I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Saturday, February 27, 2010

A Request to Bearish Bloggers, the State of the Emperors Attire, and Watched Pots

Okay, fair warning, this is another one of binv's crazy idea posts. But bear with me, I think the request part has some merit and I think the ideas I present will at the very least be a good read.

What are chances of this post actually mattering or accomplishing its goals: Well I put the odds of a big name bearish blogger actually reading this post at 1 in 10000 and the odds of them actually trying out this idea at another 1 in 10000. So I think this post has a 1 in 100 million chance of having an impact or conversely will be 99.9999999% ineffective. .... never tell me the odds :)

Basic Premise and Request

I want all of the bearish bloggers to tone down the overly bearish rhetoric for one month.

.... Whaaaaa? binv, what are you smoking?

Hear me out. I have a basis for this crazy idea. I actually had a very similar idea back in August: Do Your Part to Help End the Current Bull Market. Become a Bull!, but the conditions were not ripe for a top nor did I make a request as focused as this one is.

So I wrote in December that conditions are ripe for a top (The Long View). But if conditions are ripe, why am I asking bearish bloggers to ease off? Aren't things already in motion for the bearish case?

First off, nobody knows if this is the top or not. Not me, you, Robert Prechter, Marc Faber, Larry Kudlow, Jim Rogers, Paul Krugman or Nouriel Roubini. And like I have said before, whether this is the exact top or not, the only way we will know is after there is a confirmation move, and here is what one could look like: What To Look For As a Long Term Trend Change Confirmation.

But shouldn't the bearish bloggers continue to point out the problems? Shouldn't we continue to show that point of view?

In short: no.

The market is already extremely polarized. The bulls are exceptionally bullish (crisis averted, Dow 15000, financial system stabilized, etc.) and the bears are exceptionally bearish. There are very few who are agnostic on the market right now.

So what does ringing the alarm bell do when everybody has already chosen a side?

But if you subscribe to the bearish scenario, you want to see hubris peak again. Hubris had a very strong peak in Dec and January, with bullish sentiment indicators from a number of different measurement sources near all time highs.

Remember markets climb a wall of worry and fall down a slope of hope.

The Emperor Isn't Wearing Any Clothes (Almost)

The point that many of us bearish bloggers make is that the "recovery" was a product of a bounce off extremely oversold conditions in March and extreme fear. There was never any compelling bottom in valuations on a number of different fronts (earnings, book value or dividend yields). The GDP "growth" was a function of government spending and an inventory rebuild cycle (read: unsustainable).

And I bet any bullish reader reading this (which is highly unlikely) is getting angry and saying I am wrong / taking these things out of context.

That is more or less my point. These developments are not bullish and pointing out the unsustainability of the recovery and the fact that none of the underlying problems being fixed just gives fuel to the bulls "climbing the wall of worry".

It is like pointing out that the Emperor is *about* to be naked.

That doesn't work.

In March the Emperor was wearing a parka and several layers of thermal underwear. His attire was getting much more skimpy from March to November. In December and January, when many us of bearish bloggers were loudly pointing out problems and demonstrating the topping behavior on many indices across the developed world, the Emperor was wearing a Speedo.

But he was not naked. Saying he is "practically" naked doesn't work. So yelling "the Emperor has no clothes!" gives him an opportunity to put a t-shirt back on.

To catch the market with it's "pants down" they really have to be off.

So what I am saying is hubris and over-confidence needs to return. The Emperor really needs to be naked when the call comes that he isn't wearing any clothes. And the only way for him to be naked is for his charlatan dressers to convince him that "he looks maaahhh-velous" and to parade around Wall St. in his birthday suit.

Let me put this another way:

The Watched Pot Never Boils

On Caps there have been a lot of posts stating to the effect that "its okay to be bullish because the number of bearish posts have been increasing"

And you know what? That thought is absolutely right.

Because there is no such thing as "the market" and we all engage in it from the outside, separately. All of us, our words, actions, probably even our thoughts, make the market

Peaks happen at extreme sentiment, when everybody is one-side on a trade. They don't happen when there are a large number of people calling for the fall.

The watched pot never boils.

And bearishness did pick up back in January. There was quite a shift in sentiment. And in looking back on how that played out (Jan-Feb), it was almost a "too perfect" momentum change.

So What am I Asking?

