Monthly Archives: August 2007

They Don’t Know

-So if the stock market’s 10% slide was simply a “correction”—as most of the talking heads seem to think—and if the subprime problem is “contained”—as most talking heads seem to contend, one has to wonder why the heck the FOMC felt compelled to step in at all…unless of course they know something that we don’t, or even worse, they don’t know what they don’t know! 

The Great Liquidity Bottleneck of 2007

The two most notorious liquidity bottlenecks of the past 100 years took place during the 1929-1931 period in the United States and again during the 1990-19–? period in Japan.  In both cases the liquidity bottlenecks were preceded by a huge surge of liquidity which subsequently created a huge boom in asset prices of all types—driven of course by investors’ use of too much leverage–and in both cases the inevitable bust was just as dramatic.   The reason we think it’s so likely that we’re on the verge of the third great liquidity bottleneck is threefold.  Number one, our model says it will happen, number two, the “backdrop” is correct, i.e. casinos, lotteries, art, real estate, and hedge fund billionaires etc. and number three…complacency is ripe with so many “experts” telling us it’s impossible.  

Practically Everything is Over-valued and Over-leveraged!

Bubbles are funny.  Most smart people realize that they’re in one as it unfolds but I guess their greed and ego must keep them involved right to the bitter end.  Maybe they think that as long as they’re positioned close to the exit door they’ll have enough time to slip out with their sack of dough before everything crashes.  Unfortunately for the less astute, the fact that the smartest of the group are always so near the exit means that many of them will actually get out the door—with their sack of dough in tow—and that fact only adds to the rapidity of the swing from optimism to pessimism which in turn accelerates the crash.  The other sad fact—and it adds considerably to the debilitating length of the liquidity bottleneck—is that even the smart money tends to lose a decent portion of their wealth and, as the primary “middleman” and bubble facilitator, their lack of funds combined with a stubborn resolve in waiting for perceived value to re-appear, often act to prolong the cycle even further.

Full report coming soon



-Ehrich Weiss, better know as Harry Houdini, was looked upon as the greatest “escapologist” the world had ever known.  Handcuffed and shackled, he would wiggle and contort—sometimes dislocating his shoulders in the process—until finally he would free himself.  But after escaping from jails, handcuffs, chains, ropes and straightjackets became mundane; he eventually transitioned to more and more difficult tricks like the “Water-Filled Milk Can” and his coup de gras–the “Chinese Water Torture Cell.”

Contrary to popular belief though, Houdini’s death–widely thought to have occurred while attempting to free himself from the Chinese Water Torture Cell–was actually the result of a blow to the mid-section by a less-than-hulking college student.  The trick gone wrong–performed many times during his long career–was a simple show of strength and thought to be immeasurably safer than any of his other under water escapes.  But unfortunately, even a master escapologist—given to the human frailty of overconfidence—is vulnerable to making the most obvious of mistakes. 

Here’s what happened.

Houdini claimed he could walk away unharmed after withstanding any blow to the stomach.  But after a show on the evening of October 22, 1926, a young man by the name of J. Gordon Whitehead struck Houdini before he had time to “lock in” his abdominal muscles, and the results proved tragic.  Within hours, Houdini was running a very high fever—later understood to have been a result of his ruptured appendix—and within nine days the master escapologist was pronounced dead. 

The Houdini Market

For decades now, the US financial market geniuses have, like Houdini, moved to ever more complex “tricks” as they invented and passed around scraps of paper in what may later be labeled the most reckless financial engineering experiment of all time. Like Houdini, they became overconfident.   After all, the tricks–their egos convinced them–would perform within their “defined” risk parameters…just as planned. 

Their critics on the other hand, continued waving red flags and talked incessantly about the scraps of paper and the chaos they would later spawn.  The “tricks” as far as the critics were concerned, represented the worst kind of financial engineering–the kind that was meant to magically mimic any desired hedge while allowing its borrower to sleep tight at night.  The list of tricks is long and we’ve all heard it many times before so I’ll skip it.  But like Houdini, the US financial markets have, for years, pulled off trick after trick—many of them at the hand of the once beloved illusionist–Greenspanian—only to come out on the other end almost completely unscathed. 

