Monday, January 21, 2008

Recession is now in the cards

I think its safe to say that we are in a bear market and that the stock market is discounting a recession. The first chart is the last time a right translated cycle discounted a recession. The 90 recession started in July 1990. The market didn't predict this recession it reacted to it. Also notice the similar waterfall decline that we are now experiencing. This happens as the market is forced to accept the fact that the economy is already in a recession. This is what happens when the Fed tinkers with the markets by flooding the system with liquidity. The market is buoyed till it is no longer possible to remain in denial. Then everyone runs for the door at once. Take note that we just saw a short consolidation in the S&P. The 1990 drop had two of these weak consolidations and 5 waves down. Obviously there's no way to tell how far the market will drop this time. I will point out that in 1990 the market was in a secular bull market and this time we are in a secular bear market. The next two charts show the VIX during the last two 4 year lows. Both spiked to the 45 level. As of Friday the Vix was at 28. I see where some investors seem to believe that the inverse funds (QID, SDS) are now being used to hedge and that is why the VIX isn't spiking yet. I'm not sure that is the answer for the simple reason that the VIX spiked in Aug. and Nov. The inverse funds have been available for the last year and a half. It doesn't seem reasonable that investors just now discovered these funds during the last month. No I think we will most likely see the Vix spike to "normal" 4 year cycle low levels before this is over.

I think we are at a very critical level right now. The market is screaming for Bernanke to cut big. The problem is there is a 1.2 trillion dollar sword hanging over the market in the form of the carry trade. A big cut now might crash the dollar and spike the Yen. This could cause an avalanche of carry trades to unwind all at once. Let's just say I wouldn't want to be Bernanke right now.
Most importantly how do we spot the bottom? As you can see it would have been fairly difficult to spot the bottom in 1990 in real time with just TA. Personally I will be not only looking at the technicals but also watching the COT reports for signs the big money is buying.