I am *not* asking for the bears to stop being bearish. Hell, I am extremely bearish. I am asking for the bears to not be "loud about their bearishness".

We need to catch the Emperor naked and we need to stop anticipating a boiling pot and just listen for the clear whistle of a trend change.

Many of the bears are a) already positioned for a crash, and there are far more b) who will jump on board when the momentum changes.

I am asking for the group a) bears (such as myself and fellow bearish bloggers) to tone down the rhetoric so that hubris can re-peak unimpeded.

Please continue to post News and articles that show bearish developments, please continue with Technical Analysis and Wave Counts. We are all trying to understand the environment. Just refrain from the overly bearish rhetoric so that bullish complacency can return.

"Why do you hate the market so much binve?"

.... I DON'T!!!!

I am not bearish for the sake of being a bear. I would much rather be long. I would much rather be bullish. I am a very optimistic guy, and I want to invest in companies and the US economy for the long term. But when I honestly assess the problems that our economy faces in the near term (next couple of years) and the actions that have been taken to deal with those problems, I am utterly unconvinced that they are being solved or in some cases even taken seriously.

This is ultimately why I believe that the current environment suggests that investors should still be very defensive. That is my honest $0.02. I have no agenda other than to call things like I see them.

But my real beef with this stupid rally is that it is suckering in so many people and the only way to stop that is to just end the charade quickly.

If I actually believed that this really was a recovery, actual and sustainable, then I would be all over it.

I want to be long, and in fact I have no doubt that we will completely rebuild our economy and I will be 100% on board. I will become the most bullish investor you have ever seen.

.... but that day is not today, and other than a short bounce (in the grand scheme) that day was not March 9, 2009

I am not a "the world is ending, stock your bunker" bear.

I have a 5 month old daughter. I am not calling for the end of the economy because I want her to grow up in Mad Max's world! I want the economy to purge itself of its excesses so that we can rebuild our economy while America is still a very strong country and to clean the Financial house.

And that will not happen until we acknowledge the underlying problems and fix them. Yes, it will suck and be painful. But for the long term sustainability of the US economy, it is mandatory.

I want to leave my daughter an honest economy and a bright economic future.

.... So.

To the bearish bloggers: Tone down rhetoric for one month. And lets see if this market might give us the turn we are looking for. Patiently and quietly.

Friday, February 26, 2010

I Hate to Say It

But it looks like the "currently in Minor 3" count is dead. See the chart below and read my notes.

I think we will be making higher highs before lower lows. And based on my short positions, I *really* hate to say that.

Addition 12:45

Here is the way I am leaning toward a new preferred count

Thursday, February 25, 2010

Do You Validate?

NO! (to continue the gag)

Old count is broken. ES has continued to make higher highs overnight. And so the 1-2, 1-2 that I was showing uncomfortably in my last post is gone.

Here is a new count, the last one that I find likely to salvage the 'Minor 3 now' count.

What do I think about it?

The word puke comes to mind. Vomit is a nice alternative. How about hurl? As in "binve is hurling up this count onto his computer screen". Rhymes with curling. So at least it is sort of in the Olympic spirit.

Anyways. Large expanded flat for 2. And no, I don't really buy it either.

Here Comes the Meat Wagon

..weoweoweo. the medic gets out and says, 'oh my God!' the new guy in the corner puking his guts out "rrruughh rrrugggghhh". All because you wanted to save a couple extra pennies. To me it doesn't...

Get out!

... Yep, I too am in the corner puking my guts out.

But (probably like a fool) I am still holding on to my shorts and I am still holding on to the beginning of Minor 3 count. I guess we will see tomorrow.

And We Got the Move Down!

Like I was saying last night And Down We Go:

Now why do I say "Down We Go?". The futures are again confirming the breakdown.

Look at the 60 min chart first. After last night and today it was hugging the support lines (breaking below, then breaking back above, but always hugging it), we finally have a very clear departure.

But if you look at the structure of the move on the 5 min chart, you can see it is **VERY** impulsive down. The move yesterday both above and below the trendline was very spiky and corrective.

I will not be surprised at all with a big gap down in the morning.

And that is exactly what we got.

I will update this post with charts as the morning goes on. But the impulse count on the futures is *VERY* definitive.

-- Addition 9:45

All upward support lines are smashed. Move is able to develop into a free fall. There is one more support line below. Perhaps the bounce for Minuette 4?

