Friday, December 23, 2011

The Market's Technicals - Get back In The Water ?

The current condition is, in a word, seductive. We have drifted back up from the volatile, scary days of August. Europe is taking measures, albeit can-kicking measures. The US recovery is bumping along, albeit a grossly sub-par recovery. If we are to believe the government's figures (a big if) unemployment is going down.

But there are disturbing signs emerging that the main horror show is yet to be. Before I get into the charts, consider this basic fact. We have been in a "recovery" for going on four years now. In this day and age, four years is actually more like the lifespan of an expansion and a bull market. As I pointed out in my last post about the fear roller coaster, there is a striking similarity between the end of the 2003 -2007 four year run and the 2008-2012 version. If we are in a post debt bubble adjustment period, maybe 4-5 years is all the shelf life we should expect from a bull move - like the 1932-1937 five year bull phase.

Now to the charts. And they certainly agree with this notion of an expiration date of a four year run. In the roller coaster piece, I outlined the larger scale fractal nature of the 2003-2007 period and the 2008-2012 approaching period. Now let's zero in on a more detailed technical view of now compared to 2008 (click on image, right click on image then select "view image" then click to magnify)

As you can see, there is an astonishing similarity. This similarity takes on more significance when you consider that it is in response to very similar market dynamics. In 2008, it was the US banks and their ability to function. Now it is the very same thing with the European banks, who throw around about four times the money of the US banks. But then, these banks are so interlinked, that distinction may be muted.

The main technical feature of 2008 was the large head and shoulders top that was put into place, then the intense, VIX spiking selloff coming off the right shoulder of the top. As we technical types like to say "volume tells the truth" and this selling told no lie about the future direction of the '08 market. We had the very same ultra-high volume with the August selling, and it moved us through a critical break of the neckline of the head and shoulders top.

That in and of itself often can be misleading, as in the case of the mid 2010 weakness where everyone was watching the head and shoulders formation there, and we got a break of the neckline and massive shorting, followed by much covering. But this break was not accompanied by the kind of volume increase in the above charts, and it also did not lead to the 140/200 crossover, which doesn't happen that often and most usually has much follow through in a major trend change. We have seen both of these conditions with the 2008 neckline break and the current one.

What we have going now is a critical test of the broken neckline as resistance. This is typical and it took place in 2008 in May through June. It is happening now starting in November. Note how closely the two above charts match in the time frames involved. This means that we are now at the June '08 juncture and we're beginning to walk through the valley of the shadow of death - a time span of about three months. We will either break away from this course soon or complete it.

Until we know which it is, a very defensive portfolio makes sense. This could be a huge overweight in cash, with a core holding of gold that you don't trade, and not much else, except maybe a little VXX, the volatility ETN, which would go ballistic in another '08 style event. Or, it could mean a line-up of mainly very high yielders, the natural gas pipelines, utilities, and such. But keep in mind that these will get hit in another steep selloff - they just recover more quickly and more surely than the other stocks, but they will get hit. A large cash stash waiting to buy these brief low points would be better.

Thursday, December 15, 2011

The Fear Roller Coaster - Are We There Yet ?

I always take with a grain of salt all the chart comparisons showing why something in the markets must happen just because it happened that way before. Most of the time, it seems the macro-economic fundamentals are so different between the two cases that a comparison isn't very predictive.

But there is an element of market truth in George Santayana's general wisdom "Those who cannot remember the past are condemned to repeat it". When similar fundamentals are working on the investor psyche, a repeating market pattern can be as unchanging as human nature.

With that in mind, a stunning fear comparison can be drawn between the human reactions to the events surrounding the mortgage meltdown of 2006 to 2008 and the evolving Euro banking crisis we have before us. Both of these involved the development of a 4 year bull turning back into a larger bear trend. Going into 2007, we had climbed up from the 2003 bottom, but ran into the US mortgage mess. Now, it's been nearly four years since the 2008 bottom (most markets bottomed in '08) and we are again running into a banking mess, only this time it's in Europe. Investors fear banking problems more than anything. It screws up and brings to naught everything else.

