Value of Perfect Information

The “D” Word is coming in 2012 … DEFLATION. It will create the rationale for QE III.

BUT, will $500 billion in mortgage bond purchases be enough to ignite the liquidity engine? Or simply draw a like amount of corporate cash out of money markets?

Gold’s drop was the harbinger; creating conditions that allow even the ECB’s Mario Draghi to commit funds to support European Sovereigns: Gold dropping even as the currency falls. This week he deftly employed the “Carrot & Stick”, a favorite tool of central bankers; talking the market expectations lower while opening the liquidity window through the ECB’s new three year loan program [Creating a torrent of $650 billion in liquidity]. Some are already calling this the “New Carry Trade”. As a result Spanish yields shrank dramatically on three and six month obligations, but not on the Italian 10 yr bonds. You will remember we forecast he would not be cut from the same mold as Trichet, back in October.

The message in the sharp re-valuation of gold’s price is being confirmed by a slew of indicators worldwide. In the U. S. Industrial Production fell for the first time in 7 months. In addition, most commodity prices are following (or leading) gold prices lower as production slows. Factor in continued contractions of PMI in China and Germany (manufacturing powerhouses) that speaks to spare capacity on the rise. Also evidence acceleration of the “Risk-off” trade in India as the Rupee cascades to all-time lows against the Dollar, even as rates rise domestically. Thus economic contraction in three-quarters of the world’s GDP drivers looks likely to continue.

While we are chronicling Asian weakness; the steady erosion, to sometimes sharp implosion in real estate prices from Singapore and Malaysia, to Hong Kong, Shanghai, and much of interior China, is UNDENIABLY a “tell” that capital flight may have passed the point of critical momentum. This time China’s boom/bust cycle may have morphed into a regional contagion.

Most alarming to forward-looking analysis is the drop in monetary velocity. Chinese M-2 is now at levels last seen in 2001. That the Chinese Central Bank has the ability and track record to quickly inject monetary stimulus directly in the economy is not the issue. With the already historically high level of capital spending to GDP of 50% -a watershed for any developing economy – the “Build it and they will come” philosophy will no longer sustain the growth engine as the wealth transference no longer adds to sustainable growth. [Not enough bang for the buck.] This time the Chinese leaders will have to act quickly and forcefully with discount rate cuts and direct purchases to support the Shanghai Index. We have always anticipated and often written about dramatic measures if the Shanghai drops below 2300, a critical fail-safe.

The drop in M-2 combined with the cascading Rupee and the drop in Gold is alarming given the size of these economic behemoths and given the importance of the BRIC trade to emerging market investing and the entire risk-on carry trade.

As the U. S. Dollar moves past the 80 level on the index and 130 Euro, it signals the possibility of a new leg higher and de-facto re-ignition of the currency wars – if indeed, it ever subsided. This then presents another rationale for Chairman Bernanke to employ more monetary stimulus to weaken the developing flight to safety. Of course, QE II was such an international success in inflating hard asset prices that the push back to renewed dollar depreciation, up to and including, a Chinese depreciation of the Yuan is not outside the realm of possibility. In a pre-emptive strike last week the Chinese announced the resumption of the peg with the dollar.

When you factor into your econometric modeling: Add to the problems in Europe -which by now are legend – the slowdown in hard asset countries Canada and Australia, which are rapidly shrinking in employment and GDP, respectively. Are we beginning to witness a scenario where the BRIC’s are entering a growth recession following in the vacuum spawned by the devastating Japanese earthquake last March? Building upon, negatively, the festering political squabbles and infighting both in the USA, which presents a “W” shaped recovery; and in Europe which seems intent on replaying the ‘Beggar thy Neighbor’ Syndrome of the 1930′s with disastrous consequence – of which we have written many months ago?

This concrete vision of Synchronized Worldwide Depression as displayed in the 2011 stock prices for most major world indices -ex. U. S. has given Chairman Bernanke and his colleagues around the world the green light to pump liquidity early and often! With the just-in-time manufacturing engine in reverse and the palpable threat of Europe’s liquidity contagion going global – the threatened implosion of European banks; the $650 billion in three year loans is a good place to start, mitigating the possibility of the “D” word. The fear is that any action taken will not be enough to mitigate a chain-reaction of Lehman-like proportions. The message behind Gold’s plummet

Hence, we view the current nadir in the VIX as the eye of the storm!

BUT HEY, RELAX! ITS 2012 – THE END OF THE MAYAN CALENDAR – AND I FEEL FINE.

