Tuesday, January 13, 2009

Technical Update

On January 2nd I was writing about the progress of the countertrend rally in US equity markets in Part 5 of my "Themes for 2009."

I am seeing some early signs of exhaustion in some indicators that I follow that may be hinting that the rally is already nearing it's end. Of course, none of this excludes the possibility of stocks moving higher, or even substantially so. It just makes it increasingly more unlikely.

Indeed, the markets pushed marginally higher over the next two days, thus extending the indicators to even higher extremes. But the S&P 500 has proceeded to lose 9% over the subsequent 6 trading days (including today's overnight session). The decline has been led by the financial sector, which has not taken kindly to Citigroup's desperation move to joint venture their Smith Barney unit with Morgan Stanley. My sources have been telling me that going the JV route is basically the last resort for a financials company that cannot sell assets for cash, stock or even for payment in installments. This is suggesting that Citi is essentially toast and will be nationalized "AIG style" in the near future. Wouldn't that be a nice inauguration gift for President Obama? And how many other derivative-juiced banks would go down with that sinking ship?

Above is a chart of the KBW Bank Index. It has been especially weak during this correction, not even being able to reach it's 50 day EMA or post an RSI reading much higher than 50. The relative underperformance of the banks does not bode well for the major averages. It's really hard to say how low this index can go. Surely every bank won't be nationalized. However, I do think that the current model for banking will not survive. What emerges will be much smaller regional banks offering traditional deposit accounts and conservative mortgages. I would be disinclined to go bargain hunting among the big banking monsters, even if this index were to plummet much further.

As for the major averages, I am leaning towards a fairly significant bounce from around the 820 area - perhaps all the way back up to 920. However, being in a bear market, the potential is great that we just plough through 800 on our way to new lows. Should that happen, my first target would be 600 for the S&P. There is also a confluence of support around current levels 866-871 that could provide a small respite.

As the markets were pushing higher, I used the opportunity to start collecting puts on a few companies I feel are in less than good shape. Among them were industrial companies with major financial exposure, Canadian banks and discretionary restaurants. (Send me an e-mail if you'd like to know specifically). The companies I chose mostly had large debt loads compared to their competitors or had over-expanded during the boom. I am expecting huge pressures on the Canadian banks this spring and summer as home prices fall dramatically.

Gold's 4% selloff yesterday appears to have confirmed a 4th lower high dating back to March's all-time high. I am sticking to my December 4th target range of $552-644 as the most likely destination for this next round of selling. At such levels, I would think about accumulating or increasing my holdings of physical bullion as a percentage of total assets.

That's all for now.


EconStudent said...

Hi Matt,

Could hyperinflation really occur like Weimar Republic? So far, I have concluded that it is highly unlikely to occur and Japan's lost decade is a better example of what could happen to the global economy. As a result, I feel gold and silver may be not have good returns due to the lack of inflation.


Matt Stiles said...


Sure. Anything is possible. But I doubt it is probable. In my mind, the psychology of deflation is an immovable force.

Try reading some of my previous articles:

If deflation really gets out of hand, there is potential for governments to get really creative and find a way to tax even your savings. This is why gold and silver could still be a good investment in deflation. They cannot confiscate it (if you hide it) and they cannot tax you on it. It cannot go to zero. Nearly everything else has at least one of those drawbacks.


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