Sunday, October 22, 2006

Waiting game: A plunge is inevitable / fleckenstein

man muß zugeben das timing sicher nicht die stärke von fleckensetin ist.

More signals -- and more observers -- emphasize the disconnect between economic reality and the current euphoria.

Let's begin with a multitrillion-dollar question: Will this rally of the past 2 1/2 months be defined, in retrospect, as the ending blowoff to the rally of the past few years (fueled by what the housing bubble did for the economy)? Or, will it -- for reasons unknown to me -- signal the start of some new leg higher? That silence you hear is the "answer" to this question.

Last week, I anticipated a huge reversal -- admittedly, a low-probability event -- as both Wednesday and Thursday saw disappointing tech news trumped by soft-landing/Dow 12,000 euphoria. Furthermore, critical revelations surfaced on Thursday regarding loan losses at several institutions involved in the "housing ATM" finance business., my daily column, I described the situation as follows:

"The stage is set for some real fireworks, especially since this has been such a straight-up, bulletproof rampage for the last 2 1/2 months. In fact, given how we've powered through the large pre-announcement season into an earnings season that I expect to be pregnant with disappointment ... (we're) more ripe for reversal than at any point in time since the fall of 2000."

11,999 points on the Wall
But those two days came and went, with the aforementioned low-probability event a no-show (though the Dow was able to hold the hallowed, magical ground of 12,000). However, that doesn't mean we won't see the reversal around here somewhere.

Along those lines, it turns out that a proprietary stock-to-bond indicator from Jason Goepfert at the subscription Web site sentimenTrader is stretched to a level that is three standard deviations away from the norm, an event that should only happen about 0.1% of the time

In any case, what's remarkable about the indicator is its accuracy in catching major turning points in the past (though in the past couple of years, it has not been quite as timely). This indicator caught turns on March 23, 2000, the day before the peak, based on the S&P 500 ($INX); on July 17, 1998, the day before the start of a big plunge; and on Aug. 11, 1987, a couple weeks before the market topped. (There are other examples as well.) I don't put much stock in mechanical indicators, but the potency of this one struck me as something worth sharing.

Now to turn from charts to Colonials. The fact that home builder stock prices have stabilized despite bad news has, in my opinion, caused folks to believe that whatever fallout attends the housing-market unwinding will be manageable. Consequently, I believe that if the home builders start sinking again, that could have a negative psychological effect throughout the stock market, and possibly the economy. (Which is why they're worth keeping an eye on as potential stock-market and economic indicators.)

Hard-wired for happily ever afters
According to market observer Justin Mamis, the home builders may indeed be in the process of staging failing rallies. Since recent comments of his are appropriate not only for housing but also for how the stock market works in general, I would like to share them here:

"The 'word' on the Street now is that the housing problem is survivable. Won't be as bad as people had expected at their gloomiest. Won't interfere with the soft landing, etc., etc., etc. Greenspan and many others are being quoted, Richard Russell points out, as saying that 'maybe housing has already discounted the worst.' Isn't this the classic way the stock market works! Starts to hold on bad news, doesn't want to go down anymore on worse news, and instead seductively begins to improve. Sentiment changes toward optimism, sweeping aside the now widely known negatives, and bids start being raised, as interest becomes increasingly eager on any news, indeed often interpreting the 'bad' to be good, as in 'the worst has now been seen' ... as the rise begins to peak, (but) proving to be just a big intervening rebound, as it had promised to be way back when, rather than the start of something entirely fresh

Game over down under
Of course, as I have been saying for some time, the unwinding of the housing bubble is something I expect to be quite ugly -- not just a benign, easy-to-digest process that's largely been discounted. In Australia, a picture of generic unpleasantness was illuminated recently in a Daily Telegraph story titled "Sydney's Pay-Later Poor." The chief executive of the local St. Vincent de Paul society had some rather interesting comments about how folks got into this predicament:

"I call them the pay-nothing-now poor -- couples who have wanted everything now. Retailers have created this new breed of poor. People who have overextended themselves to buy a new home and then signed up to all these contracts to get the furniture, the television and cable. Suddenly there is a quarter-percent rise in interest rates and/or a hike in petrol prices and of course, it's a disaster. We never heard of borrowing money from the bank to pay for wine or to get our hair done in the 1970s. That would have been absolute nonsense, but that's what we are doing now through all these credit cards."

Sadly, the same can be said for Americans. The use-your-house-as-an-ATM phenomenon is exactly why the economy recovered in the wake of the last stock bubble. I don't think there's any reason to believe that Americans won't find themselves in a similar predicament to what some of the Aussies are experiencing right now. But that's not what the market thinks at the moment -- and therein lies the disconnect that I have been discussing for some time.


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