Important support levels at 1230.59 to 1227 were breached … now what?

Today’s graph is an update of last week’s S&P 500′s action for 2011.

The bottom line for last Tuesday’s update was that the S&P 500 was at the point of testing its 1230.59 to 1227 support levels.   As you know by now, the S&P did breach its trading range supports and it fell to 1205.35 at yesterday’s close.

What happens now?  

If you look at the S&P 500, and its C-RSI Strength indicator, you can see that both are working their way through a triangular formation.   The important event to watch is “what will happen when the S&P and the C-RSI both tests their respective support levels”?

The short term bias is negative, but the medium term is neutral.   Why neutral?  Because if you look at the C-RSI triangular formation, its converging apex occurs at the zero level …. Not positive and not negative.  So, medium term, this is a consolidation pattern that will break out before the apex is reached.   When it does, it could be a surprisingly large move, because the S&P could move 10%+ to 15% in the direction of the breakout.

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Today, we will discuss one of Jesse Livermore’s conclusions about the stock market.

One of the conclusions he reached was that the stock market was a reflection of money flows.  He postulated that if money was flowing into the stock market, it would rise.   Conversely, if money was leaving the market, it would fall.

It sounds pretty simple doesn’t it?   So a number of years ago, we began plotting the daily amount of Liquidity Flows in and out of the stock market.

Here is a description of today’s chart that we posted below …

First, there is a thick horizontal line going through the middle of the chart.   Above that line is where the amount of Liquidity is in Expansion, and that is where the stock market should move up.  Below that line, is where Inflowing Liquidity is in Contraction … and when that happens, the market will move down according to Livermore’s observations.

By the way, you can see that there are 4 Quadrants on the chart.  Two above and two below the middle, horizontal line.   Quadrant 1 is where enormous amounts of Liquidity are pouring in, and Quadrant 4 is where enormous amounts of Liquidity are pouring out of the market.

Although we post about 3 dozen charts every day for our subscribers, this is one of my favorite charts.   You can quickly see why, if you observe how the NYA Index moves while in Quadrant 1 and Quadrant 4.    The bigup or down moves happen when Liquidity Flows are in these Quadrants.

The message is clear for many investors … “Be in invested when the Liquidity Flows are in Quadrants 1 or 2 …especially Quadrant 1“.

And, “Be in cash when the Liquidity Flows are in Quadrants 3 or 4 … especially Quadrant 4“.   Alternatively, Quadrant 4 is a good place for those who want to short the market.

So, what is happening now?

Well, the market is trying to decide whether or not it should take its third leg up in this Bull market.   With all the EU problems, Greece, and high risk concerns that we have been seeing, Liquidity Inflows have beenoscillating just above and below the black, horizontal center line.   Specifically, Liquidity has oscillated between Quadrants 2 and 3.  This is the reason why the market has been so volatile, and why it has been unable to trend in any direction.  The big up trend that many investors want to see, needs to have Inflowing Liquidity in Expansion territory, and in Quadrant 1.

What Liquidity Levels are the best for investors?

For the best safety in “long positions”, investors would want to see the Liquidity Inflows in Quadrant 1.  For the best safety in “short positions” investors would want to see the Liquidity Inflows in Quadrant 4.

Comment:  This chart is posted every day in Section 4, Chart 8-2 of our www.StockTiming.com – Standard Subscriber site.