Art Cashin's 12/15 CNBC interview expresses this fear well. Cashin mentioned the "roller coaster" ride of the VIX index, the market's main measure of fear. In trying to explain why the VIX has receded below 30, more or less the panic threshold, when we have plenty to panic over, he said that perhaps the VIX was "fatigued". It was suggested that maybe the FXE, the Euro index, would be a better measure of fear now. But "fatigue" sounds suspiciously human in nature, and not something a carefully crafted index would be prone to.

The receding VIX seems nice. It's been suggested that this is a market tell that everything is getting fixed in Europe and that we shouldn't argue with it. Just be thankful and go long. But the Cashin interview pointed out the worry-some problem well. Europe doesn't have the hand-in-glove management of Geihtner and Bernanke in the '08 US banking crisis. They don't have a fire department to put out the flames. They don't even have a fire code. A quick fire hose on any surprise banking problems? "That's not going to happen over there" was Cashin's take. We sometimes think of Europe's problems as a junior version of the US problems by belittling a country's GDP with a comparison to the GDP of Rhode Island or whatever. But the truth is, Europe's total banking assets is four times that of the US. So an equivalent out-of-control blaze over there would be four times as big a mess.

So what's all the complacency about in the VIX ? Well, you could argue it's just human nature. And if it's human nature, it is as predictable as the sun rising in the morning. Let's take a look at a side by side time-line comparison of fear as measured by the VIX over the course of the 2006-2008 roller coaster and the 2010-2012 roller coaster. The major events are noted with the resultant market fear reactions: (click on image, then right click on this image and select "view image", then click on this image to magnify)

Those of us who believe the markets are a fractal beast could point to this in the Exhibit A collection. Except for the artificial interference of QE, the two roller coasters seem to have been built per the same plans. The same plans perhaps have something to do with the same human DNA involved. We panic when at first presented with a frightening problem. The problem doesn't go away, but our fear level must recede. We are not programmed to stay very scared for very long. Our fear gets fixed before the problem does. As humans, we can all relate to that in our non-market psychology as well.

The large fear reactions, the runs to over a 30 VIX, not only occur in the same time sequence in reaction to similar developments over these two banking scares, they form almost identical topping patterns before they recede. And the overall trend as shown by the 140 day moving average (blue line) runs the same course except for the QE 2 period. However, within this QE 2 period, the fear spikes transpire in the same manner - just at a muted amplitude, until the medicine wears off.

Of note is the apparent loathing of fear that sets in after each huge bout of it. The underlying, structural problems are not fixed, but there are always some compelling positives to avert our gaze to. We get "fatigued" by fear as Cashin phrased it. It's purely human. So, is our current relaxing of the VIX a market tell that everything is indeed getting fixed in Europe and that we shouldn't argue with it? Should we just be thankful and go long? Well, in the context of the above comparison, which clearly shows this same exact complacency pattern after a significant market top and just before the harrowing slide of 2008 - I'd say let's call it fatigue, false bravado, foolishness, or anything but the truth.

Speaking of market tops, this fear progression played out in precision timing with the rises and falls of the S&P 500 over these two roller coaster rides. If you do the same side by side time-line comparison as above, you see another matched set:(click on image, then right click on this image and select "view image", then click on this image to magnify)

There were relatively small initial reactions by the market to the approaching crises - the end of the housing boom in 2006 and the end of QE 1 in 2009. These both were turned back to the upside with the very similar head and shoulders turns, then both went into the big tops with very similar head and shoulders turns back into bear markets. The current receding of the VIX below 30 has to be called the complacency before the storm - unless some "bazooka" from the Europeans is strong enough to knock our car off the tracks. A bazooka, firehouse, or some draconian surprise may have to blast us, or - to answer our kid in the back seat - we will be there.