While reading Barron’s recently I noticed an interview where the expert was talking about the real estate bubble and stressing how truly epic it was in scale and how, therefore, truly epic the coming decline would be.  One of his arguments—and I’ve heard this in the past—was that rental prices compared to home sales prices compared to median income as out of whack and that in order to revert to the mean, we would have to have a large price decline in home values.  But more important, and this is what really caught my eye, is the fact that a graphic he included showed the huge disparity in home prices compared to rental prices began in 1995 and that’s exactly when the BAM stock model says the US stock market “jumped the track” and started the set up that—if we’re correct in our analysis—will result in the most devastating decline in equity prices since the 1929-1932 period.  And that brings us to the big question. 

Why did the US stock and real estate markets begin inflating at a parabolic rate back in 1995 and, more importantly, if the 1995 through 2007 period reflects a massive inflationary bubble, will it be violently unwound as the BAM model suggests or will the FED be able to successfully guide the economy through a less damaging period of prolonged “consolidation?” 

My Money is on the Magnets  

As long-time subscribers know, the BAM model tracks “magnet” price levels which carry with them a certain set of rules. The most important rule—and this one is written in stone—is the fact that price MUST revisit (retest) magnet levels after they’re created and this unbreakable rule applies whether the market is trending up or down.  In other words, markets—after creating new magnet levels—must consolidate, and regardless of how long or short the period of consolidation, a portion of the consolidation period MUST include contact with the magnet price level. 

The danger—and this is the situation we’re currently in—is that during periods of mass optimism (which tend to spawn almost unstoppable momentum) the market stretches a great deal (on a percentage basis) prior to snapping-back to retest the magnet and that snap-back, because it’s coming from such an extended level, creates a crash.  Both 1929 and 1987 are examples of strongly uptrending markets neglecting to retest magnets until they were stretched so far above the magnet price that the “snap-back” to the magnet created a crash.  

The origin of my price level magnets is proprietary and, as far as I know, exclusive to my work but their accuracy has been uncanny as far back as I can retrieve data, and this period (1995-2007) is the LONGEST period on record that a market has remained above an “untested” magnet.    Once again, the “untested” INDU magnet levels are 6606 and 3971, the SPX is 527 and the OEX is 251.  Everything I look at tells me we’re headed for a 50-70% decline in the averages over the next two-to-seven years and the fact that we need to retest magnets tells me we’ll most likely crash to those levels fairly soon ( 2008-2009) and then bounce along them for the remainder of the seven year bear market.

Full report coming soon

As most of you are aware, I base my forecasts 100% on the Behavioral Analysis Model, which is an emotion-driven model that tracks topping and bottoming counts within various time frames. (Think Elliott Wave Theory without the subjectivity factor) 

I also use three other proprietary indicators in order to anticipate the violence of the subsequent price reversal once a top or bottom is identified because I think the violence of a price reversal—more often referred to as “velocity”—is key to my value-add as a forecaster (especially during today’s market participants’ propensity toward excessive leverage.) 

With that in mind, I decided to recap the build up of negative data that led to my call for a TOP in 2007, because the only way for clients to get comfortable both selling strength and buying weakness is to revisit my thoughts and forecasts prior to periods where the model was correctly fading the 2007 market strength. 

As most of you will recall, my ultra-bearish forecast looked pretty silly at times during 2007—especially given that the vast majority of advisory services were raving bullish and only focusing on “breakouts, bullish flows of private equity money, and DOW 16,000,”—but I’m hoping the stock model’s correctness (telling us to use strength as a selling opportunity 20%, 40% and even 80% above current levels) will make it a bit easier to at least entertain the thought that we might be correct in our call for a crash or at least a relentless decline to the 6606 level during 2007-2008 with an eventual decline to the 3971 level over the coming years. 

Full report coming soon