July 4th Market Musings – Half-Year Checkup


By Karl Denninger

With all the screaming going on this weekend by various market prognosticators – and the truly pitiful performance Friday late, I thought I’d try to put forward some balance on this Independence Day.

First, Gold. 

Momentum is unfavorable and the close under the 50MA not positive at all.  Short-term regaining and holding the 50MA, and preventing it from turning downward, is critical.  Should that fail first-level support is around the 1160 level and second-level around 1075 – the latter, however, is under the 200MA and isn’t very likely to hold if we get there.

This isn’t the sort of pattern you want to see if you’re bullish on Gold.  I’ve talked about it for months now – the original triple-ascending slope is a relatively-common and dangerous parabolic blow-off sort of move.  Gold then fell through the second trendline and wallowed along the lowest-slope one for over a month, leading many to proclaim it as a “buying opportunity.”  I warned on the 28th that if it did not regain that trendline with at least a chart pin in the next few days a huge selloff was likely, and what’s exactly we got.

Yes, that is a 50/200MA “Death Cross” – by a fraction of a point, but it is indeed. The S&P 500 looks like total crap on a daily chart, with only one little glimmer of hope – stochastics, which imply a short-term bottom may be at hand. The key here is “short-term.”  It seems that everyone is looking for a crash ala 1987 – they rarely happen when everyone is looking for it, of course.  Indeed, those placing bets on it tend to provide exactly the fuel for short-covering rallies that stop it from happening with the smallest pretext. 

Calling crashes is a fool’s game.  What one can say, however, is that this current decline – 10 days of red with one tiny spinning top in the middle – is the worst consecutive string of declines in this Bear Market, including the October 2008 nastiness (in which we managed to string eight together, including a massive reversal on the last day on 10/10.)  In point count it’s not the worst, but in terms of the relentless nature of the “grind downward” it sure is.

If you recall my earlier writings I said that while you might not feel like the market was crashing it wouldn’t really matter in terms of the impact on your account if you stayed too long in the game.  Such it now appears to be.  The weekly chart makes the problem more-clear:

That’s the 13/34 weekly exponential moving average, one of the long-term timing signals that I follow.  Back in September of last year when it crossed positive I opined that I was not going to put my long-term funds back into the market on the signal, even though a purely-mechanical trading system would call for exactly that.  This is what I fully expected to happen, and is why – it is virtually impossible to avoid a sell signal now on that indicator unless we were to rally beyond 1100 this week.

80 points straight up?  I kinda doubt it.  But the buy was at 1010, which means right now you’re a paltry 1.2% to the good if you followed that signal.  Blech.

The 20/50WMA (another long-term timing signal I’ve covered in the past) crossed at 1005, incidentally, and remains reasonably-apart now, with the 20W at 1129.72 and the 50W at 1091.86.  The danger here should be obvious – you could easily be well underwater before you get a SELL on that indicator.  Again, back when it crossed I said I was not going to follow it this time, and this is why – the insane divergence in slope of the indicator and price at the time it crossed positive meant you could easily be 10 or even 20% underwater before you got a SELL if it turned out badly – the risk was simply too high for long-term (defined as “intended to be in the market for five years or more”) money.

To those who argued with my logic at the time – how’s it looking now?  Remember, these are mechanical signals – if you’re going to trade them you have to trade them as they come.  In the fullness of time, I like my decision from last fall, despite all the people telling me I was “nuts” and that we were “in a new bull market” last year.

Scoring the 2010 Look Forward Ticker, I get the following thus far:

  • This is not a new bull market: Any questions?
  • The long end of the Bond Curve will move higher.  Miss thus far.  Quite possibly a massive miss, but we shall see.  My personal nightmare scenario is a back-half selloff in equities, bonds and the dollar.  That leaves Benny and Friends with damn little room to act.  So far, however, this is a clean bust.
  • House prices will fall another 20%.  Not yet, but the year is not over.  This much we do know – there has been no material increase in prices.
  • Banks will “give up” on holding real estate.  They’re doing it.  And everyone is trying like hell to shove back their bad paper.  I believe this tend will continue to accelerate.
  • Credit will not ease for “ordinary people.”  It hasn’t.  Bullseye.
  • A massive second wave of small-business bankruptcies.  I couldn’t have predicted the oil leak, but damn, you should have seen the Destin Commons last night for the fireworks.  Easily down by half on traffic from last year.  The government continues to say that small businesses are firing rather than hiring, so this looks good so far.
  • Unemployment will appear to stabilize, but that will prove illusory.  We got the first half, now let’s see if the second pans out.
  • The “revolting” call for last year was early – but not wrong.  Greece anyone?  That’s not over – by a long shot.
  • The states will go to the government well, but it won’t matter.  Bingo.  Ill-noise has become the poster child on this one.  Gee, where’s Obama from again?  Interestingly enough the states haven’t gotten bailed out – at least not yet.
  • A “double dip” will be recognized.  Lotsa talk so far.  ECRI’s LEI complex says it’s in the bag.  I agree as this was exactly what I was looking to happen.  We’ll see.
  • China will lose control of their bubbles.  Looks like they may be.  The PMI report recently is likely just the first of big trouble over there.  Beware.
  • Canada’s real estate market will crack.  Creaking, but not break – yet.  So far in line with expectations.
  • The Fed’s games will “leak” and their credibility will be shaken.  Heh heh heh…. yep.  I could spend five Tickers on this one; the “junk bond” fiasco is just part of it.
  • The Democrats lose big in the House.  November approacheth.
  • Congress tries to spend its way out – and fails.  No bond market dislocation yet, but I don’t like those TBAC reports nor do I like the updated GDP and debt graph. 
  • One or more of the PIIGS is forced into austerity.  Bullseye!
  • Contrary to virtually EVERY “investment pundit” return OF capital will re-assert itself.  Uh huh.  1220 to 1022 in less than two months, all gains from early September 2009 gone.

Six months left to falsify any of these, or prove ’em up.  So far, however, I like how this is playing out.

Short-term there are just too many people calling for an immediate collapse down another 130-150 handles, or roughly 15%.  While this could happen – indeed, crashes come from severely oversold conditions, the odds do not favor this.  Instead, the more-likely path is to scare the living bejeebus out of people and then rally like a SOB, trapping all the bears that got too aggressive and cocky in their short positions and destroying their accounts – then the market falls apart.

Speaking of which, this is a good time to talk about general strategies – specifically, being short in a deflationary environment.

Sure, you can make money.  But let’s look at this objectively.

Being short a $100 stock has a maximum possible profit of 100%.  That is, the stock can go to zero, and you get to keep the entire $100.

But consider the $100 stock that goes to $10 and doesn’t bankrupt, but then recovers.  If you buy at $10 you have 10x your original investment, or a profit of 900%.

The fallacy of “holding through downturns” also applies.  If you start with a $100 stock and it loses half, you now need a double to get back to even.  If it loses 90% you need a ten bagger to get back to even.  The Jim Cramers of the world will try to tell you that there’s a decent strategy for this sort of thing if you get caught holding stocks into a big dump. 

I disagree.

For most, if not nearly all, people who are in the market they have absolutely no business trading actively.  This is particularly true in markets like this, where 2, 3 even 4% swings on a daily basis have become commonplace.  While the last year has seen these be nearly all upward, the last few weeks and months has seen it be nearly all down.

For the long term investor the point is to wind up with more money than you started with – in purchasing power – over a 10, 20 or 30 year horizon.  You cannot afford big mistakes as they will force you to take big risks in order to recover, and if you’re wrong on the latter you will wind up with a destroyed account. 

Speculation is an entirely different thing.  There has been good money to be made in the last few years and with the volatility being what it is there will be plenty to be made for years to come.  But the wise long-term money isn’t short in this market – it’s out and has been since the end of 2007, when I (and a very few others) called “everyone out of the pool!”

Always remember that it’s risk-adjusted return that matters.  If you wish to gamble with 1/20th of your net worth, have at it.  As you make gains take them and move them to your long-term accounts and sit on them.  Gamble with the house money and so long as you do so effectively, keep at it.  No harm there at all.

Near the lows in 2009 I was selling $5 PUTs on GE like a mofo, trying to get intentionally assigned.  Why?  I didn’t believe GE would go bankrupt, and I was willing to buy tens of thousands of shares at $5 each.  GE never traded $5 and I got to keep the premium from those PUTs I wrote.  C’est la vie.

The key to making a true fortune in anything folks is to buy smart – not sell smart.  This is something I’ve learned through my entrepreneurial affairs.  MCSNet was successful in large part because I was a bare-knuckled negotiator for what I needed to acquire for the company. In short, I was a hard-nosed SOB and made no apologies for it, as that’s how you make money legitimately in any business venture.  If you buy smart making money is easy.  If you have to sell smart you’re always one mistake away from massive losses and potential bankruptcy. 

Nobody is good enough to bat 1,000.  600, 700, sure.  1,000?  Nope.  Not unless you’re God – or are cheating.

During The Depression people who had capital and sat on it were able to buy stocks at extremely cheap prices.  But they didn’t buy in 1930.  They bought during the second downward move, in 1932 and 33.  They bought at an 80% or 90% discount, not a 60% one.  They were able to buy houses, machine tools, land, all for a literal nickel on the dollar.  They didn’t get rich fast, but they became rich with certainty over time, because they bought smart.

Such it will be this time, just as it was last time.

There are a lot of people who have been chasing real estate at “half off.”  They’re fools.  I’m a buyer at 90% off with both fists.  Ditto for stock in companies I believe will survive.  Sure, I’ll be wrong about some of them, but the others will be 10 baggers.  Until then I’m a patient man with my capital, happy to speculate short-term with small amounts of my “nut” but ever-mindful that it’s when you buy, not when you sell that matters.

There is no reason in a deflationary environment, which we are now in, to add beta to your long-term funds.  The cowboys who want to do that with their entire net worth are welcome to it – you’ll still have a place to live when they blow up and are under a freeway overpass.  Most of them will – indeed, while there is always someone who claims to have “nailed it” ex-post-facto for each big market move, you’ll note if you bother to view things through an objective lens that 100 people had opinions prior to the move and only one of them still has an account with a positive balance in it.  Worse, that person’s prognostications for what’s to come next are almost-certain to be dead wrong.

There were many who predicted in the summer of 2009 that we were “up up and away” and would “exceed the 1576 SPX high” some time in the next two years.  If you listened to them in September of 2009 you’ve lost all your gains.  If you listened to them after that point you now have a loss.  It matters not what someone does over the short term – what matters is whether they can manage their portfolio over ten or twenty years and, including what they spend to live on, whether they still have it.

Jesse Livermore thought he could beat those odds – and the math.  He went from being extremely wealthy to broke several times during his trading career, having made $100 million in the 1929 market crash – at a time when $100 million was roughly equivalent to a few billion today. 

In 1940, having lost all of it, he blew his brains out in a cloakroom.

Don’t be Jesse.

The Market-Ticker