Sorting Through the Bull: Lagging or Leading?

Much of the economic troubles we are coping with today were brought about as a function of faulty analysis and logic greatly amplified by a truly embarrassing level of groupthink.

Concepts like “home prices never go down” or “dot-com stocks with a P/E of 50 are still a good buy” are some notable examples but what about others we don’t easily recognize as false?

For example, notions like “prime borrowers have strong credit quality” or “government can spend us into prosperity again” are still not universally seen as instances of faulty thinking.

How many times have you heard that “jobs data lags economic recovery” while “the stock market looks ahead (is a discounting mechanism)”?

Given the events of the last year or so you should have at least a bit of skepticism about the validity of that notion.

Study the following charts carefully (click for larger) to see if you can spot the faulty logic.

UPDATE: added the following chart which has "real" (inflation adjusted with CPI) S&P 500... both stocks and jobs have been declining since 2000.




As you can plainly see, the stock market is hardly an oracle… Clearly there is more at play here.

So if you bought into this simple notion you need to first ask yourself “why?” and more importantly start to question other similar junk concepts.

Video of The Day - Volcker: "Rebuild From The Ground Up"

Former Federal Reserve Chairman Paul Volcker speaks at length on the unprecedented circumstances hitting the financial system, Wall Street and Main Street.

Question(s) of The Day - Paulson and Bernanke Flawed Characters?

Will Bernanke and Paulson eventually both be judged by history to be tragically flawed characters?

Bernanke… Expert on the Great Depression… possibly too much so?

Paulson… Wall Street insider… possibly too much so?

The Almost Daily 2¢ - Leaderless Washington

On this momentous day of government bailout, I’d like to take a moment to draw your attention to the complete and total lack of leadership that exists in Washington.

No matter what side of the aisle you identify with or profound respect you might have for our government as an institution, given the current state of economic affairs, it’s easy to recognize that things are not well.

What is leadership anyway?

Is it in knowing how to deftly position oneself within a host of topical issues that, for the most part, are merely the obsession of a polarized fringe of ideological demagogues?

Is it measured by the sum total of your campaign donations?

Does it come as a result of merely performing your civil “service” for multiple decades?

Think for a moment about the significance of the 11th hour phone call made by congress to billionaire investor Warren Buffet on the eve of the first House vote of the massive bailout bill.

Just imagine… The combined knowledge and experience of hundreds of elected officials, in theory representing YOUR knowledge and experience and will, reduced to seeking critical advice on something as fundamental as a nearly one trillion dollar tax-payer funded bailout of Wall Street from a billionaire investor.

Who are they representing?

In our email exchange from last March, Representative Barney Frank said the following:

“I am glad to have your prediction that we will soon be engaged in a "federal bailout of Fannie Mae and Freddie Mac," because I disagree and this will give us some measure of the accuracy of our respective predictions in this regard.” – Rep. Barney Frank

Let me remind you that Rep. Frank is the chairman of the House Financial Services Committee, possibly the most critical legislating committee dedicated to financial affairs of the United States.

Why did he not know?

I’d like to make another appeal that readers, come voting time, remember the feckless and ignorant, jaded, elitist and truly miserable current state of our government and vote against all incumbents.

If you can’t get yourself to vote for a major party you don’t support, consider voting for a third party running for the seat or simply leave that space blank.

Question of The Day? - Wall Street Bailout

What will be the effect if today’s massive Wall Street bailout bill passes?

The Almost Daily 2¢ - Shock and Awe

Unbelievable!

What else can be said?

I am completely shocked by what transpired yesterday not because the market plunged… it was bound to sink to unsettling lows at some point during this cataclysmic meltdown… but because Congress actually listened to constituents and made the morally correct choice with 95 of 235 Democrats and 133 of 198 Republicans voting in opposition to the massive Wall Street bailout bill.

Let’s not forget the depth and extent of the narrative of dire circumstances and certain and immediate collapse used by Bernanke and Paulson to hold members of Congress and, by association, all Americans hostage to this mega Wall Street bailout.

For that reason alone, no matter where you came down ideologically on the bill, it seemed that you had to accept that the bill would pass.

The Chairman of the Federal Reserve, the Treasury Secretary and the President of the United States specifically stated that the American economy, and more broadly the entire world financial system, would literally collapse should the bill not pass … and it doesn’t pass!

That’s surely a far cry from the days when minute and barely comprehensible Greenspan mutterings like “irrational exuberance” would instantly drop markets around the world… the Feds gravitas has clearly been played out.

