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T-Waves Market Thoughts and Technical Perspective

by Stephen Tetreault, T-Waves | July 28, 2009

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I believe unlike those on the various bubble-vision networks that we are in now in the top/bottom of the ninth inning in this proverbial game with regard toward this huge swell of bullish tonality and the rally off of the march Lows and as such we need to forge ahead in a very cautionary environment (especially if you are induced into taking on new long positions, by the spinsters/hypsters) as we are now trending in my opinion within a proverbial mine field and one slip and boom/bang…a bouncing betty will trigger and cut you in half…one false move and this house of cards will come tumbling down.

Its very important that you remember that stocks drop 3-5x faster than they rise, and any disappointments or negative news at these nose bleed valuation levels (yes we can all hope that we will grow into these valuations over the next 2-3 years) will be dealt with severely and quickly....so please remember that when in doubt, stay-out, if you enter the game in an attempt to enrich your investments please keep your share size manageable and utilize good money management techniques that I have emphasized and taught many times until we can once again see an trend establish itself. The Big question has still yet to be resolved and that is whether the market is undergoing another major shift in sentiment after the patriotic rally or now that we have reached an all-time high in the Russell-2000 and 4-year highs in the SPX and Nasdog will it stall-out and then resume the downtrend that was in process, this is the 11th day after that knee-jerk (liquidity infused rally, and as such we are ripe for a pull back…the Weekly/Daily and 180/120/60 minute charts are extremely overbought and we are start to see significant signs of distribution on a rotating sector basis into strength (see technical sectors below) .

In the 1987 film classic "Wall Street," actor Michael Douglas, when portraying Gekko, proclaimed: “Greed - for lack of a better word - is good. Greed is right. Greed works.” What he failed to state is that greed creates massive pain for the herd….as it keeps the masses feeding on Loco-weed far to long as the wall-street wolves and worse yet grizzly-bears circle around and in for the kill…please do not take this the wrong way. When it comes to trading/investing, in particular, there's nothing wrong with being just a little bit greedy. After all, someone's going to make the some nice profits off of the herd psychology so why not us….but the key to reaping profits is knowing when to book them, and far to many folks just let them ride and subsequent erode! The new mantra on bubblevision is that Americans will once again be excited about stocks and start to venture back into the markets now that the indexes have made new highs, and regained all of the losses for the year and then some!

On Friday there were little in the way of economic reports to restrain what I believe is irrational bullish enthusiasm. The only report of note was the Consumer Sentiment Survey for July and the headline number came in at 66.0; which was 2 points better than the initial reading for July and this was still 5 points below the 70.8 reading posted in June a bearish reading. The biggest decline came in the expectations component (again not a bullish reading), which fell to 63.2 from 69.2. The present conditions component dropped to 70.5 from 73.2 and the 66.0 headline number was the lowest reading since April. Likely factors causing the drop-off included significant job losses in June, continued house price declines and a huge ramp up in foreclosures, while the rise in interest rates hurt and likely cut off much need refinancing efforts and when coupled with concerns over the massive jamb-down-your throat changes happening in Washington.

The economic calendar this week could be market moving as we have a couple of high profile economic releases….and events the Beige Book and the GDP report for the second quarter. The Fed Beige Book on Wednesday will be an update from the regional federal-reserves on the economic conditions in all of the 12 regions….this could be a huge market mover….the bulls are hoping and praying that we could see another wave of positive economic conditions heading into 2009Q3; the bears are looking for the mitigation in the green-shoot trend and cheerleading. This is likely going to be an important preview of the impending 2-day Fed meeting that will start in 2-weeks. Looming late in the week is the second quarter GDP report on Friday and it also better be stellar or the green-shoot-cheerleaders will abruptle be forced to scramble for the exits. The last reading on the Q1 GDP was a drop of 5.49%. Now the estimates for the 2009Q2 GDP range from a -1.4% to 2.0%. Any reading in distinct positive territory could prompt rally in the market. The consensus opinion is closer to a -1.5% decline, which would be a major improvement but still inline with what the market is now expecting….the whisper numbers are at 0.9-1.2%.

A Typical Climax-Top?

Through my research and experience folks a climax run/top usually appears after index/sector/stock/commodity has gained 70-75% or more from their reversal breakouts consolidation and then it suddenly moves into a fast-break or gallop higher and soars 15% to 25% or more within one to three weeks despite what appears to be a distinct deteriorating earnings and an economic environment that is very lackluster. When this happens the various stocks/indexes/ETF’s go on a climax run and blasts up to new relative highs, then positive news begins to circulate and then the so-called bullish sentiment and tonality in these indexes/sectors/stocks etc. becomes an everyday mantra with euphoric headlines popping up for daily in all the major financial media for days on end….and we see that the market sheep (herd-followers) as I call them are sucked right into the frenzy and the herd/crowd buys into the hype and jive and they begin bidding up shares at any cost.

I have learnt that when this situation develops it usually means few buyers are left to push and add liquidity to send the indexes/sectors/stock higher. Hence for those who have followed my writings and research for many years I have always been very-skeptical of buying when there is such bullishness with non-conforming volume or real buying sentiment as historically it suggests that we should be Selling into this manipulated strength and the euphoric excitement and not to follow the giddy herd into wildly buying into this type of climatic wave of giddiness, for more than a day trade… I have said many times (out-side of following real trends which are confirmed with real volume and money-flow) we want to sell tops and buy when others are selling…that is how we have historically made above average returns (especially for our value play portfolio)…never forgetting to utilize and practice high-quality money management practices as I repeatedly preach day in and day out!

