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Forever Blowing Bubbles (by Springheel Jack)

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I've been promising a weekend post for a while setting out my thoughts
on how the new few years might play out on the markets, and this seems a
good weekend to do it, as EURUSD broke key support with conviction on
Friday, and my bear scenario is back to being my primary scenario as a
result, somewhat aided by important support breaks as well in ES, GBPUSD
and Oil over the last few days.

My bear scenario has a downside target of 870 and I laid it out in the post below on 21st May:

Just as an aside, I see that I posted a rectangle target for 30 year
treasuries at 134 in that post, and we reached it this week.

Looking at the world around us it is hard to imagine the economic
policies that are being followed round the world nowadays ending well,
and I have read a lot of economic history which suggests that they will
end badly.

Furthermore, from my reading of secular bear cycles in the past it
looks clear that the current secular bear cycle is likely to last
several years more before bottoming out, and that we have at least one
more harsh cyclical bear market to come before the end of that cycle.

None of that means however that equities will make new lows soon, and
the key lesson of the last eighteen months is that if governments are
prepared to throw all fiscal caution to the wind, and print and borrow
staggering sums to counterfeit the appearance of genuine prosperity,
then it can be counterfeited for a while, and if it can be counterfeited
for eighteen months, then potentially it can be counterfeited for a
while longer than that. Alan Greenspan's comments at the beginning of
August were a revealing insight into the thinking of the clever fools at
the Fed who let the asset bubbles of recent years inflate, and are now
doing their very best to 'save' the economy by reinflating them.

Alan Greenspan speaking to Meet The Press on 1st August 2010

'I wish I could answer that one. It’s a critical issue because, as
you point out and as I’ve always believed, we underestimate the
impact of stock prices on economic activity. Asset prices are having
a profoundly important effect. What created the extent of the contraction globally was the loss of $37 trillion in market value.
It collapsed the value of collateral in the system and it disabled
finance. We’ve come all the way back–maybe a little more than
halfway, and it’s had a very positive effect. I don’t know where
the stock market is going, but I will say this, that if it continues
higher, this will do more to stimulate the economy than anything
we’ve been talking about today or anything anybody else was talking


My belief is that we are in the last of a series of bubbles, with this
current bubble being a government debt bubble, and that this bubble
will end in a bond crisis centered on US treasuries that will raise
interest rates, enforce austerity, and cripple both the US (and other)
governments' ability to borrow irresponsibly, and as importantly to
print money to boost the economy and finance their deficits. Minor
issues like Greece notwithstanding, I don't see any sign at all of that
crisis in the near future.

We are therefore currently in a mainly technical market,
where longer term economic fundamentals mean little in assessing short
term valuations, and while that is the case then we may go up further
before gravity catches up with us. Meanwhile we're living through a
very strange period in economic terms.

My theory, which I'm hoping to make the central theme of
a book on this secular bear that I'm thinking of writing after it has
all played out, is that we are in a three stage debt bubble as follows:

The start of the series of bubbles, loosely speaking, was in 1995 when
the SPX broke the long term rising resistance trendline dating back to
1937 that had been hit previously at the major highs in 1966 and 1987,
and that SPX had bumped along just underneath in 1993 – 1995. It was in
1996 of course that Greenspan famously referred to 'irrational
exuberance' in the stock markets, and no doubt he was referring to this
initial break above the long term trend. Just as famously he then did
nothing to stop that bubble inflating, and we have been riding the waves
ever since.

That first bubble was the corporate debt bubble, culminating in the
peak in 2000. As that bubble deflated, central banks responded with low
interest rates and a flood of liquidity and inflated the second bubble
in the series.

The second bubble, 2003 – 2007 was the personal debt bubble. After the
peak in October 2007, and the brutal bear market that followed, central
banks responded once again with low interest rates and a flood of

The third and final bubble, starting 2009 and end date to be advised in due course, is the government debt bubble.

  1. 1995 – 2000 Corporate debt bubble
  2. 2003 – 2007 Personal debt bubble
  3. 2009 – 2012 (?) Government debt bubble

To put this into the longer term historical context I have borrowed and
annotated a chart from Atilla to show the long term SPX rising channel
and to illustrate how far we moved away from the longer term trend
during the first bubble particularly. You'll note that is is a rising
channel going back to the 30s with a short break below in WWII and the
major break above from 1995.


