Tuesday, October 19, 2010

Emini Futures Trading / Garrett Jones Special Alert

People are losing their homes and the stock market is in the midst of its biggest September/October rally since 1939. In addition, there is strong motivation to buy bonds which, if you think about it, makes no sense at all. Why?

Well, a simple comparison with November 1981 will answer that pretty quickly. The ideal time to buy bonds was November 1981. Why? At that time interest rates had been soaring and bond prices had plummeted. That environment produced historic price lows and interest rate highs. That produced an ultra low risk price entry and the opportunity to be paid 18% for taking the risk. If interest rates declined you had the opportunity to double your money. Currently, you have just the opposite. Historically high prices with historically low interest rates, thus providing an environment of extraordinarily high price risk and not being paid anything to speak of to assume that risk. Rather than looking at potential price appreciation, you are looking at strong price depreciation when rates increase. In addition, you would be assuming the position of being a creditor in a debt default environment. As I mentioned, it makes no sense on any level.

Dow Jones Industrials 1920-1943

At the peak of the market in 1929, the song Happy Days are Here Again was copyrighted. After the initial market crash in 1929, the market rallied into 1930 – at the peak of that rally, the song Chasing Rainbows was quite popular – thus showing the incredibly positive mood that was just 3 years away from the bottom of the worst depression in the country’s history … and some argue that history doesn’t repeat itself.

The current sentiment is highly favorable and the news that is getting the attention from the talking heads is positive – for the most part. The chart below shows what happened during a similar period where the economic background was failing, but the mood was positive … for awhile. What followed was historic. The point to keep in mind was that investors at the time believed the worst was over and the bottom was in with the low made in 1929. It wasn’t.

‘Irrational Exuberance’ may have more meaning today than it had when the phrase was first coined. People appear equally motivated to move back into the stock market just like they did leading into 2000 and 2007. Let’s take a look at some charts: The chart below is a monthly chart of the S&P 500. It is important because it clearly shows the major tops of 2000 and 2007 and the recent top in April 2010. The white lines are trend lines from the 1974 low connecting with the 2000 top and from the 1982 low connecting with the 2007 top. Both of these tops are “double tops” – in 2000, the main top came first with a test 6 months later. In 2007, the first top was in July followed by the all-time high three months later. Currently, the top was made in April and we are in the process of testing it right now. The market has broken out above the trend line from the 2007 top and the April high of this year. If it can stay above that line then everything should be fine – at least for awhile. If not, then it’s another story.

I think this is a fascinating chart because it provides a big picture look at what has occurred over the past 40 years. I commented in recent Alerts about ‘something bad happening every 40 years or so.” This shows what transpires over that time to set up the market to make that statement true. Obviously, ‘something bad’ did happen. The concern is that every other 40 years or so something ‘really bad’ happens.

S&P 500 Major All Time Tops
Probably the biggest current news has to do with the foreboding foreclosures problem. At this stage of the cycle, liars and cheaters seem to be at a maximum (Bernie Madoff, etc.). During the housing boom, dishonesty was at a premium and all sectors of that industry seemed to participate. Banks made loans to seemingly anyone and didn’t seem to have any restrictions. Borrowers lied on their loan applications. The mortgage companies didn’t seem to require any documentation of income or even have any income levels to correlate to the loans they were giving. The companies that turned the loans into securities and the rating agencies that rated those securities seemed to rubber stamp whatever came by their desks. The insurance companies that sold default insurance against the securities (bonds) employed leverage i.e. they insured the bonds multiple times. To add icing on the cake, the government encouraged home-ownership by subsidizing people who had no business owning a home, much less owning a car. Their subsidy came by way of the implied guarantees by Fannie Mae and Freddie Mac – those wonderful agencies that were more bankrupt than those taking the loans. In my view, it starts at the top – if you act honestly and regulate properly, these things don’t happen. However, at this stage of the cycle they always occur and Mother Nature assures that a debt default will be the ultimate outcome … as expected (by those who study history and are aware of the sequence of events in the cycle). 

Is the US Dollar about to rally? Rumor has it the bullish consensus has dropped to 3%. 3% isn’t 2%, but it is pretty low. There is nothing in my work yet that says the US Dollar is reversing, however, one would think that it is getting close to at least have a rally … if not a move that lasts for awhile. It should be fun to see. 

A final note as of noon 10/19/2010: Peter Eliades (Stockmarket Cycle Management, Inc.) just called and pointed out that the NYSE Advance/Decline line (based on TradeStation) just double topped with its prior high on June 4, 2007 which led into the orthodox July top in 2007. This should be a very interesting week indeed.

Garrett Jones
CFRN Contributing Columnist

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