Is This the Big One, Elizabeth?

On the television sitcom Sanford and Son protagonist Fred Sanford, played by veteran comedian Redd Foxx, would clutch his chest and say, "This is the big one! You hear that, Elizabeth? I'm coming to join ya, honey!" faking a heart attack in key dramatic moments, often when he was shocked (or cornered in his scheme) by unforeseen events.

With regard to the US equity markets, we're sure that many a punter had that same thought cross their mind when the major indices failed at overhead resistance, fell down to support, and then broke further plunging hard into the close. Is this it? Is this the big one?

The markets took three hard body shots today. First, the pending home sales number came in at a negative 2.6% this morning, on top of some truly gruesome financial results from KBH homes. Secondly, a rumour swept the markets today that Countrywide Financial, prince among subprime mortgage companies, was going to be in bankruptcy because of a capital funding crunch, taking CFC down another chunk in the 80% drop it has seen since its heyday last year. At one time CFC was even one of the primary dealers, those anointed among financial institutions on the best buddy list and elite crew that borrows directly from the New York Federal Reserve. Third, and taking down the markets to the floor, the esteemed CEO of AT&T, Randall Stephenson, told a group of investors that "ever since Q3 ended, the company has seen an up tick in non-paid disconnects in both broadband and traditional access (wireline) subscribers. Mobile is still growing strong—people aren’t canceling their cell phones just yet—but the market is obviously spooked."

Well, anyone who doesn't think the US housing business is in the tank has been on an extended vacation from reality. And although we don't know that CFC will be declaring bankruptcy anytime soon, with an 80% haircut in their stock in less than a year, what does it matter? They are dead men walking.

The AT&T news was a bit much, not so to hear that AT&T is struggling with their consumer business, but rather that consumers are hitting the wall with basic phone services, although we suppose a phone isn't viewed as the necessity it used to be. If it had been their mobile business that was tanking, then by God we might have seen the Crash of 2008 today, since all those texting youngsters would have undoubtedly been responsible for bankupting their poor parents.

We don't know if this is the big one or not. But as usual, we think we know what to look for, and have a couple charts to illustrate our signposts. The first chart is the long term weekly chart of the SP 500. Since this reflationary reinflating of the stock indices began in 2003, the SP 500 has not broken the 100 week moving average on a weekly close. Not one time. Ok, interesting, but not decisive.

We also like to watch the cumulative measure of NYSE Highs and Lows, as illustrated in this next chart. As one can see, the 360 day moving average has proven to be a reliable indicator of trend changes in the SP 500. Again, there is nothing written in stone, but if we get a confirming break of the moving average by the highs and lows, together with the break of the long term moving average by the SP500, then the probability becomes very high that the market is at a key turning point, and a new bear market has come back to town.

One of THE most reliable indicators of recession, hardly ever without fail, is that shortly before a recession formally commences, the stock market will have a 10+% correction. Further, the stock market will reach a clear trough and begin to rally before the recession is over.

Well, we're there, on the 10% correction at least. Now we'll have to see how deep this rabbit hole goes. Is this IT? Maybe, if IT is a bear market. Probably not, if IT is a market crash. Big crashes are always very long odds. But with the financials leading the way lower, and the dollar following, its a bit dicey. If corporate bonds join in to this fun fest, we'd keep in mind another of Fred Sandford's familiar sayings: "Beauty may be skin deep, but ugly goes clear to the bone."

Fed Policy Actions in Anticipation of Economic Recession

We've been studying and updating spreadsheets correlating market performance and various monetary aggregates and interest rates and spreads lately, in the hopes of gaining more understanding of what we think the Fed is doing. From time to time we like to share a chart because it might have some particular interest in and of itself to others.

Here is a chart of several of the primary monetary aggregates during the Greenspan - Bernanke chairmanships. We think they clearly demonstrate the Fed's anticipation of economic recessions which are also indicated according to the official NBER ruling. Keep in mind that economic weakness can be apparent long before the date on which the NBER formally declares (well after the fact) that the economy had entered a formal recession.

Although the chart is a bit dense with data, and not immediately and easily understood, it worth looking at it a bit, to get the idea of how the Fed reacts to an economic slowdown, and how the monetary aggregates react to the policy decisions by the FOMC Believe it or not this is a simplified version, not including interest rate spreads and stock market indices. Eyeballing charts like this is a first phase in our economic detective work, where we turn up suspects for more rigorous analysis using statistics and spreadsheets. But it does contain the big picture if you have the eye for it.

Does the Fed have a perfect control over the money supply and the economy? Certainly not! The analogy would be to that of a ship's captain. The ship travels in various conditions, and the captain does not personally propel the ship, does not maintain a perfect control sometimes to their dismay and that of the passengers, and may encounter previously unknown conditions. But in keeping with our analogy, we'd like to observe that both the captain and the Fed have quite a bit of influence over where the ship or the fiat money supply might be heading, and what routes they might take in getting there.