-- Addition 10:45

Current micro count of the ES

-- Addition 2:10

Retesting broken trendline?

Wednesday, February 24, 2010

And Down We Go

On Monday, I changed my preferred count to the *immediately* bearish count (end of Minor 2) based on the pattern showing up on the XLF. Here was that post from Monday for both Financials (XLF: That'll Do Correction, That'll Do) and the SPX (Possible SPX Count)

This is the count that I have been maintaining the past few days. Even during today's craziness, I thought that the move up looked corrective: What Craziness Is This ?!

Here are my current XLF and SPX counts:

Now why do I say "Down We Go?". The futures are again confirming the breakdown.

Look at the 60 min chart first. After last night and today it was hugging the support lines (breaking below, then breaking back above, but always hugging it), we finally have a very clear departure.

But if you look at the structure of the move on the 5 min chart, you can see it is **VERY** impulsive down. The move yesterday both above and below the trendline was very spiky and corrective.

I will not be surprised at all with a big gap down in the morning.

What Craziness Is This ?!

I was away for most of the morning and I come back and see this! What a crazy volatile mess!!

After looking at XLF (which I think is giving us the cleanest pattern), this is my count:

Still Churning Under Trendline

Broken support is acting like resistance.

The 4 has traced out a 3-3-5 flat

Tuesday, February 23, 2010

Still Looking Bearish

Could this still be 4 of C of 2? You bet it could!. But, I switched my preferred count to the more immediately bearish count last night (Possible SPX Count) after I was looking at the XLF count and decided that it was immediately bearish: XLF: That'll Do Correction, That'll Do

Take NOTHING for granted in the market. That said, the immediately bearish case (start of Minor 3) is still my preferred count.

Why? -- Because like I was saying this morning (Is This Move For Real?), I think the ES has been telling us the true move.

So here is an update on my ES Count.

I was noting today that it broke the first channel but that the lower channel lines would be support. And it did bounce off them. But then it consolidated right above the channel lines in a triangle for about an hour and a half and then broke convincingly below.

Now it it consolidating beneath the broken channel lines (yellow oval). But former support is now new resistance

I see this consolidating in a 4 overnight, ready to greet us with a gap down 5 on the SPX / Cash in the morning while the futures trace out a lower low overnight.

Here is how the count looks on the cash index. This is the same count that I was showing earlier today. The ES and the Cash never count exactly the same. But the important point here is that they are telling the same story with the same sized waves (same degree) with the same sequencing.

I think we make another move lower before a move higher.

And an Update of the XLF Count for Good Measure

From last night: XLF: That'll Do Correction, That'll Do.

You can see this morning there was a retest of the broken wedge line and then a crash. *Exactly* what we would expect as the reaction to an ending diagonal.

SPX Count Theory

I am still operating under my count hypothesis from last night - Possible SPX Count. Here is an update on this count option:

Hathor Exploration

I am not being a tout here. This is not a "Buy NOW!" post. But I want to call your attention to Hathor Exploration (HAT.V / HTHXF). I did a write up on Hathor back in November: A Look at Two Junior Canadian Miners - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=294226 and http://marketthoughtsandanalysis.blogspot.com/2009/11/look-at-two-junior-canadian-miners.html.

I stated my fundamental case for being bullish, as well as the technical case. My technical observation was that the pattern was consolidating in a very large bullish continuation triangle. Since November, the last wave of the triangle has itself become a triangle. You think of triangles like a spring being compressed. It is a balanced fight between bulls and bears right to the apex.

And I believe the next move out of the triangle will be a thrust up.

This is NOT ADVICE!. Just letting you know in case you want to keep this on your radar.

Disclosure: I am long Hathor

Addition 11:00 - I posted this earlier today because I saw that it was starting to break out. But then I forgot all about it in during the bearish excitement. As I was updating charts tonight, I find a very nice surprise on the Hathor chart :)

Looks like we are getting the breakout!

Addition Feb 25

And just to keep track of the record

First Hathor post (11/15/09) - HAT.V (1.90) and HTHXF (1.82)
Second Hathor post (2/23/10) - HAT.V (1.97) and HTHXF (1.89)

Current price (2/15/10 - 12:30) - HAT.V (2.17) and HTHXF (2.10)

Is This Move For Real?

I have an ES count that says "It is *very* possible". Based on the volume, I am even going with probably.

We have some trendline support just a few points down, let's see how it reacts.

