Is This the Beginning of the Big One?

April 25th, 2013
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One has to be cautious when predicting a collapse of stock prices. There are millions of fundamental reasons this stock rally should be ending. There is one fundamental / technical reason we should be utterly cautious in predicting this. There is a man in the central bank (the most powerful man in the world today, perhaps) whose historical reputation relies on stock prices (the so-called 'wealth effect') going up.  He has spent $4 trillion dollars so far to keep stocks appreciating; and to try to keep the banks insolvency invisible based on levitating asset prices.

Follow up:

But there is finally infighting on the Fed Board, disagreement, a lack of consensus - nothing roils a bureaucrat like a lack of consensus, which is a form of disloyalty. Several weeks ago a committee of bankers and researchers chaired by ex-Fed member Frederick Mishkin released a report - Mishkin has been described at Benanke's shadow, his alter-ego - suggesting that QE would be endangered by rising interest rates as early as 2013, which might wipe out the entire Fed Balance Sheet some time in 2014.

[Mishkin,] agreeing with the findings of a recent Fed staff paper, the report - negating the Fed's substantial contributions to the federal budget - warns that,

"under some conditions, the Fed could suffer substantial net income losses as it exits its current extraordinarily accommodative policy stance in the years to come."

Mishkin and Co. ask

"Given such concerns in what remains a remarkably calm fiscal environment (given near record-low Treasury yields), how much worse could the picture become if sovereign debt concerns heat up? And to what degree could U.S. monetary policy be constrained as a result?"

The Fed's net income could even turn negative and losses could exceed its capital, they warn. Then, not only would the Fed be unable to pay the Treasury, it would be unable to pay interest on reserves and meet other obligations in the normal way.

In other words, the Fed could 'fail' - and could need a bailout from the US Treasury. This would be politically consequential, with more public money being shoveled over to bankers.

Recent Fed minutes reveal resistance to Bernanke's continued QE policies; Richmond Fed President Jeffrey Lacker said this week that if he were a dictator he would end QE this week.

What all this indicates is that there is growing doubt about Bernanke's policies. The economy is stuck in neutral or worse; the global economy is sinking; and attempts to build bubbles in housing and in stocks do not seem to be spilling over significantly into the real world economy. The rich get richer; the poor get poorer. Europe seems to be sliding into a political pressure-cooker that might result in extremist political parties taking over in Italy, Spain, and even in Germany. In response to this, EU enthusiasts have come up with a plan to fund future bailouts by just siphoning customer deposits directly to the banks.

Is this the end of the world as we know it? It seems to be.

So, this article is about stocks breaking down. Also, with the caveat, that Ben Bernanke has a big safety net he has been very willing to use in the past four years to keep stocks from cratering. In fact, there is plenty of information that Fed chairs Greenspan and Bernanke have been willing to spend Fed money to support stocks since the 1987 crash - and have been doing so ever since. In other words, trying to 'fix' the markets. Yes; that is the issue here. Are the markets 'fixed' not to go down? Essentially Bernanke has told the world that they can safely invest in US stocks because he will fix-it so they don't go down.  QE is his policy of 'fixing' stocks, commodities, US housing prices, so that they don't go down. Is it working? Is this intent infallible?

Well, commodities have been going down for months now.

He has managed to prop up housing prices by essentially helping to buy all the bad mortgages on the market, since another drop in housing prices (which I think is inevitable) will destroy US banks.

What about stocks?

One of my favorite writers on Seeking Alpha, Gary A. writes that QE is designed to fuel the derivatives market with 'clean collateral' and keep all the banks from becoming, at once, from becoming Lehman Brothers. Gary A. writes:

The Federal Reserve Bank is in a very serious box as it pertains to the current financial system. The banks need profits or their creditworthiness becomes suspect. They can only profit if they lend based on the sound collateral found on their balance sheets. The most sound collateral is liquid, AAA-rated treasury bonds that continue to keep their value, as yields decline or stay very low.

As it turns out, the Fed is necessary in creating that collateral through QE. The Fed swaps treasuries from their balance sheet, to banks who use it to fund traders in commodities and stocks, for the bad collateral that cannot be traded by the banks. There is no market for the bad collateral. Also, some of the bad collateral is mortgage backed securities for which there is no market. So, QE is instrumental in infusing banks with good collateral, which is used to fund traders.

However, there is a big problem. The Fed, in sustaining QE, is buying all the good, long-term collateral up itself. The Fed issues short term bills, up to 10-year notes, and buys long-term bonds. There is more demand for long term bonds than there are bonds because the Fed is buying them up. Not only do banks need these bonds, but so do pension funds and insurance companies. They have been forced to take on bad bank collateral in deals that will help the banks get good collateral, but put the insurance companies and pension funds under pressure as they hold bad paper. The pension funds and banks would prefer to buy quality paper but there is no return there, so they are forced to take unacceptable risk on opaque collateral that cannot be valued.