D’NILE

IT IS ONE OF THE GREAT FAILURES OF HOMO SAPIENS  – OUR SHARED LINK WITH THE DINOSAURS – IF ONLY THEY COULD COGITATE (“WHAT IS THAT BRIGHT LIGHT?  OH WELL.  WHAT A LOVELY PATCH OF GREENERY”).  THE FAILURE TO RECOGNIZE CHANGE AND PROFIT FROM IT OR AT LEAST, MOVE OUT OF THE WAY!  AND NO I’M NOT JUST SPEAKING OF GOLD’S PRICE. DENIAL - One of the major sins committed by investors and captains of industry alike.  Again not listening to the changing message, the vagaries of the marketplace.  It is easy to fall in love with your brilliance:  drink your own Kool-Aide.  I’ve done it more times than I care to remember or admit.  The trick is not just to be right but to consistently profit from the experience. Mel Brooks summed it up beautifully when he said “Death is easy.  Comedy is hard.” However, it is year-end the season for D’NILE: -REED HASTINGS’ HUBRIS, “JUST WAIT FIVE YEARS TO JUDGE MY COMPANY.” -ASK JERRY WANG (SELL YAHOO@$41) ABOUT THAT ONE -LET’S ASK (IN THE CONFERENCE CALL) THE CO-CEO’S OF RIMM – OWNERS OF THE VALUE TRAP – ABOUT PROSPECTS FOR 2012 -THEN THERE’S THE HONORABLE JOHN CORZINE WHO SHOULD HAVE FOLLOWED THE IMMORTAL WORDS OF PRESIDENT WILLIAM JEFFERSON CLINTON:  “DENY, DENY, DENY!” -EUROPEAN LEADERS [ESPECIALLY GERMANY] ON THE NATURE AND REQUIREMENTS FOR RESOLUTION OF THE LIQUIDITY CRISIS -INVESTORS WORLDWIDE WHO THINK EU LEADERS “DON’T GET IT!” -FINALLY, INVESTORS WHO ARE STILL WAITING FOR THE SANTA CLAUSE RALLY! As global markets search for a bottom the pertinent question is how quickly can China return to the growth path following second month of contracting PMI numbers.  Let us hope THEIR financial leadership is not similarly – in denial! Is the VIX Volatility Index in denial as the Arms Index swings violently between extreme overbought and oversold on successive days?  As the latest sell off from S&P 1265 continues to gather steam (YES WE CALLED IT!) curiously the VIX has petered out.  Could this conundrum be caused by year-end boredom on the part of traders inured of the daily triple-digit moves?  Or could it smack of a certain resignation of the crowd as to the direction -DOWN.  Hint: note the MACD is showing the same pattern now as in the October/November period.  Be prepared for renewed trajectory catapult if supports are broken.

Important support levels at 1230.59 to 1227 …

Today’s graph shows the S&P 500′s action for 2011.   Our C-RSI indicator in red measures the strength of the underlying index.

I should say that it is measuring the strength of the market on this chart because the S&P 500 is regarded as the best index for depicting the condition of the economy.   The reason Institutional Investors give for this, is that they say “the S&P 500 represents the best picture of what is happening to important Sectors in our economy“.

So, let’s discuss what today’s chart is showing.   First, the C-RSI strength is showing down movement from its peak this past February.    Note the blue, down sloping line we drew, it is a resistance line showing that the S&P’s strength has not been able to rise above it … which is where you want it to be for another Bull leg up.

Yesterday’s close came in at a (minus) -0.08 on our C-RSI which is essentially a Neutral reading because it was so close to zero, but it also means that this is a Danger condition for the upside.

When you get this kind of reading, it is good to look at the support level of the underlying instrument being analyzed.  In this case, it is the S&P 500 and it is showing a support level range of 1230.59 to 1227.   With the current weakness in strength, the 1230.59 to 1227 support levels become something investors should keep an eye on.

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FYI … Last Friday’s (Dec. 2nd.) comments are below for reference, and are followed by today’s (Dec. 9th) updated comments below that with the current updated chart.   See below for the current VIX number we need to avoid in order to not have trouble on Monday morning.
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December 2nd. commentary: What becomes more dangerous when it is above 26, and less dangerous when it is below 26?

The answer is the Volatility Index (the VIX) which is often called the the Fear Index.

What some investors may not be aware of, is the importance of 26 on the VIX.   It so happens that many Institutional investors initiate what are often referred to as “program trades” when the VIX rises above 26.

What is a program trade?   It is a term that describes a situation where baskets of stocks are traded all at the same time, and the event is triggered by the execution of a computer program.   Sometimes, these are block trades with a total value of over a million dollars, that are executed on the New York Stock Exchange.

The impact can cause unusual swings in volatility which carries a higher than normal exposure to risk levels for smaller investors.

Since program trades typically increase after a value of 26 on the VIX, then below 26 would be a quieter, safer place to be when trading long positions.

Take a look at the two year chart below, where you can see the correlation between the S&P and the VIX when the VIX was above or below 26.  It is not a trader’s magical tool, but it can alert an investor when he is in a territory where volatility and whipsawing can be exceptionally high.

This daily chart shows the daily movement of the VIX.  The VIX closed at 28.67 (on December 21st.) and it was below the trouble area of 30.16+ … 28.67 is still best described as a lesser Negative level.

