The End of Denial
By Frank Barbera CMT. October 2, 2007
Well, let's see, that wasn't dramatic, was it? I mean, it’s not like anyone jumped off the 100th floor of the Empire State Building, or leaped in front of an oncoming bus. No, it was more like an ant being squashed by a steam-roller going forward and then backward several times. Seriously, down 299 points in 105 minutes, (that's almost 3 points per minute on the DJIA); good thing there's no volatility in the stock market. I mean, that was Unreal! At 11:14 the DJIA was +48.04, and then at the first stroke of 11:16 it was down -106.73, and falling with a vengeance. Hope you didn't blink an eye and hope you had your Mylanta, Tums or whatever other antacid of choice with you post the Fed announcement. Clearly, those dimbo's at the Fed just don't get it. At least, that's what Wall Street was saying with today's violent Post Fed announcement sell off.
Jim Cramer certainly agrees, viewing his post Fed emotional collapse on CNBC, one can only imagine how many chairs would have flying through the air aimed at Mr. Bernanke, had there been a post-Fed announcement Cramer-Bernanke forum. Hey, that's a good idea, perhaps Cramer and Bernanke with dueling swords ‘mano-a-mano’ – Don't laugh, this would probably boost ratings at CNBC, and give us all something interesting to watch, distracting us while the economy sinks into the credit crunch abyss. Had they been in the same room, the Cramer barrage of loud noises and roaring bear sounds would have been positively deafening. What a spectacle it would have been and what a shame no one else has done it. For the Ratings Game, the Day Time Soaps would never have had a fighting chance.
Histrionics aside, after romping up 9% in the last 9 to 10 days, you had to be weary that anything on the order of a consensus outcome from today's Fed meeting would be met with violent protestations. The argument, the loophole, and the wiggle room was all there, had the Fed wanted to cut by 50 basis points. Just look at the news over the last two days; Washington Mutual, Bank America, UBS, Freddie Mac, one disastrous piece of news after another. At the same time, the One Year Libor Rate overseas has been moving higher in the last few weeks, away from Fed Funds, a sure fire sign that the credit markets remain roiled.
So what does it all mean? In our view, while the Wall Street establishment may be trying to Buffalo the new Fed Chair into drastic action on rate cuts, at least this writer isn't so sure the Fed didn't do the right thing. Think about it. Had the Fed gone with a 1/2 point cut on Fed Funds, and maybe a 3/4 point cut in the Discount Rate as some of the big Wall Street Bulls have hoped, there is a really good chance that the US Dollar would have fallen out of bed. Not that it hasn't already fallen out of bed, but it could have resumed the gut wrenching decline. In addition, it is also very possible that had the Fed made the aggressive move, that the markets might have construed that action as an act of desperation given that the economy is supposedly growing 5%.
Don't you just love our economic statistical capabilities. The 3% CPI is the one that really gets my goat. Com'on guys -- 3% CPI, no way! Whose kidding who? Seriously, had the Fed cut 1/2 point, Wall Street would have likely sold the market off on the grounds that this was the act of an emergency cut, and that by default things in the credit markets must be falling off a cliff and therefore, SELL and let 5% GDP be damned. Thus, had they gone aggressive, they probably would have had a falling stock market and a falling currency, while at least with the gradualism, we only have a falling stock market.
I say this �tongue in cheek� because the real point in all of this is that we are in a mega bust. The root of the problem is the bad debt and credit boom that dates back to 2005 and 2006, and while busts have always generated interventionist policies from the powers that be to attempt at ameliorating the problem, in the end, all the lever pulling in the world doesn't change the direction of the primary trend. For anyone who remembers the Nikkei 225 and the Japanese Post Office Land Boom of the mid and late 1980's, once that was over and the bubble popped, that was it -- it was DONE, DONE, DONE for years. Gold in 1980, Gaming stocks in 1979, Energy Stocks in 1980, Internet and Technology stocks in 2000 -- same outcome every time; once they pop, it's on to the next arena. A good friend of mine told me early in my career, �Frank, there is always another casino.� A bit crude, but accurate. As one bull market ends, inexorably the down fall of one arena opens up opportunity somewhere else. Government intervention only staves off and delays the un-delayable. I remember with the Nikkei, every year, in order to save the Banks, the BOJ would manipulate the Nikkei back above 16,000 for the close of tax season in March, and then every year immediately in the wake of the �managed� rally, the market would roll over with the market going down for 14 years and losing over 70%. Yes, the BOJ successfully stretched out the problem, but they sure didn't make it all go away.
