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Three separate stories that combined may paint a bleak picture for the US stock market. The entire 50% increase in the S&P 500 has been based strictly on confidence. There has not been one shred of good economic news in the last 6 months. You can't spend confidence. The game is just about up. Robert Shiller is a thoughtful, nice person. He called both the NASDAQ and the Housing bubbles before anyone else. He did it in a matter of fact sort of way, not screaming at the top of his lungs. He again is pointing out that the contagion of confidence is likely nearing its end.

I don't pretend to understand the Elliott Wave theory, but they have a decent track record. They see a big drop for US stocks as this bear market rally runs out of steam.

The Chinese market fell 6.7% last night. It has now dropped 23% in a couple weeks. The stimulus sham in China is being revealed. They led world markets up and they will lead them down.

Lastly, John Hussman has his entire portfolio fully hedged at this point. If the market drops 20%, his fund will be flat to slightly higher. I respect his view more than anyone on Wall Street or CNBC.

To quote the sargeant from Hill Street Blues - "Be careful out there". 

An Echo Chamber of Boom and Bust




Published: August 29, 2009

THE global signs of a recovery in economic confidence seem puzzling.

It is a large and diverse world, after all, so why should confidence have rebounded so quickly in so many places? Government stimulus and bailout packages have generally not been big enough to have such a profound effect.

What happened? Economic analysts often turn to indicators like employment, housing starts or retail sales as causes of a recovery, when in fact they are merely symptoms. For a fuller explanation, look beyond the traditional economic links and think of the world economy as driven by social epidemics, contagion of ideas and huge feedback loops that gradually change world views. These social epidemics can travel as swiftly as swine flu: both spread from person to person and can reach every corner of the world in short order.

As George Akerlof and I argue in our book, “Animal Spirits,” the business cycle is tied to feedback loops involving speculative price movements and other economic activity — and to the talk that these movements incite. A downward movement in stock prices, for example, generates chatter and media response, and reminds people of longstanding pessimistic stories and theories. These stories, newly prominent in their minds, incline them toward gloomy intuitive assessments. As a result, the downward spiral can continue: declining prices cause the stories to spread, causing still more price declines and further reinforcement of the stories.

At some point, of course, the process must end, as when the market falls so low that it becomes enticing, or when new stories emerge. Similarly, an upward movement in stock prices generates its own upward feedback.

At first, the feedback explanation may sound too simple, and may suggest that the stock market and its turning points are easy to predict. But because day-to-day noise shrouds these changes, and because the stories change in their retelling and as new evidence emerges, the process is actually very complex.

And even when feedback mechanisms are straightforward, they can produce very strange outcomes, not predictable very far into the future, as the modern mathematics of chaos theory can attest.

Still, when there is a change in the economy, it is worth seeking some sense of what actually happened. We should be able to look back at the recent swings and get some idea, after the fact, of what caused us to change our stories and mind-set.

On the downward path between the stock market peak of Oct. 9, 2007 (when the Dow reached 14,164.53), and its bottom (more than 50 percent lower) on March 9 this year, there was a proliferation of negative stories.

In news media accounts and in conversations worldwide, one theme was that something was fundamentally wrong with our economic system, and that it desperately needed to be fixed. The news media seemed full of stories of deceptive accounting and of crony boards of directors — not just because they were news, but also because they answered a public demand for culprits behind the price declines.

These stories led to popular anger, which led business people to become more cautious in their decisions, like those involving hiring and capital expenditures.

Talk of a “crisis of capitalism” was everywhere. In countries around the world, bad guys were found by the news media to personify this narrative. In the United States, the Bernie Madoff story, which broke in December, was a human-interest story that would have been a hit at any time, but it took on supernormal significance as a symbol of an increasingly negative economic perspective. It may be hard to remember now, but these views led to fears that the market might entirely collapse.

I have been collecting survey data since 1989 on public opinion about the stock market; since 2001, the surveys have been conducted under the auspices of the Yale School of Management. We compute a “Crash Confidence Index,” which measures people’s confidence that there will not be a stock market crash like that of Oct. 28, 1929, or Oct. 19, 1987. The index reached its all-time high in 2006, as the market was still soaring. It reached its low at the beginning of this year.

Recently, the Crash Confidence Index has been on an upswing again. Stories about market crashes are less frequent and are being crowded out by a wide variety of other, more normal narratives. The markets have repeatedly been shrugging off bad news because people have a different mind-set.

The popularity of the term “green shoots” shows the kind of social epidemic underlying our changing thinking. The phrase was propelled in Britain by Shriti Vadera, the business minister, in January, and mutated into a more contagious form after Ben Bernanke, the Federal Reserve chairman, used it on “60 Minutes” on March 15.

The news media didn’t need to change the term for different cultures around the world. With nothing more than a quick translation — brotes verdes, pousses vertes, grüne Sprösslinge, etc. — it is now recognized as a symbol of a revival coming soon.

All of this suggests that a social epidemic is supporting renewed confidence. This confidence can keep growing by contagion, as a kind of self-fulfilling prophecy, and we may see the markets and the economy recover further.

But in an economy that is still unstable, the stories could also morph into different forms, the price feedback could turn downward and the dynamic could turn ugly again — just as it has in the past.

Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets L.L.C.


Aug 31, 2009, 2:23 a.m. EST

Elliott Wave pulls plug on stocks (and Obama)Commentary: Moment of truth for one of 2008's few money-makers -- and it bets on bearishness

By Peter Brimelow, MarketWatch

NEW YORK (MarketWatch) -- The Elliott Wave Financial Forecaster was roundly hated by many MarketWatch readers because of its irritating pessimism throughout the late, lamented bull market.

But the letter was also one of the very few to make money in during the Crash of 2008. ( See Dec. 17, 2008 column.)

In fact right now, it looks like pessimism has paid off. Over the past 12 months through July, EWFF is up 11.4% by Hulbert Financial Digest count, versus negative 20.03% for the dividend-reinvested Wilshire 5000 Total Stock Market Index.

Over the past three years, the letter has achieved an annualized gain of 3.58%, against negative 5.78% annualized for the total return Wilshire 5000. Over the past 10 years, the letter has achieved a 1.2% annualized gain, compared to negative 0.26% annualized for the total return Wilshire.

It's easy to sniff at this modest return. But considerably more than half the 180+-plus letters followed by the HFD lost money over the last 10 years. That's what happens when you have a crash.

And EWFF achieved this return with notably low risk. Indeed, on a risk adjusted basis, it has beaten the market over the nearly 30 years that the HFD has been following it -- a remarkable achievement given its radical stands. (Both ways. Presiding Elliott Waver Bob Prechter was controversially bullish in the early 1980s, contrary to his image among a later Wall Street generation.)

But here's the problem: Over the year to date, EWFF is up just 0.1% versus 12.5% for the Wilshire.

This is ironic, given that EWFF was an early proponent of the view that a rally, albeit probably a bear-market rally, was coming. ( See June 29 column.)

True to the Elliott Wave tradition, EWFF is responding by boldly calling a market turn rather than submitting to the trend.

Its current issue, dated Aug. 27, says: "The stock market is poised to complete the bear-market rally from March. Besides achieving to price objectives originally forecast in March, the five-month push has generated optimistic extremes that exceed those that were recorded at the October 2007 all-time high."

The Elliott Wave is a complex pattern theory, hard to summarize and even harder to justify on any other basis but success.

This is what the letter actually says: "The Dow is just short of the most likely stopping point, 9654/9764, previous fourth wave extreme. ... The worst seasonal month of the year is at hand (September). Prices should decline at least as fast as they rebounded. For those who felt trapped in Primary Wave 1, Wave 2 will offer a respectable place to exit. But we know from past experience that many will hold out for even higher prices, hoping to 'break even.'"

However, Elliott Wavers are also very interested in sentiment signs and cultural cues. (Bob Prechter was once a rock musician.)

For example, EWFF says: "If the turn is big enough, the public will sometimes turn on the president ahead of the actual [market] peak. The bigger the discrepancy between George Bush's approval rating relative to the rising Dow Jones Industrial Average, the more convinced we were that the upcoming stock decline would be one for the record books. ... The divergence between the two is back, as President Obama's approval rating is slipping fast even as the Dow rises."

For good measure, EWFF adds: "A debate over 'universal health care' is the perfect place for the optimistic psychology of a Grand Supercycle degree peak to have its last stand, as stocks reach back toward Dow 10,000 one last time ... such reforms [are] obvious manifestations of an extreme attitude about entitlements to comfort and support that may not have existed in history except perhaps in the late Roman Empire."


Shanghai cracks
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By Prieur du Plessis - August 31st, 2009, 10:30AM

Words from the Wise“, the Chinese Shanghai Composite Index has now recorded four consecutive down-weeks. The Index witnessed another massive sell-off this morning, declining by a further 6.7% to take its total loss since the peak of August 4 to 23.2%.

The losses happened on concerns of large Chinese share issuance and slowing bank lending. The banking regulator has already instructed lenders to raise reserves to 150% of their non-performing loans by the end of this year – up from 134.8% at the end of June, and the central bank has increased money-market rates to drain liquidity.

I have written a fair bit over the past two weeks about the overbought level of most global stock markets and also how China – a leading market on the way up – could be the catalyst for triggering a reversal of fortune in global stock markets.

Of the global stock markets I monitor, the Shanghai Composite (2,667) is the only one to have breached its 50-day moving average (3,125) and now has the key 200-day line (2,476) firmly in its sight.



Interestingly, emerging markets have now seen two back-to-back weeks of declines and have been underperforming developed markets for four weeks running, as shown by the declining trend of the MSCI Emerging Markets Index relative to the Dow Jones World Index. Could this be a sign of a broad retrenchment in risk appetite?



A global stock market correction could take the form of either a pullback or a consolidation (i.e. ranging). I suspect we may see at least some degree of reversion to the 200-day moving averages in a number of instances, but will be watching closely to ascertain whether we are dealing with a normal short-term correction or a more significant move threatening the primary trend. In the meantime, sit tight and be cautious as markets hopefully realign with the reality on the ground.