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Contrarian Thoughts: A slow market explosion

Wayne Lochore

The change in tone in global financial markets and websites in the past two weeks has been sudden and alarming and I must comment on the change.

As reluctant as I am to be swayed too much by emotion it seems the recent appearance of the “<a hr

ef=”http://en.wikipedia.org/wiki/Hindenburg_Omen” target=”_blank”>Hindenburg Omen‘ has the major American markets quite mesmerised and this is always dangerous.

Given it occurs in global markets that have every reason to feel frail and a little scared, the danger becomes significantly greater.

The Hindenburg Omen is a technical signal based on a number of simultaneous technical readings from the NYSE – the detail can be found easily on the web should you be interested, but suffice to say it has been quite accurate in forewarning a sizable collapse in equity markets – it has apparently been present in every sharp sell off in the past 25 years, with the last occasion being October 2008.

Since the first sighting on August 12 there has been two confirmations recorded, and every confirmation strengthens the signal. The resulting expectation is that the market will collapse sometime between one day and four months from the initial signal.

There have of course been ‘false positives’ where the markets have not suffered a sizable setback, but these have generally occurred when only one Hindenburg Omen appearance was seen.

Wikipedia however suggests that most often the Omen has been identified by back-testing and hasn’t been recognised as present until the sell-off occurs.

So, what do I think?

I have been saying for some months that the major factor at play in the markets generally is confidence. If the actual economic and financial numbers were the only things at issue we would have fallen on our face some time ago.

So I’m concerned about the self-actualising potential of any signal with a successful history, as I am about the high level of correlation in global markets generally.

With all the words of warning I’ve penned over the last years how can I recommend anything other than be very careful if your money is important to you – ‘head in sand’ is not the ideal posture right now.

Nevertheless large sell-offs do occur from time to time, and most often they represent opportunity as well as chaos, so be ready for anything.

However my underlying attitude is this; If governments worldwide had been following realistic policies that benefitted their constituents then what the markets did or didn’t do would hold no fear at all.

But they haven’t, they’ve been wasting resources at an ever increasing rate, and putting most of the cost on the tab.

So of course they are scared of what markets might do because they’re beholden to them in their fund-raising efforts, and borrowing is getting competitive.

But markets don’t care who is right and wrong, neither really do the individual participants – every player would take a win over a correct opinion every time, and the global players they don’t care which side of the trade they take either, just so long as they win.

Politicians don’t understand this. They think that if they help out the financial sector once then the financiers will help them next time – they won’t, not if it means a large and legal profit on a trade comes between them.

What politicians need to comprehend is that markets have an even greater worry – the turnover volume is collapsing, investors world wide are deserting markets as they get chopped and diced by volatility and High Frequency Trading, and so the game itself is under threat.

Steering a country on the basis of the confidence of markets is a futile task, the markets are shell-shocked, collectively they would probably wish to be anywhere than right here, right now.

Equities are struggling, the major bond markets are frighteningly overpriced and still being bought, real estate is still slipping – everyone is seeking safety without being certain what that means.

But knowing they could be fatally wrong in 30 minutes.

(N.B. Tuesday’s trading in the US produced a third confirmation of the Hindenburg Omen. Given this comes from a increase of both new highs and new lows it goes some way to show just how schizoid the market has become.)

This further confirms the thought that investors have begun a flight to safety even though they are fleeing in all directions, not all of them apparently sane. Just a few standout details of the last 24 hours in the trenches:

  • Yen at a 15 year high against the US dollar
  • Swiss Franc at an all time high against the Euro
  • US bond yields at historic lows
  • US existing home sales down 27.2% against an expected 13.4%
  • Nikkei at a 15 month low
  • Congressional Budget Office estimates 4.5% of Q2 GDP came from stimulus (suggesting a negative stand-alone figure of 3% plus)
  • Ireland receives a rating downgrade from S&P – AA to AA-

These market concerns lead sooner or later to the rather large elephant that has taken up residence in the front room – how the hell do we deal with the overhang of global debt without blowing up what debt has created?

Most people I talk to and read have some idea that we are looking at a significant reduction of living standards, and most of them don’t mind that much about the prospect provided everyone takes a cut.

But how do we do this without destroying what has been created, without blowing away the fabric of life because a vast number of people have been caught in a massive Ponzi scheme fashioned by central banks, politicians and banks between them?

What I’m talking about is the impossibility of settling up in a fractional banking system when gearing levels have escaped the corral.

Depositors globally can’t have their money back because the fractional banking system cannot pony up without destroying itself.