Monday, February 22, 2010

Possible SPX Count

I was revising my SPX count based on my XLF Count XLF: That'll Do Correction, That'll Do

AussieKen is thinking along very similar lines http://marketthoughtsandanalysis.blogspot.com/2010/02/xlf-thatll-do-correction-thatll-do.html#comment-36015679

I don't love it because my triple zigzag for Y feels kind of like a cop-out. But it is a valid count. If we don't break down *hard* tomorrow morning, then consider this count invalid (I would).

FTSE Schmootsie II

Following up on the FTSE (see: FTSE Schmootsie).

The FTSE stopped at a perfect 62% retrace with a nice bearish reversal candle. Now a reversal candle only signals potential reversal. But if we get some follow through tomorrow ... watch out.

Stochastics are also in the overbought territory. Also the DAX has a bearish candle sitting in the same spot.

This definitely bears watching.

XLF: That'll Do Correction, That'll Do

I have been going crazy trying to figure out an XLF count. Even the uber-bullish case does not work (the overlapping waves at the beginning do not count like a valid series of 1-2's). Yet the move kept extending.

Then it hit me... What about an ABC last leg with a C ending diagonal?

I think it count *very* well including a trendline overshoot and immediate breakdown.

Wishful thinking? Maybe (perhaps probably), but I am actually giddy to see tomorrows open for the first time in the past few days :)

Overnight Count Update

AussieKen, joske and I have had some very good discussions regarding the count this weekend. I have come to the conclusion that the move on Friday was not large enough to be in proportion to the Wave 2 after the triangle. In essence, we have not seen Minuette 4 yet. Here is a possibility on how it could play out

Addition 2:30 - XLF Count

Sunday, February 21, 2010

Of Modeling, Risk, Financial Innovation, and Liquidity Crises

I was reading the Feb 13th issue of The Economist and they have a section on risk and risk modeling for financial institutions. The one that I thought was particularly relevant was the article about liquidity risk - "When the river runs dry: The perils of a sudden evaporation of liquidity". The whole section is a very well written set of pieces, as most Economist articles are, but was not as hard-hitting as I think the topic deserves (I think a lot of punches were being pulled and a lot of the conclusions for future systemic risk were not being fully drawn).

"But binv is just a permabear, and he's always coming up with reasons to be bearish, and we just had a massive stock market rally. So why should we listen to him?"

..... You shouldn't.

I am not going to sit here and make some argument about why I am the finest macroeconomic mind around, nor am I going to try to convince and dazzle you with my charting prowess.

I am an analyst. I make observations. I examine the macroeconomic landscape and I draw conclusions.

I lay my observations out for you to follow.

So you read them and you agree with them, or you read them and you disagree, or you ignore them altogether. It is immaterial to me. Because the point of this post is not to convince you of anything. The point of this post is to share information and observations. I will draw and share my conclusions, and I offer them to you if you are interested in reading them. But your conclusions are up to you.

But more to the point, I am not bearish for the sake of being a bear. I would much rather be long. I would much rather be bullish. I am a very optimistic guy, and I want to invest in companies and the US economy for the long term. But when I honestly assess the problems that our economy faces in the near term (next couple of years) and the actions that have been taken to deal with those problems, I am utterly unconvinced that they are being solved or in some cases even taken seriously.

This is ultimately why I believe that the current environment suggests that investors should still be very defensive. That is my honest $0.02. I have no agenda other than to call things like I see them.

Yet I know something about modeling, creating mathematical representations to describe phenomena. But more importantly I know quite a lot regarding the limitations and abuses of models.


I have stated before that I am a thermal and structural analyst for the Aerospace industry. I create mathematical models to describe physical systems on a daily basis. And it is very important that these models are accurate, as there is often very expensive hardware performance dependent on the predictions from these models.

Also I have made the argument that financial systems are quasi-physical systems (one example from here: First and Second Derivatives of the SPX - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=298547), that is they display properties such as inertia, capacitance, flow, diffusion, and respond to inputs such as impulses, step functions, ramps, etc. I am not making the argument that you can model financial systems and physical systems in a strict one-to-one manner, rather I am saying that there is often a corollary between the two systems and an understanding of physical systems will often given you insight into the behavior of financial systems.

Physical systems are inherently non-linear.

