Archive for September, 2008

The Frantic Call Index

We have an index of phone calls at Orpheus. This is an internal sentiment index that we use. The more the calls we receive in a certain week, the stronger the market sentiment. The week that went started with frantic calls regarding the market volatility. “I am long on the market after markets fell 10%, but they don’t seem to stop falling, and now DOW is down too, what should I do?” Another query was, “When will this fall stop. How low can it go?” Another one involved Fannie Mae, Freddie Mac, and Merrill. “What was their future?” Another was regarding short selling ban and how will it modify market behavior? “What else will the regulator do? Open interest has increased in the market, what does it mean? I am still in doubt regarding the bottom. Does doubt about a bottom make it a better bottom?” Of course once in a while we also have the regular confessions regarding leverage and need for vacations and detachment. Markets do take a toll on human psyche and more the emotional maturity better it gets for the investor, trader or speculator.

On the first impression, the frantic call index spiking near panic lows, or capitulation bottoms might look like a strange phenomenon. But a deeper thought and you can start seeing a cycle. We at Orpheus consciously monitor market sentiment. The need to understand sentiment is so strong that whenever we conduct a conference with more than 50-100 people, we do a survey. We did one in Dec 2006, weeks before Romania was to enter the European Union. I raised my hand and asked the large group, how many think markets will become half from here. Not even one hand rose. Jan 2007 saw a collapse of 30% after Romanians celebrated the EU entry and went across the Hungarian border to have coffee without being asked for visa or passport details.

On another occasion in 2007, the same question saw another hand raised along with mine. This time it was head research of an Institutional brokerage company. But we were still in minority, two loners who believed markets can halve in value. Market sentiment is like this, lonely at tops and overwhelming at bottoms. Tops we are kings and bottoms scared prisoners of war, searching for survival trenches to hide in. Capitulations are chaotic while euphoric up moves are celebrations. Tops are when we celebrate and dine with our broker and bottoms are when we fire and sue him. This is the reason the frantic call sentiment Index never spikes at a market top. It is only after markets start falling that the bells start ringing. This is human nature. We pay more for Put options in a market collapse, than we pay for calls in a euphoric rise. Fear remains a stronger motivator than greed.

This is why capitulations can be measured easily compared to euphoric tops. There are also more signals near a bottom than there are exhaustion signs at a top. Above this price rockets can push up higher, but market has a limit to where it can fall to, 50%, 60%, 90% are clear limits on the downside. But upside is technically unlimited, till the moon. There are of course other problems linked with capitulations. Even if we hit or identify a capitulation bottom, prices take more time to rise than to fall. We take more time to build than we take to destroy. We move from margin lending schemes at market tops to banning short sales at lows. There is a complete history of short sale bans and revokes.

The proponents of globalization have also contributed to this capitulation. They just made it global. There are cycles of liberalization and protectionism. We open up and build walls cyclically. Globalization brought free trade, economic growth, and consumerism. Along with all this came speculation and global capitulation where contagions happen together around the world. We talked about one such impending capitulation in The October low. Global contagions and capitulations have group power. When many countries fall at the same time, it creates a stronger sentiment than what a single market collapse would have evoked. Group power hence has more signal power. If we have 10 sectors in the market and all of them are in gear, that’s just the turnaround signal one needs, everything falling and negative at the same time. What happened now was a global contagion. Year to date, Russia is down 50%, Shanghai composite is down 60%, Brazil BVSP and Indian Sensex are down 30%. And along with this if you hear about bankruptcies and bailouts, the panic is bound to be global.

Capitulation cycles can also be linked with simplicity cycles. Markets wake up and ask, “Why we made it all so complex?” There is a strong need to simplify things again. The need for affiliation increases and need for achievement decreases. It is a clear move from the conscious to the subconscious, and introspection. Market knowledge also moves from short term to long term memory. The bigger the crisis, the deeper it gets into market memory. Capitulation is like grieving and mourning. It is a five stage process, anger and intense emotion, denial, guilt, depression and sorrow and finally acceptance.

