Preparing Precisely for Bottoms in the Markets

Let me ask you something. How many times have you heard a bottom called in a market...any market? I mean, it's amazing that not only are these people still allowed to publicly express their opinions, but people still listen to them as well.

It shouldn't be that surprising. Almost every Tom, Dick, and Harry with an Ameritrade or Schwab trading account doesn't have a clue what's going on in the stock market or any other financial market for that matter. So I guess the advisers and analysts that they get their advice from only have to be slightly more intelligent.

I'm not complaining. In fact, it's just the opposite. Financial markets are a zero sum game. For every 20% gain you have, the counter party in the trade loses 20%. So we should be thankful for bad analysts and worse investors. Just remember, wealth is never destroyed, only transferred.

Bottoms, Risk, and Asset Prices

I've discussed very little about market bottoms. I did discuss in a prior issue of B&B about a gold potentially forming a consolidated base that it could rally from, but that is the extent of it. I happen to have some very interesting insight on the coming market bottom, but to understand my hypothesis, we must first identify how we got here.

The road to DOW 7500 has been covered and analyzed rather extensively. Although it's been beaten to death, I would simply like to restate the driving force behind the decline of asset prices.

The cause was a deflationary process resulting from the de-leveraging of a financial system that was leveraged to extreme Keynesian standards. Leading the way in this massive margin call were the banks, hedge funds, and other investment fund. As these piles of money liquidated assets, risk was repriced into the markets. Hence we entered, and are currently in, a "preserve" instead of a "risk-taking" climate.

When risk reenters the market, we will set asset prices begin their next rally. I think we are nearing that point. I'm not calling a bottom yet, but I have two practical ways to identify when the risk is returning, which implies a bottom in asset prices.

Charting Bottoms

This first chart is the price of the 10-year Treasury Note:

Obviously you can see the fantastic run up in price. It's been well documented. But I'm not here today to talk about the Treasury market bubble and the growing liabilities of our nation. Before that bubble really pops we can use the 10-year Treasury price as an indicator of risk and tool to identify market reentry points.

You can see the pull back which has turned and rallied in sync with the decline in stock prices over the past week. What I'm looking for is a correction below the 50 day MA and a period of consolidation between the 50 and 200 day MA. I believe asset prices will begin to rise as that occurs.

Once we break support at the 50 day, looking at the chart you can see that there really isn't any support until 120. Beyond that, it's hard to say. When the bond bubble pops, the Treasury market may no longer be a good judge of risk. I have another chart that should help

The next chart looks at a market that is one of the purest ways to identify risk.

We are looking at the daily Light Crude chart here. Oil will probably be one of the easiest ways to identify when risk reenters the market. I'm here to use it as just that.

Oil just doesn't seem to be quite ready to move higher. You can see how it just about kissed the 50 day MA before turning around. Oil has yet to stop making lower lows and has formed a formidable double top at the 50 level. The 50 level also happens to coincide with the 50 day MA, making any tests at breaking resistance here even more difficult.

Long term outlook is a different story. In the past 6 months, oil's range is from 145-35. So as far as risk-reward scenarios go, you have to like the long side here. Add that to the reflation story and it seems like a place worth committing some capital.

For the sake of this article, it doesn't matter. When oil rallies through resistance at 50, and starts to form a base above its 50 day MA, that will signify risk returning to the market.

Conclusion

So I'm not exactly calling a bottom, but I'm telling you when I can. Look for the 10-year Treasury Note to break below and hold below its 50 day MA and look for oil to break above and hold above its 50 day MA. Although we aren't there yet, I believe this point to be in the not so distant future

Please note that this article focuses on risk and asset prices as a whole. Besides a brief reference to oil, I didn't focus on the specifics of any markets. That’s because I believe this to have a "rising tide lifts all boats" type of rally.

Look for a bear market rally of around 40% in domestic equities. I look for gold to lag other commodities early, but have a strong surge late. The last thing I wanted to say is that when these markets move, it will most likely be fast and violent. The pundits will be quick to jump on board, especially with the rally in stocks. Be aware of this, as it will present opportunity.

Disclosure: No positions.

Comments

[punk_ash:]

You are one of those morons too. There is something called value creation also. If a group of investors support the equity of a company, that makes the debt to equity ratio better, which can enable the company to better manage their debt, that was one of 1000s of ways value can be generated by an equity holder. So, not every investment is a trade.

Jan 15 04:32 AM

[Steven Hansen:]

there is nothing in this market that resembles the past. models are suspect for that reason.

Jan 15 04:42 AM

[tjh33990:]

Calling a bottom is like calling a recession. It only happens well after the fact!

Jan 15 05:39 AM

[Hefaistos:]

"Financial markets are a zero sum game." ... "wealth is never destroyed, only transferred"
These statements are Not correct. The market has an inherent long-term trend, we might say it is positive in the very long-term perspective. Either way, the market either creates wealth, or destroys it. It's only in the derivatives markets we have zero sum games.
Actually, long-term there is a correlation with GDP growth, the wealth that is created in the real economy is reflected in the market valuations.
Also, it's not a given thing that Treasuries are a bubble: They will not be a bubble if the period of deflation continues, which it probably will for some time.
Otherwise, I agree!

