Pre-Monday Update

Here’s a reminder of historical analogs (manias of similar valuations, leverage, bullishness extremes, etc), and their common topping pattern:

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Source: Financial-Spread-Betting12oc8

Here is the Dax in 2014, with a similar topping pattern:

12oc5Source: Stockcharts

If we look at the Wilshire 5000, the broadest measure of US stocks, then these developments over the same timeline look like this:

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The ‘second chance’ sticks out, being a higher high, so there’s the question mark.

That WLSH chart shows the importance of last week’s action. After 18 months of higher lows and levitation above the 200MA,  we now have a lower low and a break of the moving average.

The SP500 ended Friday pretty much on the 200MA and at a double bottom with the August low, so hasn’t broken yet, but the leading action in RUT, DAX, FTSE and others, plus the selling into the close on Friday suggests the SP500 should follow suit and print the break and lower low.

Historically we have seen a phenomenon of strong selling into the close on a Friday bringing about major Monday sell-offs due to weekend stewing. The Nikkei chart above shows some examples. Meanwhile, the waterfall declines post-second-chance on the historical analogs occurred when a technical breakdown of a key level in price took place. Combined, they present the potential for this Monday, 13th Oct, to be a panic selling day, if buyers do not step in early and defend the SP500 $1900 support. So back to the question mark of whether we are post-second-chance.

I’ve shown before that various behind-the-scenes indicators suggest we are indeed post-second-chance, e.g. HYG:TLT, NAAIM, Investor Intelligence, Rydex and margin debt. So, despite US large caps having made higher nominal highs through to September, these indicators plus charts such as RUT and DAX suggest the September highs were rather a second chance peak. If so, then a quick look back up the page at the historical analogs show things rapidly fell apart after that point. Bears engulfed bulls in a steepening trend which snapped once key supports were broken and became several days of panic selling. It happened very fast. The steepening engulfing trend is what we saw in the markets last week, which adds weight to us being now on the cusp of the panic selling.

Therefore, if we are indeed post-second-chance and closed Friday under strong selling at the key twin support on the SP500 of $1900, then there really is a compelling set-up for Monday to be a major sell-off – a crash – should that support fail to hold from the outset, as weekend stewers press sell. So, all eyes on how the markets open overnight Sunday-Monday. If we do see the panic selling on Monday then the analogs suggest a rapid collapse could ensue over several days, taking us very swiftly to my targets. As a reminder I am looking for a minimum 18% off the peaks and large caps closed Friday about 6% down.

If, conversely, we are not post-second-chance on US large caps, and price needs to make a true lower nominal high, then we should instead see no panic selling and either the SP500 defended at $1900 or at a lower level, before being bid up again to perhaps make a ‘right shoulder’  beneath $2000. Whilst this may be considered the more likely option by many, I just reiterate that indicators and other indices instead position us post-second-chance, with the September higher nominal high in large caps being the ‘red-herring’.

Below is the longer term picture for the historical analogs. After the swift and devastating waterfall declines came a multi-month partial retrace of the falls, before the long bear market kicked in properly.

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My aim is to try to exit my short trades after the waterfall declines and before that recovery rally erupts. To this end I will be looking to indicators for signs of exhaustion. At the end of Friday, capitulative breadth was still below 10 so the short term does not look washed out, whilst indicators such as stocks above 50MA show we would need to drop some way yet for a true correction:

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Source: Charlie Bilello

Because we have levitated in a mania for so long, postponing any meaningful correction, I believe the correction has to be nasty when it hits. For example, with this intensity and duration of investors intelligence skewing can we really avoid a repair like 1987?:

12oc16Source: Fat-Pitch

If we draw in the 1937 analog we see a less panicky decline post-second-chance over a more measured 8 weeks:

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However, I believe the odds favour a more sudden collapse like the other historical analogs, because we can see in asset allocations, leverage, sentiment, volume and complacency that a limited group of buyers are all-in and leveraged with no bears left to convert, in an extremely lop-sided positioning historically. Therefore, if selling erupts it will be like an exit through a key hole and margin calls will quickly generate further selling in a series of forced redemptions.

Nonetheless, we can draw a range from the various analogs displayed of anything up to 8 weeks for the waterfall declines to complete, whilst the average falls were 30% with a minimum 18%. With this time and price guide in mind I am then looking to cross-reference with indicators that can signal exhaustion (e.g. CBI, II, stocks above MA, positive divergences, a volume surge etc) and see if we can pick the bottom before the recovery rally emerges. Important to get these parameters in perspective in case things occur very fast this coming week. If they don’t, then maybe the bulls can come back and generate a lower high in large caps. Anything more bullish than that now looks improbable, given the breakdowns in RUT, JNK and others.

So a big week ahead. Opex is usually positive, but this week’s proper kick-off of US earnings ought to be negative. If the panic selling erupts on Monday then neither will matter.

V-Correction Or Breakdown Part 2

Tuesday’s selling to a lower low delivered the missing positive RSI divergence on the SP500 and out of that we saw a strong rally on Wednesday.

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It was a necessary stick save for the bulls at key support in most indices, particularly the Russell 2000. So we are back to: is this another v-correction or just a save before a true breakdown?

There were clues behind the scenes yesterday.

The best performing sectors in the rally were the defensives: utilities and healthcare.

Gold and gold miners rallied and appear to be turning last week’s breakdown into a fake-down.

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Treasuries also rallied, so either risk or defensives have it wrong.

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Breadth weakened rather than strengthened, casting doubt that equities have it right.

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The above chart shows Vix remains divergent too.

Investor Intelligence % Bears are at 14.1 this week, still at the historic extreme, so there has been nothing remotely resembling a washout. Complacency rules.

The US dollar’s parabolic has broken.

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Lastly, to respond to the point that this chart may be cherry picking the RUT as it fits time-wise:

Screen Shot 2014-10-07 at 07.15.41

My case is that the RUT was the speculative target as evidenced by the p/e, hence the epicentre with RUT and margin debt right at the smoothed solar max. However, the point is that all stock indices should top out close to the solar max, without any cherry picking. So, the last solar max peak looks like this:

March 2000 = Smoothed solar max

December 1999 = FTSE peak

January 2000 = Dow peak

March 2000 = Margin debt peak; Hang Seng peak; Dax peak; Nasdaq peak; SP500 peak; Russell 2000 peak

April 2000 = Nikkei peak

So, the epicentre was March, and all major global indices topped out within 4 months of this. Now, if you assume here in 2014 the smoothed solar max was March and that all stock indices have now topped out (for which there is a strong case), it looks like this:

March 2014 = Smoothed solar max

February 2014 = Margin debt peak

March 2014 = Russell 2000 peak

May 2014 = FTSE peak

July 2014 = Dax peak

September 2014 = Hang Seng peak, Nikkei peak, SP500 peak, Nasdaq peak, Dow peak

So, the epicentre was March and all major global indices topped out within 6 months.

However, this can’t be validated until we are sure that the smoothed solar max was then and that stock indices do not make new highs from here. Nonetheless, with every month that passes odds are that this is correct and that stocks were on borrowed time since March.

To sum up, by the looking under the hood, the probability is that yesterday’s rally in stocks is quickly reversed again. This could happen as soon as today, or perhaps more upside can be squeezed out into the end of this week. But the signals point to ultimate failure, which means the stick save at support is just a temporary reprieve for the bulls. To those who think yesterday’s save means waterfall declines aren’t going to happen this year, understand that this was a crucial save at the final support on the RUT: it was unlikely to break without a fight. Traders have become conditioned to buy the V-bounce at support over the last 18 months, but the clues are that this time should fail, as covered in recent posts. 6 of the top 10 biggest Dow down days occurred in the window right ahead:

19 Oct 1987
26 Oct 1987
28&29 Oct 1929
6 Nov 1929
15 Oct 2008

And I believe this picture nicely sums up the Q4 2014 scene:

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The Only Chart That Matters

Ask 100 analysts and traders what that is, and chances are that not one of them will point to this:

Screen Shot 2014-10-07 at 07.15.41Yet I maintain that this is it. The last 5 solar cycles all produced speculative peaks within 5 months of the smoothed solar maximum, and in this era of global, instant access, it seemed reasonable to expect something similarly tight at this peak, which, in this real time test, appears to be the case. We see evidence that small caps were the main speculative target of this solar max, with the R2K p/e reaching over 100 at the top, like the Nikkei did in 1989 and the Nasdaq in 2000. We won’t know all this for sure for several more months, but with each month that passes the likelihood grows.

So am I delusional, or are other analysts failing? I am open to both possibilities and I mean that sincerely: I am just one self-taught guy, so how come all the veterans in the business aren’t aware of this phenomenon or don’t rate it?

I have doubters amongst you readers too. However, for the chart to be invalidated, we would need to see small caps and leverage make new highs whilst the solar maximum wanes. That would imply the 2014 formation in the R2K is not a topping process but a consolidation or coiling for a move higher. Chances of that are slim:

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 Source: ShortSideOfLong

Screen Shot 2014-10-07 at 06.46.34

Source: WSJ

The topping option gains further weight when we look at relative performance to large caps:

7oc3Source: Charlie Bilello

Plus, many topping indicators for equities have congregated since the end of 2013, which I have covered exhaustively on this site. And to be clear, if small caps break down then large caps will follow, in line with history.

There is still a question mark over whether the smoothed solar maximum is definitely behind us, but the majority of solar models predict so. Therefore, as things stand, we have pretty good evidence of a speculative mania in the markets centred on a particular asset class or index topping out very close to the solar smoothed maximum, just like in 2000 (Nasdaq) and 1989 (Nikkei, 5 months after smoothed solar max) and 1980 (gold, 1 month after smoothed solar max).

Going back to the title of this post, I believe the most popular answer amongst analysts for ‘the only chart that matters’ would be the QE versus stocks chart, but in a recent post (here) I instead showed that ‘Fed policy trumps all’ has been the mantra rather than the driver, just as into the year 2000 internet stocks were ‘revalued’ on expectations rather than earnings. In other words, the speculative mania is driven by the influence of the sun but people unwittingly assign some other justification for buying high: a ‘new normal’ which ultimately fails to be.

As stock indices were down for September, we can expect that margin debt retreated in that month, which keeps the leverage peak close to the smoothed solar max. If the R2K can break down decisively here in October – and it is currently at the critical last support – then it would likely seal the joint solar/speculation peak around March time. Should that occur, then the implications are major, namely that much of what is written about the markets is not true, and that humans, including central bank members, are more dumb subjects and less intelligent creatures of free will. But more on these implications once we have the validation seal.

It wasn’t easy trading this in real time, trying to gauge where both the speculation peak and the smoothed solar maximum fell. With both variables unknowable in advance it has been a process of cross-referencing and leaning on prediction probabilities, only made more certain with hindsight. Nonetheless, in trying to gauge the peak in the markets, there appears to have been no more critical factor to consider. However, we now need the decisive breakdown in equities to confirm it.

In the very short term, indicators still point to the bounce Thursday-Monday being short-lived and giving way to a lower low than last week. So, per my last post, this would likely entail the Russell 2000 making a decisive break beneath the last line of support. If this transpires then the selling should gain momentum and that would be the validation seal that I am looking for.

V-Correction Or Breakdown?

The bounce yesterday in equities arrived at an appropriate point when stock indices are cross-referenced technically: channel support on the SP500 and key horizontal support on the Russell 2000:

Screen Shot 2014-10-03 at 09.04.23 Screen Shot 2014-10-03 at 09.33.33

Plus rising support on the Hang Seng – which has generated what could be a fake-out above the long term wedge followed by a breakdown (if it can break):Screen Shot 2014-10-03 at 09.05.12So can all these indices break down, or are we to see another dip-buying v-correction?

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 Source: Stockcharts

On the above chart a positive RSI divergence was a reliable signal for a v-correction bottom. We do not have that yet, which suggests there should be another leg down of selling, even if shallow, where momentum wanes, if this were to be another v-bounce. This period into next Wednesday’s full moon is the likely window for this additional selling to occur.

However, beyond the prospects of a slightly lower low ahead, could this be the correction that does not produce another V above the 200MA, but forms a ‘true’ correction? I believe the clues are in what’s different this time compared to the previous corrections:

Breadth has made a lower low on the SP500 this time:

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Breadth deterioration is notable on the Dow since the last peak, plus Vix divergence:

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Nasdaq breadth has deteriorated sharply since the last correction:

3oc9The bubble-end flagged strongly on technology at the latest peak:

Screen Shot 2014-10-03 at 08.57.14

Source: Sornette

Junk bonds double-topped at the last peak and have since made a lower low:

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Recent deterioration in stock market internals has been a global phenomenon:

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Source: GaveKal Kapital

The disconnect between global GDP trends and global stocks reached its greatest in the last couple of months:

3oc5Source: Zero Hedge

And inflation expectations have dropped to the lowest since the 2011 bottom:

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Source: Sober Look

By yesterday’s bounce in equities, NAAIM exposure had pretty well washed out, whilst conversely Investors Intelligence bears remain extreme at 15%. Put-call had reached a suitable extreme for a bounce whilst exhaustion signals are still largely absent. So, some case for a longer bounce here, and some case for the markets to continue downwards. However, note that the extremes in II, Rydex and Skew and the lack of fear spike in the Vix are at this point very mature and at every correction the odds increase that we see the true breakdown.

If we tie in the worst seasonal geomagnetic month of October, an earnings season beginning next week that should cement the disconnect between reality and valuations/projections, the ‘borrowed time’ clues post-solar-maximum (circa March), and the extreme positioning in gold and silver (which I believe are ripe for a short squeeze as/if stocks fall through support), then the case grows for this being the correction that becomes the breakdown.

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Source: Market Anthropology

To sum up, there has been a broad deterioration over the last 3 months that suggests this should be it: namely, the correction that becomes the breakdown. Stocks bounced yesterday at necessary levels to prevent such a breakdown, but drawing on the historical analogs any attempted rally out of that should be quickly reversed by the bears. The lack of positive divergence at yesterday’s low suggests there should be a lower low ahead, which could then provide the technical break for a much more voluminous sell-off. At that point (the dawning of this being the dip that isn’t bought), I expect precious metals to finally take off, creating a sharp short-squeeze in gold and silver.

Last Quarter Of 2014

September finished as a down month for all US stock indices, which means the peak in margin debt should remain as February. Cross-referencing: SOCL, RUT and Nasdaq breadth peaks are still signalling a likely Feb/Mar speculation top, whilst biotech remains tentatively supportive, at a double top with March. The smoothed solar maximum continues to look like it occurred around March, so the whole picture remains strong for a sun-driven speculation peak around March and a period of ‘borrowed time’ for equities since.

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The SIDC chart shows that they are still running with an alternative in which the smoothed solar max double tops ahead at the end of the year, but the majority of other solar scientist models are aligned to their SC prediction (smoothed max behind us, circa March). By cross-referencing with measures of speculation above, the behind-us scenario gains further weight.

The Russell 2000 has now reached the key technical level around 1100 for triggering potential waterfall declines, and it arrives here at the most bearish point in the year, the seasonal geomagnetic low of October supplemented by downward pressure into the full moon of next Wednesday 8th.

1oc1Conversely, if the RUT and other US stock indices can hold up through the full moon and the rest of October, then a year end peak in large caps would gain weight, with the seasonal upward pressure out of November. As things stand though, the recent collapses in junk bonds and inflation expectations, the September declines in all stock indices and the acuteness and maturity of many different stock market indicators (which I have detailed on this site) all support the October breakdown option.

Turning to other markets, the US dollar is in a parabolic ascent, the Euro a parabolic descent, and the slide in precious metals continues. All three show extremes in positioning and indicators that are suggestive of a reversal, and the parabolic trajectory of the FX pair suggest a snapback should be imminent, but when?

1oc8 1oc5I see it as linking in nicely with the situation in equities. If US equities break down through the key technical supports (to clearly kill the prospect of another v-bounce), then gold should at that point reverse course, and the dollar may then be sold off. Much of my recent work on stock market indicators shows that the case is strong for equities to break down without delay, suggesting these intercorrelated reversals ought to indeed occur here in this pertinent window at the beginning of October.

The rising Dollar negatively affects 45% of S&P companies. Earnings season for Q3 gets underway next Wednesday, and the predicted earnings growth rate is 4.7%. This stood at 8.9% on June 30th and 12.2% at the start of the year. For the YTD picture, US earnings growth forecasts at the start of 2014 were Q1 4.4%, Q2 9.2%, Q3 12.2%, Q4 13.5%, whilst actuals are Q1 2.2%, Q2 7.7%, Q3 4.7% (est). In other words, to justify valuations, average quarterly 10% earnings growth was required and projected, but the reality looks like less than half that. As earnings season typically have a ‘sell’ or ‘buy’ theme, I suggest odds are this one will be a sell (as reality dawns), and help pull down equities in October.

At the macro economic level, economic surprises in Europe and China continue to languish negative, whilst the US remains positive. The global real narrow money leading indicator predicts a slowdown once we hit 2015, whilst ECRI leading indicators for the US remain poised at a low level from which a fall in equities would likely tip then negative. This brings me back to what leads what. I recently covered that equities in fact tend to lead leading indicators by a month on average and that previous major tops reversals in leading indicators only occurred once equities had made initial hard falls, which in 2014 they have yet to.

This in turn leads me to the question of whether equities could yet have a second chance peak ahead, like in August 2000 (after the first March peak) or October 2007 (after the June top). In both those scenarios, large caps dropped around 15% before rallying to the second chance peak, whilst leading indicators diverged negative into the second chance peak. The possibility here would be for large cap stocks to break down in October, perhaps 15% again, but then rally back up towards the recent peaks by year end, perhaps for a 31 Dec second chance (lower) peak.

Well, the speculative targets of RUT, SOCL and IBB all show second chance peaks already. Developments in margin debt, HYG:TLT, NAAIM, Rydex and various mature divergences also suggest we should be at second not first chance peak. But the price patterns in large caps don’t really fit. UBS side with the year-end second chance prediction, shown below, yet beneath that their TNX divergence chart is another indicator conversely suggesting we should be at second chance peak already:

Screen Shot 2014-10-01 at 12.12.28 Screen Shot 2014-10-01 at 09.56.18I suggest that if we are post-second-chance but having ‘cheated’ a decent first chance correction (and this is the picture painted by most stock market indicators), then the falls from here should be twice as hard and echo action post-second-chance in 1929, 1987, or 1989 (Nikkei) whereby the falls become waterfall declines or panic selling. If the selling is more measured and back and forth then we should alternatively look to indicators to washout and align for a bottom at perhaps a 10% or 15% correction, before a potential rally into year end.

This last quarter was the best quarter so far for viewing stats on solarcycles.net. The best month was this last month (shown below), the best day just yesterday. So, thanks for reading my analysis and thanks to all those who contribute and make for a good discussion board.

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To sum up, I’d give 80% odds to equities falling in October through technical supports and cementing a new bear market. I’d give 20% odds to equities holding up into or making a second chance peak at year end (both around 31 Dec). I don’t have a case for a bull market extending into 2015, as this would invalidate a variety of historically reliable indicators with different angles on the market.

As this is the last quarter, it seems appropriate to stick this up: predictions from the professionals at the start of 2014 for year-end. We can see that all were bullish on equities, predicting an up-year (accepting that they largely play it safe and align with each other). As you know, I was bearish at the turn of 2014 and always expected us to end the year in a bear market, so it’s a black mark against me if we don’t. But I believe the weight of evidence still supports the markets swinging to me by year-end, so let’s see at 31 Dec.

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