It is especially impossible when the assets that banks hold have suffered serious erosion in value, although we don’t talk about that either. Nevertheless the weekly parade of closing US banks shows a regular shortfall of around 40% in book values which given the collapse in US real estate is about what one would expect.

Bill Gross from Pimco, the globe’s largest bond fund, had this to say: “Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy.”

Given our own big four banks have an exposure to real estate between 60-70% of assets New Zealand is in the same situation, but without yet experiencing the gut-wrenching total collapse in house prices and employment.

The same story exists in Australia, but they’re in a position of believing they actually beat the recession and are heading to their deserved place fairly close to the sun. Dan Denning had a paragraph on that yesterday – “This is what “avoiding the recession” accomplished in Australia. It encouraged Australians to believe the world is not as financially dangerous place as it actually is and to continue with behaviour (taking on mortgage debt) which makes them even more vulnerable to the next credit shock. That is not “saving” anyone. That’s leading them straight into the waiting room of the next financial slaughterhouse.”

A response to my previous post by Tony Kan summed up my thoughts precisely – “The problem can only be solved through massive debt forgiveness or we print more money and devalue everyone’s assets once again.”

I’ve been thinking about potential solutions ever since I figured we had a large problem looming and these are the only alternatives I can see. However I don’t see any likelihood that massive debt forgiveness will occur until all other efforts have been exhausted, (and maybe not even then), and predicting the timing of this is impossible.

I expect that we’ll see further money creation first in an attempt to establish manageable inflation that slowly erodes the impact of debt. Whether or not this is even possible time will tell, but it certainly isn’t a quick fix.

Meanwhile the markets will have a very beady eye on the Jackson Hole Kansas City Fed Economic Symposium being held on 26-28 August, eagerly awaiting the speech by Ben Bernanke on Friday – should he not get the words exactly right then look out below. However given the presence of so much angst, the odds are probably just as good for a moon shot.

Wayne Lochore

Format

The change in tone in global financial markets and websites in the past two weeks has been sudden and alarming and I must comment on the change.
As reluctant as I am to be swayed too much by emotion it seems the recent appearance of the “Hindenburg Omen’ has the major American markets quite mesmerised and this is always dangerous.
Given it occurs in global markets that have every reason to feel frail and a little scared, the danger becomes significantly greater.
The Hindenburg Omen is a technical signal based on a number of simultaneous technical readings from the NYSE – the detail can be found easily on the web should you be interested, but suffice to say it has been quite accurate in forewarning a sizable collapse in equity markets – it has apparently been present in every sharp sell off in the past 25 years, with the last occasion being October 2008.
Since the first sighting on August 12 there has been two confirmations recorded, and every confirmation strengthens the signal. The resulting expectation is that the market will collapse sometime between one day and four months from the initial signal.
There have of course been ‘false positives’ where the markets have not suffered a sizable setback, but these have generally occurred when only one Hindenburg Omen appearance was seen.
Wikipedia however suggests that most often the Omen has been identified by back-testing and hasn’t been recognised as present until the sell-off occurs.
So, what do I think?
I have been saying for some months that the major factor at play in the markets generally is confidence. If the actual economic and financial numbers were the only things at issue we would have fallen on our face some time ago.
So I’m concerned about the self-actualising potential of any signal with a successful history, as I am about the high level of correlation in global markets generally.
With all the words of warning I’ve penned over the last years how can I recommend anything other than be very careful if your money is important to you – ‘head in sand’ is not the ideal posture right now.
Nevertheless large sell-offs do occur from time to time, and most often they represent opportunity as well as chaos, so be viagra en gel ready for anything.
However my underlying attitude is this; If governments worldwide had been following realistic policies that benefitted their constituents then what the markets did or didn’t do would hold no fear at all.
But they haven’t, they’ve been wasting resources at an ever increasing rate, and putting most of the cost on the tab.
So of course they are scared of what markets might do because they’re beholden to them in their fund-raising efforts, and borrowing is getting competitive.
But markets don’t care who is right and wrong, neither really do the individual participants – every player would take a win over a correct opinion every time, and the global players they don’t care which side of the trade they take either, just so long as they win.
Politicians don’t understand this. They think that if they help out the financial sector once then the financiers will help them next time – they won’t, not if it means a large and legal profit on a trade comes between them.
What politicians need to comprehend is that markets have an even greater worry – the turnover volume is collapsing, investors world wide are deserting markets as they get chopped and diced by volatility and High Frequency Trading, and so the game itself is under threat.
Steering