-Two weeks ago we said our model suggested a spike to 36-37 on the VIX and last week’s high was 37.50.

-The model is suggesting that the XBD is positioned similarly to the HGX in 2005.  Brokers look to be down 50% into Q2 2008!

-I talked about the idea that a housing bubble the size of the one we’re unwinding would not normally be expected to spare anyone, including the richest of the rich.  The problem with the reasoning, according to most I spoke with, was that the rich had so much money now that it seemed impossible for anything to hurt them enough (financially) to shut down the massive liquidity driving the real estate investment bubble at the high-end.   After seeing an article about a hedge fund manager dumping his 150 ft. yacht and his new helicopter I think I have convincing proof that the high end of the real estate market can implode just as quickly as any other.

BKX as good a long term short between 2007 and 2008 as HGX was 2005-2006!

SHLD is now back below where we sold it and we continue to hold to our target of 67.67 into January 2007 through February 2008!  We told everyone that it was an “EPIC” short in our work and they all said the person who runs the business is a genius and that it was a tough call. Remember though, that even geniuses make mistakes.  In fact, we recall a Wall Street Journal article talking about his use of extremely complex investment vehicles and the outstanding returns he was achieving through leverage.  We think the model is telling us that some of those may have backfired at the same time that his retail business and the real estate portfolio (always thought to be a huge positive) will all be “repriced” moving forward.

-Look at the HGX and stocks like CFC.  They’re all unwinding 100% of their gains from the 2002-2003 lows because the advance into 2005-2006 was based on bogus funny-money.  The only people who don’t get it yet are home owners.  Home prices are going to follow with a disastrous 20-60% decline the people who refied and pulled equity are going to feel worse than they did after the blow-up.  Our parents and grandparents paid down their mortgages religiously and this generation stripped out equity religiously.  This is a disaster for the consumer and the US economy and the FOMC is not going to be able to help.  They may be able to bail out a few big banks etc, but the deflationary spiral is set in stone and bailing out the banks will only add to our national debt and create a boycott on new purchases of our government bonds by foreigners.

-The way we see it, this market has nothing to do with earnings, nothing to do with the economy, nothing to do with geopolitics as a matter of fact we don’t think it has anything to do with anything going on currently.  But what this market has everything to do with is the past.  Mistakes made in the past must be paid for in the future and as far as the housing bubble, stock market LBO bubble and hedge fund bubble, the future has arrived.

-On an unrelated note, a women in my neighborhood recently announced that her veterinarian prescribed Prozac for her dog.  Just a heads up that things ain’t quite right out there…in case you haven’t noticed. 

-The Carry Trade unwind has started and it is ugly.  Just ask Australia.

Full report coming soon


Rage Against the Machines

-This is strictly a guess, but I think many of the current quant fund problems and their all-to-simple excuses about markets not acting “normally” are akin to a group of poker players trying to hide a losing hand.  The real problem, I’m guessing, was created by a massive margin-driven liquidity squeeze that forced trade executions having nothing to do with the buy or sell triggers built into their quant models in the first place.  The decline seems too shallow to warrant excuses about not expecting “a correction” or markets not acting “normally” especially given the fact that this decline, so far, has been historically shallow and the VIX has only registered an intraday high of (29.84)!   Take a look at how that stacks up against VIX spikes during other periods of panic and you can see that we’re way too early in this decline to be blaming things on the computers.

VIX Intraday Highs During Market Declines or Panics

August of 2002 (45.08)

September of 2001 (43.74)

October of 1998 (45.74)

October of 1997 (38.20)

NOTE: We think the VIX will spike to at least 36.00-37 over the coming weeks.

-Contrary to popular belief, Market crashes DO NOT happen out of the blue.  They are events that only occur after the proper emotional set up is created and that set-up normally takes several months or weeks to form.  The fact most people miss—even some technical analysts I’ve heard speak—is that crashes, although rare, can occur off the highest high within an uptrend as opposed to the more common crash which occurs off a failing rally high within the early stages of a downtrend.

-When RSI is setting up for a potential crash it acts in a very specific manner.  Remember, crash set-ups NEVER predict that the crash will happen, they only warn us that conditions are proper for the crash to take place and that if the market is “pushed off the cliff” the fall will be fast and deep as opposed to fast and shallow.  Markets can always get whacked to the downside under almost any configuration of RSI but without the proper configuration they cannot crash.  (It’s simply a mathematical impossibility)  The easiest way to understand it is to think of the market (any market) as always walking along a ledge but whereas most of the time the ledge is only 5 feet above the ground, a crash set up warns us that the ledge is temporarily 50 feet above the ground and that if the market were to slip off the ledge, the fall would be very painful—if you’re long. 

-FACT:  The most bullish moves occur after a market becomes “overbought” and the most bearish moves occur after a market becomes “oversold.” I always cringe when the talking heads speak in terms of overbought or oversold, because what they fail to understand is that those terms are worthless—in fact they’re very dangerous—unless you understand where market price lies with relation to the overbought or oversold reading.

Extreme overbought RSI readings, when they’re reversing off a period of sustained decline, are actually very bullish whereas extreme overbought readings moving into a high after a sustained advance are (immediately or eventually) bearish.  The same is true when moving in the other direction, in other words extreme oversold RSI readings, when they’re reversing off a period of sustained advance—as is the case currently–are actually very BEARISH whereas extreme oversold readings moving into a low after a sustained decline are bullish.

But the most bearish of all (I’ll speak in terms of bearish set-ups only for purposes of helping you understand why I’m so bearish currently) is when a market declines sharply in price with the RSI holding near the 35-38 level—as opposed to getting hammered down to or through the 30 level— then rebounding to the 40-51 level before reversing again below 35-38.  That set-up is the kiss of death because the slight blip up to the 50 level after the first trip down allows the market to gather even more downside momentum for the next leg down.  In real-life terms the bounce that allows the RSI to lift to the 40-50 level is a signal that shorts are covering and that bottom fishing is taking place which in turn leaves a new group of potential sellers down near the lows.    

As far as determining whether you’re in a sustained advance or a sustained decline, that’s something specific to each time frame we track and the model’s topping and bottoming counts answer that question very nicely for us.  Today’s set up however, is very obvious since we’ve been in a sustained advance since the 2002 lows which means the current RSI set-up is coming off a top.  Again, this is very bearish.

I know this sounds over-confident but the advantage I have here is in following the BAM model’s dynamic of “fractal” market movements, meaning that markets act in the exact same manner whether you’re studying a 1min, 5min, hourly, daily, weekly or monthly price bar along with its RSI movement.   What this means, is that I’ve seen and studied every type of emotional set-up you can imagine as they unfold in intraday set-ups 10’s and 100’s of times each and every week.  In other words I have, in essence, studied thousands of year’s worth of daily and weekly market movements through my study of 1 minute, 5 minute, and hourly bars.  A one minute bar is equal to a one year bar…so you can do the math.   Anyway, today’s current RSI configuration is potentially very bearish (read crash bearish) so we’ll be keeping a close eye on it for all of you.

Full report coming soon


The Greatest Financial Collapse

-One of the most interesting and appealing features of the BAM model (for me at least) is its apparent ability to predict sea-change events in markets.  These turning points–whether related to shifts related to nature or human mass psychology–produce major tops or bottoms and are, at times, very surprising given an otherwise contrary consensus fundamental view.  But, with its benefits, it also at times, gives me an uneasy feeling about what might lie ahead if its predictions do indeed come to fruition.  At times its predictions seem harmless in relation to our everyday lives, as in the case of its very unlikely call during May of 2004 that OJ would end its fourteen year bear market.  That call turned out to be correct and although it was, in retrospect, mainly due to the string of hurricanes that would batter Florida later that summer–along with the death of the Atkins low-carb diet craze–the fundamentals that drove the move were fairly harmless.  At other times though—and I’m speaking specifically about the current predictions regarding the US stock and bond markets—the predictions are much more ominous with respect to the fundamental fall-out that might result from its call being correct.

-Here’s what we said about the market over the past several months-

April 2 Report-All I can say is that I am certain of what the model is saying about the current set up and once it breaks—even if that occurs after another higher high—we will most likely witness something that none of us have witnessed before in real time.  I hope I’m completely wrong about what I think we’re facing because it looks to be more than a normal bear market.” 

April 30 Report- “The chart draws a nice clear picture of falling domino’s and although the outcome of this (housing) bubble seemed as predictable as anything I’ve ever watched, the shorts were “chased away” in each and every group unless they had a strong enough conviction to either stand their ground or add to their shorts as others gave up and “went away.”  I have to believe that we’re seeing a similar move now in certain banks and/or brokers.  Common sense says there’s got to be another “shoe to drop” related to the ridiculous loans that were written (maybe a few more pairs of shoes in fact) so it might be a good time to dig a little deeper in order to determine where the garbage was dumped.” 

May 14 Report-  “Something is out of whack and price will eventually provide the answer but my hunch, based on the model’s forecast, is that the NDX is correct in its pricing while the rest of the market averages—led by bubble-like advances in energy, financials and the possibility of further LBO’s–have it wrong up here.  In other words, we believe the investment environment is about to change so drastically that the major averages will be viewed as wildly over valued as opposed to technology being viewed as wildly undervalued.  We mentioned this idea months ago and we’re now starting to hear others echo our sentiments.  The big-boys are piling into LBO’s, using private equity financing, at as hectic a pace as individuals were piling into the real estate market using subprime financing two years ago and we believe both will meet the same demise because it doesn’t matter how smart they are, if you give human beings a long enough rope, (enough leverage) they’ll hang themselves every time.” 

June 11 Report-We experienced a rare “capitulation sell signal” in the XBD hourly model last week and this is a very important development because I had always assumed we were going to make a bull market top followed by a correction followed by new highs a few years from now but I’m beginning to believe that we are witnessing a top of epic proportions.” 

June 11 Report-  “Again, the fact that the housing market has crashed with rates barely wiggling higher and the fact that they’re (investors, commentators etc.) even focusing on the possibility of a 5% or 6% or even 7% yield creating problems for the US stock market confirms our thesis that once again everyone is massively overleveraged.   Let’s face it, this is a gambling generation and somebody somewhere is making a ridiculously large bet that will eventually take the market out by its knees because the only difference between an individual making a monumentally bad decision at exactly the worst time and a hedge fund making a monumentally bad decision at exactly the wrong time is purely in the size of the bet.  Human nature doesn’t change and the only difference in a harmlessly bad decision and a tragically bad decision is the level of leverage backing the bad decision.” 

June 11 Report- “Human behavioral cycles are so cruel it’s amazing.  Just think about where we’ve come from in the current cycle and where it will likely lead us.  Low interest rates and exotic mortgage instruments allowed an increase in risk appetite at precisely the wrong time.  The housing bubble–fueled by no-money down, interest only ARMS’s and endorsed by Alan Greenspan at the exact moment 30YR fixed rates were at an all-time low—is now facing new, more strict, lending rules, higher rates and plunging prices.” 

June 18 Report– “I have to wonder about recent news concerning sub prime mortgage exposure.  I wonder if there are a few funds feeling the same way that I felt on that ice years ago.   They probably know the ice is getting thin and they probably know the illiquid nature of their holdings, if the ice ever breaks, will carry them straight to the bottom.” 

June 18 Report-

-Equity fund cash levels just posted a record low of 3.7% which broke the previous record of 3.9% set in May 1972 prior to the worst bear market since the Great Depression.

-The SEC recently voted to abolish longstanding rules that restricted short selling in declining markets.

-1st quarter 2007 broke the previous nationwide foreclosure record of the  4th quarter of 2006 and we’re not even in an economic recession.

-A record 157 billion was invested in commercial real estate during the January-April 2007 period.

-Housing demand at the high end is masking the dramatic decline in home prices at the entry level.  Declines of 20-40% have already taken place. 

June 18 Report- “One of the reasons I believe we’ll see another push higher is that the move off the top I’m expecting should be a straight-line cascading decline without a big bounce like the one we saw late last week.  If I’m correct, that means that the next decline will be even worse than the one we just saw off the highs.  This would be very unusual (a multi hundred point decline straight off a new all time high) but it has happened before and this cluster of sell signals we’re triggering up here call for a tremendous straight-line decline so we have to believe that we’re about to see a rare anomaly.”

Full report coming soon