I have found that in most cases during a climax top/run, the index/sector/stock etc. will rise in price 9-11+/- days out of 12 straight days before it tops and rolls over, and the last 1-3-days are strangely-bullish…as it may also post the greatest one-day price gain on the highest volume since the start of its recent advance.

Climax Tops often precede future weakness in the economy/sector/company's fundamentals…and quite often we have seen that if we totally ignore forecasting, and the analysis of market trends, economic data, and various business cycles and we decide to run with the blinded giddy heard; we could get burned badly as when we take the rose rose-colored glasses, and iPod playing the redundant tune “Lets part like its 1999” from the various cheerleaders and come down to reality it could be far to late as your various investment positions in the various indexes/sectors/stocks might have already tanked, stripping away most if not all of your recent gains. I call this last surge the bag-holder hand-off, as quite often these new investors take on the proverbial look of “a deer caught in the headlights of an 18-wheeler bearing down on them” as the watch stocks sell-off, while they keep trying to buy on the dips, and recant that its only a minor blip!

I have written about before the distinct 4-stages or cycles of markets…and these stages/cycles have been written about in great detail by many great authors and they are strong-patterns that should not be ignored no matter what the cheerleaders on the various bubble-vision say…I will not go on in depth here I will save it for another week, but just for simplistic sake there are 4-distinct phases/cycles of markets and they can be summed up basically as a basing, an advancing, a topping and lastly a decline cycle/period. And by my assessment we are in the topping phase/cycle right now, and that we are very quickly approaching what I call the top of this recent distribution phase.

I want to emphasis that what I call a distribution phase can be an very emotional time for the market bullish participants as they are gripped by periods of fear, then interspersed with blasts hope, and periods of extreme euphoric sentiment and even greed as the various stocks, indexes and maybe the markets as a whole may at times appear to be taking off again after a brief and shallow correction/retracement that the media and hypsters sing out loudly as a huge-buying opportunities.

The price action during the past 2-weeks following the Sell-signals that were clearly generated this month can only be described as a monstrous manipulated bear-trap (caught my proverbial ass as well)! We got sell signals, and they appeared to be very solid and decent ones!

Even though rising prices (for a bull during the stealth bull market) is a very positive signal this very vicious rally that followed clear technical and fundamental sell-signals is sounding my alarm bells, as while it can be entertaining to gloat at the crushing of the bears (as Cramer so often does….*he missed the bear market entirely as he hyped stocks all the way down, saying just buy more at lower prices), however these fools like him must take a moment and look in the proverbial mirror, as I believe they are the next idiots to be pondering how was it that they were caught in a very vicious bull-trap!

This is a vicious market to say the least and whether one is a bull or a bear…I caution you both, as you need to be on guard every-day as trading desks and hedge funds employing massive leverage, their internal-trading-desks front-running and trading opposite their clients and brokerage firm upgrades and downgrades and what is called high-frequency trading (what is suddenly one of the most talked-about and mysterious forces in the markets today…powerful computers housed right nest to the NYSE computers enabling high-frequency traders like GS, MS, BAC, to transmit millions of orders at lightning speed reaping billions at everyone else’s expense as they front run and run-stops that they can see.)

This stock market is no longer determined by fundamentals nor technicals nor free market forces but by the desperation of governments with insiders called the mustn’t tock-banks, central banks and policymakers hell bent to give the impression that they have averted an economic crisis of monstrous proportions which in the end will be inevitable, and bleed Americans dry!

The Dow’s recent price action has caused me to shout at the nuts on CNBC and rant and rave at my loved ones who bear the brunt of my dismay and frustrations. It’s so blatant that the, PPT are back to their old tricks again of propping up the stock-market under the direction of Supreme Commander Obama and Admiral Emanuel, not to mention bubble-creator B-52 General Bernanke and that lamebrain Treasury Secretary hyping a strong dollar while smashing it every chance he gets Colonel Klink-Geithner!

Never mind that the current stimulus package is a complete dud and that real unemployment numbers are at mid to high double-digits. They have employed the best of the best cheerleaders and hypsters/spin-doctors in order to keep the market up so as to give the illusion the numbskull economic policies of the United Socialist of America who are forever looking to expand Government-run cartels/monopolies.

At the sound of becoming a broken record....these once semi-free markets (as free as they could have been) are now determined by various government policies around the globe especially our-government). The stock market crash in 2008 won the democrats the election, so they think if they prop it up for the next year, it will win them even more seats in congress and the senate during the mid-term elections.

I have been stating for over a month now that volumes that I have seen in over 14-years (the lightest volume ever for such a mysterious-monstrous rally) and these anemic volume makes it very easy for the PPT-team manipulators to manipulate the market. The bulls are arguing that earnings season is better than expected which means the economy has bottomed and is on the road to recovery. However they fail to point out that estimates were extremely pessimistic in the first place and that profit growth has been due to massive cost-cutting deferments in capital spending, postponement in tax-payments and worse of all deferments in funding pension-plans and healthcare plans and in many cases suspension of 401-k contributions, as for the most part the beats have not come from an increase in revenue. The “better than expected” and “green-shoot” mantras have been lifting markets due to Pavlov’s-old-premise of conditioning into to bubble territory.

