"Maharaja Of The Keyboards." 1925-2007

Oscar Peterson, whose speedy fingers, propulsive swing and melodic inventiveness made him one of the world's best known and influential jazz pianists, has died. He was 82.

During an illustrious career spanning seven decades, Peterson played with some of the biggest names in jazz, including Ella Fitzgerald, Count Basie, Duke Ellington, Charlie Parker and Dizzy Gillespie. He is also remembered for the trio he led with Ray Brown on bass and Herb Ellis on guitar in the 1950s.

"Oscar Peterson is a mother fucking piano player!" - Ray Charles, in Martin Scorsese Presents the Blues - Piano Blues (2003).

Sadly missed, You always have that swing !

C Jam Blues.mp3. http://www.raisethepraise.tv/songs/mp3/Oscar%20Peterson%20-%20C%20Jam%20Blues.mp3

Watch that Jobless claims data.

The market is starting to suggest that we are going into – or may already be in – a recession, the Pavlovian response is that there can’t be a recession unless job creation falters. But the chart above is indicating that the jobless claims trend is starting to skew upwards despite going into the traditionally busy festive season.

If we are not yet in a primary bear market, the probabilities that one is developing are as high as they have been since the 2002 bottom. Taking it a step further, though it may not matter for the here and now, we must also consider that if we have a bear market in the offing, the possibility (rather than probability) that the S&P 500 (SPX) has put in a massive double top must be respected.

How far the market can rally and January Effect (likely to be short-lived) or not, we'll soon find out by mid-January and what's in the offing for the 1st Q.

Clear And Present Danger.

Richard Russell, an 83-year old author of the Dow Theory Letters, said: “In the stock market, hope gets in the way of reality. Hope gets in the way of common sense. If the stock market turns bearish and you're staying put with your whole position, and you're hoping that what you see is not really happening, then welcome to.. Poverty City.”

In order to gain some perspective on the outlook for equities it serves a useful purpose to study a long-term graph of the S&P 500 Index (above). This chart is based on monthly data, which tends to be more helpful than daily or weekly series when trying to identify the stock market’s primary trend.

There are a number of interesting observations that one can make from this graph:

* The MACD indicator (bottom section of graph) has just given a sell signal, as evidenced by the blue histogram bars falling below the zero line. These signals do not occur often – the last one, a buy signal, was given in May 2003 and the sell signal before that happened in September 1999.

* The more sensitive RSI (Relative Strength Index, which measures internal relative strength) oscillator (top section of graph) has fallen below 70, thereby giving its first sell signal since 1998. (A buy signal was registered four years later in 2002.)

* The 20- and 40-month moving averages (middle section of graph) are still intact, but these are lagging indicators and the turning down and crossing over of the two lines typically only serve as final confirmation of turning points in the index.

After the multiple Fed cuts, stocks had usually firstly experienced a bear market decline of 20% to 40% prior to recovering, and the average P/E on the S&P 500 Index was typically below 14 (compared with a multiple of 19.1 at the moment).

US profit margins, inflated by super-cheap credit in early 2007 (i.e. the lowest spreads ever seen), are clearly unsustainable. As a matter of fact, profits for the Standard & Poor’s 500 companies fell almost 25% on a per-share basis in the third quarter, the biggest year-on-year decline in almost five years.

“The earnings recession has already arrived,” adds David Rosenberg, North America economist for Merrill Lynch.

It's time to consider The January Effect.

If you already understand that supply and demand determine prices, then you'll quickly grasp how to trade the "January Effect".

We hear a lot this time of year about the "January Effect." The name suggests that it happens only once a year, so it is understandable why many investors don't bother to learn what it is. But there really isn't anything mystical going on, and its influences are quite normal.

The January Effect happens when it does because of the United States Tax Code. Wake up!! Sorry.., thought I saw you dozing off there when I mentioned the United States Tax... wake up! Seriously, you don't need to be a CPA for this exercise, you just need to understand that tax consequences on your portfolio are based on whatever happened during a single calendar year.

In other words, if you close out a position in your portfolio before the market closes on December 31, then its profit or loss should be considered in calculating your 2007 taxes. This is not an investment decision. To be sure, the decision to sell may be purely for investment reasons. But unlike any other time of year, that can be augmented and perhaps even overshadowed by tax considerations.

The loss taken on one stock can offset an equal gain from another stock. If I sold a stock earlier this year for $8000 that I bought previously at only $5000 (yes, I'm just that good) then I must declare a $3000 gain to pay taxes on. If I have another position worth $5000 that I originally bought for $8000 (yes, I'm just that good) then I can sell it and avoid paying taxes on the other stock's gain. At year-end, investors are more likely to sell their losing positions. So, under performing stocks tend to continue under performing into year-end.

Investors can sell a stock at a loss in January and still get the tax benefit, but they won't get that benefit until after year-end. So, this selling pressure suddenly disappears when the market closes at midnight December 31, when the time value of money meets human nature of not wanting to admit being wrong. Now add another reason to sell: the tax loss that can help to avoid paying some taxes a couple of months later. This increases supply, which makes price decline further.

Well, this sounds easy, right? Look for stocks that have been declining, find the ones that decline even further into December 31, buy them when the market re-opens on January 2, then choose between the red Ferrari or the black one. Too easy. Firstly, those bad-boys Ferraris are so.. last decade. To keep up with the times, think Lamborghinis instead!

In reality, everyone and their dogs have already figured out this strategy's timing. Buyers are already acquiring their positions well before year-end, anticipating the January Effect rally, even while some shareholders continue selling to realize their tax loss. We can take out some of the guesswork by limiting our choices to stocks that already stopped declining, or else those that are trying to bottom. I like to see price momentum indicators like MACD & RSI giving buy signals, and I also like to see Money Flow or On-Balance-Volume indicators under accumulation. Even if all systems say "go," the actual impact of the January Effect rally should subside by month-end.

By the way.., the season is changing, Winter Solstice is just round the corner - 21st Dec 07, and market will experience a directional change too.

Merry X'mas..and hav'a profitable 08!

Gold Rush.

Gold is weak once again this morning on this silly idea that the Fed is going to be a tough guy because the inflation data is finally beginning to show some of the inflation that's been there all along. Sure, the Fed may be forced at some point by the market to stop feeding inflation with more rate cuts, but the Fed won't be tightening anytime soon with the economy and financial system in the mess it's in.

This is the stagflationary. It's finally beginning to show up in the government's data (which is a feat in and of itself), and stagflation is probably the most bullish environment for gold known to man.

The interesting thing that jumps out at me about gold this morning is that it's finally beginning to break free of its euro and dollar-related shackles. Gold has been rallying in all currencies, including the euro, but it has had a rather tight correlation to the euro over the past six months (and as a result, a negative correlation to the dollar index). This morning, however, that appears to be in the process of changing.

Note that while the dollar index has made a new one-month high and the euro has made a new one-month low, gold is resisting the decline in the euro (and the rally in the dollar) and not following the euro to a new one-month low of its own.

China Investment Corporation.

