will rival the housing bubble TOP of the summer of 2005 and if I’m correct on that call a decline to the 50 dollar level looks conservative and we could actually be headed to the 26-36 dollar level within the next 18-24 months!*
*Based on my “rule of four” whereby post-bubble prices collapse four times faster than they inflate.
In the 1980 movie “Airplane,” actor Lloyd Bridges responded to a crisis in the air traffic control tower by making a series of ever more outlandish comments regarding giving up those things he considered potentially helpful when dealing with stressful periods. “Looks like I picked the wrong week to quit smoking,” was soon followed by “looks like I picked the wrong week to quit drinking” which gave way to “looks like I picked the wrong week to quit amphetamines,” and finally—just prior to passing out and collapsing on the floor—“looks like I picked the wrong week to quit sniffing glue.”
Since the summer of 2005, when the BAM model correctly identified a MAJOR top in the real estate bubble, I’ve been telling subscribers that what I see in the model over the coming years “DOES NOT LOOK LIKE A NORMAL BEAR MARKET.” In fact, the model has been making ever more outlandish predictions about markets of all kinds and, unfortunately for investor on the wrong side of the markets, it’s been spot-on so far.
As we move forward during the unwinding of what will most likely be viewed as an “unprecedented bungling” of the entire world’s financial system—and thanks in large part to the leverage associated with high-octane derivatives products—I think we’re all going to be forced to expand our perception of what might be possible with regard to market movement and “value.”
Please review the charts below. I use the VXO (the original volatility index) because it provides data on “the big one” in 1987 and that, I believe, helps us to better establish a “high water mark” as opposed to using recent “market panics” represented in the newer volatility index— referred to as the “VIX.” Remember, the FED intervened during the LTCM debacle and that set the stage for volatility spike readings that have subsequently fallen far below what might otherwise have been considered as “panic readings” if people were left to sort out market inefficiencies all by themselves. As you’ll see below, the “Crash of 1987” spiked the VXO to 172.79, the “Asian Currency Crisis” spiked us to the 55.48 level, the “LTCM Crisis” spiked us to the 60.63 level, and then 2001 and 2002 only raised the VIX into the high 50’s (because the market was thankfully and correctly closed after 9-11-01). Now, during 2008—with write-offs over 50 times higher than during the LTCM debacle—these guys think a VIX reading of “just over 30” will bottom us? Come on.
The question of whether or not the FED has indeed created an environment of complacency (a moral hazard) has been well established in my work so I’m assuming the worst which implies a catastrophic event for the financial markets as we move through the coming years. I’ve said this before but it might be worth repeating here. The BAM model sees multiple crashes coming as we trade forward as opposed to a single 1987 type event so even after we see a spike high in volatility over the coming months, it should only offer us a temporary multi-month low prior to another crash leg later in 2008 or early in 2009.
The bottom-line is that they must think they’re hedge but, as the wheels fall-off, the model is telling us that hedges will fail. Who knows…maybe solvency and the inability to “honor hedges” will become an important topic as the crash unfolds.
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