The Obama administration is in full spin mode. The media will almost do anything to bring a quick end to the recession. They even took Dr. Doom's Nouriel Roubini comments last week and twisted them which also gave the markets a boost. No one cares about employment data anymore (the bulls will say this is lagging data) and house prices no longer figures into the equation as the bubblevision networks down play the significance of the data (unless they can spin it positive). We are in dangerous times. Instead of taking their medicine, our elected folks running this lamebrain government have once again opted for another attempted at a quick fix and their cronies are obliging. This may give the markets a short term boost but will result in a devastating second leg down for the economy and a very nasty down leg for the markets taking us to plunging new-lows.

Coming off its best two-week rally in many years, our indexes will start off the week ahead at their best levels this year…what a surprise, all those trapped from the drop-off in January now have a chance at breaking-even. Whether this climb continues likely depends on hype, hops-prayers and market manipulation that will be subjected somewhat by earnings, economic data and Treasury auctions.

It seems entirely appropriate that as we approach the 40th anniversary of the landing on the moon that the markets are nearing their parabolic rocket ride to the moon, what irony huh. Capping a week that had the Dow back above 9,000 (almost above 9,100) for the first time since early January, the Dow on Friday added another 23.95 points, to end the week at 9,093.24, leaving it 4.05% higher on the week and at its highest closing since 11/5/2008. The SPX-500 rose 2.97 points, to close out this week at 979.26, gaining 4.1% on the week. The Nasdog due to weakness in some big-cap players snapped a 12- session winning streak, dropping 7.64 points on Friday to close out the week at 1,965.96, up 4.2% on the week. Crude prices gained 7.1% for the week, with crude closing at $68.05 a barrel on Friday!

Of the 500 firms in the SPX-500, 181 firms or 36% have reported quarterly results, which were down on average 26% from the year-ago quarter, vs. consensus estimates calling for a drop of 36% (a better then worse case scenario…meaning these firms beat their massaged and overly pessimistic lowered earnings {EPS} though most have not meet revenue-expectations). So far this earnings season, 71% have beat earnings estimates, beating the historic 20-year average of 61%.

The economic calendar picks up in coming days, as Tuesday's consumer-confidence index and Wednesday's durable-goods report could be market drivers as these reports are especially important in this very sentiment-driven market. Not to mention Friday’s GDP-release! This Christmas-in-July market utopia won't last forever and could evaporate as quickly as it developed when the earnings-reporting season begins to wind down, and firms are forced to issue their 10k’s that will show just how really putrid their real-earnings were as 10k’s do not report in the pro forma arena!

Investors will likely need to keep very close tabs at the impending Treasury auctions this week as they are monstrous…this week will be only the second time the Treasury auctions three so-called coupon issues and an inflation-linked maturity in a five-day period since the U.S. started selling debt regularly back in 1976 and as our debt-ridden government accelerates their unprecedented pace of borrowing to stimulate the economy and service ballooning deficits.

This week’s supply needing to be sold still carries a lot of shock value….the U.S. plans to sell $6 billion in 20-year Treasury Inflation Protected Securities, $42 billion in 2-year notes, $39 billion in 5-year securities, and $28 billion in notes maturing in seven years…a whopping $115.00 billion, not to mention and $90 billion of three and six-month and one-year bills….and this is just this next week; the auctions will be held over four consecutive days starting on Monday. The previous record was $104 billion in 2, 5, and 7-year notes sold the week of 6/22/2009. What is a big surprise is the huge increase in issuance in the front end of the curve. There is a realization that you can’t rely only buying on the back end of the curve; due to increased fears of hyper inflation. The government more than doubled note and bond offerings to $963 billion in the first half of 2009 as it attempts to ratchet up the printing presses in an attempt to soften the landing of this economic recession. They are scheduled to likely sell another $1.1-1.3 trillion by year-end, according to primary dealer Barclays Plc.

Obama is depending on foreign investors like China as he sells record amounts of debt to stimulate the economy and service unprecedented deficits. China, the largest foreign holder of U.S. debt with $801.5 billion, added net $38 billion to its holdings in May, according to Treasury data. Russia, Japan, and Caribbean banking centers reduced their holdings.

Lower prices for U.S. debt today may reflect investor concern that demand for Treasuries will be weak at current prices. You are already getting a concession in yields this past week! If equities begin to struggle and don’t follow through on this manipulated rally you will find plenty of demand at those auctions (hum, setting up for a manipulated plunge in stocks to increase demand for bonds…a likely scenario), but if demand wanes it could be disastrous as there will be plenty more issuances coming.

Treasury auctions have been a point of deep concern for investors this year. The fear is that demand for government debt will weaken or plunge, considering the vast of amounts the Treasury is issuing to help fund the deficit, taxpayer-bailouts and the stimulus programs. If that happens, the government would be forced to vastly increase returns on the bonds it offers to sweeten the deal and entice buyers, subsequently hiking up borrowing costs for consumers and possibly even snuffing out the economy's recovery.

The government and the Fed have spent, lent or committed more than $14 trillion in a bid to revive the economy and credit markets already and the amount keeps building. The budget deficit this year is projected to reach $1.85-$2.0 trillion, equivalent to 13.9% of the nation’s GDP, according to the nonpartisan Congressional Budget Office (but they have been given little press on their assumptions). I am not hoping the auctions go poorly, but I am concerned whether or not these things will be fully subscribed.

The market's fixation remains on pro forma earnings (beating the EPS expectations at any expense), but I really question whether the market has gone extremely too far, too fast, sprinting from being overly pessimistic to overly optimistic…on hopes & prayers (the Field of Dreams scenario).

I guarantee what is going to happen this week, but when sentiment gets this bullish, and people are very complacent (as evidenced by the VIX [the Chicago Options Exchange Volatility Index], there is bound to be a dramatic pullback (bull-trap), and it feels like it's going to be sooner rather than later. The stock market is starting to write checks that firms and real-fundamentals in the deteriorating economy are going to have extreme trouble cashing. Wall Street and Congress created silly-ass investment vehicles to facilitate the barrage of consumers over consumption, and then it spread this shit all over the world; stinking up the whole planet. I still believe that we have a massive amount of deleveraging still ahead. Unlike Las Vegas, what happens on Wall Street doesn't stay on Wall Street…they manage to spread their toxic crap to everyone else as they employe the very best sales-people who could sell water to a fish!

Please Note My turn wave forecast is getting significantly stronger, and it pointing toward a HUGE inflection period ahead, the window is tightening as we get nearer to the potential turn....and according to my wave analysis we have multiple waves converging and a major Inflection & Fibonacci collision possibility hitting the overall markets on/between 7/23 and 7/28 and since we have been in strong bullish up-trend from the March 6th lows This corrective wave could be (key-word could) be the start of a significant major Bearish corrective period ...my system and analysis is telling me that this could be a very significant correction period lasting 18-27 trading days...with the potential for a slight retracement after the initial down-cycle then another downward corrective wave will likely play...it could be that we have seen an options-X fake out, and that we will reverse abruptly on heavy volume and take out the previously forecasted head & shoulder necklines (I have seen light volume fake-out reversals before)

Interesting confluence of seasonal fundamental along with technical indicators and elements are converging in my opinion. Most importantly we have opened up a significant topside gap between the 55 and 200 day simple moving averages (~15-point gap) and this appears to be the widest gap between these averages since 1986. As such these technicals suggest the potential for a rapid move towards the 200 day moving average now at 45+/- a very distinct probability…it’s also note worthy that the 61.8% fib come into play at 45.65+/- as well. The last time we saw a good move of this magnitude (a doubling of volatility) was in November 2008. This technical analysis is backed up by highly suspicious options trading (huge call position out of the money $45’s, 50’s and 55 strike prices) during the past several weeks, strong seasonal trends and deteriorating stock market fundamentals. We also have a near-perfect falling wedge pattern setting up as well (see chart)

Recently we saw that a trader spent $946 million in pure premium on buying 22,000 July calls at the 45 strike while selling the same amount of 55 strike calls, thus lowering the overall premium to $0.425. The VIX hasn’t traded above 40 since April 21 and one would have to wonder what this trader knows that has yet to be made public.

We should reflect on the following

So if we look back over all these major years in over a quarter of a century (9 instances) in 7 of them the period from the 7/17/ to 7/26 we have begun a significant move lower in equities. In the 2 instances (1987 and 2008) that we did not immediately head lower we ended up with stock market crashes later in those years…..all in all an ominous set up…heading forward right at us so please be very cautions taking new-long-positions!

A potential market Contagion, The ballooning Powers of the Federal-Reserve!!
1

The Fed's balance sheet liabilities (a broad gauge of its lending to the financial system) decreased to $2.024 trillion on Wednesday from $2.057 trillion a week ago, Fed data showed (however their off sheet balance is estimated to have grown by 350-billion, nearly 14-15 trillion now). The week's decline stemmed from fewer loans to banks, less dollar lending overseas and a drop in commercial paper holdings. The Fed's liquidity swap lines with foreign central banks to provide dollars averaged $89.86 billion per day in the latest week, down from $111.78 billion per day in the prior week's average, according to Fed data. The dwindling CPFF program reflects the overall decline in the U.S. commercial paper market, as a still weak economy has sapped demand for working capital and firms have favored longer-term financings over short-term ones to lock in historically low rates.

The markets have ignored the FOMC statements wherein most Fed-heads judged the economy at risk to further shocks last month even as they rejected an expansion in asset purchases, reflecting doubt at the likely impact of such a move. “Most participants saw the economy as still quite weak and vulnerable to further adverse shocks,” the central bank said in minutes of the Federal Open Market Committee’s June 23-24 meeting released today in Washington. “Although financial market conditions had improved, credit was still quite tight in many sectors.”
Policy makers were concerned that consumer spending will resume its negative-trend/decline once temporary benefits to household incomes from the fiscal stimulus subside, the minutes indicated. Some officials also saw a danger of renewed declines in the housing market, in part as mortgage rates increase. **(seems strange that the markets would rally on this) At the same time, the FOMC concluded that it was best to keep its programs for purchasing Treasuries and mortgage debt unchanged. “Although an expansion of such purchases might provide additional support to the economy, the effects of further asset purchases, especially purchases of Treasury securities, on the economy and on inflation expectations were uncertain,” the minutes stated.

The Bernanke’s answer was basically I do not know to whom we gave billions or taxpayer dollars too…..This week I witnesses Congressman Alan Grayson questioned Bernanke when he appeared before Congress to present his fluffed and overly optimistic update on the economic crisis gripping America and much of the world. Congressman Grayson demanded details from Bernanke on a half trillion dollars in liquidity swaps to foreign central banks undertaken by the Federal Reserve, (apparently these transactions went under the radar and in the dead of night), Grayson noted that in 2007 these swaps with overseas central banks were a mere $20-24 billion, but had ballooned to a staggering $553 billion in 2008 with the onset of the Global Economic Crisis, and they are now estimated at 700-800 billion. The exchange between the two definitely made Bernanke very nervous; as he attempted to provide a distressed explanation regarding this massive transaction:

Bernanke: “Those are swaps that were done with foreign central banks...”
Grayson: “So who got the money?”
Bernanke: “Financial institutions in Europe and other countries...”
Grayson: “Which ones?”
Bernanke: “I don't know.”
Grayson: “More than half a trillion dollars and you don't know who got the money?”
Bernanke: “Um, um, the loans go to the central banks and they then put them out to their institutions...”

These credit swaps that exchanged American dollars for various foreign currencies were done without any consultation with elected officials, and they continue to be made at the whim of the Federal Reserve most likely due to requests and demands from the mustn’t touch too big the fail banks, that basically control our Federal Reserve…this amounts to more than $2,100 for every man, woman and child residing in the United States.
Bernanke cited that under section 14 of the Federal Reserve Act, the Fed's Open Market Committee (FOMC) can engage in swapping U.S. dollars with foreign central banks without any limitations, at any time, without any requirement for congressional scrutiny (so he was in essence saying, that he can do what ever he wants when ever he wants and no-one can override or do anything about it).

Never mind that the Federal Reserve Act was originally passed (I believe illegally as do most scholars) in 1913, nearly a century ago. I believe its safe to assume that no-one in 1913 contemplated that a small little group of lecherous greedy people would decide to hand out more than half a trillion dollars to foreigners at a whim. Grayson raised as an example that the little country of New Zealand, which received $9+ billion from the Fed, equated to an amount equal to $3,000 for every one of that nation's citizens (What was the money used for?). I believe this illegal bubble creating entity bill soon be fighting for its survival when the truth come out as it will about their under-handed dealing!

The future of our country is contained in a garbage bag. Or, rather, that's was the metaphor chosen by MSNBC's Dylan Ratigan, who hosted former New York State Governor Eliot Spitzer on his show this past week (see the show using this LINK, this is a decent video to watch). Is actually a pretty good description of the bank bailout and the Federal Reserve's much-maligned secrecy (no wonder CNBC didn’t want to renew Dylan’s contract as he’s slipped from being a cheerleader). Where does the garbage bag come in? The mystery bag is an analogy for the $14+ trillion in bad financial assets purchased by the Fed during the massive bank-taxpayer bailout. Ratigan argues the Fed has fought to conceal (and has basically flipped the bird to congress) exactly which assets it purchased from banks. The central bank has become “a Goodwill store for the banks,” Ratigan says, and kept the details of the bank rescue private. A massive Ponzi scheme according to Eliot Spitzer stated! Spitzer said “Let me tell you a dirty secret, the Fed has done a disastrous job since Paul Volcker left...They've created multiple bubbles without permitting the economy underneath it to grow.” “This is a Ponzi scheme, an inside job. It is outrageous. It is time for the Congress to say *Enough of this*.” Ratigan stated that “I feel as if the American has suffered the greatest theft and cover-up ever.”

A Bubble...forming and ballooning!

Emerging markets are on fire. From March 2nd through July 23rd, the EEM (iShares or the MCSI emerging market fund) increased from 19.86 to 35.86 a whopping 80.50% the sector's strongest rally ever over so brief a period; and most of the talking bubble-heads and paid analysts that get bonuses to pump up their accounts in order to attract new monies are stating that it is not too late at all to hop aboard this train! Of course we have to keep in mind that the index plummeted 65% from October 29, 2007 ($55.73) until March 2nd 2009. That means emerging markets are still trading at little more than half of where they were 18 months ago.

Emerging markets (those developing nations that used to be called the “Third World” like India, China, Turkey Thailand, Brazil and India have been hotter than a blazing inferno. The MSCI Emerging Markets index has gained 45% so far this year, a huge imbalance when compared to the U.S….and bubble-investors those late to the party have noticed, pouring $10.6 billion into emerging-markets mutual funds so far this year, or more than 34 times the total they added into U.S. stock funds (a mega imbalance and a bubble in the making in my opinion). The iShares MSCI Emerging Markets Index Fund “EEM” is now the fourth-biggest of all exchange-traded funds, with $31 billion in assets. Nevertheless stocks have soared and so have valuations. In 2008, as U.S. stocks plunged 37.6%, emerging markets crashed 53.5%.

China's stock market is up a whopping 87.5% this year, and it owes its good fortunes largely to very loose bank lending and foreign speculators (where have we heard a similar story like this before), leaving it awash with cash and lifting share prices well above what economic reality and sound fundamentals can support. Just this past week the China Securities Regulatory Commission and other regulators have taken a series of baby steps to cool trading, such as adding stock supplies through IPO’s and tightening supervision, but are very skittish to intercede in the bubble’s management (deflation) as it could disrupt China's economic recovery.

But the stock market should respond long before any such policy action if clear signs emerge that an inflation scenario is unfolding. Such expectations could easily drop the benchmark Shanghai Composite Index down more than 20-22% to 2,400-2,500 points in the months ahead. Note: they are in real danger of creating another stock bubble similar to what we saw in 2006 and 2007. And the situation is far worse this time; as in 2006 and 2007 the overall growth in China's economy and corporate earnings were at their proverbial peak. This year, the economy has just started improving and corporate earnings growth is still expected to be negative.”

