Saturday, March 28, 2009

Weekend Update 3/28

Last night, after writing about politicians receiving TARP money, I was thinking about a theme for this update and was reflecting upon how this nation’s politicians and media are controlled by debt money provided by the central bankers when the tune “Bye, Bye Miss American Pie” jumped into my conscious except the words came out “… the day America died:”

Don McLean – American Pie:

While it’s hopefully premature to bury America, there are two themes that I want to keep hammering in an attempt to breathe some life back into her. The first is that the MATH of debt is now completely unworkable. We are so far beyond the tipping point when it comes to income versus debt, that there is no longer any hope whatsoever of reviving what was. That doesn’t mean that America’s dead, it means that Americans must get off their butts and find a long term solution.

That solution brings me to theme number two. The root of the debt can be found in our currency system and in the way that central banks, the Fed, and all corporations interact and influence our political system. I think the way to breathe life back into America is to return the central banking function to the PEOPLE, replace the Fed with free market mechanisms to set interest rates and money supply, and to completely separate corporations and their money from the political system. In my mind that will lead to long term decision making, allow government to shrink to an appropriate size, restore free market principles, and move from a debt and credit infused never ending growth model.

Does that sound radical? It sounds like common sense to me. America will not spring back to life unless changes on this scale occur. A zombie America is the best that can result from the current Administration’s approach.

Not just a zombie banking system, a zombie America whose people are placated with fast food, flat screens, and never ending credit – DEBT.

Along these same lines, Karl Denninger just wrote an article that includes a video that has evidently gotten the Administration’s attention. This is worth spending a few minutes on: What’s Disturbing About The Truth…

Keep in mind that as I write these market updates that WE ARE NO LONGER TALKING ABOUT FREE MARKETS. Our government is now in complete control of the bond market and that market underlies every aspect of all markets, especially the stock market.

But let me more accurately describe what I just said… While I say that they are in complete control, what I mean is that THEY THINK they are in complete control. In fact, the opposite is the truth. They have lost control and they have become the buyer of last resort – using money that does not exist. While this is a game that will ultimately end in heartbreak and disaster, the interim becomes very difficult to play as the rules are shifted and base currency is played with. The short and intermediate results of which are difficult to forecast, to say the least. Opinions range from deflationary collapse to hyper-inflation. That’s quite a range. Of course Bernanke thinks he can find the exact middle plus 2%. He won’t.

So, we are left to do the best we can in evaluating the three segments that make the markets… Fundamentals, Technicals, and Psychological.

For me, the fundamentals are currently ruled by debt. Incomes cannot service all the debt. The normal solution to this problem would be to default on the debt, but that is not being allowed. Instead we are adding massive amounts of debt onto the massive debt we already have. That’s not a way out, that’s a way to disaster. Our government is attempting to change the fundamentals, but they are lost because they are controlled by the central bankers. The true fundamentals always win in the end but can certainly be distorted in the short term.

Those short term distortions of the fundamentals can distort and twist the technical landscape, that’s why you must keep the long term destination of the fundamentals in mind.

Psychology can affect the short term in a huge way. It affects the flow of capital, both the amount and where it flows. But the one thing psychology cannot do is create a world beyond the bounds of math. Yes, positive thinking is powerful, but it cannot create something from nothing and it cannot allow you to defy physics, math, or economic rules.

Right now I have less faith in reading the technicals because of the interference and manipulation. For example, let’s say that we are studying waves on a small lake. If we study and watch the lake over long time periods, we can see that waves are created under certain weather conditions. When the wind blows at X, from Y direction, then we know that waves of Z magnitude are created. But if you drop Paul Allen’s yacht onto our little lake, the waves as we have come to know them will be influenced greatly. How he steers his yacht, we cannot know because we are not him and thus the waves on the lake are no longer free.

That’s an extreme example. I would liken our market in reality to a huge ocean whose waves will overwhelm those who try to manipulate it in the short term. So, in this environment I think it’s helpful to back up and look at the bigger picture.

In that vein, here’s a 20 year chart of the S&P 500. You are looking at the greatest collapse in this index EVER. It is making lows that are lower faster than during the Great Depression. While we have experienced quite the 3 week rally, you will see that in comparison to the losses it is really just a part of the process (which can kill your account in the short run):

And here’s an update of Doug Short’s Four Bad Bears. Note that this chart is comparing the SPX to the DOW during the Great Depression and thus looks like it’s a little ahead, but in fact when you compare the SPX to the SPX, it is making lower lows faster. And note how the math works… while a 20%+ rally sounds and is impressive, once something has been cut by more than half, you are gaining little in real terms compared to what you lost. Thus, despite this impressive rally, we are still at half the level we were only 17 months ago… and we are extremely overbought in the short run and running into volume resistance!

That’s the big picture, now let’s do the best we can with a manipulated short term picture. The tape is still the tape and while we can be right in the long run, making money from it requires us to be right in the short run.

On Friday the DOW closed down 148 points, the S&P lost 2%, the NDX lost 2.3%, and the RUT, as usual, was the most volatile, losing 3.7%. The dollar rose strongly sending gold and oil downwards. The dollar, by the way, is bouncing powerfully off an exact 61.8% retracement of the last rally. Finding support at that level is bullish for the dollar. The XLF lost 3.1% (on Dimon’s manipulations), and IYR lost 4%. Of note, the CMBX indices turned back up slightly on Friday.

The internals were negative with decliners 3 to 1 over advancers and a hefty 86% of the volume was on the downside. Volume, however, was the issue as it was far lower, in fact the lowest of the past two weeks. Since volume confirms price, that indicates that this rally leg may not be entirely over yet (but overall prices have been rising and volume falling during the past week). New 52 week lows rose from zero to five. The Put/Call ratio ended the week at .92. Looking at the advance decline lines, we are back to a small positive divergence on the NYSE, but a very large negative divergence on the Nasdaq telling us that the rally has been mostly on a few of the big names. There are many small negative divergences on RSI and MACD. Below is a one year chart of the Nasdaq with the index in black and the A/D line in red/black:

ALL the hammers that I showed on Thursday night’s update are now confirmed reversal indicators. Doesn’t mean it can’t reverse again, but it would be unusual to do so now. Here’s what the Emerging Market ETF looks like… you can see the hammer I pointed out is a top of at least short duration and the selling here was on higher volume. In fact that candle, like the other one I have highlighted is a good example of a shooting star:

USO produced a hammer on Thursday that is now a confirmed reversal, but it was on lower volume. The stochastic, however, just produced a daily sell signal:

On the DOW weekly six month chart, you can see that we just finished 3 up weeks in a row, very unusual for this bear market, that is a bear killer. The weekly stochastic still has lots of room to run to get oversold, but it hasn’t been making it that far during most of the bear market to date. Note that this week had lower volume than the prior two – rising prices, lower volume:

Here’s a 10 day, 10 minute chart of the SPX. First let’s note what the stochastics are saying… the 10 minute here is basically neutral, but the 30 minute and 60 minute are oversold or close to oversold already, but the slow does have room for further descent, thus picking a direction for Monday is difficult. On this chart, however, I have drawn in what looks like a potential ending diagonal. If that’s the pattern in play, it may need one more run to the top with a possible overthrow to complete. Of course it could break down from here, and a close beneath that lower blue line will be bearish:

When zooming out to look at a one month daily, you can see that the candle failed to close beneath Thursday’s candle. That’s a bullish indication to go along with lower volume on the pullback. The next higher pivot is at 848 and there is now much support in the 790 to 800 area with the 50dma in that region and the next lower pivot is 789 and then 768. Note the fresh sell signal on the stochastic, but I would want to see the fast exit oversold to verify it:

The DOW daily is pretty much the same picture as the SPX, but here you can see the weak volume on Friday. Note, however, that the slope of the volume is down while the slope of the price is up – that’s a clue, and is often what we see just prior to rolling over. Once the roll over becomes clear, THEN the volume picks up (that’s been the pattern in this bear market so far):

The NDX is the only major index that closed beneath Thursday’s candle. That upsloping red line is the bottom of that big pennant. Note how we tapped it and came down – was that a retest? The blue rising wedge is broken again and at best we are now in Doc’s shifted channel that I have marked with the green channel lines:

The XLF is a tough read with Friday’s candle… that inverted hammer candlestick has two meanings to me. It opposes the prior upright candle and thus prices could run up the handle higher. It also looks like a gravestone doji which if is on the top of a run is very bearish. In the big picture, it is close to the top of a run, but not ON TOP. It’s on low volume too, which favors upside, but on the other other hand (lol), the general volume pattern is lower on rising prices. Like I said, it’s a tough call. That makes Monday important as it will tell us the meaning of that candle:

IYR has been moving very similarly to the financials. Note how it is still well below its 50dma and Thursday’s hammer was confirmed with no opposing hammer, just lower volume. Monday becomes an important read here as well. If it weren’t for the low volume I would call it bearish:

The VIX has stubbornly refused to stay below 40, but it did close beneath the 200dma which is currently at 41.50. That’s an inverted hammer that would look a lot like a bottom where it not completely shadowed by the previous day’s candle. So, it could be a reversal candle, but again will need to see confirmation on Monday:

All in all, a tough call for the short term. We are very overbought on the daily with divergences in place, but there could be one more run upwards to complete that potential ending diagonal. We could also be done and just need some more downward push to get out of the channels. Regardless, at some point next week, probably early, I would expect that a retrace of some scale needs to happen. I would also expect that another good run upwards is possible after that retrace. If this market behaves as the market did during the Great Depression, any rally will fail to get through the overhead volume resistance of the large pennant area. Should prices break through that area, then my outlook would turn substantially more bullish in the medium term. Remember that a bear market’s job is to draw in money to be destroyed by creating new believers at each step down the ladder.

While I was looking for the American Pie song on YouTube, I saw and was reminded of his other song that I really like, Vincent. Of course that song is about Vincent Van Gogh, but I think it’s a beautiful song and as I listened some of the lyrics sound very applicable to all of us who have been trying to spread the word of this INSANITY. His lyrics are a terrific poem and his song is moving…

Don McLean – Vincent:

Starry, starry night.
Paint your palette blue and grey,
Look out on a summer's day,
With eyes that know the darkness in my soul.
Shadows on the hills,
Sketch the trees and the daffodils,
Catch the breeze and the winter chills,
In colors on the snowy linen land.

Now I understand what you tried to say to me,
How you suffered for your sanity,
How you tried to set them free.
They would not listen, they did not know how.
Perhaps they'll listen now.

Starry, starry night.
Flaming flowers that brightly blaze,
Swirling clouds in violet haze,
Reflect in Vincent's eyes of china blue.
Colors changing hue, morning field of amber grain,
Weathered faces lined in pain,
Are soothed beneath the artist's loving hand.

Now I understand what you tried to say to me,
How you suffered for your sanity,
How you tried to set them free.
They would not listen, they did not know how.
Perhaps they'll listen now.

For they could not love you,
But still your love was true.
And when no hope was left in sight
On that starry, starry night,
You took your life, as lovers often do.
But I could have told you, Vincent,
This world was never meant for one
As beautiful as you.

Starry, starry night.
Portraits hung in empty halls,
Frameless head on nameless walls,
With eyes that watch the world and can't forget.
Like the strangers that you've met,
The ragged men in the ragged clothes,
The silver thorn of bloody rose,
Lie crushed and broken on the virgin snow.

Now I think I know what you tried to say to me,
How you suffered for your sanity,
How you tried to set them free.
They would not listen, they're not listening still.
Perhaps they never will...