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Last
week I took a short position against the broad market on Monday. As I entered
this position I immediately posted a WSW Power Investor Elite bulletin. Two
days later my indicators gave me a confirmed sell signal. I believe the bear
is out of the box. The market may bounce a day or two after Friday's big
drop, but the next 150-200 point move in the S&P 500 is down.
I'm not the only
one worried about the market. George Soros came out
of retirement and has taken back control of his hedge fund to make money
shorting the market. You may have been trained to hate him by Bill O'Reilly
and FOX News where they demonize Soros for opposing
George Bush and his Iraq
war game, but when it comes to financial markets he has a history of being
right and being right big. He is one of the most successful investors in
history.
At 77 years old
he appears to be coming out of retirement with the goal of making a name of himself for the history books. He is releasing a new book
called "The New Paradigm for Financial Markets" in which he claims
we are witnessing the bursting of a "superbubble."
He claims we are in the "biggest financial crisis of my lifetime." According
to the International Herald Tribune:
Soros has been worrying about the fragile state of the
markets for years. But last summer, at a luncheon at his home in Southampton with 20 prominent financiers, he struck an
unusually bearish note.
"The mood
of the group was generally gloomy, but George said we were going into a
serious recession," said Byron Wien, the chief
investment strategist of Pequot Capital, a hedge fund.
Soros was one of only two people there who predicted the
American economy was headed for a recession, he said.
Shortly after
that luncheon Soros began meeting with hedge fund
managers like John Paulson, who was early to predict a crisis in the housing
market. He interrogated his portfolio managers and external hedge funds that
manage his fund's money, and he took on new positions to hedge where they
might have gone wrong. His last-minute strategies contributed to a 32 percent
return -- or roughly $4 billion for the year.
The more Soros learned about the crisis, the more certain he
became that he should rebroadcast his theories. In the book, Soros, a fierce critic of the Bush administration, faults
regulators for allowing the buildup of the housing
and mortgage bubbles. He envisions a time, not so distant, when the dollar is
no longer the world's main currency and people will have a
harder time borrowing money.
He isn't the
only one concerned. Former Fed Chairman Paul Volker called the current
problems "the mother of all crisis" in a
speech last week. He made the comment that before he became Fed Chairman
there hadn't been a financial crisis in over 40 years. Since the 1970's
though he counts 20 of them. He claims this one though is going to be the
worst of them all and that the US is in the early stage of a
dollar crisis.
My thinking is
simple. The last bear market lasted almost three years in duration. It came as
the result of the unwinding of the tech bubble in the late 1990's. This bear
market isn't going to end just six months after it started and those that
think it is over now are nuts. This bear market is the unwinding of the real
estate and credit bubble and that has much bigger consequences for the
economy than the tech bubble did.
This week
Citigroup and Merrill Lynch are expected to announce write-downs of over $15
billion for worthless "level three" mortgage debt. The worlds biggest banks have so far written down over $250
billion in debt in the past year. The IMF claims that the size of the losses
is likely to top $945 billion. So far the banks have been revealing losses
piecemeal every quarter in fear that if they reveal the true extent of them
they'll cause a Bear Stearns style run on their reserves. The government has
turned a blind eye to their accounting games so far, but the bear market will
not come to an end until the size of the losses are
finally revealed.
At this weekend
G-7 summit there was talk of forcing banks to reveal their losses over the
next 100 days. According to Reuters:
Policy-makers
pledged over the weekend to purge capitalism of the excess that caused the
latest crisis in financial markets.
It is a tall
order, made taller when governments of the Group of Seven free-market
democracies promised after meeting in Washington
to finish much of the groundwork within 100 days, and the rest by year-end.
The 100-day
deadline, based on recommendations formulated by the Financial Stability Forum,
commits supervisory bodies to set higher capital requirements and tells banks
to reveal the full extent of their losses in their first-half earnings
reports....
...How to value
assets in markets that are no longer liquid goes to the heart of what the current
credit crunch, now in its ninth month, is all about.
But not everyone
is rushing to write off the G7 initiative, at least while the ink was drying
on the reform plan, which the policy-makers said was about making the system
safer for the future rather than providing a fast fix to the current turmoil.
It is hard to
believe that the banks will all of a sudden reveal their losses for the good
of the system. Not when so far the Fed has done everything it can to try to
accommodate them at the risk of the dollar and inflation. When you go to the
gas pump and pay more for gas you are doing so as a direct result of the Fed
printing money to help the banks. More money in circulation makes the price
of goods and energy rise. It is an invisible tax you are paying to help the
banks and fund the bloated government deficit.
 
We had a little
bounce off of the January lows in March. That rally has been much weaker than
the previous two rallies we have seen since the S&P 500 market topped in
October. Volume has been lighter on this rally than the previous two and
already the advance/decline line has broken down on the NYSE, with the A/D
line for the Nasdaq already sitting on its March
low. The Libor rate, which banks charge each other, also has been rising in
the past few weeks - suggesting that the credit crisis is actually worsening.
Last week when the Bank of England cuts rates down to 4.6% the Libor rate
didn't drop at all, maintaining its 1.2% spread.
Of course in the
US
attention isn't paid much to the Libor rate on Fox Business News. Right now
its earnings season and that focus is hoping for
some silver linings. Last week UPS lowered their earnings estimates and GE
blew up for a 12.79% loss on Friday when it missed earnings and gave lower
guidance. Moves like you see in the chart above are why you respect bear
markets.
The daily stochastics for the S&P 500 gave a sell signal last
week. We have had four such sell signals so far in this bear market and after
each one corrections in the market followed.
Last weekend I
was reading and listening to many market analysts - many of whom I have a lot
of respect for. Almost all of them said the market might go higher. Even ones
who were bearish on the big picture said such things as you have to
"give the market the benefit of the doubt." We had two big up days
since the March low and those type of days make
people hesitant to say the market is going to start to drop. No one wants to
be wrong or tell people the market may drop only to see it go higher. Being
wrong like that can cost you your job if you are in
the financial business, because people are always more obsessed with missing
a rally than what they may lose by holding on in a bear market. But the big
picture is clear.
It is easy to
get caught up trying to figure out what the market is going to do this week
or next week, but if you step back from everything all you need to recognize
is that this is a classic bear market. That's all you need to focus on. When
the market averages are below their 150 and 200-day moving averages and those
moving averages are pointing down it's a bear market. In times like that you
don't want to make big bets on stocks. You want to preserve your capital so
you can buy as the next bull market begins and make money on the short side.
I've traded and
experienced bear markets before. To me the situation we are in now is very
similar to where the markets were in February of 2001. Back then the markets
were into their fifth month of the bear market. Notice how the long-term
moving averages were sloping down just as they are now. Notice how the 1300
level on the S&P 500 was acting as support from November through February
back then just as the 1270 area is now. And finally notice what happened in
February once the market closed below this level. The market fell all of the
way down to the 1100 area by April for a 20% drop from its February high. I
believe a similar drop is ahead of us in this coming quarter.
For the
short-term though the market is oversold on a 60 minute chart. It would not
surprise me if it bounces for 2-3 days this week. If such a bounce happens
the low of that bounce will become the critical support area. If that bounce
fades and then market closes below the next short-term support level I expect
the drop to speed up with a quick drop to the March lows, similar in
magnitude to the drop we saw in January.
The rest of this
article is for WSW Power Investor members only. To take a
risk-free 30-day trial to WSW Power Investor simply click here.
Mike
Swanson
Editor, Wall
Street Window
Disclaimer: Michael Swanson is the President
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