More Bear Tracks To Follow

With a couple weeks left to go for the year, many stock market analysts are still hoping for a Santa Claus rally.  They were emboldened by the huge October rally in the stock market, and then a big bounce out of the worst Thanksgiving week since the Great Depression.  But after selling off again last week, the S&P 500 has still failed to trade above the 30-week moving average for an entire week since July!  If you look at the chart below you can see that for the last 9 weeks the S&P 500 has failed to retake the 30-week moving average.

This type of bearish action occurred during the last two bear markets.  During the 2008 bear market, once the S&P 500 dipped below the 30-week moving average during the last week of 2007, it never again traded completely above the 30-week moving average until the bear market was over.  It tried to re-take the 30-week moving average in May of 2008, but failed.

During the 2000-2002 bear market, which was much more drawn out than the 2008 bear market, the S&P 500 made more attempts to re-take the 30-week moving average.  But it failed every time except for a single week in March 2002.  Only when the end of the bear market was reached in April 2003 was the S&P 500 able to trade above the 30-week moving average for more than a week.

Besides the bearish implications above, there’s more bear tracks showing up in other markets.  Some markets are looking like they could breakdown below their October lows.  Canadian banks are one, which is interesting because they were supposed to be relatively healthy, due to the fact they didn’t use as much crazy leverage as U.S. or European banks.  Bank of Montreal made a new closing low for the year last week, and is clearly in a Stage 4 downtrend.

Bank of Nova Scotia is also threatening it’s October lows, and like Bank of Montreal is in a Stage 4 downtrend.  I’m not showing them below, but Stage 4 downtrends are also occurring in the Royal Bank of Canada and Toronto Dominion Bank.

India made a new closing low for the year last week and looks set to continue moving lower.  This is obviously bearish since India is supposed to be a source of global growth.

Now you might say why should I care about Canadian banks or India, if I’m only concerned with U.S. markets?  If these markets weren’t heavily intertwined with the rest of the world I would agree.  But since they are important parts of the world economy, the signals they are giving can’t be ignored.

Finally, for the October rally to be something other than a simple mean reversion rally, the tech sector needs to re-establish its leadership position.  If the Nasdaq 100 was to break below the November lows it would start a pattern of lower highs and lower lows, which would add to the bear case.

The market will continue to remain unhealthy if these bearish trends proceed.  Watch those October lows and whether other markets are able to hold those lows or fall below them.

Trend Following Bear Markets

One of the beauties of trend following is ignoring the constant swirl of noise that surrounds the market.  Charts don’t lie, and they don’t have opinions.  By pouring through a wide variety of charts, from the major market indexes, to commodities, bonds, and foreign markets, you can develop an overall feel for what is going on in the markets.  This objective method of looking at the market can dramatically improve your confidence and understanding.

To get a simple view of the trend I like to use weekly charts with a 30-week moving average and a TRIX indicator.  The relationship of the weekly price action to the 30-week moving average determines what stage the market is in, according to Stage Analysis.  Stage Analysis is one of my preferred trend following methods since it is easy to visualize but still very effective in understanding the current trend.

The TRIX indicator is used to confirm the trend, and also determine whether the market is trending or pulling back within a trend.  My interpretation of the TRIX is as follows:  when the TRIX is above zero, the long term trend is up, and when the TRIX is below zero, the long term trend is down.  Along with that rule, if the TRIX is above zero but has crossed back below it’s signal line and is traveling back down, then the market is pulling back within a longer term uptrend.  Conversely, when the TRIX is below zero, but has crossed back up above its signal line and is moving higher, then the market is bouncing within a longer term downtrend.

The weekly chart of the S&P 500 below shows the stage transitions through the bull and bear markets of the last 10+ years.  Notice how the TRIX helped confirm the trend, it stays below zero during bear markets and above zero during bull markets.

Looking closer at the S&P 500, it started losing momentum back in March of this year, as evidenced by the TRIX crossing over and moving to the downside.  Then the S&P 500 topped in May, and the TRIX continued to move lower and cross below zero.  The cross below zero is key, since it signals a long term trend change to a downtrend.  This is a clear warning sign to long term investors.  Since October the TRIX has crossed over to the upside, but is still below the zero line.  So according to the rules laid out above the bounce from October is still a bounce within a downtrend.

It’s important to follow the major indexes since they form the foundation for where the market is headed.  But smaller components of the market, such as sectors, commodities, currencies, and even individual stocks or collections of stocks can give clues as to when the overall market could slowly be undergoing a trend change.  One thing I like to focus on is where the strength in the market is, and where the weakness is.

The financial sector was the primary cause of the bear market in 2008 and topped well ahead of the rest of the stock market.  The same thing has happened again with the financials topping in February of this year ahead of the market.  Notice how the financials have shown some strength with their recent bounce, but it still hasn’t developed into a definitive trend change.

The commodities sector is one of the weakest components of the market currently.  The CCI Commodities index broke to new lows this week, and the TRIX hasn’t even crossed over to the upside yet, and is still below zero.

Looking at commodity sub-sectors, the agricultural sector is especially weak compared to other commodities like gold and oil.

Gold finally broke below it’s 30-week moving average this week.  The fact that silver, platinum, and palladium had broken down previously into a Stage 4 downtrend was a warning sign that gold could be vulnerable.  Usually the precious metals move in more or less the same direction, so it’s important to note when there are divergences within the sector.  This time around the weakness that the other three metals were showing finally caught up to gold.

The charts presented above represent a portion of the overall market, but if one were to delve further into charts across other sectors, commodities, and foreign indexes there is a predominance of Stage 4 downtrends currently in the market.  The key question now is how long will it take for these downtrends to play out?  If you set aside attempts to forecast a bottom, all you can do is wait for it to come.  Think of a bear market like a horrific accident, it’s much better to experience it as an innocent bystander passing by it, than a participant right in the middle of it.  You want to be in a safe place and let the bear market run its course.

The most positive end to the current bear market would be if the early October bottom held up for portions of the market that haven’t broken below it yet.  Commodities have already broken below this bottom, but if other sectors diverged and didn’t break below their October lows that would setup the basis for a much healthier market.  So the October lows will provide an important area to monitor as this bear market plays out.

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The original article and much more can be found at:

Kyle Bass: In Depth Interview On The European Debt Crisis

Kyle Bass of Hayman Capital Management is known for successfully betting against the housing bubble, and was featured in the book Boomerang by Michael Lewis.  He also has done substantial, thought-provoking work on the sovereign debt crisis facing Europe.  In this video Bass covers the potential timing, order, and magnitude of sovereign debt defaults in Europe.  He also discusses his view on the housing market, Japan sovereign debt problems, and the U.S. dollar among other topics.

AC2011 Session 1.2 Come Undone: Kyle Bass redux

Some noteworthy quotes and points from the interview:

“Debt has grown in the last 9 years at a 12% annual growth rate.  GDP has grown at 4% (annually).  So what do you expect when you have a pillar of the world community, the European Union, entering a prolonged stage of deleveraging.  The rest of the world in the absence of private credit demand isn’t going to grow.”

“The bottom line is the bill is due today.  The bill is due in Europe today, in Japan tomorrow, it’s due in the U.S. the next day.  And those days are separated by years of course.  And no one wants to admit it.”

“For those of you that think a 50 cent default on the private sector is going to fix Greece, you’ve lost your mind.  It is a full writedown of what the Troika doesn’t own….if you just do that math you’ll realize it is a full wipeout.”

Bass thinks December 19th is a critical date for the Greeks since they require another tranche of money to finance their debts on that date.

“There’s a divide between reality and belief in Europe that is going to sink Europe before we sink.”

“We haven’t had a developed western sovereign restructure (it’s debt) since WWII….as soon as they do, you have to think about the qualitative analysis of the participants changing.  If it just changes on the margin, for countries like Japan or Italy, then the dominoes start falling….I’ve never seen an orderly default process, I think it’s going to be a forest fire….it’s not the end of the world, it just means a lot of people are going to lose a lot of money.”

“What this means is a very difficult time for the world.  This is not a cyclical rebound from a crisis we had two years ago and you should be buying stocks because a P/E ratio is low comparatively speaking with the rest of the S&P years.  Because the E is wrong.  And we’re going to see declines, and people don’t know how to position themselves for declines.”

“If you’re an individual you need to be much more conservative then you even think you need to be.  Return of capital is much more important in the next few years than return on capital.”

“In the environment we’re talking about here, the U.S. dollar should be fine in the short to medium term, if we’re right about Europe and Japan….I think you should be more in cash, and hanging onto productive assets and less invested in financial assets.”

Bass says productive assets could still experience losses but they should provide a better inflation hedge.

Bass discusses why he took physical delivery of gold, and it had to do with the fractional reserve nature of the COMEX.  He alluded to the idea that the COMEX wouldn’t be able to handle a large request for gold delivery because they only actually hold a small percentage of the gold traded on the exchange in physical form.

“What’s going to happen in Europe is going to happen very soon.”

Bass thinks the 30-year bond rate in the U.S. could go lower than 2% if money starts running to the U.S. during the upcoming European sovereign crisis.

Bass doesn’t believe collective participants in the market fully appreciate how negatively the debt crisis will affect the markets.

“I don’t get paid to be an optimist or a pessimist, I get paid to be a realist. Being a realist in this scenario is pretty negative.”

“Don’t believe these governments, when they tell you that everything is going to be fine….think about Mexico in 1994….if you remember the crisis, the day before the government devalued 60% they said they wouldn’t devalue. The government can never tell you what they are about to do….the key takeaway is develop your own opinion.”

More Kyle Bass interviews:

Kyle Bass BBC Interview

Debt Sustainability: Which Countries Are Beyond The Point Of Return And Why

Where Is Value Now?

Kyle Bass Explains Impending Greek Default

Kyle Bass Interview

Kyle Bass On European Banking Crisis

Kyle Bass @ AmeriCatalyst 2010 | ‘Confessions of a Dangerous Mind’