Sentiment in terms of news also reaches historic proportions when market hits capitulation lows. The bulls thank the Federal Reserve while the bears blame and curse the bailouts. We are in historic times and such high number of capitulations for us may make the stock study redundant, but as a panic extreme, such extreme sentiments still favors potential impending bottoms rather than continued precipitating declines. We need to look at time cycles more to understand whether the capitulation low happened already or is it coming in October? A smarter investor, on the other hand would wonder “What Capitulation?” His green stocks like Vestas Wind, ITT Corp, First Solar are still positive for the year.

Food Crisis Updated

If WHEAT is down 34% (back to 2007 levels), SUGAR is down 28% (sub 2005 levels), COCOA is down 20% (back to 2003 highs), COTTON is falling since 1995 and is down 87%, CORN is down 34% (back to 2007 levels) and even COFFEE which we gave a positive upturn reco in MAR 2007 (after which it turned up 60% from sub 100 levels to 160) has also retraced 19% from its historical highs. The bean is back to 2005 levels. So one can wonder about what happened to the food crisis? Is it over now that agro commodities are falling again.

Markets are a lot about patience and timing. The people who cry about food crisis are definitely not speculators who profit from rising food crisis. Noise is always tough to quantify. This is why we were early when we were speaking about the agro bull being already seven years old and the current rises finally pushing the prices lower than higher, it all seemed so strange. We wrote about this in Jan 2007 (Westernisation of Asian Diet).

Now after agro prices are back to 2007 lows and in some cases back to multi years lows, agro commodities need a review. First and foremost, even if on a multi month basis prices are down, the cycle (multi year) uptrend on agro prices is far from over. What happened was a normal retracement, which is now pushing most agro commodities into consolidation zone. The conventional head and shoulder on wheat may suggest it is over for the grain, but for us at orpheus this is a classic previous iv support zone. And the down move on wheat is an ending correction, after which the multi year uptrend should re-exert itself again.

The latest issue of WAVES.AGRO carries ANTICIPATED and HAPPENED case on COFFEE. An updated view on COTTON, CORN, SUGAR, WHEAT and a few different fractals of different time frames. We also carry an updated tracker at the end of the report, which carried the preferred MINOR TRENDS on the the various assets.

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Waiting for a depression might take more than a life time. And what might hit us is inflation and not deflation.

Everything is good with an economy, till it meets with an accident. After which the economy takes time to come back on track and starts growing again. This simple understanding of a business cycle is the very reason why accidents keep happening.

In his 1966 article on business cycles, James Meigs, senior economist, First National City Bank, New York City said, “Money is the missing ingredient from the contemporary discussion of the business cycle.”

But we the society don’t understand the money that we desire. “I am in favour of all kinds of money - the more the better”, these famous words of a politician Richard Boss Croker uttered in 1900 doesn’t really mean any different for the society today. And if you consider the mass psychology aspect, we never will really understand. Like we will never realise that inflation targeting is a myth and cannot be controlled or managed at single digits forever.

Inflation defined as a disproportionate and relatively sharp and sudden increase in quantity of money or credit or both can come in times of business activity by expansion of credit through banks, or it may come in times of financial difficulty in the form of fiscal stimulus from government (like what happened recently is US).

But more than increase in the quantity of money, it is the fear of inflation that creates a demand hedge, self feeding on itself. It is also the ‘economic growth at all times’ syndrome which inflates the credit cycle creating instant money.

George T Steve, currency theorist, in his 1965 write up on cycles in monetary inflation, explains that these cheap money policies to refuel waning prosperity does more harm than good.

Credit inflation causes currency debasement or capital destruction as more money pursues fewer assets creating asset bubbles. Second, as a comparison to the real currency such as gold, the paper money keeps losing purchasing power. And third, the strategy shifts to overcoming successive monetary crisis rather than preventing one.

It is because of this human incapacity, cycles work with precision. Just like interest rate cycles, inflation cycles have fixed patterns and periodicity. And though interest rate cycles are also connected with much larger civilisation cycles, cyclists have observed and written about the 60-year interest rate cycles. We have had a significant interest rate peaks in 1850’s, followed by one in 1920’s and later in 1980’s.

