I can say I've been through 2 bear markets now and the second one, I traded exclusively for my livelihood, no side job, no safety net. I have recently over the last few weeks alluded to my feeling that this market is much like the 2008 market. The 2008 market was very similar to this one in many ways. For instance, news dominated trade, technical indicators were difficult to rely on and every day was a new surprise. There were many times when there was no discernible trend for weeks and even months. Put very bluntly, there were a lot of rumors and a lot of lies coming from financial institutions which were at the heart of the 2008 bear market. At first you took them at face value, but after seeing the same institution lie, then lie again and again (predominantly about how much risk they had to subprime derivatives), you grew skeptical. Each lie or rumor, like today (literally) had the power to move the market, but not the power to create a trend, it was the collection of lies that eventually created a trend when no one on Wall Street trusted each other, no banks trusted each other because no one knew for sure just how much risk they other party was carrying, it led to a complete financial freeze of all liquidity, whether it be interbank lending or the credit markets, everything stopped functioning.
The last several months have grown increasingly like the 2008 bear market and the effect is accelerating.
The question I get most is, "When is the market going to break down?". People are amazed at the news and that the market has not fallen off a cliff. Putting aside 3C, putting aside Technical Analysis and answering the question from my perspective and experience (primarily 2008 because in 2000 I only understood that valuations were out of control, I didn't understand all of the other things going on around me) I would say that the 2007/2008 bear market really took hold and things fell off a cliff when the key players (in this instance mostly financial institutions) no longer trusted each other; that's when credit froze, banks failed one after another because they were locked out of the capital markets due to a credit freeze.
For this reason, I have had the gut feeling that we are in that era again. The technical argument is there, the top is there, the 3C readings are some of the worst I've seen, but putting that aside, it's when solutions to problems are no longer effective because there's no more trust.
Revisiting some recent events (as I have said, the effect is accelerating); the G20 demanded the EU do something to fix the EU crisis before the next meeting that jut passed last week. The EU's expansion of the EFSF was one of those events were trust was broken. It was a haphazard plan, so horrible that the G20 themselves won't even invest in it. Their trust in the EU to solve this problem is severely diminished.
Greece is on their 3rd or 4th bailout plan, the EU wants a simple letter stating that they will abide by the agreement so they can get the next tranche of money. You know the games Papandreaou played, accepting a plan and then putting it up for referendum and then backtracking on that, he was no longer trusted and that led to Samaras of the opposition coming in to power, yet even today this headline flashes:
Even Greeks don't trust their banks as this was also released today from the Bank of Greece:
September
bank of Greece deposits collapsed to the worst ever
has
dropped 23% since September of 2009.
I'm not even going to cover the implications of this alone, but they are dire.
Italy and Berlusconi have promised reforms, at the G 20 summit the trust in Silvio and the Italian parliament was so diminished that he had to sign on to a humiliating agreement in which the IMF more or less baby sits Italy to see whether they are making the adjustments they agreed to long ago.
The market has so little trust in Italy that today for the first time their 10 year notes were yielding nearly 7%, this is past the threshold that started the Greek, Portuguese and Irish crisis and bailouts, yet Italy being the 3rd largest EU economy is beyond being saved. The EFSF can't raise the money for Ireland, much less Greece and certainly not Italy.
"The yield on the 10-year Italian government bond spiked close to 7 percent Tuesday, a sign that markets are questioning the country's ability to pay its debt. Unlike Greece, Portugal or Ireland — all of which received financial lifelines — Italy has too much debt to be rescued by its European neighbors.
As per Credit Suisse today, before the Italian vote, they laid out 4 options, the most likely 3 were as follows (although #3 is what happened and is the most important):
We
see four possible scenarios:
- No elections and a new government supported by a “national unity” coalition. This would probably be the best option from a market perspective. We attach a 30% probability to this scenario.
- No elections and a new government with a broader center-right coalition. Overall, it should lower the uncertainty and provide a mild positive for the markets. We attach a 30% probability to this scenario.
- Early elections. The most market negative option in the short-term, in our view, and a sign of incapacity to reach an agreement at the political level. Uncertainty on the outcome of the elections could last for several months, as elections would be called at the earliest in January but possibly as late as March or April. As the chart below shows, it is unclear if the current opposition will win a clear mandate. The President of the Republic will likely try to avoid an early election in all possible ways, in our view. We attach a 30% probability to this scenario.
How do we know option 3 is the one, other then the vote?
From
Bloomberg:
BERLUSCONI:
`ONLY POSSIBILITY' IS EARLY ELECTIONS
BERLUSCONI:
PRESIDENT WILL DECIDE HOW TO RESOLVE CRISIS
As I'm writing this, Barclays has just come out with the following:
1) At this point, it seems Italy is now mathematically beyond point of no return
2) While reforms are necessary, in and of itself not be enough to prevent crisis
3) Reason? Simple math--growth and austerity not enough to offset cost of debt
4) On our ests, yields above 5.5% is inflection point where game is over
5) The danger:high rates reinforce stability concerns, leading to higher rates
6) and deeper conviction of a self sustaining credit event and eventual default
7) We think decisions at eurozone summit is step forward but EFSF not adequate
8) Time has run out--policy reforms not sufficient to break neg mkt dynamics
9) Investors do not have the patience to wait for austerity, growth to work
10) And rate of change in negatives not enuff to offset slow drip of positives
11) Conclusion: We think ECB needs to step up to the plate, print and buy bonds
12) At the moment ECB remains unwilling to be lender last resort on scale needed
13) But frankly will have hand forced by market given massive systemic risk
2) While reforms are necessary, in and of itself not be enough to prevent crisis
3) Reason? Simple math--growth and austerity not enough to offset cost of debt
4) On our ests, yields above 5.5% is inflection point where game is over
5) The danger:high rates reinforce stability concerns, leading to higher rates
6) and deeper conviction of a self sustaining credit event and eventual default
7) We think decisions at eurozone summit is step forward but EFSF not adequate
8) Time has run out--policy reforms not sufficient to break neg mkt dynamics
9) Investors do not have the patience to wait for austerity, growth to work
10) And rate of change in negatives not enuff to offset slow drip of positives
11) Conclusion: We think ECB needs to step up to the plate, print and buy bonds
12) At the moment ECB remains unwilling to be lender last resort on scale needed
13) But frankly will have hand forced by market given massive systemic risk
I could go on and on and on about how trust is not only fading, but nearly gone and this is what I would say is the hallmark of the turn from a top to a bear market.
Contagion, that which the EU sought to avoid is pressuring French sovereign and bank ratings and is already taking a toll in the US as MF Global, a 200 year old firm just went belly up. Commodity traders are having doubts about their brokers, everyone is under the eye of suspicion.
As to what is normal in a bear market, I have a few charts to share with you. You've seen these harts recently, the 2008 similarities are striking to the present.
As far as today's action, it looked a lot like gap filling action and that's about it. It's not unusual, look at the gap filled just before the July crash.
Here the SPY fills the gap in the red square, 2 days later the decline starts.
Why do I think it was a gap fill and nothing much more serious as in the start of a new Bull uptrend?
The 5 min chart shows some more history, but if you focus on the 8th (today, the 5 min chart, which had hours to confirm the trend, didn't and remained negative.
Next, PMs
What's a rally on Wall Street without semiconductors?
And why was the SPY more excited then the Euro itself?
As for Copper, a leading indicator for the market...
However the easiest way to look at the broad risk basket that should rally in a risk on environment as compared to ES/SP-500/SPY would be just to look at the CONTEXT model.
As for ES itself
Bottom line, I believe this was a chance to fill that gap, which is neither bearish or bullish, I showed you a previous gap filled and a few days later we saw the biggest fall in 2 weeks that we have seen in years.
The market action as I have tried to show you by the 2008 top action is no different, there's nothing unique about this week's trade in that respect, although it may feel much different as we are in a different environment.
Will volatility continue? Yes, both ways, but as I have said many times, the atmosphere of a bear market is upon us and getting worse by the day. Does the market fall 5% tomorrow? I can't say that, I can say the underlying accumulation/distribution picture is so bad that it is ready to fall off the cliff at any moment, it's not like we are waiting for the negative divergences to show themselves, they are here and ugly like I haven't seen in a long time and perhaps the worst I have seen. However, in that 2008 period I have referenced, I'm 99% sure the negative divergences were there as well, even as bear flags appeared and even as we had a huge move up only t be followed the very next day by the start of a 50% decline.
This is the closing ES 3C chart.
I hope this post helps to give you a sense of reference and why trade is so much different then what you may be use to, it's a different environment, it's a bearish environment and this time we're not talking about the failure of big US banks, we're looking at the failure of an entire continent. I would say when this is over, we'll have set a new precedent for bear markets that will eclipse 1929.