I don't see us making a final low until after the end of the final
bubble and we're just not there yet. This last bubble is necessarily
the last bubble in the series as after it ends there will be no-one
left able to inflate another. I'm expecting a US sovereign debt crisis
and bond market revolt in a year or two that forces austerity, ends the
last bubble, and starts the final cyclical bear market of this secular
bear cycle. After that bond market crisis, then governments will no
longer have the option of lowering interest rates or of releasing a
flood of liquidity into the economy, and that final cyclical bear market
will therefore take place without any major keynesian interventions.

What matters to us though is what will happen in the interim, and I have a theory for that as well.

As I said in my post on 21st May, I'm expecting a low on the bear
scenario this year in the 870 area, as that is the target area for both
the broadening formation and the big head and the shoulders pattern on
SPX, as well as being the key support / resistance level in the October
2008 to July 2009 period. There is another pattern that I should point
out too (thanks to BloodWine for bringing it to my attention), and that
is the possible bearish gartley pattern that may be developing after the
April peak on SPX hit an almost perfect 61.8% fibonacci retracement of
the fall between October 2007 and March 2009. A perfect 61.8%
retracement would have hit 1228 and SPX hit 1220 which was very close. A
bearish gartley pattern retracement of the rise into April 2010 would
target a (61.8% to 78.6%) range between 878 to 785 SPX and that would
give us the first three legs of the pattern. If we hit 878 exactly, then
the fourth leg would target a range between 1312 and 1431, and if we
hit 785 exactly then the fourth leg would target a range between 1337
and 1488. The completed pattern would then look like this:


You can see a classic example of this kind of pattern here at investopedia.

Does that sound too incredible? Perhaps, but it seems generally accepted
that if the stock market goes below 900 then the US government will
respond with a massive new round of stimulus and printing money, and
Greenspan's comments show the thinking behind that. That worked last
time, for a while, and I think that it may well work again, for a
while.  Equally it seems clear that the Fed will persist with this
strategy until it can no longer do so, which brings us back to that bond
market crisis I'm expecting.

I'm no expert with EW but that would also complete an ABC correction
from the March 2009 low, and to my eye, the wave up from March 2009 was a
five wave sequence, with the third wave ending in January 2010. Though I
know that is debatable, one five wave impulsive wave sequence strongly
implies at least one more impulsive wave up, according to EW rules.

So what else do I have to suggest that after a steep fall over the next
few months, we would then have a steep recovery? Well, there is the
first chart of course, where the scenario I am describing would complete
a retest of the rebroken upper trendline of the rising channel, and
then there's this 50 year chart of the SPX adjusted for CPI that I came
across a few months ago. I've added the arrows to show the perfect steep
real terms reversion to mean declining channel over the course of the
secular bear market since 2000, and once again the completion target for
the bearish gartley pattern would take us into the right area to hit
the upper trendline of this real terms SPX declining channel:

100520 SPX div CPI Declining Channel

So there it is, a logical theory backed up with some nice charts. Will it happen? Only time will tell. 🙂

I'll leave you with a couple of final thoughts. The first is that in
recent days we have seen at least one, and possibly as many as three
Hindenburg Omens. Now these may or may not be greatly significant in
terms of an imminent fall, and as much as anything else I think that
these omens are alerting us to something many may have missed, which is
that the market has barely moved in the last year. It will be the 23rd
of August on Monday, and on Monday 24th August last year the SPX HOD was
1035.82. SPX closed just 36 points higher than that on Friday.

Why's that significant? Because the omen requires that a significant
number of new 52 week highs and lows must be made for an omen to
trigger, and for that reason I remarked to someone a year ago that we
couldn't realistically see one for quite a while because of the huge
range over the previous 52 weeks. The range now over the last 52 weeks
is some 200 points, rather than the 700 or so points a year ago, so the
range is now narrow enough for Hindenburg Omens to trigger.  To that
extent the omens are just reminding us that the range over the last 52
weeks is narrow, and that we have come significantly off the top.

The second is a very thought-provoking recent chart from Goldman Sachs
reposted by Clusterstock Chart of the Day last week. It is the GS
analysis of the impact of fiscal stimulus on US GDP growth from the
beginning of 2009 to the end of 2011. This doesn't tell us that we could
necessarily make the upside target on the gartley pattern with a
massive new stimulus, but it does suggest that without that stimulus,
earnings forecasts over the next year look wildly overoptimistic. You
can see the full CCOTD write-up here: