Technical Summary
The BSI turned up sharply but is still short of being positive and has the system on Neutral since August 24, 07. Short term Harmonics are suggesting a 3 month cycle high bounce into September followed by more weakness from the 8, 12 and 18 month cycle lows all due in October. With the shallow 4 year cycle low in 2006 and the rise in volatility we should continue to be vigilant for a delayed 4 year cycle low like we saw in the 1982-87 cycle.
Economic Summary
The partial demise of hedge funds from the high volatility caused by the flight to safety in light of subprime defaults, is not unlike the 1998 LTCM hedge fund collapse from the rise in volatility and flight to safety from the Russian defaults. If this LTCM episode in 1998 is any guide, we should see further weakness later on this Fall as all the losses are fully known. The Economic Dashboard suggests a high level of caution since Inflation expectations remain as high as in 1987, and the Yield Curve is also high like in 1990 and 2000 which were both followed by recessions. With the US Dollar precariously low compared to US Interest rates we could see further market deterioration if US Bonds decline in value and rates rise or the US Dollar declines further causing a financial shock. While the 2006 Yield Curve inversion predicts a recession in 2008, the Volatility model suggests one will occur near 2013, unless we get a 1974 style recession or a deep pullback like in 1987, both of which also occurred after decade lows in Volatility like we just had in 2006.Breadth Summation Index
The BSI turned up sharply from very oversold levels which normally suggests the beginning of a late year rally in the weeks ahead. However the short-term components are very overbought while the long-term components did not get very oversold, warning that we may have to see further weakness before it is safe to buy. Since the BSI has been making lower lows since 2006, and the zero line also happens to be near the resistance of those declining lows, we should use that line as the Bull-Bear case line.
Cycle Harmonics
The 3 month cycle has given us a sharp rally from the August 16th low, and its positive effect should last about 6 weeks into late September. However a number of cycles are pulling down the market into October, and may shorten the positive effect of the 3 month cycle, especially with 3 different cycles pointing down into October. The most well known is the seasonal 12 month cycle, but we also expect the 8 and 18 month cycle to bottom towards the end of October.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
Flight to safety from subprime defaults cause hedge fund troubles, 1998 revisited
The partial demise of hedge funds from the high volatility caused by the subprime defaults, is not unlike the 1998 LTCM hedge fund collapse from the rise in volatility caused by the flight to safety from the Russian defaults. If this LTCM episode in 1998 is any guide, we should see further weakness later on this Fall as all the losses are fully known.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
Venus Retrogrades
The orbit of Venus is 225 days or a Fibonnaci 0.616 of the Earth's orbit and Venus overtakes the Earth about every 19 months as it races around the Sun. This behavior is seen from the Earth as an apparent backward movement of Venus called a retrograde period. Most of these retrograde dates coincide with turns in the market of varying significance, the most noteworthy being the exact low of the 2000-2002 bear market on October 10, 2002. Over the last 16 Venus retrograde periods, only the 1987 and 1991 dates were difficult and not very profitable. Five of the retrograde periods were exact matches for the highs and lows in May 2004, October 2002, October 1995, March 1993, and May 1988, while nine others were close matches and profitable.
This Venus retorgrade period is acting a lot like 1999, and we must watch the September 8th date for a possible significant turn date, and possibly a high like in 1999.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
The 4 year cycle low is well known and not to be ignored
A warning comes to us from the reliable 4 year cycle lows as shown in this chart of the SPX since 1948. Only a few of the 4 year cycle lows have been minor, and it could be argued that the 1987 crash was the delayed effect of the suppressed 1986 cycle low. With Global Equities on the rise since the last cycle low in 2002 and a correction overdue, we must be very cautious even into 2007 until Equities correct significantly. Also take note that years ending in 3 and 7 are 75% more likely to have a serious decline than any other years.
