Thursday, July 29, 2010

California Faces Issuing IOUs Again

California, and its largest city, Los Angeles, continue to be embroiled in a political deadlock. Yesterday, Governor Arnold Schwarzenegger released a new executive order requiring state workers to take 3 unpaid days off per month starting in August.  State workers were furloughed a total of 46 days when Schwarzenegger issued a similar order in February 2009, which translated to a pay cut of about 14%.

California faces a $19 billion deficit for the fiscal year that began July 1, and Schwarzenegger is demanding pension, tax and spending reforms in the new budget.  He said that if the Legislature doesn't give him a budget that meets his expectations, he won't sign it.

It's unclear how long the latest round of furloughs could last, as Schwarzenegger and lawmakers enter the 5th week of the new fiscal year without a balanced budget.  Earlier this week, the governor hinted that he might not sign a budget before he leaves office next January unless it includes pension, tax and spending reforms.

State Controller John Chiang has warned that he will start issuing IOUs in August or September if the budget stalemate drags on in the Legislature.  Chiang said the cash-saving measure is necessary because the state is projected to run out of cash in October.  While thus far IOUs have been honored at face value, it is increasingly likely that recipients may ultimately have to take a substantial discount, if the budget crisis isn't resolved.  In the 19th century, when several states had to issues notes, holders lost about half face.

Los Angeles, like many other cities, is struggling with a budget crisis of its own.  The situation is so grave that city officials have been involved in tense negotiations with the Department of Water and Power (DWP) over the transfer of funds into the city treasury.

On Tuesday, executives with the DWP issued a sharply worded defense of their decision to withhold $73.5 million from city coffers in the middle of a recent fight over electricity rates, saying they did so to protect the utility's credit rating and its customers.

After a lengthy standoff between the council and DWP over proposed rate increases, City Controller Wendy Greuel reviewed the utility's records and concluded that, contrary to its claim, the utility could have made the promised transfer to the cash-strapped city budget without first being granted the increase.  Official with the DWP, in turn, accused Greuel of making misleading statements.

Unlike investor-owned power companies that pay regular dividends to stockholders, the DWP transfers more than $200 million each year to the city's general fund, which pays for police, fire and other basic services. This year, that transfer was broken into two installments — $147 million followed later by $73.5 million.

With so many states, cities and counties in financial trouble, it would seem inevitable that some will be forced to default.  It's highly unlikely that California, which has the 8th largest economy in the world, on a stand-alone basis, would be allowed to go under.  However, cities have fewer options to plug their budget gaps.  If even one major city becomes unable to meet their debt obligations, the spillover into the investor community will be most severe. 

And, if cities begin to default with police and fire support becoming extremely understaffed, can civil disobedience be far behind?

Marko's Take

Wednesday, July 28, 2010

Economic Recovery Anything But Durable

While investors are drinking the Obama Administration's Kool-Aid and popping champagne corks over the slew of optimistic earnings reports and guidance, the economy continues to quietly deteriorate.  This morning we were treated to another disappointment:  durable goods.  Add to that the ongoing weakness in real estate and sub-par retail sales and it's hard to understand the unbridled optimism that has suddenly gripped the markets.

Not that economic statistics are a good barometer of future market prices.  Like earnings, they are backward looking and generally have ZERO predictive value.  Markets typically turn well before the economy and corporate earnings.  So, what's my beef?

The main problem with these economic data is that they are occurring in the middle of a so called "recovery" and one that began more than a year ago.  At this stage, we should be seeing growth in employment, sales, economic output and an increase in taking on credit.  None of those are happening. 

Durable Goods came in well below expectations.  The always wrong consensus had them rising about a percent.  They declined by a percent. 

Housing starts peaked in the 2005-2006 period at above 2 million units.  From there, they dropped to about 500,000 at the bottom of the financial meltdown of 2008-2009.  Since then, they have merely bounced around the lows.  No material recovery in more than a year.  We have not experienced the current low levels in decades.

June real retail sales rose at a 3.7% year-to-year pace, down from May’s revised 4.8% and from the first quarter's growth rate of 6.6%.

According to ShadowStats, adjusted for inflation, retail sales in May and June fell at an annualized pace of 7.6%.  Compared to the peak in 2008, retail sales are still down 10%.  If that pattern continues into the current quarter, a contraction in real third-quarter 2010 GDP would be a good bet.