To be fair, Wall Street is, more or less, still listening intently but I think the fact the Main Street and their political representatives were brought to the precipice by such traditionally important figures and instead of cowering and acquiescing to being fleeced, very boldly, flipped them one seriously fat bird has got to indicate something... though, to be honest I’m not quite sure what.

Are American’s overconfident? Do they posses some heretofore unforeseen and untapped mettle in the face of dire economic circumstances? Have they just simply collectively gone postal?!?! … I mean they just watched like 1 trillion dollars of stock market wealth go up in smoke in a single day!

Perhaps there is just one very large and very vocal legion of independent minded citizens out there that took to the phone fax and email in the days building up to this vote and scared the wits out of house members who already seemed all but doomed by an election season that looks set to punish incumbents.

Well, whatever the reason, it didn’t pass and it looks as if legislators will have a significantly harder time building coalitions to support a follow-up bill as legislators divide along party lines and the election rhetoric kicks into high gear.

The Almost Daily 2¢ -Twin Peaks?

At this point, it seems pretty clear that the S&P 500 is attempting another run back up to the 200 day moving average but the real questions now are will it get there and if so, what happens next?

Will the rally break right through on its way to an end of the bear market pattern or will it fail and drop miserably back down for yet another sell “into the rally” defeat for the Bulls.

My money is on the latter for the following reasons:

First, Fannie (NYSE:FNM) and Freddie (NYSE:FRE) are headed back down to their July lows at breakneck speed as Wall Street finally begins, at least slightly, to recognize the sorry state of these two behemoths and what it will mean for the economy to have taxpayers fund their “wind-down”.

Next, we now appear to be headed straight into the worst of the job losses where unemployment will likely ratchet up another 1% in just the next 6 months.

Finally, with the spring selling season now firmly behind us, there is nowhere for home sales and prices to go but down bringing with it a general acceptance that the bottom has not yet been reached for the housing market.

Looking at the S&P 500 now though, there are a host of very interesting technical similarities (which are noted below) that indicates that we have fully entered into another bear market where on average the S&P 500 index retraces 20 – 30% from its prior peak.

It’s important to keep in mind that, at best, a bear market can be viewed as a transition into an period where there is a prolonged bias to sell into strength resulting in a successive series of lower highs yielding a clear downward trend.

At worst, there are periods (days or weeks) where particular stocks and the index as a whole will crash hard.

Study the following image (click for very large and clear version) of the S&P 500 index from 1995 to today then read below for the technical blow by blow.

Notice also, that I’ve added both the “effective” federal funds rate (light grey line) and an overlay indicating the period of the last recession.

As you can see, entering the last bear market, the Fed cut rate significantly taking it from 6.5% at the start of the bear market to 1.00% in the trough.

It’s important to note that although the Federal Reserve’s response was dramatic, the market still resulted in an over 48% decline.



THEN (1998 – 2000 Top)

• A. October 1998 – S&P 500 gives early warning sign by crossing its 400 day simple moving average (SMA). Notice also that the 50 day SMA breached the 200 day SMA.
• B. October 1999 – S&P 500 gives a second signal by crossing its 200 day SMA after a solid twelve month expansion. 50 day SMA touches the 200 day SMA.
• C. Three prominent but decelerating peaks set up the top.
• D. Between second and third (last) peak S&P 500 index breaches 200 day SMA. After the final peak S&P 500 index breaches the 400 day SMA.
• E. 50 day SMA heads down fast and crosses the 200 day SMA. (Cross of Death)
• F. 50 day SMA crosses 400 day SMA. (Cross of Far More Death)
• G. 200 day SMA crosses 400 day SMA. (Cross of Fiery Gruesome Death)

NOW (Today’s Top)

• A. June 2006 – S&P 500 gives early warning sign by crossing its 400 day SMA. Notice also that the 50 day SMA breached the 200 day SMA.
• B. March 2007 – S&P 500 gives a second signal by falling near its 200 day SMA after a solid nine month expansion. 50 day SMA similarly depressed.
• C. Three prominent but decelerating peaks set up the top.
• D. Between second and third (last) peak S&P 500 index breaches 200 day SMA. After the final peak S&P 500 index breaches the 400 day SMA.
• E. 50 day SMA heads down fast and crosses the 200 day SMA. (Cross of Death)
• F. 50 day SMA crosses 400 day SMA. (Cross of Far More Death)
• G. 200 day SMA crosses 400 day SMA. (Cross of Fiery Gruesome Death)

The Almost Daily 2¢ - Twin Peaks?

Following up on a prior posts, take a look at the trend and most recent state of the S&P 500 index and compare it to the last major bear market conditions that followed the dot-com bust.

