Friday, 5 August 2011


FTSE 100 August 4th 2011

ishares Emerging Markets ETF
August 4th 2011

Brazil ishares ETF 
August 4th 2011

France CAC40 index 
August 4th 2011

Germany DAX index August 4th 2011

US S&P500 index 
August 4th 2011

Hear that strange sucking sound?  Is it the sound of stock prices swirling down the plughole?  Is it the sound of traders' sphincters suddenly tightening en mass?  Or is it the sound of millions of snoring investors across the world suddenly waking up?

Markets from Rome to Rangoon plunged Thursday as traders large and small began throwing in the towel in the face of a developing meltdown.  Historic degrees of selling were noted, with down volume swamping up volume by around 90-to-1, and sentiment measures finally began to give off a whiff of that special aroma which is a necessary precondition for every major low: panic.

Here's an updated chart of the Equity put/call ratio I posted on Wednesday.

I remarked last time about the apparent complacency of these 'dumb money' traders, who seemed so confident of seeing a bounce that they were unwilling to buy put options to protect themselves from further downside.  

That changed today - but not by as much as you would expect, given the near-5% sell-off in the S&P500.  This must give us pause.  

Only when these traders are pooping their pants, when they're scared enough to send that indicator to a statistical extreme - marked by the upper volatility band (in brown) - can we be confident that this phase of the selling is most likely done.


GOLD's heavy reversal, August 4th
All risk assets are in danger right now - including 'safe-havens' such as gold and silver. Margin requirements for gold at brokerages appear to have suddenly been raised on Wednesday, and when that happens many traders with limited capital are forced to sell.  This kind of liquidation can then create a self-reinforcing downward spiral, a phenomenon which may also infect the broad markets as mom-and-pop investors rush to get out.

US mutual funds (or unit trusts in the UK) are historically low in available cash, so when their investors want to liquidate, whether its the large pension fund lightening up or the little guy desperately trying to protect his ISA or 401k, the only option for these institutions is to sell the underlying holdings immediately.  This dynamic actually helps to create the kind of market vortex we've seen this week.


On Friday at 8.30am Eastern time, 1.30pm UK time, the US government will release its latest employment report. Analyst expectations are for around 100,000 jobs to be added.  This would be bad enough, since the economy needs to generate a quarter of a million jobs each month just to keep the unemployment rate from rising.  The fear among most traders, however, is of a negative print on Friday.  So here's how I'm roughly handicapping it:

  • if the number is less than expected but not negative, we may go lower initially, then rebound strongly during the day.

  • if it is negative but not disastrous, expect another bowel-emptying drop, then some kind of rally attempt

  • if it is around or above 100,000, we could explode higher purely on relief

  • if it is horribly negative - close the curtains, turn out the lights, take a nice long nap and whatever you do, don't check the news


This chart shows sell signals on an indicator I use to measure the volatility of advancing v. declining stocks within the NY stock exchange.  The weekly McClellan Summation Index is above, in red.  Below, the white line measures its 20-week volatility.  When that measure is unusually low (below 800 or beneath its volatility band), it means a very large move is building.

Since the data became available twelve years ago, a rise in volatility from low levels has identified all major corrections and both severe bear markets.  The depth of the recent drop-off in volatility is matched only by readings prior to the past two bear markets.

The problems we are going to face over the next several years are so great that, in my view, most investors who don't have the time or inclination to watch their money would be better off being completely in cash and out of markets (and property!) until the dust has cleared, probably sometime late in the decade.

For those willing to spend even a little time tending their savings, may I suggest taking a serious look at my three-part crash course The Compleat Investor, which shows in shockingly simple terms exactly what, how and when to buy and sell in order to make the highest and safest possible return - in all weathers.  You may be interested to know that, just before the carnage began a few days ago, this strategy gave an unambiguous sell signal for stocks and commodities.

Meantime, as mentioned previously, expect further downside even if a kneejerk bounce materializes over the next couple of days.  The Head-and-Shoulders pattern marked up in my previous post is now very much in play and projects down to 1130 on the S&P500.  The sequence of lower highs and lows mean it is possible, if not probable, that we are entering a new bear market.  

Consider selling risk assets on any rebound, otherwise hedge your holdings however you can.  Do not be surprised to see an all-out crash.

I'll post next when I start buying back in for the first substantial rebound.