Some observations connect inflation cycles with a similar 54-60 year cycle. This also closely connects interest rates, wholesale prices and inflation to Kondratieff cycles, a cycle of similar periodicity.

Tony Plummer attempts to explain and connect the K wave along with the triad cycle complex consisting of Kitchen, Juglar, Berry and Strauss & Howe. The 90-year Strauss and Howe metacycle is larger than the K wave. This is why Kondratieff lows are associated with major depressions, which many anticipate will happen.

The reason it may not happen is because not all Strauss and Howe lows coincide with a Kondratieff low. Strauss and Howe crisis alternate between deflation and accelerating inflation. This is why the previous Strauss and Howe metacycle deflationary low of 1946 should alternate with an inflationary cycle that should push until 2030 marked by a world war (every Strauss and Howe lows have witnessed a war).

And like a contrarian thought should be, we know just a few market thinkers, Bill Meridian, Robert Gover and Manfred Zimmel who talk about a total collapse of real money and financial system somewhere after 2015, a classic case of hyperinflation rather than deflation linked depression.

Though this might look improbable and insane, the rise of gold validates the case. The only benchmark of real money, also known as hedge against inflation might have paused from its relentless rise to $1,000, but the commodity cycle of 30 years starting 2000 keeps the secular trend for gold pointed up. A targeted move up till $3,000, six times from a worst case base at $500 (if it happens) can really complicate matters for paper money.

Economic cyclists have given inflation a significant role along with other significant cycles, trend and random fluctuations. And understanding whether we are in an inflationary or deflationary environment are key to understanding how our economic future will be.

And just like the omnipresent 3.5 year rhythm, present in Kitchen’s inventory cycles and stock market prices and more than half of 500 economic series being studied, the inflation cyclicality is another recurring phenomenon. Without a proper understanding of cycles of inflation, the central banker’s guess about the economic cycle stage is as good as yours.

In conclusion, inflation is another accident the business cycle is about to face for more than a few years. How we prepare for it and thrive needs effort and more than a short term approach. As if the last time we witnessed it on a similar degree was in 1857, then we are already too much in the past to relate to it. A classic problem of econohistory, how can it hit me when it happened so long ago?

The October low

October lows have extreme sentiments linked to them making them great multi month, multi year and in some cases multi decade bottoms. We are nearing October 2008. If this looks like just another calendar date, think again.

The month of October has a special place in econohistory. But, somewhere the significance has been lost. There are many reasons. First, we as human beings are more interested in highs than lows. Second, a crisis gets more attention when it begins not when it ends or pauses. Third, masses can never attach more significance to a calendar month than they can to news. We like stories not some non-descript month of the year.

Fortunately or unfortunately, October has played a key role in economic cycles from documented history as back as 1869, when United States faced its first major financial and gold crisis. ‘Black Friday’, as it became known, was the result of an attempt by financiers, Jay Gould and James Fisk, to corner the gold market. In those days, Treasury’s surplus gold was sold for greenbacks, which was used to buy back government bonds. Because the gold market was small, the federal government was essentially able to set the price; selling more of the Treasury’s gold reduced the price, while selling less raised it.

The Panic of 1907, also known as the 1907 Bankers’ Panic, was another financial crisis after 30 years in the United States. The stock market fell nearly 50 per cent from its peak in 1906, the economy was in recession, and there were numerous runs on banks and trust companies. The contagion spread across the nation and lead to the closing of banks and businesses. The panic was followed by a second crash, which occurred in October 1907.

The stock market crash of 1973–74 was a crash that lasted between January 1973 and December 1974. Affecting all the major stock markets in the world, particularly the United Kingdom, it was one of the worst stock market downturns in modern history. The crash came after the collapse of the Bretton Woods system over the previous two years, with the associated ‘Nixon Shock’ and United States dollar devaluation under the Smithsonian Agreement. It was compounded by the outbreak of the 1973 oil crisis in October of that year.

Then was the Black Monday crash on October 19, 1987, a date that is also known as Black Monday, was the climactic culmination of a market decline that had begun five days before on October 14th. The DJIA fell 3.81 per cent on October 14, followed by another 4.60 per cent drop on Friday October 16. But, this was nothing compared to what lay ahead when markets opened on the subsequent Monday. On Black Monday, the Dow Jones Industrials Average plummeted 508 points, losing 22.6 per cent of its value in one day.

The Russian financial crisis (also called “Ruble crisis”) hit Russia on 17 August 1998. It was exacerbated by the Asian financial crisis, which started in July 1997. Given the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials, such as oil, were among those most severely hit. The markets bottomed in October 1998. The RTS Moscow current collapse of 30 per cent year to date makes it one of the worst performers in global equity indices. And coincidentally we have similar conditions now like we had in 1998 with falling commodity and crude oil prices. We mentioned about the strong connection of commodity boom with Russian and Brazilian markets in ‘Revisiting BRICS’ (January 2008).

October 1998 has a strong connection with equity markets worldwide. The low happened in DOW, BVSP, NIKKEI, DAX, SENSEX along with RTS. And strange as it may seem, DOW retested this low again in October 2002. The market downturn of 2002 again happened across the globe including India in October. Dow Industrial has a history with October in the year 1869, 1907, 1929, 1958, 1960, 1966, 1974, 1987, 1990, 1998, 2002 and now we are here nearing October 2008. The story repeats when you take Nikkei, but the occurrences shift sometime from October to November. Brazil BVSP has a similar pattern in 1994, 1998, 2002, 2007, 2008. Even German Dax repeats the sequence in 1990, 1992 and 1998.

The Chinese crisis labelled as another Black Tuesday occurred in February 2007 when China fell 9 per cent; the worst ever fall in a decade. This made global headlines. But, all this 9 per cent pales in comparison with the 61.8 per cent fall in Shanghai composite since October 2007 leading to October 2008. This near 12 month fall is the real October crisis heading for another October low, retracing gains of seven years.

In all this Octobers that we have mentioned above there was an exception. This was the crisis that happened nearly 30 years after the crisis ridden 1900′s. This was the famous October 29, 1929 crash. This crash did not stop at the October low. First it was the Black Thursday (October 24), followed by Black Monday (October 28) and then the Black Tuesday on October 29. On Black Tuesday, the Dow Jones Industrial Average fell 38 points to 260, a drop of 12.8 per cent. The Dow Jones Industrial Average lost 89 per cent of its value before finally bottoming out in July 1932. This was the great depression.

October lows have extreme sentiments linked to them. This makes them great multi month, multi year and in some cases multi decade bottoms. After 1929 October breach, Dow Jones has not breached another October low. The only marginal breaches we saw were in the sideways bear market of the 1970′s when October lows were retested on multiple occasions.

Cycle lows are more important then cycle highs. Contagions are more synchronous than tops. The classic reason is the lack of mass interest that lows evoke. This makes them more solid and unflappable. Above this wealth destruction destroys social mood. It quietens the party goers, sometime for a generation. A famous quote by Richard M Salsman, American Economist, goes like this “Anyone who bought stocks in mid-1929 and held onto them saw most of his or her adult life pass by before getting back to even.”

“The fundamental business of this country is on a sound and prosperous basis,” President Hoover, in October 1929. “The economic fundamentals of this country remain sound”, Ronald Reagan, in October 1987 are clear historical precedence regarding the worthless of news, as Ralph N Elliott pointed out in 1930’s. October connects us like nothing else. Elliott also mentions about the French economist Pigou in his market letters, published by the New Classic Library. Pigou discussed at length psychological errors and their relation to booms and depression. He maintained that an error of optimism tends to create, throughout the community, a certain measure of psychological interdependence until it leads to a crisis. Then the error of optimism dies and gives birth to error of pessimism. We are nearing October 2008. If this looks like just another calendar date, think again.