To see why a crash may be coming, it is worth examining the behavior of the China Investment Corporation- the $200 billion sovereign wealth fund set up by the Chinese government in September ... Six weeks ago, the power of sovereign wealth funds was celebrated and China Investment's moves into the market were awaited with bated breath.

A third of China Investment's portfolio is to be invested in Central Huijin Investment Company, a purchaser of bad loans from the Chinese banks, and another third will recapitalize China Agricultural Bank and China Development Bank, to shape them up for privatization. $3 billion of the fund was invested in the private equity manager Blackstone Group in May - that may have bought China useful political contacts, but it is now worth $2 billion. And the remainder is being invested very carefully, primarily in U.S. Treasury securities - which are also losing money steadily in yuan terms.

The lackluster investment strategy of China Investment exposes a central flaw in the Chinese economy, its lack of a rational system of capital allocation. For more than a decade, Chinese state-owned companies have made losses, and have been propped up by the banking system. Since 2004, loss-making state-owned companies have been joined by overbuilding municipalities, erecting white-elephant office blocks in attempts to turn themselves into the next Shanghai. None of these losses has resulted in bankruptcy; instead the cash flow deficits have been covered by the Chinese banks. As a result, the Chinese banks have an enormous volume of bad loans $911 billion at May 2006, according to a later-withdrawn estimate by Ernst and Young, which must surely have ballooned to $1.2 trillion-1.3 trillion now ...

A $1 trillion problem in subprime mortgages has caused even the U.S. money market to seize up and has required frequent applications of sal volatile by the Fed. Since China's economy is around one fifth the size of the United States' the Chinese banking system's bad debt problem is in real terms about five times that of the United States, about 40% of its gross domestic product.

We have seen this movie before; the Japanese banking system's bad debts after 1990 totaled around $1 trillion, about 30% of Japan's GDP. The result was the bursting of the 1980s bubble and a period of little or no economic growth that lasted well over a decade.

Since China also has much of the corruption that bedevils Latin America and its government lacks any genuine understanding of the free market and is increasingly dominated by special interests, it may indeed be fated to follow a Latin American growth path for the next few decades, with a tiny entrenched elite enriching itself at the expense of the disfranchised masses.

Uh...Global Coordinated Liquidity Injection ?

The perceived market's disappointment on Tuesday was the refusal by the Fed to make the Discount window more attractive. Now we know why they chose that course of action: Global Coordinated Liquidity Injection.

Uh, ok... but what does all that mumbo jumbo really mean? In order to understand it, let's step back for a moment go way back in economics history...far, far away.... .

Some are calling today's coordinated move by global central banks unprecedented? Is it? Not really! But that doesn't mean it's not extraordinary. In fact, the extraordinary nature of it is.., why we say it's "bullish" but not bullish. These types of things just don't happen when times are good! To understand the present credit market conditions in context, let's go back to... Shhhhh... don't say this too loudly... 1930!

What happened in 1930? The formation of the Bank for International Settlements (BIS). The BIS essentially laid the groundwork for global coordinated liquidity facilitation. After the end of World War I there was a deep distrust among countries, which magnified the global credit contraction conditions. Debt was massive at that time. Global markets seized up.

The BIS was initially a failure. Among the first loans the bank intermediated were packages to Austria and Germany, neither of which helped those countries avoid financial crises. What is important is not that the BIS failed to stop financial crises, but why. The answer is that markets eventually chew through fiscal and monetary intervention in spite of us. So frequently, in fact, almost always, the cure is far worse than the disease. Just something to think about.

Liquidity Unfrozened.

There is a stigma attached to borrowing funds from the Fed through the discount window: the banks have to disclose it and it illustrates severe financial weakness to their shareholders and depositors.

So the Fed is considering a “new auction system”. Essentially, what the Fed is doing is taking the stigma away from the discount window--the Fed will lend directly to banks and the banks don’t have to tell anybody. Theoretically, the Fed could make these quiet loans for indefinite periods, thus giving banks more permanent capital (it’s really credit, but banks call it capital).

I have a feeling the Fed moved less yesterday than expected because foreign investors (foreign central banks) were crying foul. A bigger move would further deteriorate the dollar and thus their investments in the dollar. It would also hurt their exports. They are getting pretty tired of this game and trade pressures are building.

The Fed knows that higher stock prices are important to reflate since 90% of global liquidity is dependent on high asset prices as collateral. Thus they are desperate to finance banks’ collateral values. How to do that? The only way is to lend directly to them.

The plan won’t work. Under the repo/fractional reserve system the debt can be hidden because it is spread out among many banks. The Fed lending $10 billion (and thus their balance sheet rising by $10 billion) will turn into $500 billion as other banks lend that money out and only keep a fraction of it for themselves. This is not working. Under the “new” plan the Fed will lend directly to each bank. If they want to create $500 billion of new credit the Fed’s balance sheet will increase $500 billion.

This will be obvious to foreigners just like a big cut in the discount rate last nite. This is why gold is up this morning in response to this “new” plan which is really just a hidden discount rate cut: if the Fed is willing to pervert its balance sheet to this extent the dollar will fall. And gold (in dollars) will go up.

Decoupling.

Equity markets have decoupled from debt markets, emerging markets have decoupled from developed markets and the U.S. dollar has decoupled from just about everything.

Short-term government securities have acted as a safe haven for money in transit. Interest rate traders have bet that the U.S. yield curve will steepen as the Fed cuts short terms rates and the long end reflect fears of inflation. European interest rate may follows as economies weaken responding to a U.S. slowdown and a stronger euro.

Debt is distinctly out of favor. Debt is also less attractive in an environment of increasing inflation. Fundamental price pressures are coming from higher energy costs, increasing food prices and rising inflation in emerging markets. The price pressures are exacerbated by seemingly deliberate policies from central banks to inflate their way out of the credit crunch.

Investments reliant upon abundant and cheap debt - highly leveraged hedge funds, private equity, infrastructure and property look less attractive.

Equity markets have benefited from lower interest rates, strong corporate balance sheets and profitability.

Fear of inflation underpins demand for real businesses with strong, preferably recession insulated cash flows. Fossil energy, hard commodities and food producers are key areas of focus. Alternative energy, water resources, essential infrastructure (especially in emerging markets) and environmental services are perceived as attractive.
Support for equity markets has an emerging markets angle. Emerging market growth is expected to be insulated from the turmoil of developed markets. Suppliers to emerging markets ( e.g. commodity producers) are seen to be protected from a US and European downturn.
Outward investment flows from China, India, Russia and the Middle East - the emerging market "bid" - are a key driver of equity market resilience.

A weak U.S. economy and concern that the Fed will continue to ease interest rates further in an attempt to prevent recession and support the banking system weighs heavily on the dollar.

Major dollar investors, especially Asian central banks who have invested a substantial portion of their reserves in U.S. dollar assets (estimated around 60-70%), have started to diversify their currency investments. Moves to replace the dollar with the Euro as the settlement currency for trade in key commodities such as oil, if it eventuates, also removes an underlying pillar of support.

This has supported currencies, especially emerging market currencies or currencies seen to be closely linked to these markets. Appreciating currency values reinforce asset values in these markets triggering positive feedback loops. This helps keep the emerging market asset price bubbles going.

Rebound...