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December 9th. commentary:  Note what happened this past Monday … the VIX moved down slightly below 26 and then bounced back up again.  As we explained last week, 26 is an important program trading level.   I drew a vertical line on Monday’s tick so you can see what happened after the VIX moved back up on Monday.

So, since Monday, the VIX moved higher until the S&P buckled yesterday.

But, if you look at the chart, something important also happened yesterday.   The November 29th. tick had an unfilled gap, and yesterday’s up movement filled that gap and then closed lower, but just above the gap’s resistance at 30.59.

When gap’s are filled, sometimes it has an effect like blowing off some of the steam leaving less pressure.   That will likely be the reaction this morning, which would mean a lower VIX.  But, it will be what happens this afternoon that will be important.  If the VIX moves back up and closes above 30.56 that will spell trouble for the markets on Monday morning.

Chart 1:  This week’s VIX Chart …

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Chart 2:  LAST week’s VIX Chart for reference …

Check with the Hirsch Stock Trader’s Almanac, check with Art Cashin (UBS) and other “old fogies”, there is an old adage that covers this situation: “IF THE BEARS GET THANKSGIVING THEN THE BULLS GET CHRISTMAS”. File this under the category Equal Opportunity. Frankly, I think there’s an old adage for every conceivable situation.

Fed Chairman Bernanke is out in front once again with the liquidity fire hose – leading by example against the intransigence of French and German officials (Punch & Judy). This as the current European brinksmanship over how much to backstop foundering financial institutions and whether the ECB can buy sovereign debt threatens to drag global growth engine lower than previously forecast by 1% as reflected in current OECD forecasts.

The co-ordinated liquidity injection – taken at face value – comes at an eminently logical moment. Domestically, Thanksgiving week capped the Dow’s worst monthly performance in 70 years; threatening to set a kilter the venerated third year of the Presidential Cycle investment formula that has worked since, well…1939!
The last negative return during the third year of a presidential term was in 1939, when the loss was a barely noticeable 0.1 percent. That loss came as storm clouds gathered in Europe with the beginning of World War II. It is hard to think of any year since the war when Europe’s problems have loomed as large to investors as they have this year. See Floyd Norris piece in the 12/2 NY Times.

In China economic numbers from the PMI to real estate prices in the past week point to a gathering weakness directly as a result of the turmoil in Europe. Hence the Chinese central bank’s cut in their reserve requirement by 50 basis points. Finally, the S&P cut ratings on a slew of money center banks, internationally, better late than never. And the less said about Italian bonds over 7% the better. The Fed’s 5AM wake-up call to market participants: don’t become overly confident in the Doomsday scenario. The market’s massive response on the back of Monday’s rally based on IMF intervention rumor of 800 billion EURO -latter denied, has effectively changed investor psychology for the balance of the year. Just what the monetary mavens intended. It is a thin market peopled by a world of nervous traders; something about long-tail cats and rocking chairs comes to mind.

While the liquidity injection provides welcome relief to LIBOR woes (the focus of our last article), which were indictive of a looming crisis; it is hard to argue that the amelioration of the fear trade can lead to a sustained new up-leg in global equities. Especially given as so many of the global growth generators are registering zero to negative domestic production. In addition to economic woes in the UK the Eurozone is now widely considered to be in the beginnings of a mild recession.

It is likely that this rally, like others in the other in the last six weeks, this “in and out” trading [Dennis Gartman has new Patent Pending on "Risk-on Risk-off"]may last a few more days; and that concerns over European solvency may resurface unless augmented by some real reforms and iron-clad guarantees.

Taking the larger perspective: Since I wrote “5 Waves Down” in May, the market may have completed an Elliott Wave I end of September and is now in the process of completing an A-B-C Wave II pattern that continues into resistance around DJIA 12,250. Likely we are set for an extended trading range with Fed actions, verbal or physical, taken at 11,320 DJIA.

As with our disclaimer last time we have to add the old Marty Zweig chestnut: “DON’T FIGHT THE FED”!
S&P chart courtesy Sy Harding’s Streetsamrtpost.com.

The CNBC Million Dollar Porfolio Competition had a total of 523,734 contestants

The AD Line is a breadth indicator showing market participation. It is the number of advancing stocks minus the number of declining stocks. I am using a 50 day EMA (Exponential Moving Average). As can be seen on the charts, the advance in the S&P is supported by the advance in the NYADV. So a majority of the stocks are engaged in advancing that causes the AD Line to move up. Take away is that for a sustained advance in the S&P 500, one should see a continued improvement in the NYADV 50 day EMA.