The benchmark index the Shanghai Composite hit a 13-month closing high of 3,373 on Friday….[ The FXI the iShares China index fund which tracks the composite is up from the March 2nd lows of $22.70 to Friday’s close of $42.06 or (86%) and this has been a very stellar relief rally after the index had plunged 65% percent last year as the global financial crisis helped to burst the huge bubble that had formed after a the index rallied out of control in 2006 and 2007. This year's rally has pushed valuations of shares on China's main Shanghai Stock Exchange to 35 times forecasted 2009 earnings, while the Shenzhen market's small-cap shares are at 46.5 times (these are very high valuations).

So many analysts believe that reckon, however, that China's economic potential and a reasonable emerging market premium justifies a forward P/E of just 24-26 times (still double that of Hong Kong-listed shares). And we have now almost exceeded these expectations by 2-fold. Those estimates are based on a projected 10% fall this year in the combined net profit of the 1,600-plus Chinese firms listed on the mainland's two bourses (I am projecting a fall of 17-18%). These firm’s combined net profit dropped 26% in the first quarter and I expect no dramatic improvement in the second-quarter figures, (most will be announced the first 2-weeks of August).

I expect that earnings growth for all of 2009 will remain negative despite hyped and vastly over expected improvements in the third and fourth quarters. The current market fundamentals, including the prospects for corporate earnings growth, means to me that market was already in a significant bubble when the index was at 2,900 points (as I wrote several weeks ago 6/22….I cautioned then my top line Elliot-Wave analysis called for a top somewhere around 3,450-3,520, (and there was the possibility of a blow-off top a 3,650-3,700).

The reason for the bubble (just like the Greenspam/Bernanke bubbles) Chinese bank’s new lending in the first half of the year reached 7.37 trillion yuan, far above the government's 5-6 trillion yuan minimum target for the year (I repeat for the year, we still have 6-months left), and some regulators in China have estimated that 25-35% of that lending has been leveraged up and found its way into stocks, property and other asset classes.

Another major source of liquidity appears to be a renewed influx of money from foreign speculators, which has been reflected in the jump in China's foreign exchange reserves by $178 billion in the second quarter to $2.13 trillion, as bets (foolishly I believe) are being placed on the potential of their export driven economy (exports are 78-83% of their GDP) pulling the rest of the world out of a recession (sort of an assumption, build it/produce it and they will buy it regardless of their credit-issues, the Field-of-Dreams psychological premise) and on the potential for appreciation of the yuan and various other asset prices (inflation).
The Chinese government has taken only modest steps to cool the stock markets explosive rally, and last month's resumption of initial public offerings, culminating in this week's $7.34 billion offering by China State Construction Engineering, the world's largest IPO this year, had been expected to curb the stock market's extreme euphoria as by boosting overall stock supply and clamping down on excess lending the government hopes to drive money back into the real economy, but these efforts take time.

Now despite the irrational exuberance we saw that the Chinese Communist Party's decision-making Politburo announce on Thursday that the economic recovery was not yet on a solid footing and Beijing would stick to their relatively loose and free easy monetary stance (but they would be looking to affect a braking-plan). I have been reading such releases for some time out of Chine and I have found that such vocal reiterations of policy as actually reflecting rising concerns within many parts of the government over the possible formation of another large asset price bubble(s). Chinese consumer prices have seen five straight months of annual declines because of economic weakness, but are expected to pick up later in the year.

Bloomberg wrote a pretty fair and accurate article on the over-valuation of emerging markets. I didn’t trim this article as I found the entire piece to be interesting. Note the references to IMF and also World Bank growth forecasts. I’m not sure the game that’s being played here, but now when I see a piece that largely explains in detail the vastly over-valued truth I want to pass it along as it supports my premise and my expectation for a bubble bursting that is looming right ahead! The article is entitled….Emerging Markets Priciest Since 2007 When Shares Fell it explains that the last time stocks in developing countries got this expensive was in October 2007, just before the MSCI Emerging Markets Index began a 12-month plunge that erased more than 50% of its overall value. The MSCI gauge trades at 15.4 times reported earnings according to the article (new data shows its closer to 16.7-times), compared with 14 for the SPX-500 Index. When developing nations last commanded a premium, the 22-country benchmark sank 54% during the next year. (please read the entire article it’s a very good read!

The Obama $787 billion stimulus package is falling way short of expectations as it is still like a tiny trickle at best…as most of it has not been heading to its intended destination, and the vast majority 75-85% is still unspent to date…as such these fiscal measures will likely not even come close to pulling the economy out of this nasty recession despite the rhetoric of green shoots!

Overall credit is still very crimped and the outlook for consumer demand is very gloomy at best due to the up trend in unemployment / underemployment and increased personal saving, and right now due to the Chain-Saw Al Dunlop mentality there is no amount of government intervention that will be able to mitigate/stop the hemorrhaging of jobs and the renewed trend of outsourcing to undeveloped nations to take advantage of very-cheap-labor! As such this stimulus in my opinion will do nothing to quickly alleviate the contagions of the deepest recession since the great depression.

Far too many households that need/want to borrow can’t, and many that are able to borrow won’t because they now must save for retirement the old-fashioned way, as they have seen their wealth destroyed (401k’s have been devastated, home values have plummeted….almost halved and 40-45% of Americans who stripped equity from their homes using home-equity loans, that they utilized to buy assets with deteriorating value etc are now upside down in their homes meaning that they owe far more than the value of their homes (minus existing mortgages). So as a result, even when we apply a very modest multiplier from even a well-designed stimulus package (which this one was not) is likely to develop into a very modest growth improvement at best.

The stimulus plan passed in February appears to be helping everyone but the those in real need (small business) and individuals and it won’t affect the economy’s primary contagions, which are falling values of assets like homes, pensions 401k’s retirement accounts and investments).

What I find astonishing is that according to the CBO, so far, only about $60 billion in spending and $43 billion in tax relief has been dispensed, accounting for 13-14% of the total…worse yet many projects that could spur growth and create jobs are being put on the back burner as the monies are being diverted to states that are hemorrhaging.

Despite the headline earnings beats of late the outlook for many firms also is very clouded (we have seen headline EPS beats due to lower tax-rates, a weaker greenback-benefiting repatriation, and some inventory restocking on hopes the recover is near); we saw this week that General Electric second-quarter profit from continuing operations declined 47%, and revenue fell 17%. GE, the world’s biggest maker of power-generation equipment and services, is targeting more than 400 stimulus projects valued at $200 billion worldwide; but the money has not been allocated as yet. CEO Immelt said he expects more to be allocated in the second half, but this could be wishful thinking.

The combination of rising unemployment/under-employment and hunkering down consumers definitely lowers the multiplier effect of every stimulus dollar spent (and its about time they be spent). That just means you need more stimulus, to affect a change and this is likely a hard premise to accept and pass as the average American is very angry at Wall-Street, the banks and big business getting all their tax-dollars, but their could be no alternative.

This past week the lamebrain Treasury Secretary Geithner stated that “The stimulus program was designed to make a contribution over a two-year period (I guess they failed to under stand that a stimulus program need to be immediate) and the biggest impact on these investment will come in the second half of this year.”

Martin Feldstein, a professor of economics at Harvard University in Cambridge, Massachusetts, and former head of the National Bureau of Economic Research, said the stimulus may provide a short-term boost that will quickly evaporate as best….“We’ll get that bounce for a couple of quarters but then it will fade out,” Feldstein said.

Right now the initial trickle of stimulus has shown little impact; as the net worth of households has dropped almost 23-24%, by almost $15 trillion, since 2007. House prices have fallen more than 32% from their 2006 peak, according to the S&P/Case-Shiller index, while SPX 500 is 40% below its October 2007 levels (meaning we need a rally of 80% just to get back to break even (a terrible situation for those putting money into the markets in 2006/2007).

This economic crisis has now unfortunately jog the memory of older Americans and smacked this current investing generation (these with their heads in the clouds) that home values can fall significantly as well as increase and that bull markets don’t last forever, causing many to start to save (a new concept for many) a much larger portion of their incomes. Recent personal saving data showed that the household savings rate rose to 6.9% in May, from zero in April 2008; this figure is the highest in almost 16 years; and this is a determent to an economic recover as it stifles spending.

Nouriel Roubini forecasted the rate could rise as high as 10%. Economists Reuven Glick and Kevin Lansing of the Federal Reserve Bank of San Francisco estimated in a May 18 paper that Americans would continue to boost their rate of savings, which could reach 10% percent by 2018; and such a rise would trim three-quarters of a percentage point per year from consumer spending.

So right now there’s been a fundamental change in people’s behavior, and its getting worse as rising joblessness could further damp the ability of consumers, whose spending in recent years has made up more than 66-70% of our ponzi service economy, and as such who will be shouldering this reduced burden.

Many are already forecasting that the unemployment rate will rise to 9.8-10.1% this year (I believe it will be 11%), and this is according to the FOMC’s latest economic forecast (just 3-months ago they expected unemployment to peak this year at 8.8%). Worse yet the rolls of the long-term unemployed are growing, with 29-30% of the unemployed out of work for more than 26 weeks, the most since records began in 1948. A broader measure of underemployment that includes those who want full- time positions but work part-time has almost doubled over the past two years, to 16.6%.

Consumer spending is forecasted to rise 1.5% in the fourth quarter and 1.7% for all of 2010, according to a July survey economists (so why are the retailers rallying so hard, these are dismal numbers). The average quarterly increase from 1997 through 2007 was 3.5%. The U.S. consumer is clearly staring to get a hangover and it could take a long time for the hangover to mitigate as Americans can no longer be consumption beast that they were for the past 10 or 20 years. The ongoing and worsening Credit Crunch…credit which consumers often turn to during recessions, remains very difficult to obtain for many. In the latest Federal Reserve survey about 50% of domestic banks tightened credit standards on prime mortgages in the past few months, up from 45% in January, according to a survey of bank loan officers. Although financial market conditions have improved a bit for some of the big banks benefiting from massive leveraged bets and taxpayer bailouts, credit was still quite tight in many sectors, the FOMC said in their minutes of the FOMC meeting just held in June 23-24. What this means, is that you’re not going to get the bang per buck that so many of the stimulus proponents have been praying for

2

The Bullish Scenario
Mary Ann Bartels, Chief U.S. Market Strategist and hedge fund tracker for Merrill Lynch claimed on Friday that hedge funds were still net short Nasdog stocks and were selling their SPX-500 longs. She stated there were continued outflows in 2009Q2 but 2009Q3 could see inflows of $40-$65 billion. She said for 2009Q2 hedge funds will likely post their best quarterly gains since early 2000. Investors are moving back into hedge funds now that they believe the market bottom is behind us and the financial system is intact. Hedge funds will need to put that money to work and that suggests they will have to close their Nasdog shorts. Those Nasdog shorts were planned to take advantage of the normal August-October Dog-days of summer for technology stocks.

