Eurozone

In the last decade, demographic trends in the Eurozone turned from growth-positive and inflationary to recessionary and deflationary.

Screen Shot 2014-08-07 at 09.27.41

Cross-validating this, we see a trend of disinflation since the peak that is threatening to turn into outright deflation:Screen Shot 2014-08-07 at 09.27.05

We also see overall slowing economic and credit growth since that demographic inversion:7au12

Meanwhile the rise in stock prices over the last 2 years has been multiple-expansion rather than earnings based, in keeping with the weak economy (and the solar maximum driving the speculation):7au8In the latest data: Economic surprises for Europe continue to stay below zero; Italy has re-entered recession; German and Spanish bond yields are at record lows; German industrial orders contracted at their fastest rate since 2011; Eurozone retail sales have fallen sharply since June.

In short, Eurozone equities are due a sharp correction and the negative effect from falling stock markets is likely to tip the weak economy into outright recession and deflation, an outcome that was written some time ago in the demographic trends. Those trends suggest the next 2 decades will be difficult for the Eurozone, and that picture is consolidated rather than offset by demographic trends in USA, UK, Japan and China.


Short term US equities: Little movement the last 2 days. Stocks consolidated their breakdown, or exhausted their selling momentum, take your pick. Oversold indicators remain in place arguing for a bounce, but indicators for the overall correction suggest more downside is ultimately required. By my work we are post-second-chance and drawing on the analogs bulls should get little look in. The best fit then would be another leg down here into the weekend’s full moon, continuing to make it difficult for people to get in or out of the market, and gradually ramping up the fear. Gold broke up over 1300 again yesterday, and its large basing pattern continues to build.

Market Crashes

Here are some of the all-time records delivered in 2014:

1. Highest ever Wilshire 5000 market cap to GDP valuation for equities

2. Highest ever margin debt to GDP ratio and lowest ever net investor credit

3. Record extreme INVI bullish sentiment for equities

4. Record extreme bull-bear Rydex equity fund allocation

5. All-time low in junk bond yields

6. All-time low in the VXO volatility index (the original Vix)

7. Highest ever cluster of extreme Skew (tail-risk) readings in July

8. Highest ever Russell 2000 valuation by trailing p/e

9. Lowest ever Spanish bond yields

10. Lowest ever US quarterly GDP print that did not fall within a recession

And this week:

11. Lowest HSBC China services PMI since records began

12. Lowest ISE equity put/call ratio since records began


What I have been pondering is, what are the chances that we see not just a market crash but an all-time record market crash, given the elastic band is more stretched than ever?


Here are the biggest crashes in history, covering US, UK and Japan stock indices:

2011 August world indices

2010 May flash crash US

2008 Sep-Nov world indices

2001 Sep FTSE

2000 Mar-May Nasdaq

1990 Feb-Apr and Jul-Sep Nikkei

1987 October world indices

1929 Sep-Nov Dow

1907 Feb-Mar, Aug-Oct Dow

Draw them together and all the crashes happened in two windows in the year: Feb-May and July-November, with the latter period being the most dominant. This fits with the seasonal model of the stock markets, where geomagnetism influences collective optimism and pessimism. The two red dotted lines show the scenes of the crashes, both running from peak optimism to greatest pessimism.

5au1What also unites those historic market crashes is the preceding extremes in valuations, sentiment, leverage, allocations and complacency. The current US stock market set-up is a mirror in all those regards and global stock indices appear to have finally rolled over in July as we entered the most common window for market crashes. So it is fairly clear that we have a crash ‘set-up’ if not a crash.

Additionally, those crashes of 1907, 1929, 1990 and 2000/1 took place in the waning of the solar maximum, with the sun first driving the speculative mania to achieve the extremes and then pulling the rug from underneath. Based on the latest solar data, we appear to be a similar position now, i.e. through the smoothed solar maximum.

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To realise the biggest crash in history we would need to see the market halve in value in this window between now and November, which would mean the SP500 dropping to 1000 to August 2009 levels, i.e. the majority of the 5 year bull wiped out in a couple of months. That sounds utterly crazy, yes, but at the heart of a market crash is panic selling, whereby the selling reaches sufficient momentum to bring about a critical mass of forced redemptions and rapidly unwinds all the leverage. Sell levels trigger further sell levels and the process becomes unstoppable and out of control until exhausted. Given we are in many measures at the extreme of extremes, that process of exhaustion may cut deeper.

Amongst the historic crashes we see a cluster of big down days occurring on Mondays and Tuesdays (after weekend worrying) and close to new moons and full moons (at sentiment extremes). Also the waterfall selling typically erupted with the breaking of a notable technical support level following the passing through of a second chance peak (a failure high). I have argued that we have passed through the second chance peak as evidenced on RUT, IBB and SOCL and behind-the-scenes indicators for large caps. If I am wrong about that and large caps need to yet rally up again to a lower failure high then it would delay the initiation of the panic-selling. If however I am correct then the panic selling should be close at hand and we might then look to these possible dates for initiation, based on those historic patterns:

Mon 11 Aug, 1 day after full moon

Mon 25 Aug, new moon

To sum up, IF we were to experience the worst market devastation ever, then the set-up that we have would be pretty ideal for it, namely all-time extremes in valuation, sentiment, leverage, complacency, cross-asset valuation and allocations, the waning of the solar maximum, and the period of the year July-November.  Initiation for waterfall selling could potentially trigger around one those August dates.

I am not peddling fear, I am just drawing together the common themes of historic crashes and pointing out how we fit in. We fit in well, so we need to consider the range of potential results. I am not predicting the worst crash in history, but I am predicting there will be a period of waterfall selling at some point to wash out the leverage and I see no compelling case for that episode to be mild and anomalous compared to the others. We are flirting with deflation and nominal values are therefore at greater risk. Therefore, considering the possibility of the worst ever crash does not seem inappropriate.

Would central bank reactive measures nip a crash in the bud more easily now? These crashes all happened quickly: between 1 day and 8 weeks. That doesn’t allow them to do much. Would circuit breakers and exchange closures alter things now? They may cap the devastation on any one day, but spread it out to the following days or weeks. Might any crash be restricted to the hot targets of RUT, IBB and SOCL? It could be worst there, but unwinding leverage should affect all assets. Could any crash and unwinding of leverage be postponed until 2015? I can’t rule it out, but it doesn’t fit with the patterns in those historical mirrors. We could look to the end of October 2014 as a marker for that: if hard falls have not erupted by then, the likelihood would transfer to such steep declines not occurring until the Feb-May 2015 window.


Turning to the near term, yesterday’s bounce was in line with indicators, and sufficiently contained to be no real threat to the bear case so far. I have no expectations for today but want to see the markets turn down again into the coming weekend’s full moon. If I am correct about our positioning post-second-chance then essentially we should see bears resume control quickly. Another two day’s rallying from here, clawing back much of the 31 July falls, would not be in keeping with that.

Weekend Update

1. Dow within reach of 200MA:

2au7Source: Stockcharts

2. Nymo and Vix:Vxv both still calling for a bounce:

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Source: StockchartsScreen Shot 2014-08-02 at 07.46.48Source: CobrasMarketView

3. Put call ratios leapt up on Friday, also suggestive of a bounce imminent:

2au1Source: UKarlewitz

4. Capitulative Breadth (CBI) hit 10. This has been a fairly reliable indicator in the past of a low being in within 3 days. See the table below which shows incidences up until 2012. Also note some drawdown before the bounce was fairly typical.

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Source: QuantifiableEdges

5. Thursday was a major distribution day, a typical signal around market peaks. The chart below shows there have been 4 major distribution days (red>9) and no major accumulation days (green>9) so far in 2014:

Screen Shot 2014-08-02 at 07.44.22Source: Cobra

To sum up, Friday’s action further cemented the change of trend, and does set up the potential I referred to for a big down day on Monday (end of week selling, weekend worrying, Monday panic). However, there are several indicators shown above calling for a bounce or a low. If we look at the orange bars on the put-call chart and the common drawdown on the CBI table, maybe we could see some significant selling on Monday followed by either a recovery later in the day or a recovery Tuesday/Wednesday. If instead the market bounces strongly from the outset on Monday then I would be looking for some kind of retest of the breakdown that eventually fails and a chance to add further short during the course of next week.

Fire Is Lit

The fire is lit and should burn through pretty quickly, because if I am correct about this being the second chance peak (see HERE) then the mirrors from history reveal the end of the topping process gave way to rapid, deep declines:

Dow 1929: 3 weeks 44% declines

Dow 1937: 8 weeks 38% declines

Dow 1968: 8 weeks 18% declines

Dow 1987: 2 weeks 34% declines

Nikkei 1989: 6 weeks 27% declines

Nasdaq 2000: 3 weeks 35% declines

SP500 2011: 2 weeks 18% declines

They average out at 30% declines over 4.5 weeks. If it seems unlikely that we could see such a swift collapse after seeing such persistent strength, then know it is exactly what happened under these historic instances of similar extremes in valuations, sentiment, allocations, leverage, divergences and – for some – the peaking of the solar cycle. The lop-sidedness in sentiment and allocations, the excess leverage, the levitation above the 200MA, the mature divergences in place since the start of January: all together produce the ideal set up for waterfall declines or panic selling.

Yesterday, 31 July, finally delivered the kind of day I’ve been waiting for: a big gap down, selling that ran, a close at the lows and a major distribution day. It is also significant because I believe it is likely to cement the margin debt peak as February (all the indices ended down for July bar NDX, which was flat) along with bull market peaks in IBB, SOCL and RUT at the Feb/Mar turn. Plus, I believe it will cement the SP500 peak at 1987 (likely to get some coverage once the panic selling erupts) on July 24, which fell very close to the new moon and seasonal inverted geomagnetism (i.e. a twin optimism peak):

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All the indices look to have made ultimate highs or lower highs around those twin peaks in the middle of that chart. My seasonal chart then shows the potential for weakness from here down to October, as does the Presidential chart below:

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Source: Stock Traders Almanac

That gives us a window of 2-3 months in which we could see market falls, but the ranges from the historical mirrors further up are shorter at 2-8 weeks. So might I be wrong about the significance of yesterday (could we now rally up and print a new high in August before seeing the hard declines?) or might I be wrong about this being the ‘second chance’ peak (could large caps fall some more but then rally up again to a lower high in August/September, before hard falls erupt?)? I can’t rule either out, and the window we have (August-October) allows for both possibilities. However, my analysis puts us at the second chance peak, and the speculative-target sectors and indices of IBB, SOCL and RUT have all made clear lower highs making them likely to erupt from here into heavy falls. Could they potentially diverge from large caps? Also not impossible, but I suggest it is unlikely that small caps see panic selling whilst large caps rally or consolidate.

This is how the Dow stands after yesterday’s selling:

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 Source: Stockcharts

The wedge is clearly broken, so horizontal dotted support or the 200MA might now come into play. Nymo and Vix:Vxv are showing a potential bounce:

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Source: Stockcharts
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 Source: Cam Hui

However, if that was the second chance peak giving way, then there should be little chance given now to either get out of longs or add short, i.e. any bounce should be short-lived and the down days very unforgiving.

If the markets were to sell off again today, then historically we have seen some instances of heavy falls on the Monday following weekend worrying, so something to bear in mind. We have another week of negative lunar pressure next week, which adds to the bearish set-up. But let’s see if a bounce can be mustered today per those indicators.

If I am correct about the waterfall declines hitting now in this Aug-Oct window then drawing on those historical mirrors again, we ought then to expect a subsequent slower partial retrace of those falls lasting around 4 months. So hard falls averaging 30% over 4 weeks followed by a 50%+ retrace of those falls averaging 4 months, before we tip conclusively into a full bear market. The key then will be trying to gauge by when and at what level the panic selling leg is complete. As an initial marker, the lightest falls in those historical analogs were 18% which would be 1629 on the SP500 from the 24th July top. So as a guide I will be looking to refrain from taking any short profits until we hit at least there, but indicator readings will help refine that as we progress.

All subject to confirmation of course from the markets. It was just one day yesterday, but it does look like a killer punch, at the right time.