So it is today. The US is entering a very difficult period, and investors need to be attuned to priority Number One�don't lose valuable capital. This means being very attentive to potential risks, and looking always at both sides of the equation, and when initiating a trade, knowing in advance how much risk you plan to take, and precisely where you draw your line in the sand in order to get out. In rising markets, where the trend is strongly higher, it is easy to make money and everyone is a genius. In down markets, that algorithm is inverted, as down markets are designed to separate investors from capital, with the bottom of the downside cycle yielding the uncontrolled panic phone call to the trading desk -- �Get me out NOW!� This is the scene of despondency, desperation and capitulation which attends panic sell offs in down markets. In the chart below, we trace the human emotional side of the cycle for you, with this author�s opinion that right now, Denial marks the current stage for this cycle.
Why Denial? Simply because despite the collapse of untold businesses, and the virtual shut down of key credit markets, markets have tried to look past the problems on the hope that the Fed or Powers that be would come riding to the rescue. Today's market was significant, and all investors should take careful note. Today, was the first day that the stock market publicly questioned the Fed, in its own way saying, �things are really bad, so what are you going to do about it?� That is a sign of situational awareness, and that is a sign that we are moving from avoiding the recognition of the problem to confronting and peering toward the problem. Looking at the problem, the market sees fear, the next step in the down market, and for that reason, today represents a big psychological downshift for the stock market. Just how big, we cannot know, but the days ahead will tell the tale. It is been my experience in a now nearly 27 year career watching stock prices that the �persistency of selling� is the key ingredient to watch over the next 5 to 10 days. Can the market bounce, can it sustain a bounce, how long can it sustain a bounce, or does it continue to crater all the way back to the November 26th lows?
Above: The �Good� outcome, where prices hold up into the New Year, 1440 support is key.
As we see it, the likely best case outcome for the S&P would be for the index to move down over the next 5 to 8 days and test the .618 fibonacci to .66 two thirds retracement level at 1440. If the S&P can hold at that level, and possibly set up a small double bottom, then there may be hope for a rally back up toward today's highs heading into the New Year. Yet, in the scheme of things, the Head and Shoulder Top thesis took a huge step forward with today's rally failure and key reversal day down. If there is a next time and prices approach today's high, sellers will come out. For us, the 1390 to 1400 level remains the key medium to long term support threshold for the S&P. Could denial squeak out an inning or two more? Maybe, but at the very least today's wide range downside reversal day tells us that the days of denial are now counting down, if not already over. Broad market psychology never turns overnight, but with this turn, odds are high that a sell strength mentality will soon garner the upper hand.
So where do things get really ugly? Where does the point come where the vast crowd wishes they had sold today? On the charts, the weak Death Spiral scenario representing the dead on confrontation with Fear, see�s the S&P launch one or two small short covering rallies contained under 1490 over the next week or so, with short term lows near 1465, followed by a resumption of the aggressive selling and more bad news. Slippage becomes the order of the day and quietly or not so quietly the S&P slips below the November lows. Breaking below 1400, the index violates the 200 day lower band falling toward the low 1300 area. The last gasp of Denial then carries the day with a failing rally back to the underside of the Double Top structure with 1420 to 1425 strong resistance. The feeling on behalf of the crowd is often most intensely hopeful on these short but powerful up thrusts from below the topping structure. They are easy rallies to get suckered back in, yet they evaporate like a mirage in the desert and yield new lows and snowballing downside momentum within almost no time at all. It is the striking contrast of fleeting hope followed by a crushing downward thrust in close succession which is the anatomy of a pre-crash lead in pattern.
Above: the �Bad� and the �Ugly� outcome all rolled into one, prices slip 1440, then slip 1400-1390, and with that, the dye for a tumbling stock market will be cast.
Years ago, RN Elliott named this pattern an �Irregular Flat� which in this case, where Fear is really gaining the upper hand, becomes a downside �running correction,� a pattern I named the �Magnitude Failure� years ago. It is a pre-crash pattern -- a pattern that when it shows demands major attention as the pattern almost always leads to a waterfall style collapse. Only time will tell which outcome we will face, but gauging from the unleashed radical credit contraction now rampaging through this country's bond markets, combined with the un-maneuverable and rudderless Fed, today's reversal looks like a direct hit amidships and has all the earmarks of something not to be trifled with. Watch 1440 closely; if it can’thold, the market will likely be in major trouble within short order. It may already have taken a huge step in that direction as today's selling sounded like the End of Denial.
At the close, the DJIA ended down �299.82 at 13,427.81 for a loss of 2.18%, with the S&P 500 down 38.31 index points at 1477.65, for a loss of 2.53%. NASDAQ was also sharply lower, ending at 2652.87, down 66.08 index points for a loss of 2.43%, while the 10 Year Bond plunged to a reading of 3.99%, down .16 basis points.
© 2007 Frank Barbera