a country on the basis of the confidence of markets is a futile task, the markets are shell-shocked, collectively they would probably wish to be anywhere than right here, right now.
Equities are struggling, the major bond markets are frighteningly overpriced and still being bought, real estate is still slipping – everyone is seeking safety without being certain what that means.
But knowing they could be fatally wrong in 30 minutes.
(N.B. Tuesday’s trading in the US produced a third confirmation of the Hindenburg Omen. Given this comes from a increase of both new highs and new lows it goes some way to show just how schizoid the market has become.)
This further confirms the thought that investors have begun a flight to safety even though they are fleeing in all directions, not all of them apparently sane. Just a few standout details of the last 24 hours in the trenches:
Yen at a 15 year high against the US dollar
Swiss Franc at an all time high against the Euro
US bond yields at historic lows
US existing home sales down 27.2% against an expected 13.4%
Nikkei at a 15 month low
Congressional Budget Office estimates 4.5% of Q2 GDP came from stimulus (suggesting a negative stand-alone figure of 3% plus)
Ireland receives a rating downgrade from S&P – AA to AA-
These market concerns lead sooner or later to the rather large elephant that has taken up residence in the front room – how the hell do we deal with the overhang of global debt without blowing up what debt has created?
Most people I talk to and read have some idea that we are looking at a significant reduction of living standards, and most of them don’t mind that much about the prospect provided everyone takes a cut.
But how do we do this without destroying what has been created, without blowing away the fabric of life because a vast number of people have been caught in a massive Ponzi scheme fashioned by central banks, politicians and banks between them?
What I’m talking about is the impossibility of settling up in a fractional banking system when gearing levels have escaped the corral.
Depositors globally can’t have their money back because the fractional banking system cannot pony up without destroying itself.
It is especially impossible when the assets that banks hold have suffered serious erosion in value, although we don’t talk about that either. Nevertheless the weekly parade of closing US banks shows a regular shortfall of around 40% in book values which given the collapse in US real estate is about what one would expect.
Bill Gross from Pimco, the globe’s largest bond fund, had this to say: “Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy.”
Given our own big four banks have an exposure to real estate between 60-70% of assets New Zealand is in the same situation, but without yet experiencing the gut-wrenching total collapse in house prices and employment.
The same story exists in Australia, but they’re in a position of believing they actually beat the recession and are heading to their deserved place fairly close to the sun. Dan Denning had a paragraph on that yesterday – “This is what “avoiding the recession” accomplished in Australia. It encouraged Australians to believe the world is not as financially dangerous place as it actually is and to continue with behaviour (taking on mortgage debt) which makes them even more vulnerable to the next credit shock. That is not “saving” anyone. That’s leading them straight into the waiting room of the next financial slaughterhouse.”
A response to my previous post by Tony Kan summed up my thoughts precisely – “The problem can only be solved through massive debt forgiveness or we print more money and devalue everyone’s assets once again.”
I’ve been thinking about potential solutions ever since I figured we had a large problem looming and these are the only alternatives I can see. However I don’t see any likelihood that massive debt forgiveness will occur until all other efforts have been exhausted, (and maybe not even then), and predicting the timing of this is impossible.
I expect that we’ll see further money creation first in an attempt to establish manageable inflation that slowly erodes the impact of debt. Whether or not this is even possible time will tell, but it certainly isn’t a quick fix.
Meanwhile the markets will have a very beady eye on the Jackson Hole Kansas City Fed Economic Symposium being held on 26-28 August, eagerly awaiting the speech by Ben Bernanke on Friday – should he not get the words exactly right then look out below. However given the presence of so much angst, the odds are probably just as good for a moon shot.
Wayne Lochore
Path:

2 Responses to “Contrarian Thoughts: A slow market explosion”

  1. John Rothschild says:

    No problem with what you right except that it has been clear throughout on technical analysis grounds alone, and in particular applying Elliot principles on a medium term, as opposed to a short term, basis, that the move up in the global equity markets beginning early March 2009, was simply a retracement, albeit extended, but nevertheless, only that, in part of an on going downtrend which the markets commenced in November of 2007, and which still has a fifth wave to the downside to make to complete that downward cycle. The analysis has further suggested that there is a high probability in many instances of global and sector indices, as well as for individual stocks, that the low of that yet to be completed down leg of the cycle could take prices below the previous 2008/2009 lows.

    It became clear, not in the past two weeks, but with the sell off commencing in April of this year that it seemed the markets had turned over out of this retracement rally and were heading into the further downleg of the cycle.