In a deflationary environment, which we are looking at, long-term bonds could go higher in value with lower yields. The treasury market is being held up in value, according to Zero Hedge, because there is a shortage of quality treasuries the world over for the $700 trillion derivatives market. As more derivatives go toward clearinghouses from direct swaps that proved suspect in the last credit crisis, more collateral is needed. The clearinghouses must have quality debt on their books that can be seized for losses....

Bernanke is trying to keep the $700 TRILLION derivatives market (leverage 50-1 or even as high as 300-1) from imploding. So says Gary A.

Forbes Magazine in January 2013 published an article by Steve Denning, "Big Banks and Derivatives: Why Another Financial Crash is Inevitable", which highlighted similar issues about the derivatives market bubble.

Gary A. published another article on Seeking Alpha, titled "Ben Bernanke Proved Today That He is a Common Criminal". This is also excellent reading.

Getting back to our point: Are US stock crashing? We published an article earlier in April about the crash in China, Asian shares (non-Japan) and in commodity stocks. This continues. Now the more normal household name stocks are joining the party. Earnings are deteriorating right across the board. IBM tanked after an earnings miss; EBay; United Health; Bank of America; Goldman Sachs; MacDonalds; JC Penney is apparently heading toward bankruptcy. Bottom-up operating earnings per share for the S&P 500 are withering.

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Last week was rough on stocks, with selling in gold setting off a negative reaction that swept through the markets. Ordinarily I would claim this is the beginning of a major sell-off. But I remember Ben Bernanke lurking in the background, not as powerful as before, but dangerous nontheless - dangerous to short positions. I did buy puts last week, on several issues I will show now.

Reading these charts, I understand they are cluttered with information.

PANE 1 (TOP): BUYER SELLER STRUGGLE DIALOGUE: Green line are buyers; red line are sellers; blue line is the result of their struggle. When the green line is at the top of the chart, buyers are winning; when the red line is up from the bottom of the chart, buyers are stronger; when the green line is falling, and when the red line falls back to the bottom, seller are winning. When the blue line is up, buyers are winning; when the blue line is down, sellers are winning.

PANE 2: TRENDS: Red line is the short-term trend; blue line is the intermediate term trend. The brown line is a moving average of the intermediate trend. It matters if the trend is moving up or down but it also matters in the trends of the trends are making higher highs and higher lows (bullish) or lower lows and lower highs (bearish). When the moving average appears above and outside the falling trend-lines, this is a warning of coming losses.

PANE 3: These are merely secondary pictures of the trends in PANE 2. Red is a negative downturn; green is a positive upturn.

PANE 4: Price in green. Bolinger Bands included. CGTS Indicator in black. This is a leading indicator of where the price may go. This indicator tends to ride up above the price and the Bolinger Bands during an advance; and then drop in advance of a decline.  The red line is a moving average of the CGTS Indicator.

PANE 5, 6 and 7: These are the best intermediate term indicators we have: T11 Sunmarry; CGTS PB 50; and BB MJC Sum Trend. When these all three are down, we expect price declines.

Please remember, markets are in flux and can change quickly. This has been especially true from 2009 on, with massive manipulation of markets by central banks, that continues today.

Chicago Bridge and Iron is a negative picture at this moment.

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FLR, Fluor Corp is negative.

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GS, Goldman Sachs, is negative.

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JPM, JP Morgan, is negative.

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GVA, Granite Construction, is negative.

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NFLX, Netflix, is negative.

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JEC, Jacobs Engineering, is negative.

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TTI, Tetra Technologies, is negative.

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We all know that France is in trouble. The FCHI Index is also negative.

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The German DAX index is negative. Note: neither of these indexes have seen the T11 Sunmarry indicator go negative. It is almost always the last to change direction.

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I'm showing HUI, the Gold Stock Index, to show how low an index can go after turning negative.

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ETFs that are supposed to shadow US indexes are looking scary also. The IYJ, which is supposed to replicate the Dow Jones Industrials, is negative.

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IYT, the Dow Jones Transportation Index replicate, is also negative, although the two longer term indicators at the bottom panes, T11 Sunmarry and CGTS PB 50, have not yet turned negative.

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IYW, US Technology ETF, is negative.

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What about housing? The HGX, Housing Index, is also negative. As is CUT, the Lumber ETF, a play on the US housing market.

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As I have written, these markets can change fast, especially when one shorts stocks against the Federal Reserve Bank whirlwind. The XOI, Oil and Gas Index, shows how quickly a trend can reverse. Note how we use the Trends resistance and support levels - that is the support level in this instance - as a potential buy signal. This is insurance against the Bernanke put.

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A few more stock we like (or don't like), depending on your perspective. HAL, Haliburton; QCOM, Qualcom; and CTSH, Cognizant Tech Solutions.

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How confident am I in these calls? Without the Bernanke put, I would be very confident. However, I realize we are living in desperate times. Our leaders are desperate to preserve the status quo; and they are willing to steal all the money in the world from taxpayers and bank depositors to save the status quo. So I am taking these short positions with a healthy dose of trepidation.


Best trading to all. And to all a good night.

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