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Twist n' Shout: It's a Trap!

For Release on Monday at 8:00 AM EST

This article is meant to be an update, follow up or more precisely, shamelessly brag on the article I call my closing argument for the market crashBonds Hammer Bernanke at Jackson Hole.

The information within this article concerning Financial Markets is for informational purposes and do constitute a strong advise to sell securities. This article contains all you need to know about price movements on fixed rates, stock indices, minerals (oil, precious metals, and base metals) for the next 3 weeks.


I explained, and this is the basis of all my reasoning for a market crash since the spring of 1994, that long-term yields were undervalued and that they had reached an unsustainable low level. This is why as a Hammer formed the day before Bernanke speech and rates went up sharply with that speech.

Minimum yield curve (orange) last yield curve on Friday (Green)

That was not based on any economic data or any value of the speech but finding out that there was no more hope in Quantitative Easing and a sharp return toward the fair value of long-term yields.

Those fair values are 4.60% for the Yields of the 30 Years US Treasury Bonds and 3.50% for the Yields of the 10 Years US Treasury Notes.

This new behavior of the yield curve has a major meaning about the short run behavior of financial markets and economy.

Monday September 30th:

I expect an opening for the Yields on 10 Years Treasury Notes around 2.686% (30 Years US Treasury Bonds around 3.732% and that this gap won't be fully filled which will create a very bullish island reversal.

The consequences of that twist of the yield curve will be formidable. 

Economic Consequences:

Although the demand for investment necessary to maintain the prevalent level of economic activity is very low, probably less than 2.40% on 10 years (discounted for all the risks except interest rate risks). The offer of funds is higher and will get even at higher rates as the market get closer to the fair valuation of long-term interest rates. 

We are witnessing a retreat of savers from long-term investments to cash with a below par level of transaction between the savers and the investors. In term of economic growth it is not so much the price of the transactions that count but rather their volume.

The Economic Outlook and Monetary Policy
Chairman Ben S. Bernanke
At the Federal Reserve Bank of Kansas City Economic Symposium, 
Jackson Hole, Wyoming
August 27, 2010

Presents a list of policy options which have or already been used with dismal results or not even plausible.

Note: for those not familiar with the Fed eggheads lingo in

"Market expectations for continued accommodative policy have in turn helped reduce interest rates on a range of short- and medium-term financial instruments to quite low levels, indeed not far above the zero lower bound on nominal interest rates in many cases."

"Zero lower bound on nominal interest rates" means "Keynes' Liquidity Trap".

Try that Google Search

What you must know is that the Zero Lower Bound is for 0% short-term interest rate and obviously, as my option model proves, it is higher for long-term yields. So we are not "not far above" but "far below".

Of course when you replace "Zero lower bound on nominal interest rates" by " Keynes' Liquidity Trap" it gets a lot more freaky!

My estimate of the use of that syntax is that it make it less frightening and you will not find on Bing or Google the amount of research the Federal Reserve System did on the subject since 1994.

Bernanke Says Fed Will Do `All It Can' to Ensure U.S. Recovery 

I am sure 'It will do All it Can" the problem is I am also sure 'It' can't do anything!

Market expectations for continued accommodative policy have in turn helped reduce interest rates on a range of short- and medium-term financial instruments to quite low levels, indeed not far above the zero lower bound on nominal interest rates in many cases.
"The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do. As I will discuss next, the issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool."

The burden of proof is on him and he didn't describe specific and credible tools. In the meantime I have proved that none of the tools he and his eggheads have envisioned work.

Even if the Fed did the "unexpected", buy stocks to avert a crash, it would be met with a resounding failure:

At 1 p.m. on the same day (October 24), several leading Wall Street bankers met to find a solution to the panic and chaos on the trading floor.The meeting included Thomas W. Lamont, acting head of Morgan BankAlbert Wiggin, head of the Chase National Bank; and Charles E. Mitchell, president of the National City Bank of New York. They chose Richard Whitney, vice president of the Exchange, to act on their behalf. With the bankers' financial resources behind him, Whitney placed a bid to purchase a large block of shares in U.S. Steelat a price well above the current market. As traders watched, Whitney then placed similar bids on other "blue chip" stocks. This tactic was similar to a tactic that ended the Panic of 1907, and succeeded in halting the slide that day. In this case, however, the respite was only temporary.