Jan 15 07:52 AM

[silver-bullet:]

This is obviously a traders' market. The the amateurs, you should steer clear and stay safe.

There will be other opportunities down the road, this one is just too violent for most to handle.

Jan 15 09:04 AM

[retiredpharma:]

Mr.Jones,

I found your article a useful read and also watch oil and treasuries to try and find a base, but I have never been able to find the " Bottom" although I have looked hard and long all my life through many market gyrations over the last 30 + years. This one is quite different to me somehow yet the similiarities are striking! I remember after 1987 in the October meltdown the same rumblings as in "I will never buy stocks again!"...heard throughout! But sure enough they did. So what if anything is different this time that makes it hard to find this base?

Lack of Trust this time! No punishments that I can see and lots who need a good spanking! Martha went to jail in the Erbitux scandal but these bankers and insurers are getting off scott free! Until this poison is sucked out of this wound it does not heal!!!

It seems like we went after the villians last time but for some reason we are actually giving them money this time around! I find that perplexing and wonder where this all shakes out. I have as low confidence as I have ever had in our Markets today and I am now 57! Been doing this for 30+ years. I have gone hard into cash,treasuries,CD's as of Fall of 2007 and only play the select Bio-Pharma companies I like due to a baby boomer assault on Healthcare that is like a tsunami coming.

I see more of the same in 2009 and this market will soon price in inherent inflation about to come and that will be the next leg down! 2 trillion more debt this time around must be calculated into your "bottom" and we are a ways off my friend!

Frank

Jan 15 09:08 AM

[mckeddie:]

Way to call it, Frank. I love the persective of you oldtimers and I'm glad you took the time to write your comments.


On Jan 15 09:08 AM retired pharma wrote:

> Mr.Jones,
>
> I found your article a useful read and also watch oil and treasuries
> to try and find a base, but I have never been able to find the "
> Bottom" although I have looked hard and long all my life through
> many market gyrations over the last 30 + years. This one is quite
> different to me somehow yet the similiarities are striking! I remember
> after 1987 in the October meltdown the same rumblings as in "I will
> never buy stocks again!"...heard throughout! But sure enough they
> did. So what if anything is different this time that makes it hard
> to find this base?
>
> Lack of Trust this time! No punishments that I can see and lots who
> need a good spanking! Martha went to jail in the Erbitux scandal
> but these bankers and insurers are getting off scott free! Until
> this poison is sucked out of this wound it does not heal!!!
>
> It seems like we went after the villians last time but for some reason
> we are actually giving them money this time around! I find that perplexing
> and wonder where this all shakes out. I have as low confidence as
> I have ever had in our Markets today and I am now 57! Been doing
> this for 30+ years. I have gone hard into cash,treasuries,CD's as
> of Fall of 2007 and only play the select Bio-Pharma companies I like
> due to a baby boomer assault on Healthcare that is like a tsunami
> coming.
>
> I see more of the same in 2009 and this market will soon price in
> inherent inflation about to come and that will be the next leg down!
> 2 trillion more debt this time around must be calculated into your
> "bottom" and we are a ways off my friend!
>
> Frank

Jan 15 10:21 AM

[OldLimey:]

Frank: good comments. I think the lack of trust is indeed critical, but it's not 'just' about the absence of jail-time - that may come (although I'm inclined to doubt it). One of the important things that separates this recession from all the others I've experienced since the 1970s is - aside from the near-collapse of the banking system and the speed of economic deterioration - the wider perception that the government is part of the problem this time around rather than part of the solution.

I had a tradesman in my house today. He owns a 48 year old company he took over from his father. It employs 8 people, 3 of whom are going to be made redundant next week - the first redundancies in the company's history. He doesn't spend his days glued to Reuters or Bloomberg, but without any prompting at all he went straight to the key points when we got around to talking about the economy: 1. This mess isn't an accident; the government set us up for the fall by the way it has mismanaged the economy for the last decade - too much debt, too little regulation, and inadequate interest rates. 2. You don't cure a problem created by too much cheap credit by doling out more cheap credit.

This is not news to SA readers, but plenty of folks like my plumber know what's going on this time around. (His name isn't 'Joe', by the way.) Yet our government here in the UK just churns out lie after lie in a barrage of spin that is clearly designed by people who think we're a nation of morons. Hardly surprising that trust is in short supply.

Jan 15 12:21 PM

[sr9web:]

This statement "For every 20% gain you have, the counter party in the trade loses 20%." is absurdly false.

For example:

XYZ co is trading at $100 and you own it. Later it rises to $110 and you sell your shares to me. I hold them and later sell at $120.

The $10 which I made was not "lost" to you. Rather, you sold because (presumably) you were satisifed with a $10 gain.

That said, this indicator looks like a good one:

"So I'm not exactly calling a bottom, but I'm telling you when I can. Look for the 10-year Treasury Note to break below and hold below its 50 day MA and look for oil to break above and hold above its 50 day MA. Although we aren't there yet, I believe this point to be in the not so distant future"

Jan 16 12:49 AM