Tuesday, March 9, 2010

ON THE BRINK OF AN ASSET EXPLOSION

I can virtually guarantee that what I’m about to suggest isn’t on anybody’s radar screen. But before I share my prediction, a little background analysis is in order.

There have been seven previous bull markets that were born in the depths of vicious bear markets similar to what we just went through. Each one of those bulls racked up impressive gains during the initial thrust out of the final low. Throwing out the `32 to `37 bull as an anomaly not likely to be repeated, the average gain for the first two legs of bulls with similar DNA as our own has been between 41% and 73%. After the second leg each one of these bulls underwent a mild corrective pullback of 8% to 14%.

I’ve been looking for that pullback since December and we obviously got it from mid January into early February.


Next I’m going to put up a long term chart of the S&P from the `02 bottom to present so we can make some comparisons for what should and should not happen in a “normal” bull market…if there is such a thing. Both bulls were born on the back of massive liquidity injections by the Fed. So it’s not surprising they have followed a similar path…well at least up to now.

Generally we will see the most aggressive moves at the beginning and the end of a bull market. At the beginning smart money piles into perceived value. At this stage of the game retail traders are still too shell shocked from the bear to trust the rally.

Finally towards the end of the bull, retail investors will panic into the market on fears of getting left behind sending the market surging higher. This is of course when smart money is unloading their shares.


You can see that the `02 -`07 cyclical bull followed this script almost to a T. The sharpest rallies occurred from March `03 to early `04 and then again as the market surged out of the `06 bottom into the final top in October of `07.

The cyclical bull we are in right now is about to morph into a completely different animal than just about any other bull market in history. And most certainly this bull will not fit in the same category as the `02-`07 bull. I think we are about to bypass the second phase of a normal bull market and jump straight to phase three, the ending stage.

This is a bull spawned by the printing of literally trillions and trillions of dollars by central banks around the world. You can see by examination of the chart above that this bull has been much more aggressive than the last one, rallying over 70% in its first 10 months.

The recent move to new highs by the Russell, Mid Caps, and Nasdaq suggests that the third leg of the bull is now underway. As most intermediate term rallies last 20-25 weeks trough to trough and this rally is on week 4, we probably have at least 10 to 15 weeks left before we can expect a top.


Now keep in mind that this has transpired while the dollar has been rising. As a matter of fact, the dollar is the key element in what I’m about to suggest.

So next, let’s take a look the dollar.


I’ve marked the last two major 3 year cycle lows with a blue arrow. Now to understand where I’m going with this you need to understand the concept of left and right translated cycles.

A left translated cycle is a cycle that tops left of center. For instance, if the rally out of a 3 year cycle low were to top out in less than 18 months we would consider it left translated. Generally speaking the majority of cycles that top in a left translated manner move below the prior cycle low.

You can see in the chart (above) that the 3 year cycle that began in December of 04 did in fact top in less than 18 months. As expected it broke to new lows at the next 3 year cycle low in `08.

We are currently in the same position in this 3 year cycle as it has obviously topped in a left translated manner. As such, we should expect to see the dollar break to new lows by the next major 3 year cycle low due sometime in 2011.

Now if we zoom in a bit I’ll tie this together with how it relates to what I think is brewing in all asset markets.

There’s no doubt the rally in the dollar over the last three months has been violent (the most violent rallies occur in bear markets). However, as you can see from the chart below, so far the dollar has not been able to move above the peak of the last intermediate cycle.


We now have a failed intermediate cycle in the making. If the dollar fails to break the June `09 highs and continues to roll over it is in jeopardy of succumbing to the secular bear trend again.

Next I’m going to note that last week was the 14th week of the dollar rally. The intermediate cycle in the dollar rarely lasts more than 20-25 weeks so not only is the dollar getting deep into an intermediate cycle and in jeopardy of topping at any time but it’s also contending with the multi-decade resistance level at 80.

Not only that, but sentiment has now turned to extreme bullishness for the dollar and extreme bearishness on the Euro. That is a recipe for running out of buyers of dollars and a prescription for a violent short covering rally in the Euro.

Now remember, the stock market has been rallying despite the dollar. Oil is over $80 despite a strong dollar. Copper is only about 15% from all time highs despite a strong dollar. Gold, the strongest commodity of all, is holding well above the prior bull market high of $1025 in defiance of a strong dollar.

All asset classes are now wound up as tight as a drum. If, or should I say when, the dollar begins the trip down into the next intermediate cycle low all assets are set to explode higher.

As hard as it is to believe I think there’s a very good possibility that the third leg of this cyclical bull could match the first leg and tack on 200-300 points in the next few months.

I think virtually everyone underestimates the effect that the multi-trillions of dollars the Fed has pumped into the system is going to have on all markets.



Unfortunately that’s probably the single worst thing that could happen for two reasons.

First, I’m afraid that not only will the stock market surge higher but so will the commodity markets in an inflationary explosion. It was $147 oil and $4.00+ gasoline that eventually broke the back of the global economy in `08 when it was already reeling from a bursting credit and real estate bubble.

Second, I’m afraid the average investor is going to fall for the hype that the Fed has “fixed” all of our problems. If the S&P is trading north of 1400 it’s going to appear that the coast is clear.

Nothing could be further from the truth, so when the market tops and rolls over into the next bear phase virtually no one will recognize what’s happening and everyone will again get sucked down into the depths of the bear.

Only this bear will be much worse than the last one.

This bear won’t be caused by problems in the credit markets. No, this bear is going to be driven by structural problems in the currency markets and soaring inflation. Unfortunately we aren’t going to fix a currency crisis by printing money. Money printing is going to be the cause of the crisis in the first place.

The only asset class that is going to offer any protection in this environment is commodities. And the one sector that will thrive in a currency crisis is the precious metals.

Not only will gold and silver outperform in the pending inflationary surge, but they will protect investors during the inevitable crisis that the Fed’s insane monetary policy is going to unleash next year.

6 comments:

  1. A left translated cycle is a cycle that tops left of center. For instance, if the rally out of a 3 year cycle low were to top
    out in less than 18 months we would consider it left translated. Generally speaking the majority of cycles that top in
    a left translated manner move below the prior cycle low.

    =============================


    Friday
    3.12.2010

    Toby,

    Hope this finds you well ... nice blog page, and
    good charts, keep up the good work my friend.

    A couple of questions please, if I may as follows :

    Ok ... assuming this is true, and I do believe that it is, then how can we not know for absolute certain at this point in
    time that this "top" which is forming now (in mid March of 2010), is "not" within the first half of a much longer term
    left translated cycle ? In other words, how do we not know that this three to four year cycle which has begun as bullish
    as it obviously has, is not the bullish beginning of a longer term left translated cycle ? After all, in such a case, wouldn't
    it be true, that cycles are "scalable" and therefore, a left translated four year cycle might have begun (I've never heard of
    a three year cycle such as you mention) in March of 2009, so thus far we've only so far seen twelve months of it, hmm ?
    Such a new four year cycle would begin as this one has "very bullishly", and yet "could" still end up being very bearish in
    the entire four years, or even six, eight, or ten, all of which are only some of the cycle lengths that we do know exist, eh ?

    ALSO ... how do not know for certain, that what appears to be the beginning of the next cycle with the February 5th. low,
    is "perhaps" not "an extension" of the previous year long cycle beyond the "exact" time frame of one year ? After all, a low
    formed on February 5th. 2010, is not exactly one year from the March low of 2009, it was "short" about one month, thus it
    would seem still within the realm of possibility, that we "could" yet head down into a low of eleven or twelve months from
    the year + - cycle which obviously began in March 2009, hmmm ? The "year cycle" does not have to be exactly one year, eh ?

    ReplyDelete
  2. Lindsay,
    I actually go over a lot of this stuff in the daily updates. But real quick.

    The dollar cycle is different from the stock market cycle. The longer term dollar cycle loast about 3 to 3 1/2 years.

    The stock market cycle lasts on average 4 years. At this time we have no indication the 4 year cycle in stocks will top in a left translated fashion (although I think it probably will as we are in a long term secular bear market).

    Basically we would need to see this yearly cycle (that just began in Feb.) top in a left translated fashion. I.e. within 6 months. If that happens then it would likely also mark the top of the 4 year cycle.

    From that point I would expect the global stock market to begin the next grueling decline into a lower low sometime in 2011 or 12.

    ReplyDelete
  3. Toby,
    Man you got me thinking tonight for sure. Really great analysis and charts, and thank you for them.

    It reminds me of Bennett Sedacca's (Minyanville) view from about a year ago where he laid out a scenario where we bottom in October 2010, at 300-400 on the S&P.

    Are your thoughts equally as dramatic on the interest rate side? I.E. should I lock in some cheap $$ while I can?

    Again, thanks and keep it coming.

    ReplyDelete
  4. I definitely think the bull market in bonds is over for the next 15 or 20 years. So rates should generally be rising over that period.

    ReplyDelete
  5. Lot's of good work! Particularly on the SPX. While I am not so convinced about the "liquidity" argument, since 1.3 trln of it sits on deposit with the FED, it is the low rate levels that push investors into stoxx and performance breeds under-performance anxiety,so managers have to pile into it, rationale wouldn't matter at this point.
    I still like to measure the market with the DJIA as a benchmark and historical tracing back more than 100 years (yep it works!)indicates that Dow 14,800 appears to be attainable this year, perhaps by around Labor Day. Also, a new high would suck in the last retail dollar and could set the stage for a very nasty thereafter. To that extent I am a bit more optimistic than what the superimposed SPX moves call for, on the upside. For that scenario to become valid, we should take out DJ 10,800 first.
    As for post 14,800, it is my take, that it will be plain ugly. We should have gone there in 2007, but events took over and my research suggests, that the target "has" to be met, which means we are running quickly out of time. Hence the race to the top. Which also will accelerate the drop thereafter. How far down then? At least the old lows, but again research suggest that it might get much uglier. But if you are out on top, you will have ample time to assess the steps at the old lows.
    As for Gold, L/T technical surveillance suggest that 1355 seems to be attainable. For the Euro I can see 1.48 max from here (exit <1.35, and then deflation hell should break loose.
    So stay tuned.

    ReplyDelete

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