There are a host of very interesting technical similarities (which are noted below) that may indicate that we have entered another bear market where on average the S&P 500 index retraces 20 – 30% from its prior peak.

It’s important to keep in mind that, at best, a bear market can be viewed as a transition into an period where there is a prolonged bias to sell into strength resulting in a successive series of lower highs yielding a clear downward trend.

At worst, there are periods (days or weeks) where particular stocks and the index as a whole will crash hard.

Study the following image (click for very large and clear version) of the S&P 500 index from 1995 to today then read below for the technical blow by blow.

Notice that I’ve updated the chart to reflect the fact that during the last month of trading the 200 day moving average broke through the 400 day moving average signaling a second “cross of death” that I will term the “cross of fiery gruesome death“ for all future posts.

Notice also, that I’ve added both the “effective” federal funds rate and an overlay indicating the period of the last recession.

As you can see, entering the last bear market, the Fed cut rate significantly taking it from 6.5% at the start of the bear market to 1.00% in the trough.

It’s important to note that although the Federal Reserve’s response was dramatic, the market still resulted in an over 48% decline.



THEN (1998 – 2000 Top)

• A. October 1998 – S&P 500 gives early warning sign by crossing its 400 day simple moving average (SMA). Notice also that the 50 day SMA breached the 200 day SMA.
• B. October 1999 – S&P 500 gives a second signal by crossing its 200 day SMA after a solid twelve month expansion. 50 day SMA touches the 200 day SMA.
• C. Three prominent but decelerating peaks set up the top.
• D. Between second and third (last) peak S&P 500 index breaches 200 day SMA. After the final peak S&P 500 index breaches the 400 day SMA.
• E. 50 day SMA heads down fast and crosses the 200 day SMA. (Cross of Death)
• F. 50 day SMA crosses 400 day SMA. (Cross of Far More Death)
• G. 200 day SMA crosses 400 day SMA. (Cross of Fiery Gruesome Death)

NOW (Today’s Top?)

• A. June 2006 – S&P 500 gives early warning sign by crossing its 400 day SMA. Notice also that the 50 day SMA breached the 200 day SMA.
• B. March 2007 – S&P 500 gives a second signal by falling near its 200 day SMA after a solid nine month expansion. 50 day SMA similarly depressed.
• C. Three prominent but decelerating peaks set up the top.
• D. Between second and third (last) peak S&P 500 index breaches 200 day SMA. After the final peak S&P 500 index breaches the 400 day SMA.
• E. 50 day SMA heads down fast and crosses the 200 day SMA. (Cross of Death)
• F. 50 day SMA crosses 400 day SMA. (Cross of Far More Death)
• G. 200 day SMA crosses 400 day SMA. (Cross of Fiery Gruesome Death)

Although the recent, highly optimistic, Wall Street rally appeared strong, it’s collapse indicates that the prospects of a protracted bear market selloff is very real especially given the steady flow of poor macroeconomic, housing, consumer, retail sales and employment data that will continue to flow throughout 2008.

Socializing The Loss: Carrying To and Fro

Here’s another beauty…

Not to be left out of the fun of robbing "Main Street" (middleclass taxpayers and everyone else) blind to bailout Wall Street, the IRS today announced that it will change (and/or not enforce) regulations to allow Wall Street finance and mortgage lending firms to count losses on delinquent mortgages (or foreclosed and all other mortgage losses) against their ordinary income.

Better still, this change fits perfectly with recent legislation proposed in the Senate that would expand “carry back” and “carry forward” rules to allow these losses to be “carried back” as much as four years, meaning the losses could be applied against regular income for any of the last four tax years and also “carried forward” to future tax years.

So effective immediately Wall Street lending and other financial firms, including Fannie Mae and Freddie Mac, can seek refunds for these losses going back two years and, if the Senate bill is approved and passed as law, an additional two years.

Here’s my favorite quote from the Bloomberg piece that noted that to date, 70 of the world's biggest banks, securities firms and mortgage companies have taken about $290 billion in asset write-downs and credit losses since the beginning of 2007:

``This is a serious windfall,'' said Christopher Whalen, managing director of Hawthorne, California-based Institutional Risk Analytics. ``Essentially, the Street gets a $290 billion tax shelter they did not have available'' under the earlier IRS position.

The Almost Daily 2¢ - Don't Be Silly!

Jim Cramer last week emphatically recommended that you hold your position in Bear Stearns!

Don’t Be Silly! Bear Stearns is Not In Trouble!

Today though, Jim offers a bit of a back peddle...