I've decided to put together this piece for two reasons. Firstly being that my friends seem to like to gather at my 'latest' post, whatever it may be about, to chat. Since I don't post on a regular basis, for which I feel rather bad but non-apologetic, I need to freshen things up from time to time in order to simply provide a clean slate for us to write on.
The second reason is that for some reason my previous post certainly resonated with a few people out there in the blogosphere who took the opportunity to cast a little fun at yours truly by declaring "Short the hell out of the markets! AR has gone bullish!". I found that to be fairly amusing but at the same time a bit disturbing. Disturbing because the two or three people who jumped on that bandwagon apparently did not read that post. They had to have only read the "Title". Not only that, they then proceeded to draw the wrong conclusion from it and from that point the spin was on.
In that post, I presented a case where an argument could certainly be made for higher prices. Indications for potentially higher prices were emerging from so many different sources that I just couldn't ignore them... including moving averages, momentum indicators and perhaps most importantly, market internals. But I also made it clear that the evidence was not conclusive, that I was struggling with it. And that's why it was entitled "Why Does it Agonize Me To Get Bullish?" The markets (as well as the indicators I was taking into consideration) were either at an inflection point where they were about to roll higher - OR - we were simply in a consolidation phase where prices could suddenly collapse. Both those outcomes could be supported by conditions which still exist this evening. The bottom line is that I didn't know which way the market was headed when I wrote that piece 7 short days ago. And I didn't declare that I knew. I still don't. I'm sure sorry about that but whoever out there 'does' know with certainty, I urge you to telephone me at your earliest convenience and help me out here.
So with those two reasons in mind, I'd like to present a study in exponential decay that is as legitimate as any other mathematical model and as legitimate as any other opinion out there. In fact this brief study doesn't even necessarily represent my 'opinion' but rather just a presentation of a result that is a distinct possibility. Because I still don't know with any degree of certainty which way the market is headed... certainly not this evening. Actually not "ever", not with "certainty". But what follows is a model that is completely within the realm of possibility and I won't be one bit surprised if the markets were to take the path shown in the charts and paragraphs below You may find it to be rather outlandish or radical or so bearish that those same people who chuckled at my bullish argument may now want to declare "Never mind... AR was only joking. He's gone insane now". To those people I'd only provide a friendly reminder that just as an exponential progression can develop like this, it can unwind in the same fashion in an equally devastating exponential decay. That's what we're going to look at here although we're certainly not talking about something that's anywhere near the same degree of severity as shown in that view of the Weimar currency experience.
In the weekly chart below of the S&P 500 we've combined two simple studies overlaid one atop the other and then used the two of them 'separately and completely independently of each other' to see if they point toward anything that might be common to both. Lo and behold, they both point toward a time slot... the first two weeks of August.
|Click here for a live and updating version. We'll know real soon whether or not these targets are nothing more than whimsy or a little bit more real than that. For now at least, it's just a bit too interesting to dismiss outright.|
What is perhaps the more obvious of the two studies is the 'cycles' study shown by the yellow semi-circles. Admittedly, I'm not the biggest fan of these types of cycles because more often that not they have to be fudged somewhat to make them appear as legitimate in the first place although in this case I did not have to fudge them. But there is also the issue that the next low in the yellow semi-circles does not necessarily represent a low in the price of equities. It could be representing a high in equities.
What is less obvious though is the application of a relatively simple formula representing an exponential decay in the price of equities. As far as I'm concerned, that mathematical model is more legitimate than is the cycles study. Not because it's more likely to happen necessarily but because there are simply so darned many reasons why it "should" happen. I say that based solely on the fact that the reasons the markets got this high in the first place are themselves based on an exponential progression in the growth in the supply of liquidity to primary dealers who were then able to drive the prices of the American stock markets higher by 37% in the past 7 months. I mean... come on let's get real here.
In theory that liquidity could unwind just as easily and fast as it came into being. What? You call BS on that? Then I've to two words for you... Lehman Brothers. But let's be clear here folks, in no way am I calling for anything like a Lehman event in the coming months. I have no specific suspicions nor suspects to justify it. I don't know who could be next. All I know with certainty is that there are about 1000 choices to pick from. We certainly do have reasons to expect lower prices and this study is simply based on the theme that those lower prices are already in progress. Indeed, that may not even be the case. We're having some fun here... so cut me a little slack and let's just play 'pretend' for a while.
So how is the exponential progression calculated in this case? As opposed to a geometrical progression where every succeeding number in the sequence is multiplied by the same factor or percentage such as would be the case with your money compounding in a term deposit at Goldmans Sachs bearing the incredibly unprofitable rate of 1.75% per year for example, in an exponential progression each succeeding number is grown by applying an exponent. The only difference is that in this case we're considering "growth in the size of a correction". In other words "decay". Therefore the exponent is less than one. To be specific, in this case it is 0.7399. And where did that factor come from? From the growth in the size of the corrections in the spring of 2010 and the summer of 2011. "Pretty flimsy" the permabulls might say and I'd have no argument with that. Just as they should have no argument with my assertion that any reason to "expect" higher prices is exponentially weaker. Ok, so the application of an exponential decay results in a decline that is 26% larger than the last one suggesting a target of 1053 to occur sometime in the first two weeks of August. The cyclical picture also points to the first two weeks of August.
|Let's face it, clones really do exist and they're everywhere|
Look friends, I have no illusions here. I have no reason to jump up and declare that "this is a sound analysis, this is the way the market is going to unfold." But by golly it's a fun exercise and it's not based on nonsense either. Although it absolutely is non-conclusive, it's more than interesting that what emerged is a price target and time target from one study and the nearly identical time target emerging from the other. Is that sheer coincidence that ultimately means nothing? Could be! But the nice thing is that we won't have to wait until the first week of August to find out. This entire study could theoretically be totally blown out of the water two weeks from now and I'd be more than happy to accept that and continue with my other studies. After all, that's what I do. Every day.
I hope you can see some merit in this type of analysis because let's be honest, it's as good as everything else out there that "isn't working these days". But in the event that you'd prefer to consider an exercise like this to be of little value, then I'd recommend that you don't waste your time reading this article.
UPDATE: May 3, 2012
|This is an amazing development. As predicted a year ago, that lower 13 year old trend line is being tested. I say it gets breached, providing evidence that a credit contraction is in progress. This event is definitely worthy of a new article on its own merit. Click here for a full blown version complete with a couple of indicators.|
|In this chart, we 'respect' the July 1 lows that occurred in 2009 and 2010. If that occurs again in 2012, the S&P would be on the white 'clone' line at 1140. Click here for a live and updating chart showing some foreign markets. And here to see those foreign markets in candlestick form instead.|
|Daily view of the US dollar courtesy of Pretzel Logic.|
The always-entertaining Michael Lewis:
The Russell daily chart below shows the H&S developing very nicely so far. I'd expect a bounce to about 800 before the floor falls out. The measurable target based on the H&S would be around 718 as the 'minimum.
|Click here for live and upbeat virgin.|
Wishing you all the best in the coming trading week...