Even something as simple as a beam in bending, which is described by kinematic, equilibrium and constitutive relationships, has non-linear terms in them. For engineers to be able to work with these relationships in a practical manner we make simplifying assumptions. In the case of the beam equation above, we assume a small angle approximation (sin theta = theta) and this allows us to linearize many of the relationships. And this is a very good approximation for small deflections and angles. Whenever you look up a beam diagram to determine the deflection or bending moments from a particular load case, baked into those relationships are these linearizing assumptions. The point is that these assumptions allow you to build and successfully analyze very complex systems, but you must always be aware of their limitations. Deflections cannot be extrapolated infinitely because at some point the linearizing assumptions are no longer valid, and non-linear effects become very important.

The key concept here is that there is a range of conditions over which these linearized systems can be properly analyzed, and cannot be extrapolated out indefinitely with out serious error (i.e. the model gives you false predictions).

I keep talking about linearization. Why is this so important? Linearization means that effects can be added to each other to give a valid composite result. This is the principle behind superposition. An example would be a fast transient signal on top of a slower transient signal: such as the temperature response of a filter wheel on an Optical Bench that is responding to diurnal temperature swings, or the flutter response of a control surface relative to a wing which is responding to the air stream. Superposition is the key for models to be able to accurately predict the responses of several combined inputs.

Then there are some effects that are non-linear and have no linearizable simplifcation: Radiation and Convection from a high temperature exhaust plume as the vehicle moves from atmosphere to vacuum, the effective clamping constraint (degree of freedom) of card locks on a PCB as the chassis goes from low frequency to high frequency vibration, etc. When your system is subjected to these non-linear inputs then the must be tested and verified against these inputs.

This brings together the next key concept: When a system is subject to inputs, especially non-linear inputs, or an input will cause the system to behave in a non-linear fashion, the model must be correlated to these conditions. Using a model to extrapolate beyond correlated conditions will lead to inaccurate predictions

Together, these concepts of model correlation and the range of applicability for a model are the basis for all aerospace analysis and testing procedures. Think about it, do you design a new thruster that has a new plume shape and temperature profile and stick it on a satellite and just launch it? What if it doesn't work the way your model predicts (non-linear behavior). What if it breaks hardware? What if it ends the mission? It is impossible to retrieve a satellite and fix it when it is in orbit 22,000 miles above you. This is why models and hardware are verified before they are deployed, so that you can be sure they work and you can be sure that the model will predict all of the situations the system will encounter on orbit (sun angles, surface degradation, shadowing, thruster pulse timing, etc).

What this does it allows you to retire risk. The more you know about your system, and the better your models predict the system behavior through correlation, the more confident you are that the system will behave for conditions that are similar to the ones that you tested for. AND RETIRING RISK WILL GIVE YOU CONFIDENCE THAT YOUR MODEL WILL ACCURATELY PREDICT SYSTEM BEHAVIOR AT THE EXTREMES (i.e. IN A CRISIS)!

Risk and Financial Innovation

Good economics, just like good engineering, should be BORING!.

Models should be clean and as simple as possible, so that they can be vetted by multiple analysts that should agree on the interpretation of the results. And when new designs are introduced in (which happens all the time in engineering), the design must be tested thoroughly and the models describing the behavior of the new design very well understood before the design goes into production.

The term "financial innovation" should scare the SH** OUT OF YOU!!. For 2 reasons:

a-1) There was never any mechanism by which these instruments (CDOs, CDSs, MBSs, etc.) were truly exercised before mass proliferation within the marketplace. The first time we saw how these derivatives reacted during a crisis was when they collectively represented more than the GDP of the entire world.

It would be the same as designing a new satellite, putting it in a thermal vacuum chamber and testing it for nominal conditions only. Then doing some handwaving and saying "yeah it works fine at hot and cold conditions too". Are the radiators properly sized for the hot case? Is there any heat leak to sensitive components during hot conditions? Are the heaters properly sized for the cold case? Are there any conditions where the propellant freezes creating a catastrophic scenario? These are the questions that you want to have answers to on the ground before you launch, where you can take action if the system does not perform as expected. That last thing you want to have happen is to find out there is a major system design flaw on orbit.

Same with these financial instruments. The last thing you want to have happen is to find out that these responded to crisis conditions not at all like you expected while in the middle of a crisis. Yet that is *exactly* what happened.

a-2) It didn't really matter anyways because this instruments were fraudulent to begin with: Financial Carcinoma -- Denninger: Did You Need a PhD For That? - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=322718

So why did these models perform so poorly? Why was risk so grossly under-represented?

