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Thursday, October 23, 2014

Daily update 10/23

Now we are getting into the true resistance area.  Here is the daily SPX chart.

SPX touched the 100 SMA today.  However, it found resting sell orders there and turned back down quickly.  It also kissed that 2011 trend line.  It remains to be seen if it is a goodbye kiss or not.  Breadth was strong again at 74% positive.  There were 113 new highs and 33 new lows.  The number of new lows has increased the last two days.  That is likely from some earnings reports not going very well.  Lets take a look at the futures chart.

The futures got up to the 200 SMA before turning back and closing back below the 100.  Price has reverted to the mean and the extreme over sold condition has been cleared.  What happens now?  Does resistance hold or do the bulls fight through it? 

They were parading professional investors on CNBC the last couple of days telling us to come on in the water is fine.  Along with Cramer they have had several other people proclaiming the low is in.  One thing I know with absolute certainty.  Nobody can possibly know if the bottom is in and we are going to new highs.  The things that have happened on this sell off have nearly always meant the market was volatile for weeks or months.  I have never seen a sell off when the institutional players panicked while the retail crowd was calm cool and collected that made a V bottom and off to new highs.  Whether that ever happened before my time I cannot say, but is seems very unlikely.  Even if the ultimate low is in there is likely to be quite a few ups and downs to come. 

We are now over bought in both short term price and breadth.  This condition is occurring below the 100 DMA.  We have had a big fast move up because of the volatility there is likely to be a desire to take some profits just in case.  I think it will be very difficult to get through the 50 DMA on this pass and the 100 may stop the rally.  Here is a look at the 60 minute futures chart of intraday data.

We have a clean looking uptrend line with 3 points of contact.  I will be watching for a confirmed break of that line as a sign the rally is at least temporarily over.  If that happens while SPX is below the 100 DMA it would likely be a good time to short.

This is a very interesting and well written article.  Quarterly Review and Outlook  Here is a particularly interesting tid bit, but I suggest reading the full article.  It is mostly about economics, but unlike many articles this one actually is well written and explains a few important concepts about the world today.

Historically, in our judgment, the most important authority on the subject of asset bubbles was the late MIT professor Charles Kindleberger, author of 20 books including the one of the greatest books on capital markets Manias, Panics and Crashes (1978). He found that asset price bubbles depend on the growth of credit. Atif Mian (Princeton) and Amir Sufi (University of Chicago) provided confirmation for Kindleberger’s pioneering work and expanded on it in their 2014 book House of Debt. Chapter 8, entitled “Debt and Bubbles,” contains the heart of their insights. Mian and Sufi demonstrate that increasing the flow of credit is extremely counterproductive when the fundamental problem is too much debt, and excessive debt can fuel asset bubbles.

Based on our reading of these two books we would define an asset bubble as a rise in prices that is caused by excess central bank liquidity rather than economic fundamentals. As Kindleberger clearly stated, the process of excess liquidity fueling higher prices in the face of faltering fundamentals can run for a long time, a phase Kindleberger called “overtrading”. But eventually, this gives way to “discredit”, when the discerning few see the discrepancy between prices and fundamentals. Eventually, discredit yields to “revulsion”, when the crowd understands the imbalance, and markets correct.

Economists have commented on the high correlation between the S&P 500 and the Fed’s balance sheet since 2009. From 2009 to the latest available month, the monetary base (MB) surged from $1.7 trillion to $4.1 trillion. We ran the MB increase against the S&P 500 and found a very high correlation of 0.69. While correlation does not prove causality, the high correlation is certainly not inconsistent with the idea that the Fed liquidity played a major role in boosting stock prices. However, even as the MB has exploded since 2009 and stock prices have soared, the U.S. economy has experienced the worst economic expansion on record. In spite of a further large rise in the base this year, the GDP growth has subsided noticeably and corporate profits after taxes and adjusted for inventory gains/losses (IVA) and over/under depreciation (CCA) has declined 10% in the latest four quarters. Such discrepancy between the liquidity implied by the base and measures of economic performance could indicate the process of bubble formation. Kindleberger’s axiom that asset price bubbles depend on excess liquidity may yet face another test.

The article discusses the velocity of money and covers things about Europe and Japan also.  A very good read. 


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