    The rest of what you have referred to is simply comfirmatory evidence of the above unfolding pattern in the equity markets; and in particular the continuing relatively low volumes, and the continuing move of funds out of equities into bonds and treasuries.

    The real concern is the level of debt now amassed by sovereign governments and related, together with the still apparent lack of real supervision from regulatory agencies, and with Govts still more concerned to ensure that the blame for what occured being placed at the feet of the investment banks rather than their own backdoors and the regulatory agencies for which they have been responsible.

    The sense of delusion, as I call in Australia has now a substantial amount of material evidence to support it, but where you are correct in concluding, that their current belief in their mineral wealth, together with Chinas continuing (although now slowing expansion) will see them through any difficulty, and where additionally they can tax in discriminatory fashion at excessive levels by any standards the very industry which makes the investment to bring that wealth to harvest and also in the belief that it will not affect the on going investment of that industry!

    Many indebted sovereign nations now have as their only way out the hope that they will effectively be gifted a huge sum of money; and which as you correctly put it such a hope from financial markets can be a hollow one at best, and where, therefore the alternative is sovereign debt default of some signficant proportion. Note the fact that five years down the track from now even the Noble laureate economists are unanimous in concluding that Greece will still an impossibly repayable 150% of its GDP, versus 110% now! And that after all the pain of the current austerity measures.

    I have been almost dumbfounded to read in your local press article after article in relation to all of this but where there has been no effort at all to relate this to NZ’s own heavily indebted and fiscal deficit status, and which as both John Key and Bill English have recently actually been reported as noting that this status puts the country in the same category as the European PIIGS.

    What is the more disturbing is that the social policy programs that are costing the country literally blns of dollars every year in a small 130bln economy on borrowed money continue to asset strip the country and where despite tax increases etc to reduce the fiscal deficit from a level which by my humble reckoning was way in excess of that for Greece, to a figure still above that for that troubled euro nation, have been enacted without any real attempt to radically dismember the legislation on which most of these programs rest, and which do not, and have never stood up to serious rigorous rational analysis, even in terms of their stated objectives.

    The country has potentially left it too late to begin the rollbacks, but where, it still and now with some measure of urgency, has no alternative but to begin and do that, or where it will find itself totally at the behest of the international shorters and bond vigilantes, without a big brother like the ECB to help it out.

    Such a crisis would in all probability tip the local residential and commercial property market over the edge, and where that in turn would then trip the signals that the country with so much of its debt leveraged in that direction, that real risks of default and restructuring were in prospect with the implications then for credit rating downgrades with the resultant increase in borrowing costs, and on the already substantial sums of outstanding debt….

    There is however, the alternative view that the recovery can and will continue, albeit not as strongly as was hoped or initially expected, that the necessary deleveraging of banks, households, companies and governments will continue and be spread over many years, and that we will ultimately return to some semblance of normalcy…albeit that this new norm is going to be significantly different from what applied previously.

    Markets will continue to function and opportunities in those markets will continue to exist but where increasingly evident will be the non and negative performance so abundant even now still of poor or incompetent advice and associated investment action.

    In this climate it is clearly imperative that NZ knuckles down and acknowledges the seriousness of its own situation and begins also to seriously address that with bold and radical policy changes that are tied with a sustainable vision for the country and its future going forward, and where the investment playing field is levelled, and the tax structure for companies is brought into line with the realities for the competitors in the region…and where the social policy madness of the past several decades ceases if for no other reason than borrowed money cannot continue to be used for such madness where the end result has no return and is akin to literally putting the funds down the toilet, while the country argues itself into oblivion over the real investment of relatively small sums which are necessary to get it back into the global game and keep it in that.

    In hopeful anticipation that the latter scenario proves more correct than the first.

    John R

  2. Arty says:

    The punter in street has little or no idea of the big debt picture and considers his debt generally manageable. When John Key and Bill English talk about debt levels being high they understate the concern we should all be feeling, but debt management starts at the top. We have no or little hope, central Government is borrowing to subsidise Kiwi saver, pay social welfare benefits and generally prop up consumption. Local Government is borrowing as heavily to fund programs that have little to do with essential public services and the public are just blindly following the leaders. Example Auckland 54m to purchase Westhaven Marina. Example Kiwi Rail – some 600m both dog investments.
    So that’s the problem, not the markets, they just react as it becomes harder to find a bigger fool to turn a dollar from.
    Am I correct? Or do I have this all wrong.

 
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