Because the financial systems these risk models are trying to describe are also extremely non-linear

Models such as Value at Risk / VAR are fine for short term forecasts where the liquidity environment is known. But leverage greatly alters the liquidity environment and a very small change in leverage can completely change how liquid any asset is. Does that change its underlying value? YOU BET IT DOES!. An MBS is worth the fully securitized cost only if somebody is willing to pay you that amount for it. And if liquidity is only available to purchase that asset in a highly leveraged environment, then its value is a function of liquidity and leverage. Regarding Economic Debates and Opinions: The Fallacy of "Purely Objective" Analysis - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=305849.

Additionally these models looked at housing risk simply from a historic default rate standpoint, without considering the possibility of a massive fall in the underlying assets (housing prices) and how that would further impact the default rate. (Effects combining in a very non-linear fashion).

There are quite a lot of financial environments that are non-linear and sometimes even binary, such as a highly leveraged liquidity environment.

The current and next generation of modeller's will benefit themselves and all of us by adhering to the Modeler's Hippocratic Oath: http://www.financialmodelingguide.com/financial-modeling-tips/tips/financial-modelers-manifesto/:

* I will remember that I didn’t make the world, and it doesn’t satisfy my equations.
* Though I will use models boldly to estimate value, I will not be overly impressed by mathematics.
* I will never sacrifice reality for elegance without explaining why I have done so.
* Nor will I give the people who use my model false comfort about its accuracy.
* Instead, I will make explicit its assumptions and oversights.
* I understand that my work may have enormous effects on society and the economy, many of them beyond my comprehension.

This is the reason why I *always* put caveats on my analysis and projections. Because any analysis, whether physical, financial, TA, EWP, etc., is an approximation and a projection, nothing more.

Liquidity, Liquidity Crisis, and why another Crisis is Extremely Likely

So we have discussed modeling and risk. And we have already had a major financial crisis and a stock market crash. Since all these effects are known, isn't the risk retired? If we are aware of some of the underlying problem, haven't we fixed them?

NO, not by a long shot.

There is a big difference between captital risk (and so called Value At Risk / VAR models) and liquidity risk. And as you will see in some of my conclusions, the latter is the one that gets significantly less attention and is significantly more dangerous. And why I ultimately believe that all of the actions of the Treasury and the Fed have almost guaranteed another liquidity crisis in the future, and has done nothing to ameliorate the underlying problems.

First, lets start with the Great Deleveraging Event of 2008. From above, I talked about how all these derivatives reacted to the collapse of liquidity and how leverage across the board began to dry up.

But why did conditions abate? Did the market just "have enough" when it came to deleveraging and the equity market find a compelling valuation bottom back in March 2009? NO

b-1) If you want to know why liquidity returned to the market, then read this fantastic post by Kristjan Velbri: Dollar Liquidity Swaps & The Financial Crisis. The reason why the Dollar rallied and then peaked while the market bottomed in March is because of massive Dollar Swaps pumped into the market by the Fed. That's all. There is no fundamental strength in the US Dollar. There was a crisis reaction into dollars by the Deleveraging Crisis in 2008 (in order to buy Treasuries / the standard "safe haven" move) and then the Fed flooded the market with Dollar Swap agreements to force liquidity in 2008/2009.

b-2) There was no meaningful valuation bottom found, as I have stated many times. Is the Market Fairly Valued? Did the Market Achieve Any Meaningful Bottom Back in March? - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=320237 and The Long View - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=314202

Okay? So maybe this is how it went down. But why am I stating that there will most likely be another liquidity crisis?

Because nothing was fixed!! All the old problems were simply wallpapered over and the same instruments with the same models are back en vogue!!