What makes the economic sluggishness so worrisome is that it comes after the orgy-like expenditures and bailouts from the Obama Administration and near-zero interest rates.  The Federal Reserve is pretty much out of bullets.  The Obama Administration is out of bullets.  Can you imagine how difficult economic conditions might become now that all the stimulative measures have already filtered through?

On Friday, the first estimate of Gross Domestic Product will be reported.  Consensus estimates are for a 3.5% advance.  That number would seem way too optimistic and sets up the market for a major surprise.

Don't get me wrong.  Rising corporate earnings are great.  They prove that corporate America can make the necessary adjustments to cope with the very harsh economic conditions.  A victory for capitalism.  But, if we are about to enter the "second-dip", tomorrow's earnings will come under renewed pressure.  So, using this one data point in the absence of context will prove quite misleading and cause investors to make poor decisions.

Marko's Take

Tuesday, July 27, 2010

String Theory

While in many ways the capital markets resemble what academics refer to as a "random walk", there is a hidden structure to how they work.  The majority of investors believe that earnings are what's important.  They are eventually, but NOT in the short-term.  Valuation only provides us with guidelines, but says virtually nothing about timing.  As they say, "Timing Is Everything".

The markets have now rallied for 14 of the last 16 days.  Statistically, that's virtually impossible.  In, addition, The Dow Jones Industrial Average (Dow) has had triple-digit gains 3 days in a row.  That's unprecedented.

Strings of up and down days are followed by very few analysts.  Not too long ago, I studied market strings.  Here's what I found:

A streak of 7 days up or more is exceedingly rare.  In fact, virtually every occurrence marked either a significant market top or bottom.  These strings suggest exhaustive moves.  Terminal moves.  Moves subject to sharp and violent reversals.  The same goes for strings such as 11 of 13 days or 9 or 10 days.  They feel good, but they do NOT indicate market health.

The 2008-2009 market meltdown witnessed 8 down days in a row.  This marked the the final panic lows.  Now, we have an even more extreme string up.  The waterfall decline we've been anticipating is all set up.

Markets make major turns at extremes of investor sentiment.  Once everyone has bought in, and all the short-sellers have been forced to run for cover, who's left to buy?   NO ONE!  That's what makes the current string so dangerous.  Everyone is bought in.  Everyone thinks earnings will carry stock prices higher.  The analysts warning you about coming problems have been temporary discredited. 

The largest percentage moves up occur in bear market rallies.  Virtually all of the 10 largest percentage moves up occurred either during the Great Depression or during the meltdown of 2008-2009.  They're a sign of emotional extremes, NOT of market health. 

Bull markets progress gradually.   The bull's job is to make sure that as few people as possible ride the wave up.  It's never easy.  Any major move will have intermittent market smashes designed to scare the hell out of anyone.  They are there to make you question your convictions.  Bear market rallies are designed to keep you bullish, to keep you from selling and to make sure you hold your stock all they way to the bottom.

Thus, while it's tempting to conclude that this recent move up is indicative that "all's well", nothing could be further from the truth.  All the extra-ordinary fundamental problems still exist.  They are far from being solved.

So, if you're cautious but looking at the recent sharp move as indicative of a recovery, think again.  The same type of sharp upward corrections have NEVER been indicative of a good buying opportunity.  They don't now. 

Remember, the key to this right now is SURVIVAL.

Marko's Take

Monday, July 26, 2010

Obama Fires Another CEO

News reports of British Petroleum's (BP) CEO Tony Hayward being fired circulated the newswires over the weekend.  As of this writing, BP has not yet made it official.

I've been wondering under what authority our President believes he has this power or moral authority. 

Hayward is the latest in a pretty high level list of CEO's and executives to cross the increasingly authoritative Obama Administration.  If Hayward is truly out, he joins General Motors's (GM) Rick Waggoner and Lehman Brothers' Richard Fuld.  Fuld was not technically fired, but Lehman was allowed to go bankrupt, which eliminated Fuld's existance. 

Of course, our president has spared EVERYONE at his pet firm, Goldman Sachs (GS), aka "Government Sachs".  So what if they were central to the ruination of the global economy?  They admitted no wrongdoing.  Why jump to conclusions?