Bartels said there was $3.65 trillion in cash in money funds, $1.21 trillion in un-invested cash in brokerages accounts and another trillion or so in miscellaneous accounts. The combined buying power in the equity market was roughly $16 trillion and once the tide turned and hedge funds decided to go long again it was going to be a strong rally. Heck, if the events worked out as she expects we will soon be dusting off those Dow 10,000 hats party again very soon.

A MEGA Contagion Brewing

Calpers, lost nearly $6 billion in the financial markets last year. Though it has more than enough money to make its payments to retirees for several-more years, this fund has a very serious long-term shortfall. At a time when local governments in the state are nearing bankrupt status and many are saying they cannot make the contributions that would be needed to shore up, the pension system or that are currently due.

Joseph A. Dear, the fund’s new head of investments…is not an investment analysts or a so called clairvoyant by training, but he thinks (key word = thinks) he has the cure for what ails Calpers, the largest retirement system in the nation with $180 billion in assets.

Mr. Dear wants to embrace some high-risk investments in hopes of higher returns (this is a very dangerous game to be playing…as a panic play-book where one looks to regain losses that were not hedged or foreseen, can and often does lead to a catastrophe). Nevertheless he aims to pour billions more into beaten-down private equity and hedge funds (the very funds that are huge under-performers due to over-leverage and huge miscalculations). Junk bonds and California real estate (which is still in a bubble mode) as these investment premises ride high on his list….and then there is timber, commodities and infrastructure plays (I agree with these for the long-haul).

What I find so darn ironic is that he wants to load up on many of the very assets that have been responsible for the fund’s recent plunge. Calpers’s real estate portfolio has tumbled 37% (means we need a huge rally just to get back to even), and its private equity holdings are down 31%. Calpers has been forced to sell stocks in a falling market last year to fulfill calls for cash from their private equity and real estate partnerships; which led to bigger losses in its stock portfolio. If this reckless (my opinion) plan fails Calpers may end up in an even bigger financial crisis than it is in today.

Now get this Dear was hired for his management skills and political savvy, which was supposedly where headed the Occupational Safety and Health Administration during the Clinton years (OSHA during this period was the most ineffective agency since its inception…but the Bush folks made he record look better as OSHA is now practically a dead). He does not have an M.B.A. or any other advanced degree in finance. Instead, his lone degree, in political economy, is from Evergreen State College in Olympia, Washington.

Mr. Dear headed the Washington State public pension fund, which gained a reputation as a daring investor under his oversight. It risked more of its portfolio 25% on private equity than any other public fund. The bet pushed the Washington State Investment Board, which now has $67 billion in assets, into the top 1.0% of its peer group in performance during the boom years. But in the fiscal year that ended last month, the fund lost 29% of its value, or $19.7 billion.

Governor Schwarzenegger, who is on the Calpers board, has called the fund “unsustainable.” specifically criticizing a decision by Calpers last month to give California municipalities a huge break on their required contributions. Rather than stepping up contribution rates to cover investment losses, Calpers set a maximum increase of 1.1% saving municipalities hundreds of millions of dollars (it will need to be recovered sometime-somewhere). Schwarzenegger called it a “pass the buck to our kid’s idea.” Calpers said municipalities, which pay 15% of their payroll or about $11 billion a year into the fund, desperately needed the break.

How is the selling being masked and bullishness exploited…its called Dark-Pools as we saw just last week 14 investment firms have become members of SmartPool, the dark pool created by NYSE Euronext in partnership with J.P. Morgan, HSBC, and BNP-Paribas. Launched in February 2009, SmartPool operates a dark order book that offers professional intermediaries (GS, MS, BAC etc.) the ability to execute wholesale transactions efficiently, with minimal market impact at improved execution prices, according to the release. Open to all European market participants, the platform is particularly suited to firms specializing in electronic, program trading and block execution. "We are delighted that so many prestigious firms have chosen SmartPool, particularly in today's challenging economic environment," stated Lee Hodgkinson, CEO of SmartPool, in the release, noting that SmartPool has been rapidly acknowledged as a leading dark pool in Europe. ‘As a result of their participant activity on the platform in the second quarter of 2009 increased by over 90%,” stated Hodginkson.

Initial Claims Numbers were much weaker than the headline number portends…..
In the week ending July 11, the advance figure for seasonally adjusted initial claims was 522,000, a decrease of 47,000 from the previous week's revised figure of 569,000. The 4-week moving average was 584,500, a decrease of 22,500 from the previous week's revised average of 607,000.

The advance seasonally adjusted insured unemployment rate was 4.7% for the week ending July 4, a decrease of 0.5 percentage point from the prior week's revised rate of 5.2%.

The advance number for seasonally adjusted insured unemployment during the week ending July 4 was 6,273,000, a decrease of 642,000 from the preceding week's revised level of 6,915,000. The 4-week moving average was 6,666,750, a decrease of 110,250 from the preceding week's revised average of 6,777,000.

The fiscal year-to-date average for seasonally adjusted insured unemployment for all programs is 5.449 million.

Unadjusted Data tells the real story

The advance number of actual initial claims under state programs, unadjusted, totaled 667,534 in the week ending July 11, an increase of 86,389 from the previous week. There were 483,981 initial claims in the comparable week in 2008.

The advance unadjusted insured unemployment rate was 4.6% during the week ending July 4, an increase of 0.1 percentage point from the prior week. The advance unadjusted number for persons claiming UI benefits in state programs totaled 6,135,066, an increase of 63,714 from the preceding week. A year earlier, the rate was 2.3% and the volume was 3,118,724.

Copyright © 2009 Stephen Tetreault
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