Charts courtesy of DecisionPoint.com
Charts courtesy of DecisionPoint.com
Economic Dashboard: Bonds, Inflation and Capital flows
The rapid economic expansion since 2003 has caused the Yield curve (white line) to rise rapidly to levels last seen in 1989 and 2000
just before economic contractions began. The contraction that started in 1989 was mild since the relative position of the US Dollar
versus US Interest Rates (red line) was favorable and Inflation expections (blue line) were recovering. The next economic expansion
that ended in 2000 was fueled by an exceptional "Goldilocks" combination of slowly rising Yield curve (white line) and declining
Inflation expectations (blue line) mostly from a rising US Dollar from foreign Capital Inflows (red line). The contraction that
followed the expansion of 2000 was severe, but not enough to significantly slow foreign Capital Inflows (red line) which kept
long-term Rates low and started a sharp recovery into 2007 mostly from mortgages. According to the Yield Curve (white line) we are
near the end of this economic expansion, and with high Inflation expectations like in 1987, and high Capital Inflows like in 2000,
this coming contraction could be severe as well.
Bond Market Cash Flows - A strong economy causes the Yield curve to flatten (white line to rise) as earnings grow and extra
cash flows to the Bond market, causing rates to drop and fueling the economic growth even more. As the Economy overheats and
Inflation rises, the Fed raises rates causing the Yield curve to invert and the process to reverse with cash flowing out of the bond
market to replace declining revenues from the economic contraction, causing rates to rise and aggravating the contraction even more.
Inflation Expectations - When Gold is stronger than Commodities (blue line declining), we have high Inflation expectations
that should cause the Fed to raise rates to slow economic growth and keep inflation under control.
Capital Inflows - When the US Dollar is stronger than Rates (red line rising) it is suggestive of foreign inflows and
supportive of US Assets.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
The Yield Curve Inversion and the Fed pause add up to caution
Contrary to popular belief, Equities have already achieved most of their gains when the Fed stops raising Rates, especially when the Yield Curve goes inverted like we had in 2006. This can be seen in the corrections in Equities after the Fed paused in 1981, 1989, 2001 and now probably 2006. The reverse also applies, it is best to buy Equities after the Fed ends an aggressive Rate easing campaign that takes the Yield Curve well below the average 1-3% spread, like in 1982, 1987, 1992 and 2003.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
Recession Watch
The Yield Curve inversion is widely known to have successfully predicted recessions and this over many decades. We have had a significant Yield Curve inversion in 2006 similar to the one in 2000, and both were stronger than the one in 1989. Since the last three Yield Curve inversions gave us recessions in 1981, 1990 and 2001, many are watching this indicator and expecting a recession in the next 12 months. I have also discovered another good predictor of recessions, based on the correlation between Solar Sunspot and ouput cycles and the Volatility index (VIX) . Recessions almost always occur after extended periods of Volatility that disrupts normal functioning of the economy like in 1960, 1970, 1981, 1990 and 2001. The single exception was the 1974 recession which was probably a continuation of the one started in 1970. While this model predicts a recession will occur near 2013, another 1974 like recession near the low of the cycle is possible in 2008 according to the Yield Curve inversion in 2006.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com
Liquidity induced Bubble Watch
After the roaring Twenties took debt to 270% of GDP in an unsustainable way, the collapse of this debt led to the great Depression, WWII, and a distinct distrust of paper assets and debt. Debt levels then returned to a more manageable 150% of GDP before rising again, mostly from the growth of mortgages as the real estate and commodities bubble took hold in the late 1970's. When these real asset bubbles collapsed, much of the funds moved to the Nikkei forming another bubble and pushing the Yen sharply higher in the late 1980's. Once the Japanese bubble collapsed, funds flowed back to US and European markets fueling their rise in the late 1990's, and confirmed by the rising US Dollar. The ensuing US market collapse of 2000 sent the funds back into real assets like Commodities and Real Estate, but this time embracing even more debt and leverage to 350% of GDP. We have phenomenal growth of credit in absolute terms too, with US Treasuries and total credit both expanded 9-10 times since the first bubble formed 27 years ago. Since we are already seeing the first flight away from risky paper, history is likely to repeat itself, and 60% of this debt will be eventually wiped out mostly worthless in the next 5 to 15 years.
Charts courtesy of StockCharts.com
Charts courtesy of StockCharts.com