There is little doubt from our study that the Fed has seen a recession on the horizon, and is trying to balance the deflation of the housing bubble against an economic slowdown that becomes overly severe. Like a ship's captain, sometimes the tides and tradewinds are with you, and sometimes they are against you, and this will influence which actions you take to achieve your objectives. Let's wish Captain Bernanke well, as he steers us between the Scylla of Recession and the Charybdis of Currency Debasement.

National Elections - Change in the Air

We've been privately arguing for some time that change is in the air, and the pat formula of Clinton vs. Romney/Guliani is a not going to be the sure thing that many thought. The Obama and Huckabee surprises in Iowa were no surprise to us. Why?

Change is in the air. The Bush presidency has alienated most of the nation, if one judges by popularity polls, to a degree not seen since the Nixon presidency. For those of us old enough to actually remember it, the national discomfort with the republican party was profound, far surpassing the particular angst about the excesses of Nixon's imperial presidency (for the record we've been republicans since 1964).

We came into this looking for the outside candidate (likely the traditional term dark horse candidate will receive little use anymore). In the 1976 election, Jimmy Carter came seemingly out of nowhere, the obscure governor of Georgia, to take the election as the candidate of change. The nation wanted someone as different from Nixon as they could find. Different, but we're not naive enough to think that these fellows have not all been vetted by the power elites to some extent. Mr. Smith may still go to Washington, but he's got at least one of the boys on his shoulder whispering advice. John Kennedy certainly had this, as a change candidate of profound proportions we hardly even realize today. They don't always have to listen once they get in office.

So now we come to 2008. Of the outside candidates, Obama, Huckabee, and Ron Paul have the greatest appeal as something different. Although the Ron Paul internet phenomenon is amazing, and reassuring, we don't think Ron Paul has enough support to be a viable candidate for any mainstream party, and would like to think he will not run as a third party candidate unless something happens. On that note, Obama reminds us of Robert Kennedy's presidential campaign for change against Lyndon B. Johnson, another imperial president, but of the democratic flavour.

Edwards positions as the change candidate, but is establishment enough to be thought of as a comfortable alternative if Obama cannot be the choice for some reason for the Democrats. He talks change, but is comfortable. If for some reason Obama falters, Edwards can most benefit perhaps. After all, Roosevelt was a patrician who betrayed his class.

Hillary, on the other hand, is the candidate of the status quo. The seeds for our current dilemna were nourished if not sown during the Clinton presidency. She is not the candidate of change. She is the candidate of the machine. She and Rudy are the most divisive candidates, and this is hurting their appeal to an electorate that is tired, and seeking a change.

As for the Republicans, Romney was the annointed, in the spirit of W's pre-primary coronation, but it appears he does not have broad appeal, and is the antithesis of change. Fred Thompson and Rudy Guiliani were brought in as back-ups, but their lack of appeal has been astonishingly predictable. The primary weakness of the power elite is the lack of diversity in their inputs, their disconnect from reality at market turns so to speak.

McCain the maverick has been courting the war wing heavily, but has the reputation as a change agent (and some Republicans might say loose cannon). Ironically, we think Huckabee might be the most like Bush in that he appeals to the evangelicals, but has a fiscal and tax policy tailored by the doyens Wall Street, that has gotten little play so far. Still, he looks like a change at first glance.

This election will be ugly, and it will get uglier in the news, and in the emails that get tagged around this time every four years. We won't be discussing it much, because politics (and religion) are outside of the purview of this blog, and this election will be mixing it up with politics, religion and race. The deomographic polls we have seen show that Obama swept all the groups except for the over 60 crowd. As the last to get it, they will never believe that change can occur until it happens.

But joys of discussing politics, and religion and race aside, the economic and fiscal policies of the candidates are of paramount interest, not only for the economy, but also for the equity markets, and now. Let's take a look at the stock market in the watershed year in which Jimmy Carter was elected.



In looking at chart analogs such as this, its important to remember that we don't put much weight on the actual timeframes or durations. For us its all about price action. Information flows at different speeds, and environmental factors and influences pro and con operate with different strengths. Its the price action that matters most in our method. This distinguishes our approach from most pundits, including the nice folks from whom we obtained this chart. Our take on it would be that as an Obama presidency becomes more likely, and his fiscal change message becomes stronger, the stock markets are going to sell off, and probably significantly. We're probably already seeing some of this profit taking now.

New Hampshire on Tuesday will be important. We don't think Huckabee will do well given the lack of evangelical support, and McCain may do extremely well, positioning him as the other alternative to the annointed Romney. We wonder if Hillary has the machine to win in New Hampshire, or at least make a decent showing so the comeback kid card can be played.

But make no mistake, if the change candidates come out on top, we might see a replay of the year in which Jimmy Carter came to power in the markets, as the boys cash in their chips ahead of the uncertainty of new tax laws driven by a Democratic change president with a Democratic congress behind him.