Here is a list of reasons why the underlying causes of the Liquidity and Deleveraging Crisis of 2008 are still around and worse than ever!

c-1) These assets were never allowed to be properly valued by the market. Congress extorted the FASB to allow for "mark to imagination" and "extend and pretend" valuation, so that financial institutions could keep these toxic assets on their balance sheets unimpaired. Former Regulator Talks Fraud and the Big Bank Getaway - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=344209

c-2) Despite the collapse of several derivatives markets in 2008, the disproportionate size of these "assets" to any meaningful metric (such as GDP of the world), and the systemic risk of the size of these assets .... they are still growing. Financial Crash Risk Increasing Exponentially as Derivatives Monster Continues to Grow - http://www.marketoracle.co.uk/Article15437.html

c-3) The Fed is backstopping the CDS market to allow for, and in fact encourage, the more rapid proliferation of derivatives. PSW: The Fed / CDS Development - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=340700

c-4) The recent rule changes regarding Money Market Redemptions has an even larger moral hazard then first observed. Connect the Dots Before Financial Depressurization - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=335085 and my response - http://marketthoughtsandanalysis.blogspot.com/2010/02/flag-day.html#comment-33841524

There is One Last Issue That Puts this Whole Discussion Into Perspective

I and many others talk about a lot of terms that are important to the conversation, and many that I discussed above, but there is one term that is important beyond all others:

maturity transformation

What this means is to borrow short in order to lend long. It is the basis behind behind our entire financial system. And financial failures are not simply a random and rare by-product, but is actually a "feature" of this system.

I have linked to these two articles before, but I have never featured a post around them. But they are extremely relevant:

Maturity transformation considered harmful: an unauthorized biography of the bank crisis -

The Misesian explanation of the bank crisis - http://unqualified-reservations.blogspot.com/2008/10/misesian-explanation-of-bank-crisis.html

These post were written by Mencius Moldbug of http://unqualified-reservations.blogspot.com. His blog is extremely interesting (although it is a bit out there sometimes / fairly often). He is a Computer Scientist who likes to look at issues from an almost diagnostic point of view. I first started reading him in September 2008 (when he wrote these posts) with his discussion of Fractional Reserve Banking and Mises Banking.

The point of these linking to these posts is to not advocate for an Austrian Banking System (not because I don't think it is a good idea, but because it won't happen), but rather it is to show you from a very logical and easy to follow reasoning why liquidity crises happen to begin with.

Once you read these posts, and then go back up and re-read points c-1 through c-4 again, you will see that the Federal Reserve's / Treasury's / Congress's absolutely irresponsible actions of not allowing financials to fail, by backstopping derivatives to further encourage the taking of risk (not only for hedge fund but for Money Market Managers as well!!!) are setting conditions up for an Epic Fail even worse than the first Deleveraging Crisis.

It is not a foregone conclusion, but I think a reasonable person looking at all of these fact can say that it is a possible, if not likely, outcome.

Friday, February 19, 2010


Well, I think the only thing a sane person can do is laugh at this market :)

Here is the micro count. I switched over to my alternate count with the higher high today. However I think the last move could be very sneaky indeed. The door is being left open for a bullish move on Monday. If there is any strength behind it (volume and breadth) ..... well, as I said to Gumbo, my last nerve has already been destroyed by the move :)

However, we are finally seeing some negative divergence on the 60 minute chart.

And we have a nice volume spike at the end. Probably just OPEX covering ... however ...

Addition Sat - 12:00 - TSX chart for iaf

And The ES So Far ... (v2)

From last night around 9:30 (And The ES So Far ...)

.... is certainly acting like this is a real breakdown. The rally channel in the last C of Y leg is broken. However it is still sitting above some longer term trend lines that should be support. Tomorrow will tell if the reaction to the Fed announcement is simply part of a Wave 4 or if this is the beginning of a breakdown that should have some *very* strong legs.

Here is the current chart. We did get a bounce off the support lines where noted.

Now lets zoom in and see what the wave structure looks like.

Interesting. I looks like it could count as an impulse down with a 78.6% retrace. Let's see how this plays out!

Thursday, February 18, 2010

FTSE Schmootsie

AussieKen and I were discussing moves on the FTSE recently http://marketthoughtsandanalysis.blogspot.com/2010/02/pee-wars.html#comment-35010748. I keep tabs on a number of international indices on a regular basis (see this series of posts: A Trip Around the Globe III: A Look at a Few International Indices) but I had not done an actual EW count of the FTSE in quite some time.

So AussieKen piqued my interest. I see that the current 5 wave move down followed by the correction up is probably clearer here than on any other index. The FTSE peaked a few days earlier than the rest of the indices with a nice reversal bar. And the Minute 2 down in Minor 1 is very clear (not small / ambiguous like the rest of the indices). Everything looks beautifully proportional including the Minor 2 wave.

A nearly perfect impulse down and retrace back up. Thanks AussieKen!!