December has been up 75% of the time since 1929 in the S&P 500, with the second highest average monthly return and the smallest average drawdown. And whenever the S&P has lost more than 4% during November, December was higher five out of five times by an average of +5.6%.

Past results is no guarantor of future performance, as the saying goes, but while history rarely repeats, it often rhymes.

The autumn swoon stopped directly on the August lows, precisely ten percent from an all-time high. While this is admittedly a bit

cute for my liking, the technicians in our midst now have a level to lean against.

Keep in mind that the sharpest rallies occur in the context of a bear market and formidable resistance resides above at S&P 1490. The bulls seems to have chewed through that resistance, and the double-bottom ten percent blink-and-you-missed-it correction will be obvious with the benefit of hindsight.

I believe that “Don’t fight the Fed” is one of the most dangerous axioms in finance. Still, the perception that the FOMC is on call and at the ready could buoy markets through year-end, particularly if he they cut Fed Funds by fifty basis points and again adjust the discount rate lower on December 11th.

However, as traders, the path we take is entirely more important than the destination we arrive at. Interesting times indeed, fraught with risk and by extension opportunities. Stay alert and understand that a litany of agendas are littering our financial landscape. You don’t have to agree with them, you simply have to respect them. All the way to the bank.

Cutting rates any good ?

As the markets seem to want to be relieved that global central banks have the “liquidity” problem under control, let us remind ourselves of the magnitude of the problem.

Just how central banks inject “liquidity” into the markets when they need it? Essentially central banks encourage debt creation - for people to borrow money, so that they buy things (consumption) to spur the economy. But due to too much debt, financial engineering has had to create new and better places to stuff more and more debt.

You may have seen the chart above before. It shows the results of that financial engineering. Central banks can only affect the bottom two parts of the chart- ie high powered money and M3. The Federal Reserve is growing as fast as it can in order to indirectly support the much larger problem of scrutinized debt and derivatives.

These two phenomenal pockets of debt are supported by asset prices: when asset prices (which act as collateral) decline, liquidity gets sucked out of the system. So the purpose of pumping new debt into the system is to keep nominal asset prices up to protect collateral values of the real problem of leverage in the system that the Fed cannot directly control. It takes more and more debt to do this because people are having huge problems servicing the debt they already have.

So we have two huge forces fighting each other right now: the central banks desperately attempting to re-flate (create more debt) and the market grudgingly but purposefully attempting to deflate by paying back (which the bureaucrats are trying to help with) or more likely destroying (write-offs) that debt. We have extremely high volatility as these two forces fight it out.

Looking at the chart above, eerr... which do you think will win?

Don't ignore the market.

We find ourselves at an inflection point where just about every piece of news imaginable indicates that our financial markets should be falling lower. The mortgage mess is just starting to heat up while the credit crunch is in full swing. Despite some improved retail numbers the general consensus is that the consumer is strapped, gas prices are high and inflation for everything except what the government counts in their basket of goods is ramping. Yet despite all this the market is actually starting to rise.

Most traders will clearly be scratching their head over this dislocation while others skip the scratching and move straight to pounding, choosing to fight the market and its ascent. While it is always fun to debate and form one's own opinion regarding the macro outlook, the simple fact is that the market is acting well in the extreme short term and while it doesn't mean we're out of the woods we must stand up and take notice or at least give it the respect it deserves.

Every market that goes higher starts from some point and while there is great danger in being overly anticipatory, it is he who identifies the move first that will typically reap the most rewards. It is during this early time when the crowd has not yet embraced the move, rather they are fighting the trend and standing stubbornly aside. Ironically, as the ascent continues, these individuals become more and more optimistic and the crowd mentality slowly shifts. Ultimately the pendulum shifts in completely the opposite direction and ironically is about the time when positive news flow starts to creep in and actually supports higher stock prices. Of course, we all know that it is also around this time when you have to start becoming more and more cautious and slowly creep out of the optimistic mentality, moving towards the exit.

The problem most traders face, however, is not just how to identify an early move but how to play it. In my opinion, it is during these early stages that time frames become incredibly important. Most would believe that during the early possibility of a turn, the short term time frame dominates as hyperactive speculators jump in and out in a matter of minutes not risking any more than they have to and capturing as much gain as possible. This activity breeds volatility, which is why short-term market moves acts so erratic at key junctions such as the where we are now. In one sense that opinion is correct but I believe this early playground is wide open and actually may present more opportunity for those with a longer time frame.

Despite this volatile short-term activity, it is also around this time when the new winners start to make themselves known and present perfect opportunities for the longer term trader who can start to slowly wade back in with a much longer leash and a smaller investment size. They are typically stocks that are just starting to show improved relative strength despite after having weathered the recent storm relatively well. They are typically also those that are the most fundamentally sounds as traders seek to move back into their favorites that they sold only weeks before during periods of high emotion and fear.

The individual seeking a longer time frame can easily start to move slowly back into these areas with a long leash, giving themselves the most opportunity for reward while keeping their risk in-line by holding a less than normal position size. Should the market not be turning and falter again, stops will be taken, but if the market does move steadily higher, the longer term trader will be well on his way to building back solid inventory in order to fully participate with the next move.

At this very moment the market has been showing signs of resiliency and is improving. The technical conditions remain extremely precarious but there are also subtle signs of improvement and early speculators are starting to step back in and scoop up inventory. It may simply be another push towards the new longer term trend line resistance, or it may be a move back towards new highs. There isn't a soul out there who knows for sure but if you find yourself already having formed an opinion on what will happen, whether you believe it or not, you are actually predicting the future.

At this juncture especially, we must remain flexible, open-minded, and with both ears listen to the charts.

Dances with energy.

Yesterday I saw a bunch of Bloomberg headlines regarding a new U.S. National Intelligence Estimate (NIE). I parsed through them quickly and made little of it; until, that is, I read an eye-opening piece last night. The bottom line is that the Dec. 3 NIE concluded that Iran halted its nuclear weapon program in 2003, and that since 2005 the U.S. has been overestimating Iran’s plans to develop nuclear weapons.

And with that, the oft discussed “geopolitical premium” presumed to be built into energy prices was pretty much eviscerated. What does it mean for energy stocks? What does it mean for the broader market? Based on recent (and not so recent) history, lower energy prices are not correlated with broad gains in equities, regardless of what the broad media feed us on a daily basis. You can search the archives for many statistical takes on this point, but merely eye-balling this 4-yr chart of crude and the S&P500 (SPX) it is rather obvious that the two have been dancing together quite nicely.

Does it mean then that equity markets will fall together with energy prices? All things being equal, I suspect that lower energy prices would indeed be a drag on equities; but things won’t be equal. The only thing keeping the Fed from mainlining the system with every dollar it can print is the risk of inflation. The mere thought that inflation might be restrained by lower energy prices should be excuse for Bennie to continue his compulsive monetary promiscuity. It matters not that, in my humble opinion, these actions will only prolong and exacerbate the current credit mess; if the Fed keeps printing, nominal asset prices will likely continue their delusional exuberance.

How I wounder what you are...?

Clearly, the various markets are currently grappling with how events will play out in the coming year.

