Blog for Trading Success

In my last blog in this series, I want to look behind the technical and fundamental picture to remind myself that behind the numbers, there are human stories and tragedies.

Adam Michaelson in “The Foreclosure of America” reveals the faces of both sides of the fence. Michaelson was senior vice president of marketing for Countrywide Financial. Countrywide was the biggest mortgage lender in the USA and one of the largest vendors of sub-prime mortgages. Michaelson’s intimate picture of the company shows that while it certainly made serious errors of judgement, it was driven  by both a desire for profits and to provide a home for those that had hitherto been unable to obtain one.

Debbie was such a person. Michaelson interviewed her for his book and said that it was one of the most heartbreaking stories. Debbie and her husband Mark lived in one of the crime infested streets of Queens. With a sub-prime loan, Debbie and Mark were able to buy a home for themselves and three sons in Long Island on no money down and US$2100.00 pm. The loan was 80/20 loan: 20% of the loan was a fixed-rate and the other 80% an Adjustable Rate Mortgage.

Their take home-pay was US$6000.00 per month. Debbie said she was not concerned about the rest of the loan’s interest after 24 months because the broker told them they could always refinance. In 2006, the loan reset to US$2500.00 pm and they were able to refinance on a house that had risen 17% in value.  However, the new loan was a completely Adjustable Rate Mortgage and rose to almost US$4000.00 per month over a number of years.

When Mark hurt his back, Debbie saw the beginning of the end of her dreams. They went bankrupt afer leaving the only home they had ever owned. Their current house has a backyard filled with a mess of dangerous concrete blocks.

If I am right about the next dangers of second-wave tsunami, variations of this story will be repeated time and again. And here is the point: sure, the parties to this tragedy must take responsibility - Countrywide, Debbie and Mark. But the biggest culprit in this whole tragedy wrings its hands and cries: “It was not our fault” - witness Paulson’s interview and his reasons for the causes of the current crisis.

The US government and other governments of the world are still at it - inflating the money supply, and spending money they don’t have - the effects of these efforts will make themselves  visible later this year.

Bookmark to:

The past 5 blogs looked at the fundamental and technical picture of the US Stock Market.

It’s important to remember that:

1. I use fundamentals not to time my trades but to provide a context. The reason for this is not hard to find. Fundamentals are not timing tools. For example, even if I were right about the coming second-wave sub-prime tsunami, it may not come until the S&P and DJIA travel to the top of their 12-month (yearly trend) PRIMARY SELL ZONE.
2. As far as trading is concerned, analysis is but one aspect of preparing for a trade; the other is the need to create a set of action plans. Here are mine, basis the E-mini March 2009 contract:

• If the market breaks above the current 5-Day (weekly trend) Primary Sell Zone and accepts above FIGURE 1’s Maximum Extension, I will buy on a pullback provided we see a decline of volume on the pullback.
• If the market breaks below 737.25 on low volume, I will cover shorts and go long on re-acceptance above 781.25.
• If the market has a strong day down closing below 829.25 I’ll look to go short provided we don’t see 781.25 on the day of the break. If we do, I will wait for acceptance below 737.25 to look to go short. The rational for this setup is the market is forming a sideways market. It has rejected off the lows at 741 and on completion of the current pause should head for the 5-day Primary Sell Zone. Acceptance below the bottom of value at 829.25 is a Negative Development setup suggesting a move below 737.25
• Stops for longs and shorts will be determined at time of entry.
• Target for longs (basis cash) is the 12-Month Primary Sell Zone 1576 to 1475.
• The minimum target for the shorts (basis cash) on a log basis is 536. I used 50% of the congestion range 1576 to 768 projected from 768 to arrive at the target.

FIGURE 1 5-day ESH9
Tonight I was going to complete this series - instead I’ll complete it tomorrow by painting a picture of the human face to the sub-prime meltdown.

Bookmark to:

The technical picture is quite clear; it offers two choices as shown by Figures 1 and 2.

FIGURE 1 1966 to 1982 Sideways Scenario

FIGURE 2 1931 to 2007

There is obviously quite a difference in the two scenarios. In the first, we can expect to see a test of the 2007 highs in both the S&P and DJIA. In the second, we’ll see a full fledged bear market with a target of DJIA 761. That would suggest a dire economic situation.

