Paul Volcker Endorses Barack Obama

Nice endorsement from the most respected living Fed Chairman. A man who fought and won the battle over inflation in the 70's.

Democratic presidential candidate Barack Obama won the endorsement of former Federal Reserve Chairman Paul Volcker.

``It is only Barack Obama, in his person, in his ideas, in his ability to understand and to articulate both our needs and our hopes that provide the potential for strong and fresh leadership,'' Volcker said in an e-mailed statement today.

Obama, 46, an Illinois senator, is locked in a tight race with New York Senator Hillary Clinton for the Democratic nomination. The two will meet head-to-head in more than 20 state primaries and caucuses on Feb. 5 after yesterday's withdrawal of former North Carolina Senator John Edwards from the race.

``This is a high-profile endorsement that is likely to strengthen Obama's credibility with respect to economic issues,'' said Costas Panagopoulos, director of the elections and campaign management program at Fordham University in New York. ``Given the growing importance of the economy as a top issue for voters, the Volcker endorsement can be very helpful.''

Paul Volcker, Former Fed Chairman, Endorses Obama

Wisdom of Crowds? Yeah Right

Every once and a while I come across something so stupid/crazy that I have to do a little research just to prove to myself that my intuition is still sound. Recently, I read something very stupid/crazy while visiting The Big Picture. (Barry Ritholtz pointed out a Bloomberg story about Barton Biggs' new book).

The book, "Wealth, War and Wisdom", tries to argue for the wisdom of crowds. How is this done? Here is a segment of the article.

The ``wisdom'' in the alliterative title refers to the spooky way markets can foreshadow the future. Biggs became fascinated with this phenomenon after discovering by chance that equity markets sensed major turning points in the war.

The British stock market bottomed out in late June 1940 and started rising again before the truly grim days of the Battle of Britain in July to October, when the Germans were splintering London with bombs and preparing to invade the U.K.

The Dow Jones Industrial Average plumbed ``an epic bottom'' in late April and early May of 1942, then began climbing well before the U.S. victory in the Battle of Midway in June turned the tide against the Japanese.

I could not believe such wild claims and suspected that Biggs had made the mistake of using "20/20 hindsight" and a poor understanding of the way markets move to reach totally ridiculous conclusions. Ok, there is my hypothesis. What does history say?

Below I have the weekly chart of the Dow 30 during World War II. Let's follow the time line of events. First you have the invasion of Poland. Due to a treaty, Britain and France respond with a declaration war, but neither want to fight and we enter the "Phony War" period. It looks like the market doesn't believe that a full-scale war will be fought as the Dow just meanders sideways (So much for the wisdom of crowds here). What happens next is the surprise invasion of France, which is promptly followed by a massive sell-off on huge volume.

This is the point where some understanding of how markets move is required. The most important fact is that markets never go up forever and they never go down forever (quote of Tom O'Brien). The reason why is quite simple. There are only a finite amount of shares and a finite amount of money out there. This fact is reflected in the volumes. When volume dries up at tops there is no more money to buy, when it dries up at bottoms, there are no shares to sell. During fast and furious sell-offs the market can quickly exhaust the amount of shares and bottoms are reached in a short period of time.

Ok, back to the chart. Look at the period after the invasion of France. The volume quickly dries up (selling exhaustion), resulting in bounce. So yes the market rose during the Battle of Britain, but this was merely a counter-trend bounce on light volume back up to the 50 period moving average. More selling would come, especially since the world's future looked very bleak.

The next big event was Pearl Harbor, resulting in another huge sell-off as America entered the war. All through the early part of 1942, while America struggled to learn how to fight in Africa and the Pacific, the market continued to fall on ever decreasing volume. Just like the markets always do, it started a counter-trend bounce when things look the darkest, this time just weeks before the decisive Battle of Midway. This was an obvious turning point of the war in the Pacific and gradually the markets began to gain confidence.

The funny thing is, the volumes, and thus crowds, do not significantly increase until months after the Battle of Midway. So much for the "wisdom of crowds". Moreover, the "epic" bottom can only be defined after several years of perspective, well past the point where the outcome of World War II was in doubt. Just because there was an exhaustion in selling pressure and a counter-trend bounce just weeks before Midway does not mean that the markets predicted the war's outcome.

It almost seems silly to point all of this stuff out because it is so obvious. It looks like Biggs was fooled by randomness.

One last thing, Biggs says that the markets "then began climbing well before the U.S. victory in the Battle of Midway in June turned the tide against the Japanese. " I really don't think one month or 20 trading days can be considered "well before" an event, especially when Biggs is defining it as a multi-year bottom. What a joke.

The selling is done

Here is my current thesis. The selling is done and the bad news is already baked into the market. It will take some time for the leaders to emerge, but buying index funds and market ETFs is a good strategy right now. Be ready, because when those new leaders emerge some serious money will be made.

Here is a great quote from Tom O'Brien during his conversation with Ken Shrieve of Investors Business Daily.

"Its Armageddon everywhere, but we'll see if the market cares about Armageddon at these lows."

DePaul Basketball

I will not be posting anything tonight as I went to see Syracuse beat DePaul tonight. It was an ugly game with poor officiating but, overall I was entertained.

Tom O'Brien is a giddy bull

"The bullhorns are out!"

These are the words of Tom O'Brien, a man who has been bearish since March 2007. What was funny is that the day before he flipped bullish he sounded about as grim as I have ever heard.

Tom is not only looking for a Dow 15,000, but he also predicts that Ben Bernanke will trade in his helicopter for a fleet of B-52's to drop cash.

TLT Short

I have been watching the meteoric rise of bond prices and have been looking for a spot to get in on the short side. The 20 year bond ETF, TLT, has finished a TD Sequential sell signal and recent price action has indicated that we are at some serious resistance. That resistance is much clearer in the long term chart below.

I would honor a stop loss if the price closes above 97.05.

Futures Blowup

By now you have probably seen this guy. He was long 10 Russell 2K contracts into the MLK weekend. Here is a pretty funny remix of his own video post. I guess he sold for a 31K loss just minutes before the Fed emergency rate cut. 31K isn't all that much, but it was obviously too much for him.

Here is his blog. http://highprobability.blogspot.com/



The dude in the video is getting tired of all of the attention and it reminded me of this REM vid.

Politics on Saturday

Congratulations Barack Obama and South Carolina. I was absolutely convinced that, while disgusting and shameful, the Clinton's tactics would prevail. Such negativity just always seems to work (especially in South Carolina) and this time it backfired. Thank God.

Who would have thought that the state that instigated the Civil War would be the state that restored my faith in American democracy.

The bottom line: I now consider myself a former Bill Clinton fan and will either vote for the Republican candidate or not vote at all if Hillary Clinton wins. Lets hope it doesn't come to that.

If you happen to be undecided about which candidate to vote for on February 5th, just take a look at the breakdown of Obama's and Clinton's constituency. I don't know about you but, if you take out the gender difference, I wouldn't want to be grouped together with Hillary Clinton's voters.

The contest from now on, Layman said, will be "a battle between distinct and fairly evenly-matched constituencies....with Obama doing better among blacks, men, younger voters, better-educated people, and independents (in open primary states), and Clinton doing better among whites, women, older voters, lower income and less-well-educated voters, and staunch Democrats." The results he said, are likely to "be just as confused on the night of Feb. 5 as they are right now."

No wonder why Bill's efforts to pin Obama's as "the black candidate" failed. All of the ignorant bigots were already voting for Hillary.

Source: This Now Becomes A Real Delegate Fight

The market's new and old leaders

Two days up does not make a new bull market. We need to watch for an IBD style follow-through day and watch for breakouts from sound bases. This market needs to prove itself so don't get too comfortable.

This doesn't mean that it is time relax, however. Keep a look out for new leaders and stay away from broken down former leaders. Take for example the two charts below. Chipotle (CMG) has held up reasonably well and looks to be forming a nice base.

Flotek Industries (FTK) is a different story. I know this company very well as I owned it way back in June 2006 and sold around February 2007 (Yes it was painful watching the run that followed). I had to laugh though when I read that they blamed their recent earnings warning on "bad weather". That is what they said just before that big dip in 2006. It looks like the market will once again punish FTK severely. This is going to take a long time to recover (probably over a year) but I wouldn't be surprised to see it hit 55 again. Flotek went too far and too fast and I think the management started to believe their own hype for a little bit.

This is a trade...repeat, this is only a trade

I bought the QLD @ 73

Sell at 94 with a stop loss of 65. I am risking 8 points with a possible reward of 21.

Back up the other side

Now that was a reversal that I can get behind. Now we just have to watch how things trade when we get back up 1425 on the S&P.

Should be interesting. If that bond market bailout turns out to be true, that other shoe might have been picked back up.

Wake Up Call

I just talked to my Mother. I've been advising her on an exit strategy for her long positions. During the conversation she mentioned that she was surprised by the emergency rate cut today and noted that "wow, things must be really bad".

Like a majority of Americans, the reality of the credit crunch hasn't penetrated into my Mom's everyday life. So it seems that the Fed's cut, while easing Wall Street's fears, has just given Main Street something else to worry about (as if the falling price on their home wasn't enough).

Goodbye American consumer. It was a good run.

Mark Hulbert talks about this unintended consequence in this interview.

MGM Short Entry or Long Exit

When TD Sequentials are completed, a break below their stop loss points are usually a very bad sign. One thing that I have observed (and posted about) is that a retest of the breakdown point usually follows, giving one a second chance to get out. The retest can also give one a chance to get short that equity.

One of my favorite things to do in technical analysis is to use several techniques to arrive at the same conclusion. As the charts of MGM show, both a retest of the TD Sequential breakdown and a return to confluence lines up at almost the exact same place. (see previous post on confluence)

If we bounce back up to the 80 price point, use 84 as a stop loss for a short entry.

Making a short list of shorts

Looking for a fabulous short? Again, we can use confluence to spot low risk entry levels. Be patient and wait for the XLF to climb back up to 28.80 level and then look for a rejection of price levels. Look how nicely confluence worked back in early December.

If you really want some action, buy the SKF, which is the 200% inverse of the financials.

Bad Timing Ben

So I was watching the TV this morning when Helicopter Ben announced the rate cut. First off, considering all of the crash talk out there, I was not surprised. After about 10 minutes of letting it sink in, I realized what an lame move this was. I would have preferred a climactic sell-off and complete wash-out. The Fed could have kept their finger on the trigger and announced a 75 basis point cut if things got out of control.

Oh well, easy for me to say.

All this means is that I will short this market at the lower levels of confluence as we have many more weak hands than we would have had if a full capitulation took place.

Price Projections for "Black Tuesday"

The Asian markets are down again and the US futures are down huge! What should we expect for tomorrow? Below are the ABC Fibonacci expansion projections for the S&P 500, Nasdaq 100, Russell 2000, and Dow 30.

In every chart we are already into the 1:1 expansion point, which means that the next level will be the 1:1.618 level. The areas are shaded in grey. If we hit those levels on some panic type selling and bounce, that will be a good sign. If we go down to the low end of the shaded areas and stall, we are probably building cause to break below them. That will not be good for anyone (except for any greedy/piggish bears out there).

The Line in the Sand:
S&P 500: 1248.53
DOW 30: 11395.16
Nasdaq 100: 1728.54
IWM (Rus 2000): 60.59

Confluence and New Short Entries

So you are watching the collapse of the financial markets, the rising probability of recession, and a stock market staring disaster in the face. What to do?

Well first of all, if you are not short here, you should by no means get short now. You missed your chance on this leg. The good news is that, if this is a serious bear market, you will have many opportunities to get short again.

One of the best tools that I have found to pinpoint entry levels for short positions is Fibonacci confluence. The method is pretty simple and projects both short entry points and stop loss levels.

The charts below show three separate short entries predicted during the bear market of 2000-2002. Basically, one takes the Fibonacci retracement levels of two separate trends and look for their overlap, or confluence. See how nicely all three retracements stopped when they hit these levels. The uppermost retracement level acts as a stop loss. Some other examples can be found here.

Patience is the key here and don't forget to stay disciplined.

Black Tuesday?

There is a lot of talk out there about "Black Tuesday". Will this be the washout that everyone's been looking for or will this be something far worse? I fear that with everyone looking for bounce we are indeed set up for a crash of 1987 proportions.

I can't get the Gene Wilder line from Willy Wonka out of my head!

"The suspense is terrible, I hope it will last."

Good luck out there.

More on the Credit Default Swaps

I was watching Bloomberg this weekend and witnessed the interview of two money managers who were touting the market's compelling valuations. It was the same-old same-old. You know, stocks are cheap and this correction represents a buying opportunity.

I am just totally baffled by such arguments. This bear market is not about valuations or earnings! It is about the end of a credit cycle. A credit cycle that, up until now, had totally ignored risk. The "repricing of risk" was thrown around in August to explain the markets initial losses, but even though you do not hear it as much anymore, that process is still taking place. Just look at the credit default swap markets.

The other day I pointed out a post in the The Big Picture that quickly explained the lunacy in the monoline insurance biz. Today, I read an even more in depth piece by John Mauldin. Here is an excerpt from the article.

As noted above, I said three weeks ago that the big story for 2008 would be the counter-party risk for credit default swaps. That story is coming faster and larger than I thought. Bill Gross of Pimco suggests that the ultimate cost could be another $250 billion dollars on top of the $250-plus billion in subprime losses. That means we have only seen the tip of the iceberg in write-offs in the financial sector.

The real problem is the "monoline insurers" like ACA, Ambac, and MBIA. Here's a quick primer on how they work. Let's say you are a small municipality and want to borrow $10,000,000 for a bond offering to build a road or a water treatment plant. If you went to the market with your credit rating, it would be a low rating and the cost of the money would be high. But if you get one of the seven monoline insurers to guarantee your bond, then you get whatever their credit rating is. The fees for such insurance are lower than the savings you get on the bond, so everyone wins.

But over the years, most of the monocline insurers went from boring municipal bonds and jumped into the mortgage-backed security markets, selling credit default swaps that significantly juiced up their earnings. But it also added a lot of risk that they clearly, in hindsight, did not understand.

ACA has already seen its rating go from A to CCC, which is basically junk. This puts it out of business, as no one will pay to be rated as junk. ACA now has only $425 million in capital to cover the $69 billion in mortgage and corporate bonds they insure. Interestingly, they added $20 billion of that between April and September of last year. Talk about doubling down on a losing trade. Merrill wrote down almost $2 billion in bonds that were insured by ACA. They will not be alone.

Very scary stuff!!!

Source: More BLS BS by John Mauldin

Larry Pesavento Update

Tom O'Brien talked with Larry Pesavento again this last Friday and clarified his doomsday market call the other day. Larry believes that this current bear market will be longer than two years.

So as I assumed, he judges the severity of bear markets on the basis of time rather than price. Don't expect at 70% + decline.

In an interesting side note, Pesavento uses cycles in much the same way that Charles Nenner does. Nenner has predicted a choppy up-and-down market for 2008.

January 18 2008 Pesavento Interview