There are four possible outcomes:-

Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further, and the U.S. economy grows past its credit crunch. If this happens, it would be massively bullish for the U.S. dollar, massively bearish for gold and potentially bearish for Hong Kong and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for U.S. Treasuries and government bonds around the world. Additionally, we would also most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) toward the more traditional "growth” sectors, such as technology, healthcare, consumer goods, and maybe even Japanese equities.

Scenario 2: The Fed sticks to its guns, does not cut rates, and the U.S. economy really tanks under the weight of the credit crunch. In essence, the U.S. would move into a Japanese-style “deflationary bust.” In this scenario, equities around the world, commodities, and the U.S.$ would collapse, while government bonds would go through the roof.

Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the U.S.$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.

Scenario 4: The Fed ultimately cuts rates, and succeeds in reigniting the economy. This would be good news for equity markets, commodity markets, and the U.S. dollar (as world trade and foreign buying of U.S. assets would again expand, increasing the need for U.S. dollars). Of course, this scenario would be terrible news for bonds.”

The bet is on Scenario 3 and thus one has to be concerned that the Fed’s hand could be forced by the market to cut rates. Cut rates indeed, yet history shows while the first rate cut has an impact, the second and third tend to not have so much of one. This is demonstrated once again by the fact that the S&P 500 is below where it was when the Fed cut interest rates for the third time on October 31.

"Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited." - George Soros.

Abu Dhabi to CITI rescue.

When I look at this deal it is quite interesting. First of all, it must be understood that this is effectively an equity deal because of the mandatory conversion provision. From the limited information I have been able to retrieve, it seems that Citigroup is selling just under 5% of the company for approximately $5.7 bln. Why is it not the $7.5 bln that it is getting from the investors? Because Citi will have to pay interest on the $7.5 bln for just over two years, which will come out to approximately $1.8 bln. $7.5 - $1.8 = $5.7.

By my estimate, Citigroup has basically issued restricted equity (to be officially issued in two-plus years) at a price per share around the mid 20's when you take into account the 11% interest it is paying on the $7.5 bln. Additionally, Citi does get the benefit of using $7.5 bln now instead of only getting $5.7 bln now (if it had just done a straightforward equity deal), while paying $1.8 bln over the next two-plus years in interest.

All in all, this deal is a tough deal for Citi in my opinion because it smells like desperation. But don't be confused about the 11%. It is clear since the deal has mandatory conversion prices that the 11% interest rate is basically a discounting mechanism for the conversion price, which is why I say the equity was effectively issued in the mid 20's. It also must be noted that doing a convertible may have certain tax advantages for Citi instead of doing a straight equity deal in the 20's.

Week ahead.

Tuesday November 27
10:00 Consumer Confidence: 91.5 cons

Wednesday, November 28
8:30 Durable Orders: 0.0% cons
10:00 Existing Home Sales: 5.00 mln
10:30 Crude Inventories: 1071 k prev.
2:00 Fed’s Beige Book

Thursday, November 29
8:30 GDP-Prel: 4.8% cons
8:30 Chain Deflator: 0.8% cons
8:30 Initial Claims: 330 k prev.
10:00 New Home Sales: 750 k cons

Friday, November 30
8:30 Personal Income: 0.4% cons
8:30 Personal Spending: 0.3% cons
8:30 Core PCE Inflation: 0.2% cons
9:45 Chicago PMI: 50.5 cons
10:00 Construction Spending: -0.2% cons

Will this bull kick save the market ?

A brilliant observer of things, W. D. Gann’s sheer genius led him to comment that : “God geometrizes!”

If the geometrical notion of "as above,.. so below" is true, then the key reversal at the 1576 S&P high on October 11 may be a mirror image of Tuesday’s, 20th Nov's, reversal at 1420 S&P. This is the level I have identified for weeks now as the pivot of the year.

Simply put, 1420-ish is 360 degrees down from the 1576 high on the Square of Nine calculator. The Square of Nine Calculator is simply a way of measuring price movements on a square root
basis as opposed to a simple linear basis.

Ha ha.., the straight line sometimes speaks with a forked tongue – otherwise everyone with a ruler would be executing trades from their yacht.

If intraday rapidity, accelerated volatility and ferocious price swings are the hallmark of turning points then Tuesday’s whipsaw and tag of 1420 S&P underscores the significance of the level in the same way that the outside day down from 1576 called the top. The problem is not all turns are created equal: it remains to be seen how much traction the 1420 level will have.

Despite more than a 10% S&P decline in five weeks, no matter how much religion you may have had about this rather quick slide to 1420 if you were trading individual stocks and taking positions home overnight, the zigs and zags would have stopped you out. And if your conviction was such that you didn’t adhere to protective stops or trailing stops then your gains are dirty money. Why? Because the bad habits learned from avoiding stops will dwarf any gains made in the long run.

The larger question to me seems to be that with so many looking to buy the dips and thinking the absolute worst is over that, it smells like the perfect ingredient for a collapsing bear market for a minimum of six months counting from the October high.

Despite the turnaround on Tuesday, stocks remain in a liquidating and in dangerous mode. Remember how quickly the stampede from Monday a week ago turned tail. That low near the mid 1450’s on the S&P now carves out initial resistance. As far as strategy is concerned, I would look to trade with the shorts into Friday’s close prior to the next plunge to start next week. That will probably coincide with something big being uncovered and someone big owning up and going under.

Critical mass was reached at 1420 on Tuesday and a break of Tuesday’s low triggers a substantial number of technical dominoes laid out in this space.

"That's me in the corner,
that's me in the spotlight...
Losing my religion.
Trying to keep up with you.
And I don't know if I can do it...."
- R.E.M

Embrace The Volatility Or Ignore It..!

As I was going through charts last night, it dawned on me that unless you are intimately involved in the financial markets all throughout the day, you may not see the incredible volatility that is taking place.

Taking a step back, it is quite clear to see that we have corrected and now we are bouncing: it's as simple as that! For people with money on the sidelines, their thought process is probably something to the effect of "Looks like the markets are still OK. If a sell off happens again, I am going to buy."

It’s only when one drills down deep, one begins to truly understand just how chaotic and volatile things are, but as I was pondering this I couldn’t help but think just how beneficial it would be for people to either embrace the volatility, or ignore it altogether.

I know that sounds a bit silly, but let me explain. I often hear things throughout the day such as : just how challenging the environment is, or how wacky the action is underneath. These statements are arguably accurate, but there is no question they come across as negative to traders when in fact traders should look to find the positive opportunities that lie within and take advantage of them for their benefit. It sounds rather selfish, but that is what trading is all about.

There are many times when trading for a medium term time frame does quite well. Trades that last a few days can add healthy gains as markets follow basic technical patterns, however we are quickly learning this is not one of those times. This is a time period where I don’t believe there is any room for the middle ground.

One can do quite well as an extreme short term trader looking to take advantage of the intraday price swings that have been very extreme, either on the long or short side. If you recognize this and set your mind on such activity, you can do quite well. Just like today in the FKLI, untill it's suspended by the exchange on YET ANOTHER technical glitch!