The two scenarios also show different potential end dates.

We know that secular bear markets last an average of 13.75 years. We also know that the secular bull market for the S&P ended in 2000. If this is a normal bear market, we can expect it to end between 2011 to 2018. And, given my fundamental view, I’d lean more to 2013 to 2018.

But if the second scenario comes to pass, we are looking at the DJIA. The bull market on the DJIA topped in 2007. This projects an end to the bear market in 2018 to 2024.

The question is do we have any signs which of the two are likely to play out. We have some indication based on a seasonal pattern I call the Xmas Rally.

The first part of my Xmas Rally runs from the Friday before options expiration (in 2008, Friday 19th) to December 23. We should see a higher close on December 23 for a bullish indication; a lower close for a bearish one.

The next part runs from Dec 27 to the second Friday in January - in this case, January 9. I would like to see a higher close for a bullish case. If we do see a higher close, then we are likely to see a higher close on January 31 when compared with December 31. A higher January close suggests the “January Effect” will lead to an up year in 2009. The same reasoning applies if we see lower closes ie favour a lower close on January 9. If that happens, I’ll expect to see the 1931 scenario play out.

Why?

Because we are currently in the 12-M (yearly trend) Primary Buy Zone. We need to see prices reject off the Buy Zone to confirm that it will provide a base to launch the next up move. If we see lower closes leading to a possibility of down year for 2009, we are more likely in the 1931 scenario rather than the 1966.

FIGURE 4 12-M DJIA

I’ll conclude this series tomorrow.

LOOKBACK ON NDTV PROFIT FOR DEC 15 2008:

Bookmark to:

First off an announcement: I am taking a Xmas break: Dec 24 to Dec 28. The next entry will be Dec 29.

I was going to start on the technical picture but a couple of e-mail questions need to be addressed:

• One asked why a little inflation was not a good thing?
• Another asked if I thought a Weimar Republic type inflation (wheelbarrows of money) was what I was envisaging when I use the words ‘inflation/hyperinflation’.

In answering Q1, we need to identify the roots of inflation: the creation of a money supply in excess of productivity. Given the amount created and the FED’s stated intent to create as much as necessary to ‘defeat’ the recession, speaking of ‘a little’ inflation is out of the question. I expect to see inflation rates at around 15%.

A book that paints a vivid picture the US faced such a situation is “The Great Inflation and Its Aftermath” by R Samuelson. You’ll see the negative consequences of inflation in the book.

Q2: As a best guess, at this point, I’d say probably not. I expect to see action taken long before that happens. But we don’t need to see that type of inflation to see a second sub-prime type crisis.

My blogs, “The Sub-Prime Second Wave? I - III” have outlined the probability of a second coming without an increase in interest rates, and this will most probably come given the expansion of the money supply. That being the case, if inflation does rear its ugly head, we’ll see an even greater credit crisis.

Bookmark to:

First off - have a very Merry Xmas and a fabulous 2009!

Today I am continuing with the series and will be considering the cost of the bailouts. Before I do that let me give you my two main sources of data:

• Shadow Stats
• ECRI

Shadow Stats produces data that provide an accurate picture of the US economy and ECRI have fabulous leading indicators.

My perspective of the FED bailout is based on Austrian economics. To have a thorough overview go to:

http://mises.org/story/3128

In essence, the Austrian school believes that an expansion of the money supply without a corresponding increase in productivity will lead to inflation. But, wait a minute you say, M3 has declined back to 8.9% after hitting a peak of 17%. So where’s the problem.

The problem is highlighted in the St. Louis Fed’s Adjusted Monetary Base. This is the tool traditionally used by the FED to control the money supply. It now stands at up 97.5% from the year before. Prior to the FED ‘bailout’, we had a growth of 3%! So what does that tell us? It tells us banks are still not lending. When they do, watch out! The FED will have no option but to increase rates.

Even without increasing rates, the US was in danger of a sub-prime second wave tsunami. An increase would just about nail the coffin down. The inflation following the bailouts is going to be far worse than the The Great Inflation. In my view, the inflation and its consequences will bring about a deflation.

That’s the fundamental picture - what about the technicals? Tomorrow.

Bookmark to: