The Ghost of 1929

We have a lot of members and I get sent a lot of articles, charts, and many other interesting data tid-bits.

One thing that I've received many times in the last week or two is this chart of the Dow-30 from the 2012 period to present, an area I've noticed to have EXTREME signals in many fashions, not just 3C, but market breadth being one of the most credible as well as market volume and many other indications,  overlaid on the Dow 30 of 1928 through 1929.

The chart looks like this, I'm sure most of you have seen it.

I think you can sort out what is what. There's an "Dooms-day" date of January 2014.

Let me state categorically that I believe history, as Mark Twain once said, "Rhythms", but doesn't repeat exactly.

I also believe that you can justify any point of view you want to take about the market if you are goal-seeking your data. There's so much data over more than a century of market charts that you can make anything fit the way you want with a little stretching or squeezing.

This is one of the greatest dangers in market and stock analysis, I suppose you could call it a "Cognitive Bias". One of the most difficult things in trading is learning and continually evolving to weed out subconscious biases and its for this reason I'm a very strong believer in keeping a journal about trading rather than a trading journal, something that is just like an every day journal that addressees emotions at the moment, circumstances at the moment, it's much different than what most people would think of as a trading journal, it's not a ledger.

For this reason and many others, I typically am dismissive of charts like the one above because I see the circumstances of today's situation being much different than 1929, for example, the economic factors, technology, global trade, the shape global markets are in, the way information moves now, things like derivatives, etc.

However after a little further investigation as I already knew the chart came from the well respected Tom McClellan, I did not know he was made aware of it by the equally well respected Tom DeMark.

Still, I viewed the chart pretty much as an interesting side note, I certainly wouldn't build any analysis around it, just the same as I find the Hindenburg Omens that were once so successful (and still have a good track record) as interesting and worthy of notation as I mentioned Friday, but again, I wouldn't make decisions based on it.

In reading more about past bouts of Central Bank "extraordinary accommodation", I read a bit about the start of Open Market Operations, I read this history directly on the Federal Reserve's own website! What I found was a bit CHILLING.

The F_E_D engages in Open Market Operations for the first time....
After World War 1 in 1923 a severe recession gripped the United States, Benjamin Strong who was the F_E_D chairman from 1914 until his death in 1928 had "realized" or "Theorized" (depending on your perspective) that by buying large quantities of US Bonds could the F_E_D could influence and generate credit availability in the banking system. Strong's Open Market Operations (just missing the Permanent, otherwise you get POMO=Permanent Open Market Operations) which consisted of  LARGE purchases of government securities, just like today's QE, were considered "AGGRESSIVE" policy to stem the 1923 depression.

It was during the 1920's that the F_E_D began using Open Market Operations as a Policy Tool (sound familiar?) Strong was also known for promoting relations and presumably policy with other Central Banks, the Bank of England being a notable example (again, much like today). Strong died in 1928.

What came next directly from the F_E_D's own site and in their words...

"During the 1920s, Virginia Representative Carter Glass warned that stock market speculation would lead to dire consequences. In October 1929, his predictions seemed to be realized when the stock market crashed, and the nation fell into the worst depression in its history. From 1930 to 1933, nearly 10,000 banks failed"

Much like the 1920's, "The Roaring 20's", the F_E_D used extraordinary accommodation to buy large quantities of Government Bonds, Just like the "Roaring 20's" which is a characterization of the decade defined as follows...

"The Roaring Twenties is a term sometimes used to refer to the 1920s in the United States, Canada, and the United Kingdom, characterizing the decade's distinctive cultural edge in New York City, Chicago, Paris, Berlin, London, and many other major cities during a period of sustained economic prosperity."

While the F_E_D is using the same Open Market Operations during the 1920's as they are using right now and have been since late 2008, better known to most of us as QE, the economy took off (sadly unlike ours now), but there were dire warnings regarding the excesses and speculation in the stock market. Strong died before he could see the end result of his Open Market Operations.

It's stunning to me that a historian of F_E_D policy like Bernanke who is more an academic than an experienced economist, more so than probably any F_E_D chair in recent history, would know what happened in the 1920's and immediately panic in 2008 and make that his hail Mary, go to ground game. Furthermore, after seeing the ineffectiveness of QE (after all, if QE were effective, why are we on the 3rd iteration and the 5th version since late 2008?) why would he push more and more knowing the ONLY "Wealth Effect" achieved is for the TBTF banks as the disparity between the have and have-nots has grown exponentially with some believing the middle class will never recover from the decimation of it over the last 5 years.

While it doesn't matter for analytical purposes, it has always been my feeling that QE always has been exactly for that reason, bailouts of the banks in 2008 were HUGELY UNPOPULAR, however QE is a stealthy mode of wealth transmission to the very same banks while having the most destructive effect on the most responsible people, the middle class "Savers" as their savings have been destroyed by QE and dollar debasement.

Unlike the 1920's, the present iteration of POMO / QE has not created any real Credit growth, just the opposite in fact as the money chases higher and higher yields. There are many structural shortcomings in the market that make a decline truly scary and it is one period of market history that I will not sit out  as I have always believed, it will have unparalleled opportunities for those who adjust and ride the wave, trading the market. 

However with the evidence of the 1920's and QE at least having done what it was meant to do for the better part of a decade, even though it ended badly, we now have something much more maddeningly dangerous and far less effective if it can be said to be effective at all, I believe it will be seen in history as the most destructive F_E_D policy ever witnessed.

It was in this research that I came to find the reason for the "January 2014" target date on this Dow chart...

The answer was not as simple minded as I had imagined, in fact I'll reproduce in its entirety the article that made me understand this date as "The Best Case Scenario" which is from the weekly update from Hussman Funds which is a Fund Management company. The Optimistic view of January 2014 doesn't come from how many days we are away when the two charts are overlaid, it comes from a "Sornette log-periodic bubble".

Before I reproduce the article, I've been an avid student of market bubbles right back to the Dutch Tulip Craze centuries ago and every one since. I've shown this before, but it would seem to me that as Glass warned in the 1920's, it was obvious to many (and likely many that we might call "Smart Money " today) that this wasn't going to end well.

This is a view of the Dow-30 with 3C chart from 1929 (I have long known about this)...

 Remember the recession was in 1923 in which the F_E_D responded with Large Scale Asset Purchases.

However by 1924, there's only one hiccup through 1928 in 1926, The Roaring 20's. The green arrow represents 3C/price trend confirmation as 3C makes higher highs with price.

Then on to 1929, something changes...

 From confirmation to a clear negative 3C divegrence in to the top just before the crash. For some context about the nature of even bear markets, the area at the white arrow is a 6 month rally (bear market rally) that gained +45%, 3C called a negative there too, but few probably realize the emotional hell this market was. There were at least 5 such bear market rallies during the decline, each successively less powerful.

#1 is 1923, #2, the Roaring 20's, #4 is the 6 month counter trend rally after the crash that made +45% and #5 is where 3C calls a bottom.

Here it is back on the daily chart, 1932/1933.

Now to present...

 The 2007 top, from confirmation to a negative divegrence.

 After the 2009 low, confirmation with a few hiccups like the Roaring 20's, most of these were at the end and/or in between QE programs. 2013 saw 3C getting more extreme that I've seen historically, many finds have come out and said plainly they have been net sellers of everything not nailed down for the last 15 months and the 10Q's / 10K's prove it or Dan Loeb returning about 10% of his client's money .

Now the entire picture, #1 is almost a -20% market decline round late July/early August 2011, #2 is where things looked pretty extreme to me in 3C terms, #3 is the most severe divergence I've seen for the entirety of the Dow's history since 1916.

This is the link to the Huffman Funds Weekly Report which will better explain why the price on this chart is called a "Best Case Scenario according to a "Sornette Log-Periodic Bubble".

***None of this changes of negates any of my analysis, I just believe it gives so extra credibility to a popular chart I had pretty much dismissed. I think there are some other very worthy data points in the article,  my thing is to follow the clues on the charts and let the market tell me. However that doesn't make the information in the article any less meaningful.