At the same time, I do believe we are starting to see stocks become extremely attractive as long as your time frame is much longer than a few days and possibly even a few weeks. Taking a step back to see the bigger picture, you can see many stocks returning to their longer term support or retesting levels at which the stock previously broke out from. This, in my opinion provides excellent points of entry however one should be fully aware that micromanaging these positions will only frustrate you and have you succumbing to the emotional roller coaster that is brought on by the recent volatility.

As I look back over my trading sheets the last few days, these two styles make themselves very clear. I see quite a few intraday trades that have added some excellent gains, while I also see longer term positions I am building starting to creep into the decent gain area despite some significant gyrations along the way. The overnight or multi-day trades, however, aren’t so hot and I see red littered throughout on these attempts due to bad-boys morning-gappings.

Trading is all about flexibility and quite possibly by the time this is read, and digested, we may be facing another change. One of the biggest lessons I have learned is while being flexible is a must, it is the speed at which one realizes a flexible change is needed that sets one apart from others.

Week ahead.

Tuesday November 13

10:00 Pending Home Sales: -2.0% cons
2:00 Treasury Budget: -$53.0 bln cons



Wednesday, November 14

8:30 Retail Sales: 0.2%
8:30 Retail Sales ex-auto: 0.3%
8:30 PPI: 0.2% cons 8:30 Core PPI: 0.2%
10:00 Business Inventories: 0.3% cons
10:30 Crude Inventories: -821k prev.

Thursday, November 15

8:30 CPI: 0.3% cons
8:30 Core CPI: 0.2% cons
8:30 Initial Claims
8:30 NY Empire State Index: 21.0 cons
12:00 Philadelphia Fed: 6.0 cons

Friday, November 16

9:00 Net Foreign Purchases: -$69.3 bln prev.
9:15 Industrial Production: 0.1% cons
9:15 Capacity Utilization: 82.1% cons

Seasonal bias.

There are many statistics about the upside bias for November. I noticed the extremely positive historicals for November through December when the Dow was up 10% year to date by October month end. But the November carnage calls into question the seasonal bias for the remainder of the month.

Over the last 50 years, the S&P 500 finished November higher 70% of the time by an average +1.62%. Of those 50 years, however, the index managed a monthly drawdown of more than 5% (as we’ve already seen) just eight times before. And the index was never able to mount a comeback to close the month positive.

If we isolate the above occurrences to those years where the 5% decline occurred over the first 10 days of November, we’re left with just three occurrences: 1973, 1987, and 2000. Worse yet, it’s worth noting that of all the November returns for the last 50 years, those three years were the worst. Will 2007 reverse that trend?

Year/ Max Nov Drawdown/ Nov Close /Dec Close

1963/-5.95 /-1.05 /2.44

1973 /-11.63 /-11.39 /1.66

1974 /-8.12 /-5.32 /-2.02

1987 /-10.34 /-8.53 /7.29

1988 /-5.58 /-1.89 /1.47

1991 /-5.31 /-4.39 /11.16

1994 /-5.96 /-3.95 /1.23

2000 /-9.41 /-8.01 /0.41

AVG /-7.79 /-5.57 /2.95

% +ve /0 /0 /2.95

% -ve /100 /100 /12.50

NASDAQ, your turn now!

So where from here? In the tech-heavy, Nasdaq 100, the 2040-2050 range is obviously huge and I suspect that exogenous market forces (Plunge Protection Team) can read the charts as well as anyone else. I am not setting forth conspiracy theories here, as any bear who has listened to Mr. Paulson and Bernanke speak of late would be “imprudent” not to factor the government into the trading equation.

Below 2040, the next stop resides at the 2000 round number.

For the S&P 500, things are a bit less clear with the 200 dma already above head at 1483, and no obvious support areas until the 1425 area (Friday closed at 1453). If the S&P closes below the fulcrum or the midpoint of the summer lows and the October high which is approximately 1474/1475, yesterday's close coincidentally, does that suggest a Black Monday?

However, while prices may be manipulated, the underlying sense of anxiety cannot, and will likely keep the volatility index (VIX)– and by extension option prices – nicely goosed up even if we were to have occasional magical rallies.

Oh, one last thought.., before the madness kicks off: Reacting to prices going against you (except for stop losses) is often a recipe for more losses. If you were not set up for what’s happening right now, there are three things that can be done: buy, sell, but perhaps more importantly, nothing.

"Paper losses don't exist until you sell."

The resignation of Citigroup chief executive Charles Prince and news of additional writedowns at the firm have raised the profile of hazy Wall Street phrases such as Collateralized Debt Obligations and Mark-to-Model.

Why aren't losses being seen? Even now, they aren't being seen.

The answer, we now know, is mark-to-model. What does "mark-to-model" mean? Let's use something even we can understand - a sports card example. Suppose you and I are collectors (investors) in sports cards, but not baseball cards, the "prime" sports card market. No, we collect professional golfer cards - the "subprime" sports card market instead.

Why would we collect professional golfer cards? Simple.., we're looking for an a fancy way of saying "excess return" - and by using leverage we believe we can buy these illiquid sports cards and sell them later to someone else for more money. Ok, ok, there are a couple of problems with this scheme you can see already.

*First, the market for professional golfer cards is far, far riskier and smaller (illiquid) than the market for professional baseball player cards.

*Second, since they so rarely traded, it's difficult to value the cards on a day-to-day (even week-to-week) basis.

Ok, so back to the sports card market. Let's say that baseball cards are "highly liquid," meaning that, like stocks or U.S. Treasuries, they trade every day. These trades provide a way to instantaneously value our portfolio of baseball cards at any time. To value our baseball card portfolio, we simply look up the most recent trade and record the value. This is called "Mark-to-Market."

This "liquidity" is particularly helpful if we are using leverage (meaning, if we are using borrowed money to buy baseball cards with the hope that the borrowed money will increase our return when we decide to sell) since it allows us to closely monitor and track exposure and adjust the amount of leverage we are using accordingly.

So how do we know, at any given time, what our leveraged portfolio of professional golfer cards are worth? They rarely trade, so we can't look up similar cards that have recently traded in the market! Well, unfortunately, in our professional golfer card portfolio we can't mark-to-market because these cards trade so infrequently!

So how do we value our portfolio then?

Simple, we have some mathematicians build us a model that values the cards based on how each golfer performed last year, the tournaments in which they made the cut, their overall earnings and rankings among their peers, and rating.

Wait, did I say, "a model that values the cards based on how each golfer performed last year"? Yes.

But what if a professional golfer's card in our portfolio is a guy who last year ranked fourth overall in earnings and won two tournaments, but suddenly gets injured this year, fails to finish a few tournaments, and slips down to 40th in overall earnings?

Hmmm.., good question. For that we would rely on that separate "professional golf card agency" we mentioned to "re-rate" this card. Then we would simply input that revised rating into our models and adjust the value accordingly.

But what if the rating agency, for a variety of reasons, chooses not to re-rate the card?

Then we have a situation where the value of the card that is being spit out by our model is in no way even close to the true market value of the card.

Wouldn't that be a problem if we suddenly feared that all the ratings of our cards were too high? Wouldn't our model be insufficient? Might we not be over-leveraged in cards that have very little real market value? Yes, yes and yes.... That's when the shit start hitting the fan !

And that is precisely where we are right now with respect to CDOs.

The credit ratings agencies' ratings are key in the mark-to-model values, and so far very few CDOs have been re-rated in a way that reflects the surging subprime default rates.

There's an old investment saying that says: "Paper losses don't exist until you sell." That old saying is being tested in real time, right now!

Citigroup + a crack in Hang Seng = A perfect storm!

The market is supposed to be an auction place where things can be valued. But things aren’t always what they seem. The long road from an auction place to a casino starts with one small step which can ultimately metamorphose into one giant leap backwards for investing mankind. Where that step began is part of an Orwellian nightmare maned by computers and lionized by financial engineering.

The market is supposed to be an auction place but fear trumps value. The problem is there is currently a lot of paper that can’t be valued. The market is supposed to be a value game and they tell us the market is always right. But how do you reconcile the myth of valuation with the fact of volatility? In my experience, the market is an information game - not a value game.

In my view there are few reasons for the current accelerated volatility. At significant turning points, if that’s what this is, it is typical for the market to flip around violently. After a period of years of persistent dampening of volatility, reversion to the mean is only normal. And with such a long stretch of low volatility and such a persistently low period of low volatility it seems reasonable to expect volatility to growl ferociously when it awakens from hibernation, as it started to this July.

Fear trumps value: there is an underlying sense that no one knows what some paper is worth in the market, when paper is marked to a model. There is an increasing sense that we don’t have enough information as to the issues affecting the financial sector and the credit market. Moreover, there is a fresh sense that whatever information there is, is not being shared with equanimity. Wat do you think?

I suppose a picture is worth a thousand words. Believe what you see in price action, until proven otherwise. At the moment, the markets looked increasingly precarious, while the storm is brewing a notch higher when Citigroup revising 3Q write-down t0 $11bln. To add salt to wound, the Hang Seng has cracked the 29836 trend line today (chart above), with fear creeping into the consciousness of fund managers, this breach would kick start a cascade as fund manager would scramble to protect year end bonuses.

I wounder why Citigroup uses the umberella..ella..ella..as their corporate logo? Hmmm...!

Wat's ahead..

Monday, November 5
10:00 ISM Services: 54.0 cons

Wednesday, November 7
8:30 Productivity – Prel: 2.5% cons
10:00 Wholesale Inventories: 0.1% cons
10:30 Crude Inventories: -3894k prev.
2:00 Consumer Credit: $8.0 bln cons

Thursday, November 8
8:30 Initial Claims: 327k Prior

Friday, November 9
8:30 Export Prices ex-ag: 0.0%
8:30 Import Prices ex-oil: -0.2%
8:30 Trade Balance: -$57.6 bln
10:00 Michigan Sentiment-Prel: 81.0 cons

Brace for another volatile week ! -especially on Tuesday!

Go east, old man..

Jesse Czelusta Nov 2, 2007.

The Chinese stock market continues to soar, despite repeated warnings of a bubble.

While you should expect a bumpy ride, China is still poised to grow rapidly for at least the next several decades. In fact, I will go so far as to issue the following prediction: By the year 2050, China will be a more important and more powerful economy than the United States.


On paper, the evidence is mounting. From gross domestic product growth, to education, to investment, to health, to technology, China's trend lines point uniformly upward. In person, the case is even stronger. The gleaming, modern Chinese cities that dot China's Eastern seaboard make all but a few American cities seem almost underdeveloped (or at least unsightly and technologically unsophisticated) by comparison. All indications are that the newest superpower will surpass the U.S. by mid-century -- if not sooner.

This shift in global leadership will occur because China's communists are beating U.S. capitalists at their own game. China is determined to achieve wholesale economic transformation, and its leaders are drawing on historical lessons from the West: Innovate, if you wish to grow. Educate, if you wish to innovate. Enforce property rights in activities that demand investment, but do not put property rights ahead of all else (especially if most of the property in question belongs to foreigners). Give entrepreneurs access to markets and credit. Build infrastructure, if you wish to keep the economic machine functioning smoothly. China is doing all of these things, arguably better than its trans-Pacific rival.

Of course, China currently lags the U.S. by a substantial margin in the one column typically given the most weight on the economic scorecard: GDP per capita. In 2006, the U.S. produced GDP per head of $44,244; the corresponding Chinese statistic was a mere $2,055.

But consider this calculation: Assume that China and the U.S. grow indefinitely at the respective average real annual rates predicted by the Economist's Intelligence Unit for the years 2007 through 2011. This would imply 8.8% per annum growth in the case of China, and 2.8% growth in the U.S. Assume, for simplicity, that both countries experience zero population growth (this assumption probably biases the calculation in favor of the US and against China, given the latter's lingering one-child policy). Under these assumptions, China will pass the U.S. in terms of GDP per capita in the year 2061. If we perform the same calculation in purchasing power parity terms, China will take the lead much sooner -- in 2038.

Even if (as seems likely) China's recent red-hot growth cools, China's GDP (currently $2.7 trillion, vs. $13.2 trillion in the U.S.) will probably surpass that of the U.S. by the mid-century mark. Some of this growth will come about via payoffs to Chinese investments in infrastructure and education. In addition, China can still do a great deal of catching up simply via technological borrowing (and stealing). It will do so with an educated, hard-working, like-minded population of over 1 billion eager to make the necessary investments, and without the barrier of an outdated installed capital base. Whether or not you think China will eventually be the world's economic king, you might want to brush up your Mandarin.

But what does this mean to you, the U.S. investor (and future resident of a less-developed country)?
First, be willing to look farther (much farther) west than the Silicon Valley when making investment decisions. While for at least one-half century Americans have taken for granted that the U.S. would be the most reliable source of investment opportunities, this presumption is beginning to crumble.

Finally, although the region appears to be a solid long-term play, be prepared for large and inevitable corrections. There are signs that China's stock market is currently overvalued, and recent swings demonstrate that when the bubble bursts, it will do so quickly.
How then, should you play China?

Carefully. China is still very much an emerging financial market, and many segments of the Chinese economy are not yet publicly traded. While we have come to expect broad diversification from ETFs, over ninety percent of FXI's holdings are concentrated in just four sectors: energy, industrial materials, telecommunications, and financial services -- with over forty percent in the latter.

Here's one last point to bear in mind, as worry about a "Chinese bubble" increases: Bubbles often inflate well beyond the maximum proportions envisioned by efficient markets theorists. One need look only as far back as 1997 to recall an overvalued U.S. stock market that continued to soar for another four years. Had you sold in 1997, you would have missed one of the biggest bull markets in history. For those currently claiming that China is experiencing a bubble, it could be a case of being right at the wrong time -- always a costly proposition.
Better to enter China cautiously, for example, through dollar-cost averaging.
And regardless of what happens in the short run, China is here to stay!

Tales of the future.

What’s the market talking about?
If the market trades on fundamentals it must be setting land speed records for metamorphosis: from the Goldilocks Butterfly to the Credit Caterpillar crawling over speculative psychology. Do things change so much overnight to cause a 360-point drop in the DJIA based on Exxon Mobil earnings and a Citigroug downgrade? Was Thursday’s shakedown the lost third “Cha” in the FOMC Cha-Cha-Cha Pattern?

Typically volatility after an FOMC announcement- there are usually three distinct moves of increasing amplitude in opposite directions from the preceding swing, with the third move giving the genuine directional bias. Wednesday the market sold off initially after the Fed ease. Then, stocks rallied strongly while Thursday’s decline eclipsed Wednesday’s swings entirely.

Was Thursday’s sell-off related to fiscal year end for many mutual funds that could “legally”? Was Thursday just another shakeout like we saw on October 19?

The difficulty in any particular situation is knowing whether or not news and fundamentals have been baked into the cake – whether good news will be bought or sold – whether the buy the rumor and sell the fact trade will rule the day; or whether the momentum freaks and quant cowboys will drive good news even higher, or bad news even lower.

Just as volatility is a gift from the gods for traders to pay the rent, momentum is a beautiful thing for a trader. Almost as beautiful as is hindsight. In hindsight, almost everything about the prior session seems so crystal clear.

It seems crystal clear to me that the market is evincing a sea change. With the Fed having pulled the net of last resort for the time being, and Ben having put the put back in his hip pocket, we need to be very precise about grabbing the trapeze when it comes to buying into downswings. Why? Because for the near future at least, good news will be good and bad news will be bad. The bulls may not charge in so ferociously to scoop up the babies thrown out with the bathwater, or to catch falling daggers between their teeth. The action recently in some of the glamors may be telegraphing this change in character.

Tales of the future.mp3.http://videocalibration.com/soundsnew/user%20controls/Tales%20Of%20The%20Future.mp3

Quantum physics for money,...Huhh ?

Heisenberg Uncertainty Principle : In quantum physics, the outcome of even an ideal measurement of a system is not deterministic, but instead is characterized by a probability distribution, and the larger the associated standard deviation is, the more "uncertain" we might say that that characteristic is for the system.

Or in English : It is impossible to have a particle that has an arbitrarily well-defined position and momentum simultaneously.

Applying that to money: By observing or attempting to observe money you alter where it is and/or the velocity at which it is traveling depending on whether or not you are watching with one eye or two. One can either determine how much money there is, where it is at, or the velocity and direction at which it is moving but not all of them at the same time!

This is complicated by the fact that watching is an aggregate thing, not an individual thing. Where money is and how fast it is traveling is influenced by everyone's attempt to watch it.

Too many people are watching Bernanke's helicopter drop right now which explains why money turns up in mysterious places like the pockets of those working for Goldman Sachs rather than blowing in the breezes or floating around in thin air as logic would dictate.

Bernanke, being the hero that he is, has tried hard to defeat this travesty of justice by eliminating M3 reporting but so far it does not seem to be working. There are simply too many people still watching M3 that money does not flow to those who desperately need it.

Quizas Quizas Quizas.mp3.http://www.charmdoctor.com/board/data/03%20Quizas%20Quizas%20Quizas.mp3

Rhythms del mundo.

Rhythms del Mundo is a nonprofit collaborative album, which fuses an all-star cast of Cuban musicians including Ibrahim Ferrer and Omara Portuondo of the the Buena Vista Social Club with tracks from US, UK and Irish artists such as U2, Coldplay, Sting, Jack Johnson, Maroon 5, Arctic Monkeys, Franz Ferdinand, Kaiser Chiefs and others.

The project was sparked off by the devastating 2004 India Ocean Tsunami. The idea came in to do a project with The Buena Vista Social Club to fuse their Latin sounds with Western artists and their familiar popular songs. The project evolved when more environmental disasters struck -- the Asian Earthquakes and Hurricane Katrina. But the big picture was climate change. You can call these natural disasters but after all the research and scientific data, we know that we're at least partly to blame for some of these disasters. Global warming is now in the news daily. If we don't act in the time frame our experts give us, our grandchildren will curse us eternally.

The main recording sessions took place in Havana at Abdala Studios from April 2005 to June 2006 and Mixed at Lazy Moon Studios (UK). While the majority of the vocals remain the same, the musicians of the Buena Vista Social Club reworked the original orchestration from each song and created something utterly unique, casting their trademark mastery over each track. "Rhythms Del Mundo" includes restructured tracks such as "Clocks" by Coldplay, "Better Together" by Jack Johnson, "She Will be Loved" by Maroon 5, "High and Dry" by Radiohead and "Dancing Shoes" by Arctic Monkeys and Modern Way by the Kaiser Chiefs and other popular songs.
"Rhythms Del Mundo" also includes music by famed Cuban singers Omara Portuondo and the last vocal recording of Afro-Cuban bolero singer, Ibrahim Ferrer, who passed away in 2005. The other Cuban musicians from The Buena Vista Social Club who perform on this album are as follows: Barbarito Torres, Amandito Valdes, Virgilio Valdes, Angel Terri Domech, Manuel 'Guajiro' Mirabal, Orlando Lopez 'Cachaito' and Demetrio Muniz. This project is the brainchild and concept of Kenny Young and the Berman Brothers. They produced the 16 new original recordings on the CD.

Wow!! simplemente incrible !! Que viva cuba !

Clock.Youtube video.http://www.youtube.com/watch?v=k85X3ZGwYtk

Wat about the Malaysian market?

I just wish, maybe one day, just one day..., I could play with the other kids outside...!

Lets take a moment for a pause of reflection.

And so here we are..., October 19th, a day of lore for historians galore. Indeed, talk about large moves of late and the conversation will likely focus on the upside. It’s human nature to discuss rewards after large rallies and risk management when losses mount. That’s the root driver of momentum investing and the self-fulfilling nature of the beast. The only difference between mistakes and lessons is the ability to learn from them. It is in that vein that we’ve paid homage to the crash with first person perspective.

Alan Greenspan, widely perceived to be finest Fed chair in history, weighed in to say that he was completely blindsided on that fateful day. Despite being the first line of defense, he simply didn’t see the supply mounting in the distance. Hank Paulson and Ben Bernanke, after poetically waxing for months that sub-prime was “contained,” quickly realized that it wasn’t. And when those thoughts crystallized, they unleashed the proverbial hounds.

We can talk about the tangible costs to investors, as measured by a 5.5% drop in the dollar since August. We can noodle the intangible ramifications of their credibility or the waning patience of foreign holders of dollar-denominated assets. We can discuss all of these things until we’re blue in the face but the simple fact is that everything is funny while you’re making money. Even if the currency itself is slowly fading away.

I’ve always said that, as a trader, I’m not as concerned with our destination as I am with the path taken to get there. I must admit, however, that I am increasingly concerned with our collective destination. If not for my sake, than for my unborn children and their children. Indeed, for many people in the U.S. and throughout the world, the recession is already in full swing.

I often ask myself if my concerns are unfounded and if I’m completely off-base with regard to the percolating pressures. I hope I am, but I fear I’m not. More likely, the structural imbalances are cumulative, which is to say that the longer we push out the cyclical ebb and flow of the business cycle, the harsher the other side of that trade will be.

Ben Bernanke and Hank Paulson are no dummies. They understand that in a finance-based, debt dependent economy, we’ve already passed the point of no return. That’s why they shifted the rules at the discount window and jump-started “The Working Group for Financial Markets.” They know the stakes and they’re fighting for their livelihoods and legacies.

On this, the 20th Anniversary of the Crash, please take a moment for a pause of reflection. The day of reckoning may not be at hand but there is risk in pretending that it doesn’t exist!

For if we’ve learned anything in the markets and in life, it’s that those who ignore history are destined to repeat it.
Melodies of love.mp3.http://www.delmonticossalon.com/media/Joe_Sample_-_Melodies_Of_Love.mp3

She's got legs..!

On Wednesday, the S&P tagged my 1525ish projection off the break of the 1550 neckline based on an hourly S&P Head & Shoulders Pattern.

The S&P shows five hourly waves down to 1525 / 1526. This suggests an impulsive downside action. Will the index reverse lower after a 1-2-3 hourly bounce?

Off 50 points from the 1576 square and down five of the last six sessions, the index bounced back from the red on Wednesday after the release of the Fed’s Beige Book showed the economy is decelerating. So, of course, let’s buy stocks. Why? Because, our friend Ben is in his turret. Wednesday’s late recovery saw the index recapture 1536 marginally, which as you recall is ninety degrees down from the 1576 high.

However, unless the 1550 level, which is 50% of the recent swing, is recaptured any rally attempt on the S&P is suspect – despite the dance of the momentum dragons.
Legs.mp3.http://www.fugly.com/staph/otis/ZZTop_Legs.mp3

Walls around China.

Cubic Oct 17, 2007.

The Chinese economy reminds me of the movie "Speed" (the flick that arguably sent Keanu Reeves to star status). In the movie, a bad guy with a grudge (masterfully played by Dennis Hopper) rigs a transit bus with multiple explosives, one of which will be triggered if the bus goes slower than 50 miles per hour.

How does that apply to China? The Chinese economy is akin to a bus with 1.2 billion people on-board, with massive financial and operation leverage as the explosives that will likely blow up if economic growth falls below its current pace. Even a small speed bump is likely to send this monstrous economy into a severe recession. Here is why: Chinese economic growth is largely driven by the manufacturing sector– industrial production growing at the double rate of GDP supports this argument. China has become a de facto manufacturer for the world. With the exception of food products, it is very difficult to find a product that is not, at least in part, manufactured in China.

The manufacturing industry is very capital intensive. To build a factory a large upfront investment is required (with commodity costs on the rise, the required investment has increased over the years) and once it is built there is a fixed cost associated with running a factory that is somewhat independent of utilization level– a classical definition of operational leverage.

Debt is the instrument of choice to finance ever-growing factories in China. A June 20, 2005 Financial Times article highlights the point: "In the first quarter of this year Chinese businesses relied on banks for 99% percent of their official fundraising, the highest rate in at least decade… The lack of fundraising alternatives means that many private companies – the motors of growth in the modern Chinese economy – borrow money from start-up finance 'underground’ banks that charge high interest rates.”

Debt (financial leverage) coupled with high fixed costs (operational leverage) create total operational leverage. Total operational leverage in China is elevated further as factories are built to accommodate a future demand, which has been rising in the past and thus automatically projected to climb in the future. This highly-leveraged growth formula works fine as long as the economy is growing at super-fast rates. As sales are growing, costs are not growing as fast as they are largely fixed (due to operational leverage) leading to expansion of operating margins (the beauty of leverage). Unfortunately, leverage works both ways: as sales growth slows down the opposite takes place.

The airline industry in the U.S. is the poster-child for a high degree of total leverage, as planes cost over a hundred million dollars and most of the time are financed with debt (yes, leases are just another off-balance sheet form of debt). Add to that a very unionized, overpaid, difficult-to-lay-off labor force and the deep cyclicality of the industry and you have a recipe for disaster. That's a fair description of the airline industry.

Chinese labor is arguably not as grossly over-compensated as United Airline’s flight attendants or pilots, but laying off workers in China is a politically sensitive process (according to FT), thus creating another layer of fixed costs.

I can think of many reasons that could cause the fatal slow down in Chinese economic growth:-

*Slow down of the U.S. economy, the world's biggest trading "partner" with China: China is financing its biggest customer – the U.S. consumer, not unlike Lucent while it was inducing its sales growth by financing its dot.com customers. China is financing U.S. consumers by buying U.S. Treasuries as if they were going out of style (pushing prices higher), thus keeping the U.S. interest rates at very low levels and creating what Mr. Greenspan calls a "conundrum". At some point, either because of the higher interest rates or simply due to debt overdose, U.S. consumer spending will become tempered, lowering demand for Chinese-produced goods.

*A mounting pile of politically-motivated bad loans may bring the Chinese banking system to a halt:
Though China is trying to move closer to Western lending practices, a combination of semi-market economy and government-controlled banks is very dangerous. Loans are often made not on the merit of investment, but based on political connection.

*Overcapacity:
It is a human tendency to draw straight lines and direct projections from the past into the future. During the fast-growth times the angle of the straight lines is usually tilted upward, causing over-investment in fixed assets as inability to keep up with demand may cause manufacturers to lose valuable customers. In the height of the dot.com mania, telecom equipment companies often could not keep up with ever-rising demand, and constantly increased capacity. Overcapacity is a death sentence in the manufacturing (fixed costs) world since it leads to price wars – a fatal deflation.

*Currency float:
There is a good reason why the Chinese don't want the renminbi to float (appreciate). As it chipped away some of the comparatively low-cost producer advantage, it would likely reduce the U.S. demand for Chinese products. In addition, renminbi appreciation would devalue the Chinese stock pile of U.S. Treasuries.

Most companies stress their China strategy on their conference calls, in the same way companies stressed their Internet strategies in the late 90s. I don't foresee companies re-naming themselves to incorporate China into their names, however, as many did with dot.com in the late stages of the Internet bubble. It is very apparent that many are making large investments in China– Bank of America's $3 bln investment into the Chinese bank comes to mind here. As usually happens after a bubble pops, the past asset turns into today's liability. Thus, Chinese exposure that is looked upon as a source of revenue growth today may turn into a written-off investment tomorrow.

I believe it is not a question of "if", but more of a question of "when" the Chinese economy will cross that metaphorical 50 miles per hour mark and fall into the deep abyss of prolonged recession. China is living through one of the world's greatest historical bubbles. Dozens of books will likely be written to describe how it happened and how it imploded, but as always, they'll be written after the fact. I even have suggestions for the book titles: “The Chinese Conundrum” or “The Great Chinese Bubble” or “Irrational Exuberance 2”.

But, as with timing any bubble, the pop is very difficult. Bears are usually too early to call it and bulls are usually too late to see it. Just as government-published numbers of economic growth cannot be trusted, investors should look for anecdotal clues for the inflection point. Conference calls from U.S. companies doing business in China are probably the best source of information.

The risk of the Chinese bubble is real: it may be wise to prepare by immunizing portfolios from that risk. Though being completely rid of the China risk is impossible and impractical, it is very important to stress-test a portfolio against that risk, one stock at a time.
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