The trading floor of the New York Stock Exchange just after the crash of 1929

Over the weekend, the events were covered by the newspapers across the United States. On Monday, October 28, the first "Black Monday",[12] more investors decided to get out of the market, and the slide continued with a record loss in the Dow for the day of 13%. 

Obviously the Stock Market didn't catch it, and stages a rally as though these higher long-term yields meant a brighter future.

Since May there have been a sharp disconnect between stock markets and bond markets. As they will necessarily reconnect at some time my estimate is that will take place between the 8th and the 17th of September.

It is very important to understand that these turning points can't be estimated from a macro economic or technical point of view. They can be understood only with an option valuation approach.


What do we expect now?

First a fast twist of the yield curve toward its normal stable equilibrium.
“It could well be that anybody’s who’s buying 20-year, 30- year Treasuries is taking a big risk,” said Feldstein, who chaired former President Ronald Reagan’s Council of Economic Advisers from 1982 to 1984. “Those prices could come down. I think the Fed is keeping those rates below any kind of long-term equilibrium.”

These are the yield curves for the minimum on Wednesday (orange) and the expected yield curve on Sept. 7th (green).

Fixed Rates:

Although long dated Treasuries will go down sharply short dated Treasuries (less than 2 years) should get lower and lower yields. It is even possible that some of these yields become negatives.

The spread between corporate and Treasuries will widen fast. Which means that their Credit Default Swap will go up.

Junk Bonds will be worth what they are Junk. (My name is Junk, Junk Bond.)

Commodities and Minerals:

Let me remind you of my article: 

Commodity Conundrum Solved: The Hidden Parameter in Interest Rates

(Please don't read the update it is a BS I wish I never wrote)

The conclusion is that on Sept. 9th will start a sharp drop of the prices of minerals including oil, gold, silver, copper...

Let me remind you that the result of that research says that in case of the normalization of the yield curve the price of minerals drop fast to its marginal cost of extraction.

For gold above $300 a fall of 76% with an overshoot as, of course, the gold that is stored outside the ground has, by definition a cost of extraction  = $0.

For oil that marginal cost of extraction is below $20 and probably closer to $10, which means an immediate fall of 74%.

Those percentage don't take into account the rise of the price of these minerals from now till Sept 7th.

These figures are bare minimums as with demand and cost going down the marginal cost of extractions will necessarily go down too. 

Stock Market:

It is very probable that during the next 10 days till Sept. 7th it will exhibit an acute bout of irrational exuberance bringing the SP500 above 1130! A s a consequence the implied volatility on stocks and stock indices [VIX] should be going down.

By mechanically increasing the Yield of US Treasury Notes from 2.419% to 3.500% and before any economic positive feedback the fall of the SP500 will be ... 31% !!! And that before counting the bout of irrational exuberance we will witness till Sept 7th!

The first step will be at around 719 not far from the famous previous low of 666.

What we Need to Watch:

Apart from the fall of long dated Treasuries a sharp decrease in short term Treasuries Yields (With a term below 2 years that could possibly become negatives.)

We have also to look closely on both the Ted Spread as banks will come to realize that trading with each other is not that safe after all and the infamous Credit Default Swaps. Expect an sharp increase of the insurance premium from now on.

Finally and apart from the normal flux of macro economic figures (especially unemployment data):

We must watch the auction of 10 Years US Treasury Notes on September 8th ,which I expect bad, and especially the auction of 30 Years US Treasury Bonds on September 9th, which I expect to be dismal.

Friday Sept 10th, after the close, the number of failed banks as published by the FDIC.


Yield on 30 US Years Treasury Bonds: Bottom: 3.462% on Wednesday, Last 3.698%.

Yield on 10 Years US Treasury Notes: Bottom 2.419% on Wednesday, my Buy Call: 4.249%, Last: 2.652%. Paper loss for a little bit less than 5 Hours, not bad (bragging :) )

TED Spread minimum: 1.53638%  for the last on Wednesday. Last: 1.5894%.


The Hindenburg Omen:

This is a buzz on Wall Street now:

Google Trend for Hindenburg Omen

Yes Folks, Hindenburg Omen Tripped Again from the Wall Street Journal.

Hindenburg Omen on Wikipedia

Mixed Signals and the Hindenburg Omen from Forbes

Note that 40 days after the first occurrence of the Hindenburg Omen is September 21st.

Labor Day:

September 6th, 2010. 

Labor Day brought the summer of 1929 to its conventional end on September 2. The next day the New York Stock Exchange had near record volume of 4,438,910 shares - The market was strong with what the press called a good undertone. On this very day, September 3, 1929 - as if by common consent - the great bull-market of the 1920s came to an end. In the days that followed, stock prices see-sawed under increasing volume as professional market veterans sought to unload.

The Quadruple Witching Hour:

September Friday 17th from 4:00 PM EST to 5:00 PM EST is Quadruple Witching Hour, which is prone to high volatility. 

Rosh Hashana and Yom Kippur:

There is a say on Wall street: "Sell at Rosh Hashana, buy at Kippur." well bad luck: this year Rosh Hashana fall on September 9th, the day of that dismal 30 Years US Treasury Bonds auction and Yom Kippur fall on a Saturday immediately after the Quadruple Witching Hour. It will be difficult to buy on a Saturday, won't it?

This year Erev Yom Kippur, falls on Sept 17th, 2010 or 9th of Tishrei, 5771, 911!

Eid al-Fitr (Arabic: عيد الفطر 'Īdu l-Fiṭr‎)

The Eid (the sacrifice that marks the end of Ramadan) will fall (approximately) on September 10th - 13th.

For us economists holidays are a way to coordinate the economic activities of those who celebrate as well as those who don't. (confer Christmas for Christians, Passover for Jews, Indian marriage season,...)

You might not believe these urban legends but your opinion or mine are irrelevant to the stock market. What counts is what the average opinion believes the average opinion will be. This is what you want to discover:


In one of the greatest investment markets in the world, namely, New York, the influence of speculation (in the above sense) is enormous. Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market. 

What do we Need to Do:

As I have explained since May on the event "MarketCrash: be Prepared" on Facebook which with 9 days to go has 479 participants:

Don't own any long term assets:

------------------> from September 09th, 2010 at 9:00 AM EST.

------------------> till September 17th, 2010 at 4:00 PM EST.

Long-Term Assets:

Long-term assets are anything you own which is not directed to your own day to day consumption: businesses, Stocks, debt instruments, real estate, and commodities including gold or silver. 

The proceeds must be held either in cash or invested in short-term Treasuries (maturing in less than two years and held with the emitting treasuries. (With Treasury Direct for the US Dollar.)

No holding must be deposited with any bank.

Best day to sell businesses, real estate and bonds: ASAP.

Best day to sell minerals: Sept 6th.

Best day to sell stocks: Sept 7th.

Playing the Market Crash:

Options on Stocks and Single Stock Futures:

Given the date of our planned market crash it can be played in a very simple and cheap way:

From the September 1st to September 17th at the open buy out of the money up to 100 points out for SP500!) put on stock index traded on any American market with an expiration date on September 17th at 5:00 PM EST or later. Being so close to the expiration their price will be ridicule even if VIX is high nowadays: it is all a question of timing!

Why not a later term for options?

We must beware when we trade on an exchange our counter party is the exchange. With a sharp downfall of the market it is very possible that a large proportion of the buyers couldn't make good on their contract so the exchange itself could be bankrupt this is why I recommend not to be greedy and take your money out of the exchange as fast as possible after Sept. 17th at 5:00 PM EST and put it in the safest vehicle on earth Treasuries with a term not longer than 2 years deposited with Treasury Direct.

Paying for a high implied volatility price is not the problem in that case. For most of us the transaction price will be even bigger than the cost of the option.

Anyway I expect VIX to trend downward from now till Sept. 7th.

Options on Minerals:

My preferred is without contest Gold!

Buy out of the money puts on Sept 6th - 7th. (The 6th the market is opened in London!)

Deus in Machina
Chairman Ben Shalom Bernanke ticking bomb: 9, 8 ... 1, 0


Any Crash we have witnessed have been the result of the yield curve suddenly returning from undervalued to normal. If for other crash the easy cure was to lower short term rate, this time it will be, of course, impossible.

With 9 Days to Go:

Our Facebook Page "The Post Crash Economy" has 374 fans.

Our Facebook Group "Prepare for Market Crash Before September 9th." has 86 members.

Economic Consequences:

On Sept. 22nd as we will have exhausted all of our other options, I will, on "Market Crash: be Prepared" start to display a series of videos in which I will present my alternative to the Deep Depression as a way to limit its chaotic social, political, military consequences.
“History teaches us that men and nations behave wisely once they have exhausted all other alternatives”.

The Site:

عید مُبارک
عيد مبارك
שנה טובה ומתוקה

Eid Mubarak
Shana Tova U Metuka

Disclosure: No Positions