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"Prediction is very difficult, especially about the future."
Niels Bohr Danish physicist (1885 - 1962)

Executive Summary:

It is necessary that Minutes Before the Crash we have a bout of extreme irrational exhuberance.

I am short 100% of my allocated position of long-term yields. When the yield on the 30 Years US TBonds gets to 4.610% then short till it gets to 3.5605%. I will square the position and if TYX transgresses, 46.30 [No short selling].

I am long stocks with a first objective of 1017.64 on the SP500 with a possible new all time high later. I will update my final objective when TYX transgresses 41.42 and I will square the position if TYX transgresses 46.30 [No short selling]. I am long 100% of my total allocated position for stocks.

Reminder: the market Crash comes with low long-term yields and a deeply inverted yield curve and very low risk spreads, hence the high level of Irrational Exuberance and Global Euphoria. Because of the fantastic amount of liquidity in the system I expect the Mother of all Bubbles.

I am long minerals (100% of my allowance) with a first objective of $89 on Oil with a possible all time high later. I will update my final objective when TYX transgresses 41.42. I will square my position and go if TYX transgresses 46.30. For the same liquidity reason I expect explosive mineral prices.

I am short the spread of the yields Corporate Bonds / Treasury Bonds with 100% of my allocated portfolio.

I time the crash with the yield on USTBonds getting at 3.5605%.

The crash will be later then I previously anticipated. However, I expect that timing it will be easier.

Abstract:

My strategy is continuously evolving as the Market gives me more information.

My strategy relies on my analysis of the Market: "Plea for a New Economic Order." However, I explain there that there is no way of predicting mathematically the Crash. Hence, the hypothesis I make here about the future behaviour of the Market is based solely on my 24 years experience of the behaviour of financial Markets, hunch and intuition. I believe it is reliable.

My strategy concerns only the Markets I have superior knowledge of: fixed rates, yield curve, stock indices and minerals.

It is highly advisable to play a portfolio in these different segments (because we have no superior knowledge of an individual specific risk, it must be diversified. Of course, if I had a superior knowledge in one segment of these Markets I would use it). It is also advisable to play a portfolio of those different Markets giving some weights to fixed incomes, stock indices and minerals.

Th ideal portfolio, for those who know what it is, is built by running an analysis of Principal Components on the historical values of the financial products and using the first component.

For those who don't know what an analysis of Principal Components is a sub optimal portfolio is made by using a weighting inversely proportionate to the implied volatility of the financial products.

The ideal weighting is modified with the results of technical analysis.

As I said, it is Mathematically impossible to predict the Crash. In fact, chairman Alan Greenspan said it was "Mission Impossible":

That is mission impossible. Indeed, the international financial community has made numerous efforts in recent years to establish such oversight, but none prevented or ameliorated the crisis that began last summer.

Much as we might wish otherwise, policy makers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances. Financial crises are characterised by discontinuous breaks in market pricing the timing of which by definition must be unanticipated - if people see them coming, then the markets arbitrage them away.

The Age of Turbulence: Adventures in a New World [Economic Order?]

First, although Alan Greespan is the economist that best understands systemic risk, he oversees one thing; the real problem with systemic risk is not that you can't foresee it, it is that you can't avoid it and insure against it. It means the system can't avoid it. You will anyway be adversely affected by the depression, it doesn't mean that you can't analyse it and foresee it. It means also that when the Market foresees it we are already in the Crash. So although the Market can't foresee it, individuals can.

The problem lies with my model, which says that the Crash is the result of an unstable equilibrium due to an inverted yield curve which is resolved by a discontinuity of the yield curve as it gets to its stable equilibrium and normalizes.

A Liquidity Trap [Confer: Keynes' Liquidity Trap: A Theoretical Curiosity.] supposes a small shock. History remembers that what triggered Black Thursday was the failure of a small Austrian bank - nothing close to a Lehman Brother or a Bear Stearn.

For a description of a Crash Confer: Chapter III.Greenspan Conundrum and Bernanke Global Saving Glut.Paragraph 3: Bubbles & Bursts.

As with any mission impossible, for those who watched that television series like Alan Greenspan did, it is possible for the Impossible Missions Force (IMF, no kidding) to accomplish the task. We are going to use a special toolbox and use it in a smart way. As usual, “Should you, or any member of your I.M. force, be caught, or killed, Alan Greenspan will disavow all knowledge of your actions. This tape will self-destruct in five seconds.”.

"New Forces" that were not yet understood were likely behind the unusual environment of low long-term interest rates around the world, he said.

I do think the most relevant likely reason why we are dealing with what we are dealing with are new forces ... in the international market. Their nature and their behaviour is not something we are going to fully understand, if ever; certainly except in retrospect.

Chairman Alan Greenspan
Central Bank Panel Discussion.
To the International Monetary Conference.
Beijing, People's Republic of China
(via satellite)
June 6th, 2005

Maestro, The Forces Be With You

But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?
And how do we factor that assessment into monetary policy?

We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy.

But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of
the development of monetary policy.


Chairman Alan Greenspan
The Challenge of Central Banking in a Democratic Society.
At the Annual Dinner and Francis Boyer Lecture of
The American Enterprise Institute for Public Policy Research,
Washington, D.C.
December 5th, 1996

My special tool is a curiosity of the Markets that makes it a special mathematical function of time: it encounters technical supports and resistances which give them small discontinuities in the derivative of the value of financial instruments. These shocks, I pretend, will be sufficient to cause the return of the yield curve to its normal configuration, if, of course, the resistance or the support is sufficiently strong. On the other hand, when the financial instruments are not on these supports or resistance, the kinetic energy of the Market would render the yield curve immune to random shocks.

Another condition is that the yield curve be sufficiently inverted: the force needed to take it away from its unstable equilibrium is inversely related to the distance between the yield curve and its normal configuration.

Strategy:

Hypothesis:

I am going to use only the three Markets I have superior knowledge of: Treasuries, Stock Indices and Minerals.

The long-term yields will continue their downward secular trend. Hence, the yield curve will get more inverted.

The volatility of interest rates will go down until the Liquidity Trap as will the volatility of any Market we are concerned with. Experience tells us that when the Market goes up the implied volatility goes down, when the Market goes down its implied volatility goes up.

The lower long-term interest rates will be favoured by their lower volatility [Confer: Chapter I: Model of the Yield Curve.].

Because in a configuration of inverted yield curve bankers chase yields, I anticipate that the inversion of the curve will increase and every risk spread will shrink (which favours stocks and corporate bonds.)

The Market will get some stability from the talks about a second round of stimulus package, whether it finally emerges or not.

However, the inversion of the yield curve will be soon unsustainable. Our hypothesis, given my empirical knowledge of the yield curve is that, in order to be sufficiently inverted, the yield on the 30 years US TBonds needs to be below 3.90%.

We will see that a key level for the yield of the 30 US TBonds is 3.62% after reaching 4.60%. Until I change my mind, this is the support we are going to use now.

We will see also that the key level on the SP500 is 1017.63. However, my final objective can be much higher and I don't exclude a new all time high.

We will see that a key level for Oil is $89.00. However my final objective can be much higher and I don't exclude a new all time high.

Source: The Age of Turbulence: Preparing for the Crash