Let's not forget the "shotgun wedding" of Bank of America and Merrill Lynch.  Was Kenneth Lewis pressured to acquire Merrill?  Nah!  Lewis clearly WANTED to overpay. 

Don't get me wrong.  All of these executives had a lot to answer for.  However, these matters were best addressed by the companies' respective board of directors and shareholders, not by presidential dictum.

My question concerns exactly what gives our President either legal authority, moral authority or the basic qualifications to be making these uni-lateral decisions. 

President Obama has NEVER held a private sector job.  President Obama despises capitalism.  President Obama has NEVER run a company, nor created a single job except at government expense.  What makes him qualified to stuff his political views down corporate America's throat?

It's easy to demonize these companies.  NO company in the America exists to benefit either consumers or environmentals or regulators.  Their mission is to benefit shareholders.  The interest of shareholders may be at odds with a political agenda.  If you want social responsibility, better you turn to the many 501c3s.

If we extrapolate, we can conclude that NO CEO has any job security.  If you run a company involved in tobacco, alcohol, fast foods, munitions, gaming, pharmaceuticals, finance, banking, or just about anything else, you are at grave risk.  If you kowtow to Obama, your shareholders will be upset.  If you protect your shareholders, Obama will be upset.  Sounds like a pretty bad recipe to me.

Of course, if you're a racist, like Sherry Sherrod, you get an apology.  Last Wednesday, White House Press Secretary Robert Gibbs apologized  to Shirley Sherrod, fired the day before from her job as Georgia Director of Rural Development for the Department of Agriculture.  Ms. Sherrod's blatantly racist comments would have gotten virtually anyone else run out of town.  Trust our President.  He can separate right and wrong.

You get Obamacare whether you want it or not.  Never mind that he exempted Congress and himself from the legislation that was touted as so good for America.  Oh, and you're not paying enough in taxes.  Just because your small business is the only driver of the economy.  Pay more in taxes and let Uncle Sam spend the money that they believe was never yours in the first place.  Only by their good graces do they allow you to keep any of it.  Be grateful.

The press told us that Richard Nixon was an imperial president.  I don't recall Nixon firing CEO's.  Nor Reagan, nor Kennedy, nor Johnson, nor Ford, nor Carter nor Clinton nor either Bush.  In fact, has ANY CEO being fired by a sitting president?   Isn't the private sector supposed to be PRIVATE? 

Obama has a legal background.  Has he read the Constiution?

Marko's Take

Wednesday, July 21, 2010

Has The Crash Sequence Begun?

All the necessary conditions are in place.  After Tuesday's trading, both the Dow Jones Industrial Average ( DJIA) and the Standard & Poor's 500 (SPX) had posted gains in 10 of the last 11 trading days.  Such strings are very, very rare.  They indicate panic.  In this case, all the short-sellers who had gotten aggressive, have been sent running for cover.

Market sentiment, which had gotten quite bearish, is now pretty bullish especially on the back of a slew of earnings reports which have deluded investors into believing that the economic "recovery" is gaining momentum.  It isn't.  Apple is not enough to save the economy.

Earnings are backward looking.  They have absolutely NO predictive value.  In fact, market bubbles peak when the news is great.  Market bottoms occur when the sky is falling.  In 1929, economists believed that the market had achieved a new plateau.  They were wrong.  In 2000, investment analysts talked about a new investment paradigm of valuation not mattering.  They were wrong.  All those hot internet stocks went bankrupt by the dozens.

The important thing to note is that it is not too late to protect your remaining assets.  Down 50%?  Fine.  You want to lose another 50%?

The most important goal for any investor here should be survival.  There will be other times to participate in stocks and other investments.  There will be lower risk entry points.  Better that you preserve your liquid assets to enter when everyone else has been wiped out. 

If you're new to this column, you may wish to read two recent pieces on why the current situation is so damn dangerous: and

You can also profit from the coming market meltdown, but be aware that short-selling and the use of inverse ETFs is very treacherous and not for the feint of heart or risk-averse.  I do, however, recommend at least a small position as a hedge to offset losses in your other assets.

Should you load up on Gold here or precious metals mining stocks?  Probably not yet, even though Gold may perform well in a crisis situation.  If we're in the middle of another deflation scare, they are unlikely to be unscathed.  That said, Gold will probably be the best asset to hold value even in the worst scenario.  However, as investors seek liquidity to meet margin calls or redemptions, they will be forced to sell the most liquid assets.  Be patient.  There will be a much better time to load the truck.

It's also time to review all your assets and exposures.  Very few will escape the imminent market meltdown.
The only assets likely to perform here are very safe bonds.  In a deflation scare, interest rates are likely to either stay very low or go even lower.  The deservedly much-maligned U.S. Dollar ought to continue to see "flight-to-safety" interest.

If I'm right about what's coming down the pike, life as we know it will turn into life as we KNEW it.

Marko's Take

Thursday, July 15, 2010

SEC No Match For Government Sachs

Now let me get this straight.  Goldman Sachs (GS), aka "Government Sachs", has just received the largest penalty ever imposed on a financial firm.  Yes, a whopping $550 million. 

Relative to Goldman's 2009 net income of roughly $12 billion, this represents less than 5%, or about two weeks worth of earnings.  In the case of British Petroleum (BP), they were arm-twisted into establishing a $20 billion escrow fund, or about 15 MONTHS of 2009 income.  BP's escrow fund is to compensate victims.

For Goldman's victims, they were assessed $300 million, payable to 2 European Banks.  Forgive me, weren't there a whole lot of other victims?  So, BP is paying about 70 times that of GS.  Seems reasonable to me.

BP's market capitalization has fallen by about half from peak to trough, a wipe-out on the order of $100 billion.  BP's shareholders are the public.  Goldman's market capitalization is down only 20%. It's shareholders are very largely Government Sachs alumni in senior policymaking positions.  And, of course, management.

Are you beginning to see the problem here?

BP may still have stiff penalties imposed on it.  The investigation is far from over.

Ok, so one company's alleged negligence led to economic disaster and the other's to ecological disaster?  Is one that many times worse than the other?

Could the difference have anything to do with the rather sizable number of GS alumni in the government?  Lloyd Blankfein walks away unscathed.  Tony Hayward is driven out of Dodge.

Goldman's settlement permits it to walk away, while admitting virtually NO wrongdoing.  Do you think that BP will be so lucky?

One can assume that investigators and senior officials of the SEC knew what they were doing.  After all, why would they EVER want to bring down their future bosses?

Goldman officials praised the settlement.  Yes, you read that correctly.  Goldman officials praised the settlement!  Doesn't that, in and of itself, say something?  Do you think for one minute that the remaining BP officials will be thinking what a great deal they got?

But, Goldman had another huge reason to celebrate:  the passage of the financial reform bill.  Not only are Goldman's business interests protected, but the bill establishes new regulatory bodies.  A full employment act for Government Sachs at government expense!

Marko's Take

The RIB Countries

The elite nations were nicknamed BRIC (Brazil, Russia, India and China).  The very un-elite nations are referred to as PIGS (Portugal, Ireland, Greece and Spain).  I propose a change to the membership of the elite.

China is in danger of losing its exalted status.  Blasphemy?  Not at all.  The reasons for this have been discussed in these very pages

While the Chinese economy grew at 10.3%  in the second quarter over the year before, this was significantly less than the 11.9% realized in the first quarter.  Beijing has undertaken efforts to cool down its economy, which shows signs of inflation and a property bubble.  Recent measures enacted include increased required down payments and extreme restrictions on buying additional properties.

Although the slowdown was expected, other recently-released figures indicate that the economy could be cooling more quickly than forecast.  Industrial production, which grew by 13.7% in June relative to the prior year, was much lower than May's 16.5% annualized increase.

The World Bank also cites factors such as a declining labor force due to China's demographics and lower increases in total factor productivity as reasons to expect China's growth rate to slow.  It expects potential annual growth to be about 8.4% between 2010 and 2015, down from 9.6% from 1995 to 2009.  From 2016 to 2020 the rate could fall further to 7% on average.  If the property bubble should burst and get ugly, this will undoubtedly reduce growth prospects even more.

India, on the other hand, does NOT have the same demographic issues plaguing China, which has taken steps to limit its birth rate.  Long-term growth requires a pyramidal population structure.

India has not been growing as fast as China, but its growth may be more sustainable and healthy. The Indian economy grew by 8.6% last quarter.   It is not believed to be in danger of over-heating.

Brazil and Russia are among the very few countries with increasing oil reserves and output, a very critical asset during a time of "Peak Oil" and a growing possibility of military conflict in the Middle East.

Therefore, I'd like to propose that the elite nations now become known as RIB (Russia, India and Brazil).

The Chinese miracle may very well be coming to a pre-mature ending.  The Shanghai Composite is looking very unhealthy.

Marko's Take

Monday, July 12, 2010

Bullion or Mining Stocks?

All of us Gold Bugs wonder how best to allocate resources.  It's no secret that mining stocks have proved to be a MAJOR disappointment for several years. 

Over the last two years, the table below demonstrates how poorly mining stocks have performed relative to the metal itself.  The HUI Gold Bugs Index,is the key benchmark for publicly traded Gold and Silver miners.

Time Frame                  HUI Peak                      Gold Peak
March, 2008                   515                               $1,025
December, 2009             510                               $1.225
June, 2010                      500                               $1,250

As is clear, mining stocks have failed to keep pace with the metal itself in a very major way.

The basic argument for investing in mining companies, as opposed to bullion, is that they have leverage relative to the metal.  This has not been the case in recent years.  In fact, despite accelerating earnings, they've performed rather dismally.

Gold, in my opinion, is, for the time being, the better bet.  Its use as an alternative currency during a period of extreme worldwide monetary debasement is proving far more valuable.  Mining stocks are still equities and subject to the extremely bearish winds now in motion for the stock market.  There will be better opportunities to re-enter.

If we are entering another deflation scare, it's important to be aware that even the metal itself may be subject to some temporary pressure.  There will probably be a better entry point for the metal itself, although, at this time, its chart still looks VERY constructive. 

Federal Reserve chairman Ben Bernanke is a student of the Great Depression and is very aware of the relationships between money supply growth, economic activity and asset performance.  Undoubtedly, as this new market smash fully expresses itself, the FED will be forced to undertake even more drastic measures to re-liquify the economy than it already has.  Bernanke earned the nickname "Helicopter Ben" for proclaiming, on numerous occasions, that he would be prepared to drop money out of helicopters if that's what it took to get money circulating again.  He may have to make good on that one.

In its desperation, the FED wil probably over shoot and, in so doing, sow the seeds of hyper-inflation.  Then, all the ingredients for Gold to achieve vastly higher levels will be in place.

This is one of the reasons that successful investing is so damn tough.  You can be completely correct in a forecast and STILL lose money.  All of us precious metals mining stock investors have stood back, watched the bullion advance and have been totally unable to cash in.

Extreme caution continues to be warranted here.

Marko's Take

Thursday, July 8, 2010

8 More Reasons To Avoid Stocks

After 2 days of scaring the wits out of anyone, including me, I thought that I'd review some of the additional possible trigger events for a stock market collapse that do NOT include eclipses or full moons. 

Not in any particular order, these are all potential dangers for the stock market meltdown that I've written about over the past couple of days.

1.  Military conflict in the Middle East

Without re-iterating why this situation is so dangerous, you can read some of the latest developments here

2.  Either a major default or a complete disintegration of the Euro-Zone.

For some recent information, try this piece on the countries' out-of-control budget deficits

3.  A key state, county, or city default.

For more information, you can read the lastest here

4.  Or, the inability of the United States, as a whole, to pay its debts.

For more information on this mess:

5.  A trade war with China.

Read about it here

6.  An inevitable and growing shortage of oil.

Yes, "Peak Oil" is not a myth.  Don't believe me?  Read this:

7.  Intensifying problems in our financial system, most notably, the banking sector.  Obama's most ill-advised new financial reform bill will only make things worse!

8.  The commercial real estate sector (not to mention residential).

You can read about that here

If you've read this far, let me leave one more for you to ponder:  The American Empire is on its last legs.  This is a long one, but well worth reading to put everything above in historical context.

Now a truism that a lot of folks hold onto, is the notion that it's darkest before the dawn.  Trust me, we will soon know dark! 

Marko's Take

Wednesday, July 7, 2010

Hindenburg Omen Confirmed... Or, Was It?

The Hindenburg Omen (HO) was described in yesterday's blog.  For more on how it works, click here

For the HO to be confirmed, it must happen at least twice in a 36-day window.  Did we get confirmation today?  Well, that's a tough one.  According to Yahoo Finance, there were 102 new highs and 85 new lows out of 3,946 issues traded.  That means that the new highs test was met, but the new lows test came in at 2.155% of issues traded.  The trigger criteria calls for 2.2%.  Are we supposed to round up?

But, the HO is not nearly the only reason to fear a market meltdown.  There are a whole slew of others.  Some are out there, some are not.

A man named Steve Puetz (pronounced "pits") is a student of stock market crashes.  He has concluded that solar eclipses combined with full moons were somehow connected to the timing of market crashes.  He does NOT suggest that full moons close to solar eclipses cause market crashes.  But, his research does demonstrate that a full moon occurring close to a solar eclipse, in particular, seems to affect investor psychology in such a way as to transform investor emotions into panic.

His research found that 8 of the greatest market crashes in history fell within a time period of 6 days before, to 3 days after, a full moon that occurred within 6 weeks of a solar eclipse.  Yes, you read that right!

Could this be random?  Statistically, he found that for all 8 crashes to accidentally fall within the required intervals would be less than one chance in 127,000.

It's important to understand that EVERY solar eclipse must, by definition, occur within six weeks of a full moon, which occurs every 4 weeks.  The combination does NOT mean a waterfall decline will ensue, but it does suggest a timing window, should one occur.

Now, here's where things get verrrrry interesting, as Arte Johnson would say.  In the year 2010, there are only 2 solar eclipses:  One occurred in January, and the only other one will occur on July 11!  The next full moon occurs on July 26th, with one to follow on August 24th.  So, if we combine the research of Robert McHugh with that of Steve Puetz, this would suggest that a crash could occur at anytime!

Don't buy that one?  I don't blame you.  But, there is a lot more.

Dow Theory holds that when the Industrials make a new low confirmed by a new low in either the Transportations or the Utilities, a new bear market has been indicated.  This signal has been given.  Dow Theory does NOT predict crashes, just suggests that the primary direction of the market is down.

Let's not forget the horrific plunge in the nation's money supply.  According to adjusted numbers crunched by John Williams of ShadowStats, inflation-adjusted M3 is declining at an annualized rate of 5.9%, the steepest since the Great Depression.  This drop reflects sharply reduced lending by financial institutions and foresages extreme problems in the banking sector.

According to Williams, whenever real annual M3 growth has turned negative, the economy has followed.  Every time real M3 has contracted, the economy has fallen into recession shortly thereafter, or, as in the case of the 1973 to 1975 recession, where the M3 contraction took place after the recession had started, the existing downturn has intensified.  Double dip, anyone?

Ignore this at your market peril.

Marko's Take

Tuesday, July 6, 2010

Hindenburg Omen Foretells Coming Market Meltdown

Investors use a variety of data points to assess the likely future course of the market.  Some are WAY out there, such as astrology, sunspots and cycles of the moon.  Others are more traditional like charts, sentiment ratios and overbought/oversold indicators.  Rarely do these types of indicators, which are followed by many, provide much value added.  Most academic studies conclude that the market is a "random walk", meaning that, over the long-term, beating the market is deemed impossible.

For an indicator to even have a chance at being valuable, it must remain somewhat unknown, or understood by very few people.  If it were widely followed, then investors would act on it and it would cease to remain useful.  That's the basis of the "efficient market hypothesis".

One very valuable and arcane indicator goes by the name of "The Hindenburg Omen" (HO). 

What, exactly, is a Hindenburg Omen?   It occurs when several technical factors that indicate certain underlying conditions of the New York Stock Exchange (NYSE) are present simultaneously.  The HO has been present before all of the stock market crashes and/or panics of the past 25 years.  No significant sell-off, during this period, has occurred without the presence of a Hindenburg Omen. 

A Hindenburg Omen is triggered when the daily number of NYSE new 52 Week highs and the daily number of new 52 week lows both exceed 2.2% of all issues traded.   In Tuesday's trading, BOTH new highs and new lows met that criteria. 
A brilliant newsletter writer named Robert McHugh, has done a tremendous amount of analysis on this indicator and used statistical analysis to perfect its signals.  According to McHugh, the traditional trigger, to be truly indicative, has several more filters.  These filters include a rising 10-week moving average and negative market breadth, as measured by an index called the McClellan Oscillator.  Both criteria are present today.

Even with these additional filters, the HO has still failed on occasion.  McHugh has developed 2 additonal filters to make the signal deadly accurate.  Condition 4 requires that new 52 week NYSE highs cannot be more than twice new 52 week lows.  However. it is acceptable for new 52 week lows to be more than double the highs.   This was met today.

McHugh's research has determined that there have been 2 incidences where the first 3 conditions existed, but new highs were more than double new lows, and no market decline resulted.

The 5th condition for a Hindenburg Omen to be completely valid is that there must be more than one signal within a 36-day period.  McHugh found 8 instances over the past 25 years where there was just one isolated Hindenburg Omen signal over a 36-day period.  In 7 of the 8, no sharp declines followed.  Most HO's occur in swarms.

But, before we totally follow McHugh off a cliff, be aware that he is also a disciple of Elliot Wave Analysis, a completely useless notion of market movement.  

McHugh also projects that the market is ultimately going to trade to near zero.  Perhaps he's read too many books on 2012!

Tuesday was HO number 1, so a warning flag has been raised.  It is nowhere near a foregone conclusion that a market plunge is imminent.  However, there were other very bad technical signs in Tuesday's trading.

The Russell 2000, a very broad measure of small capitalization stocks, completed an "outside day reversal".  These occur when a stock or index trades above the high of the previous day, reverses and then closes lower than the prior day's low.  These are far from inflammable, as Archie Bunker might say, but tend to be correlated with more movement in the direction of the close.  Since the Russell closed down, we can logically expect more downside imminently, although we don't know how much further the short-term momentum will carry.

The timing of a decline following an HO can begin the day after or as long as 4 months after the signal.  In the current situation, the confirming signal may occur at a lower level.  In fact, market crashes NEVER start from a top.  They generally occur at least 20% lower than the top.  In 1987, for example, the Dow Jones Industrial Average peaked at 2,700 and change.  The crash began with the index a full 20% lower than its peak.  The same can be said for the market crash that occurred during the Great Depression.

So, assuming we've raised your level of concern, what should an investor do with this information?  At the very least, HEDGE!  Take a position in a security that can gain if the rest of your portfolio declines.  This can  be accomplished by purchasing some aggressive inverse ETFs.  My personal favorite is FAZ, a 3x negative play on the financial sector.  If you want to hedge using the Russell 2000, an ETF with the symbol TWM will give you a great play on any downside.

FAZ, which currently trades around $18 per share, traded at $2,000 per share in late 2008!  It has that much leverage.  So, employing one of these, assuming the market melts down, can result in huge gains!  Same goes for TWM.  There are inverse, leveraged ETFs covering nearly every industry and every index.

This is no time for investors to put their heads in the sand.  While the most dire prediction may not come to fruition, ignore this signal at your own investment peril.

Marko's Take

Subsequent to this piece, more information on the HO has emerged.  For an update on this indicator, please click this correction:

Monday, July 5, 2010

The State Budget Electoral College

With elections coming up, Republicans and Democrats are fighting to control Congress.  In my mind, the voters reaction to the new hardships imposed by state austerity programs will direct the election.  Interestingly, the most problematic states are the largest, with the most electoral votes. 

California with 55 and New York with 31 lead the pack of basket cases.  Interestingly, both states are very left-leaning and Democrats have FAR more to lose.  Voters could easily turn on the liberal legislatures and make wholesale changes to party affiliation.  Other very troubled states include Illinois with 21, Michigan with 17, New Jersey with 15, North Carolina with 15 and Pennsylvania with 23.  Together these 7 states represent a total of 167 electoral votes or 60% of the total needed to win, 270.

Eight U.S. states, including Illinois, California, Pennsylvania and New Jersey, face credit downgrades because of budget stalemates.  A 9th, New York, has been without one since its year started April 1.  Credit downgrades increase borrowing costs and makes the budget deficits worse.

All are gripped by political deadlocks over how to resolve a massive collapse in tax revenue that included a $67 billion decline in the 12 months ended June 30, 2009, according to the Census Bureau.  The Nelson A. Rockefeller Institute of Government called that the biggest on record.

California, the lowest-rated state by Standard & Poor's at A-, was warned on June 8 that its $69 billion of debt outstanding might be cut unless the dogfight between Governor Arnold Schwarzenegger and the legislature over an $18.6 billion 2011 budget shortfall isn't solved.

Illinois, the5th-most populous state, had its credit rating lowered twice this month, on June 11 by Fitch Ratings to A from A+ and by Moody's on June 4 to A1 from Aa3.

Other states involved in budget fights include Louisiana, Massachusetts, Delaware and North Carolina, according to data compiled by Bloomberg News.

Five of the states choose governors this November:  California, Pennsylvania, Illinois, Massachusetts and New York.

New Jersey Democrats are wrestling with Republican Governor Chris Christie over his proposed $29.3 billion budget.  He proposes to balance it with $820 million in school-aid cuts and reductions in property-tax rebates.  An extension of an income-tax surcharge on millionaires passed by the legislature on May 20 was vetoed by the governor minutes afterward.

So, it appears that more local issues are going to be the pivoting factor in deciding the election.  On this basis, the Republicans, if they can hone their message of fiscal discipline, might be able to gain stronger footholds in Blue States.  That is, if the voters can be persuaded that George W. Bush's profligacy was merely an aberration.

Marko's Take

Thursday, July 1, 2010

50 States, 50 Budget Nightmares

It never ceases to amaze me as to just how all-encompassing the financial meltdown is.  Virtually all of Europe is clinging on by a financial thread.  China is wrestling with a property bubble and the slowdown in the economies of its export partners.  The United States is running a $1.5 trillion budget deficit.  The cracks in the financial dam don't stop there.  They extend to all 50 states, and nearly all cities and counties.

The easy places to trim spending have been exhausted long ago, forcing states to resort to very non-traditional measures such as selling ads on automobile licence plates, taxing sugary soda and borrowing from pensions.  Education was previously thought to be untouchable, but is now being gone after aggressively, including mass layoffs of teachers, administration support and vital school programs.

Of the 50 states, only Vermont, must balance its budget annually. The combination of cuts, tax hikes and accounting tricks have become familiar in state legislatures as the one-two punch of recession and housing downturn have dramatically reduced tax revenue for several years now.

For 2009 to 2012, states have faced nearly $300 billion in budget deficits, according to figures from the National Association of State Budget Officers. 

Last year, politically heated budget fights forced 9 states to miss their deadlines and begin the fiscal year without an agreement.  According to the National Conference of State Legislatures, 28 states have agreed to budgets this year and 16 had passed biennial budgets last year.  Eight states, including California, have extended their sessions or held special meetings to negotiate budgets.

New York, whose fiscal year began on April 1, is the only state yet to have missed passing a budget on time. California, which had to resort to paying its bills with IOUs during last year, is expected to miss this week’s deadline.

The budget problems continue way down to the city level.  Los Angeles is thought to be in danger of default and has resorted to closing city services several days per month.  Los Angeles Unified School District has endured extremely steep cuts to bring the budget in balance.  The desperation to balance the budget has led the city to use the Department Of Water And Power surplus to cover itself.

Most troubling to local governments is the combination of declining property taxes from the bursting of the real estate bubble combined with lower taxes from increased unemployment.  In fact, the unemployment is a double-whammy since this triggers more spending for unemployment and other mandated programs.

Only 15 of the 49 largest cities in the U.S. saw year-over-year declines in their unemployment rates in May, according to new Labor Department data, while the unadjusted national rate, at 9.3%, was 0.2 percentage points above its year-ago level.

Across the country, jobless rates were higher in May than a year earlier in 222 of the 372 metropolitan areas, lower in 141 areas, and unchanged in 9.  The Labor Department doesn’t seasonally adjust its data on city-level unemployment, making month-to-month comparisons difficult.  Adjusted for seasonal factors, the U.S. unemployment rate was 9.7% in May.

Unfortunately, the situation has turned into the most troublesome vicious cycle.  The more local governments are forced to cut back drastically, the more that the unemployment situation worsens, the more that pressure is maintained on home prices and the more that revenues to coffers are constrained.  Then, more budget cuts, more unemployment...

Marko's Take