Sunday July 25, 2010
Today we want to show you a series of charts depicting what has
happened as stocks and bonds got ‘out of kilter’ in the past leading to out and
out stock market crashes. An alert Canadian reader sent us a Dave Rosenberg
quote making just that point this week, so, let’s begin. Rosenberg’s point was that the stock market was
ignoring the bond rally. The bond rally is forecasting deflation and lowered
expectations of all kinds.
This is a daily chart of 1987. In all these charts the thirty
year bond is the black line and the red black bars are the Dow Industrials.
After a stunning bond rally beginning in 1982-84, rates had fallen from 12-14%
to single digit levels. The year 1987 saw a correction of that advance. Indeed
the October low was the last great chance to lock in double digit bond
yields. Bond yields were too
attractive to dividends from stocks, a divergence that corrected in one day in
October as shown.
This is a weekly chart of the Dow Industrials again with the
black line the thirty year bond.
From the top in 1999-2000, bond prices began moving up sharply, again
bonds in black. This was an early warning sign that the smart money was moving
out of stocks and into defensive bonds. This relates to the many graphs we have
shown for the last few months illustrating that the internals of the stock market weaken well before the ‘surprise’
crash.
Again, the picture here is that the smart money exits stocks
early on while stock prices are still high. Indeed the Dow bounced off 10,000
in March and October of 2000 and again in April of 2001. No doubt this
encouraged stock participants that this was merely a correction, the bull was
still alive and well. We know now looking at the chart that it was no such
thing. This was distribution, the smart money would intentionally rally the
markets simply so that it could distribute stock at higher prices to the late
comers. After all, this was a distribution patter from a rally that lasted
1982-2000, there was a lot of stock to distribute. The public had been lulled
into buy and hold, a mantra the bears kept repeating. By the way note that the
downtrend was well in force by 9/11/2001. The market then rallied back to
10,500 and finally really crashed to 7500.
Okay that covers the crash of 1987 and the long train wreck crash
of 2002, what about 2008?
This looks remarkably like the 2000-2003 set up. Stocks stay high
as bonds rallied.This time it appears that confidence in stocks stayed higher,
longer. After all, there had been one crash already, who would expect another,
and so soon? Indeed, when it
happened in October 2008, the same thing happened that occurred in October,
1987. Money rushed from stocks to bonds. By the way, Fibonacci numbers often date such events and sure
enough, 1987 + 21 = 2008! The
stockcharts glossary below explains the series. In this case the Fib numbers are quite
important! It is not ‘just’ the ratios.
The 1987 crash happened a near exact 5 Fib years from the start of the
bond rally in the summer of 1982 for example. The crash of 2003 happened a FIB
21 years from 1982.
:
The Fibonacci number sequence (1,2,3,5,8,13,21,34,55,89,144,…) is constructed
by adding the first two numbers to arrive at the third. The ratio of any number
to the next number is 61.8 percent, which is a popular Fibonacci retracement number. The inverse of 61.8
percent is 38.2 percent, also used as a Fibonacci retracement number. It is the
ratio of the Fibonacci sequence that is important and valuable, not the actual
numbers in the sequence.
Now let’s fast forward to today, is there a similar pattern?
This pattern looks the most like 2000-2003 to me. Once again the bond and stock prices
are diverging. Once again stocks seems to be ignoring the disparity. And once
again, Dow 10,000 is more or less a support level, ‘Rocky’ Dow keeps getting up
off the canvas and fighting back each time he gets knocked down below 10,000,
this is a daily chart.
Stock crashes are typically a fall phenomenon. But notice that a
serious crash did occur in the summer of 2002. Stocks dropped some 2,000 DOW
points from spring to late summer. When I write my book on investing I believe
Chapter One will be entitled, Understand that anything can happen, for example.
New York City was rated Baa the day it defaulted in 1976.
GM did go bankrupt and the government defaulted to the bond
holders.
Robert Rubin, who made $100 M at Goldman (primarily on inside information)
resigned in disgrace as Co Chair of CIti.
The third US Central Bank was created in 1913 to prevent crisis
like the Panic of 1907 yet we have had 1929, 1937, 1958, 1982, 1987, 2002,
2008.
Economic stagnation is often prefaced with natural disaster.
Japan suffered a large earthquake in 1989, their market topped the next year.
The 1930s had the Dust Bowl in Central USA, now we have the Gulf Oil Leak,
fires in California, and floods from Iowa to Delaware.
But overall as we say in our introduction, the business cycle has
not been repealed.
1912-1930 Up
1930-1948 Down
1948-1966 Up
1966-1982 Down
1982-2000 Up
2000-Now we are half way through another 18 year cycle. So there
is ample reason to believe there will be at least two more swoons to the downside,
we have had two thus far with rallies back just as we did in 1929-1930 or
1970-72.
NASD QQQQ
We have shown you the NYSE in past issues, here is NASD or what
was once known as the OTC Over the Counter Stocks for you youngsters. Please
spend a few minutes sudying what
is happening here, it may mean your livelihood if you are a portfolio manager.
The summation index like many breadth indicators subtracts declines from
advances and then uses a smoothing techinique. This ‘black box’ clearly vaulted
above the 200 bar MA in March 2009. It has not decisively broken that 200 bar
weekly line until April 2010. Now the index has dropped from +600, its best for
the entire year, to -800, a number not much higher than the March 2009 low.
Percentage wise, stocks have not dropped nearly that much.
Our time frame here at Market Perspectives is months, finding the
ideal exit and entry for stock purchases. Our view is that April 2010 was a
significant internal top. Look back at the previous crash charts and note how
long stocks stayed up, once the bond rally began.
Now here is a put it all together chart showing how the internals
of the New York Stock Exchange were collapsing while stock prices stayed high
amidst the cheerful assurances on CNBC that all was well.
Note this is the 2007-08 crash with the summation index
overlaying the NASD. The BIG point here, is that once the Summation index broke
the 200 bar weekly line, the end result was set in stone, and it ended badly.
Then as indeed now, the summation index made moves back to the 200 bar line,
but never crossed it. And once the decline began in late summer 2008, it was
way too late to exit. Hence the wise portfolio manager will either begin exiting
in advance this time. it is much easier to explain what appears to be mediocre
‘performance’ (actually a defensive move out early) than a 50% loss in the
fall, be it this or next fall.
Short Term
We mentioned the existence of reverse head and shoulder patterns
in both the internals and the price. By extreme caution, we meant that the
market could break either way. It as in past summers, broke to the upside, Jack
Bauer, Roy Rogers, James Bond has been rescued yet again. The next upside
targets would be previous peaks at 1130 or even possibly 1180 but that seems a
bit remote.