The Automatic Earth | Jan. 14, 2012, 10:14 PM
I’d like to try a little intellectual exercise. There were two pieces in my mailbox this week that concerned posts at Naked Capitalism. Though their topics have at first glance little to do with one another, there is a term that is pivotal to both. Inventory.
When it comes to real estate, it’s popularly called “shadow inventory”. With regards to commodities, the term “dark inventory” has been coined. While there are plenty of differences in the way the terms are applied, I’m for now intrigued more by – potential – similarities between them.
Not that I have the illusion that I can treat this in a way that could even border on comprehensive, don’t get me wrong. I want to lift only part of the veil that hides from view what underlies how and why the financial system that rules our economies is going to the dogs: market manipulation.
In particular, I’m interested in how both shadow and dark inventory phenomena pervert their respective markets, as well as the entire free market system as a whole, where everyone is supposed to have “full access to information”. Something both dark and shadow inventories make impossible. Something the 99% general public are not aware of. At all.
And it’s not like they’re alone. Try your average pension fund manager, banker, politician. Not a clue.
Let’ start with a trip back to June 2011, when Izabella Kaminska for FT Alphaville perhaps first used the term “dark inventory”:
Dark inventory: Inventory that’s out there, but which no-one else can see.
It comes in many shapes and forms. Equity inventory, which has been internalised by banks and parked off-balance sheet (appropriately via private dark pools). Copper inventory, which has been stashed off-market and encumbered via finance deals. It’s also yet-to-be-produced commodities which have been pre-sold, but which nobody else knows have been encumbered.
But if you have the power to see or command the darkside inventory, you have the power to stay ahead of the game. Especially if you can move quickly. Indeed, almost every befuddling market move of late can, if you think about it, be explained by the concept of dark inventory. For example, consider the impact of dark inventory accumulation (the possible consequence of cheap liquidity).
In oversupplied markets this can mislead fellow investors. They see buying interest coming from somewhere, though they can’t quite understand from where. The fundamentals don’t explain it, but prices are rising regardless, led usually by the cheapest securities, and in tandem. With no ability to see the dark inventory, the market finally falls for the trend. They believe the demand is real.
If you are the accumulator of dark inventory, or privy to the flow, you are able to foresee the market rallies and position yourself accordingly. This is a profitable time.
Of course, in continually oversupplied markets you will begin to suffer the costs of hedging inventory, if you are bothering to hedge, (since forward curves may eventually flatten out) as well as the burden of balance sheet expansion. Eventually it will make sense to park that inventory off-balance sheet.
Thanks to matching, aggregation and netting you can use the inventory (in a sliced up, mixed up manner) to back equitised structured products, exchange traded notes, exchange traded products as well as synthetic funds. Lots of launches follow. This especially makes sense if by then everyone is a believer in the rally, a fact which has translated into genuine buying interest which can now be captured to back your dark inventory.
The game is afoot.
Ilargi: I certainly recommend reading Izabella’s entire piece (like all other pieces I quote from). But even from the quote above alone, you can, even if you’re not familiar with the topic, still get a genuinely queasy feeling. We’re talking market manipulation here, a way to influence investment decisions without anyone ever knowing they’re being manipulated. And fully legal.
Chris Cook, former compliance and market supervision director of the International Petroleum Exchange, writes this about “dark oil inventory” at Naked Capitalism:
All is not as it appears in the global oil markets, which in my view have become entirely dysfunctional and no longer fit for its purpose. I believe that the market price is about to collapse as it did in 2008 and that this will mark the end of an era in which the market has been run by and on behalf of trading and financial intermediaries.
In this post I forecast the imminent death of the crude oil market [..]
Global Oil Pricing
The “Brent Complex” is aptly named, being an increasingly baroque collection of contracts relating to North Sea crude oil, originally based upon the Shell “Brent” quality crude oil contract which originated in the 1980s.
It now consists of physical and forward BFOE (the Brent, Forties, Oseberg and Ekofisk fields) contracts in North Sea crude oil; and the key ICE Europe BFOE futures contract which is not a deliverable contract and is purely a financial bet based upon the price in the BFOE forward market.
There is also a whole plethora of other ‘over the counter’ (OTC) contracts involving not only BFOE, but also a huge transatlantic “arbitrage” market between the BFOE contract and the US West Texas Intermediate (WTI) [..]
North Sea crude oil production has been in secular decline for many years, and even though the North Sea crude oil benchmark contract was extended from the Brent quality to become BFOE, there are now only about 60 cargoes of BFOE quality crude oil (and as low as 50 when maintenance is under way), each of 600,000 barrels, delivered out of the North Sea each month, worth at current prices about $4 billion.
It is the ‘Dated’ or spot price of these cargoes – as reported by the oil price reporting service Platts in the ‘Platts Window’– which is the benchmark for global oil prices either directly (about 60%) or indirectly, through BFOE/WTI arbitrage for most of the rest.
[..] traders of the scale of the oil majors and sovereign oil companies do not really have to put much money at risk by their standards in order to acquire enough cargoes to move or support the global market price via the BFOE market.
[..] the evolution of the BFOE market has been a response to declining production and the fact that traders could not resist manipulating the market by buying up contracts and “squeezing” those who had sold forward oil they did not have [..] The fewer cargoes produced; the easier the underlying market is to manipulate.
[..] The Platts window is the most abused market mechanism in the world.[..]
In the early 1990s Goldman Sachs created a new way of investing in commodities. The Goldman Sachs Commodity Index (GSCI) enabled investment in a basket of commodities – of which oil and oil products was the greatest component – and the new GSCI fund invested by buying futures contracts in the relevant commodity markets which were ‘rolled over’ from month to month. The genius dash of marketing fairy dust which was sprinkled on this concept was to call investment in the fund a ‘hedge against inflation’. Investors in the fund were able to offload the perceived risk of holding dollars and instead take on the risk of holding commodities.
The smartest kids on the block were not slow to realise that the GSCI – which was structurally ‘long’ of commodity markets – was taking a long term position which was precisely the opposite of a commodity producer who is structurally ‘short’ of commodities because they routinely sell futures contracts in order to insure themselves against a fall in the dollar price. ie commodity producers are offloading the risk of owning commodities, and taking on the risk of holding dollars.
So in 1995 a marriage was arranged.
BP and Goldman Sachs get Married
From 1995 to 2007 BP and Goldman Sachs were joined at the head, having the same chairman – the Irish former head of the World Trade Organisation, Peter Sutherland. From 1999, until he fell from grace in 2007 through revelations about his private life, BP’s CEO Lord Browne was also on the Goldman Sachs board.
The outcome of the relationship was that BP were in a position, if they were so minded, to obtain interest-free funding via Goldman Sachs, from GSCI investors through the simple expedient of a sale and repurchase agreement: ie BP could sell title to oil with an agreement to buy back the oil later at an agreed price.
The outcome would be a financial ‘lease’ of oil by BP to GSCI investors and the monetisation of part of BP’s oil inventory. Such agreements in relation to bilateral physical oil transactions are typically concluded privately, and are invisible to the organised markets.
Due to the invisibility of the change of ownership of inventory, ‘information asymmetry’ is created where some market participants are in possession of key market information which others do not have. This ownership by investors of inventory in the custody of a producer has been termed ‘Dark Inventory’
I must make quite clear at this point that only BP and Goldman Sachs know whether they actually did create Dark Inventory by leasing oil in this way, and readers must make up their own minds on that.
The ‘inflation hedging’ meme gradually gained traction and a new breed of Exchange Traded Funds (ETFs) and structured investment products were created to invest in commodities. In 2005 Shell entered quite transparently into a relationship with ETF Securities which enabled them to cut out as middlemen both investment banks and the futures market casinos, and with them the substantial rent both collect.
Other investment banks also started to offer similar products and a bandwagon began to roll. From 2005 to 2008 we therefore saw an increasing flood of dollars into the oil market, and this was accompanied by the most shameless, and often completely misleading hype, and led to a bubble in the price.
There was (and still is) no piece of news which cannot be interpreted as a reason to buy crude oil. The classic case was US environmental restrictions on oil products, which led to restricted supply, and to price increases in oil products. Now, anyone would think that reduced refinery throughput will reduce the demand for crude oil and should logically lead to a fall in crude oil prices.
But on Planet Hype faulty economic logic – the view that higher product prices are necessarily associated with higher crude oil prices – was instead used as justification for the higher crude oil prices which resulted from the financial buying of crude oil attracted by the hype.
You couldn’t make it up: but unfortunately, they could, and they did.
More worrying than mere hype was that a very significant amount of oil inventory had actually changed hands from producers to investors. Only those directly involved were aware that below the visible part of the oil market iceberg lurked massive unseen ‘Dark Inventory’.
Ilargi: In a nutshell: Cook argues that QE measures from the Fed and BOE have caused large investors to flee from dollars into commodities.
This in turn has led to a price bubble through contango (forward prices are higher than spot prices), for which they are all positioned, but this will down the line inevitably lead to the opposite – backwardation -, and the bubble must burst. Severely, says Cook: to as low as $45 a barrel. Given how conservative Cook is in the numbers he uses, even that may be a high estimate.
In yet another article at Naked Capitalism, Irish journalist Philip Pilkington summarizes Cook’s point so well it seems pointless to try and improve on it:
Looking at recent market trends Cook raises concerns that we could be seeing the beginnings of the end of a bubble that began to inflate in the oil market after the crash of the previous bubble in 2008. This bubble, Cook argues, was inflated due to inflation fears after the QE programs undertaken by the Federal Reserve and the Bank of England. With the markets awash with dollar and sterling liquidity, banks and investors piled into commodities to escape what they saw to be a looming inflation.
In recent months Cook focuses on the move of the market from a position of ‘contango’ to a position of ‘backwardation’ – which he sees as evidence of a bubble deflating. While some investors read in this that the short-run demand for oil has risen, Cook points out that with the global recession grinding along there is no fundamental reason that this should be occurring. Instead Cook sees in this move a sign that the long-run demand for oil is falling as the current bubble begins to burst.
Cook thinks that the price collapse is going to be very painful – falling possibly as low as $45-$55 a barrel. In response to this OPEC will try to ramp up prices by cutting production and, most importantly for our purposes, a financial crisis of sorts will occur as inflation hedged investors see their net worth cut to pieces.
If this is as Cook says – if this is a bubble of fear and it bursts – the financial sector is going to see a huge wiping out of the profits they have been reaping from it. We have no way of knowing how much profitability is tied up in these dodgy markets – but my thinking is: a lot.
Ilargi: So far, so good. We must realize, however, that while lower oil prices seem very beneficial to many sectors of our economies, a wiping out of everyone who’s betting the wrong side of this wager is not.
And if Cook is right, a large segment of the financial world, that is: those who are not privy to the magnitude of the dark inventory, have been, and are being, manipulated to be on that wrong side. And without a new bubble to flee into to boot. Indeed, there’s a real risk the entire global oil market will cease to – properly – function.
Come to think of it, again, if Cook is right, it probably already has. Since to the extent that it still seems to function, it does so only to service the interests of those that control the dark inventory, and who squeeze those investors not “in the know”. Oil prices are thus set, in essence, by derivative contracts, not by supply and demand, which is a mere illusion. Thing is, who would know?
Needless to say, there’s another party that stands to lose big if oil prices collapse: producers. The Arab Spring may well return more powerful than ever.
Still, while I think it’s important for everyone to see and understand that, and how, manipulation sets market prices for commodities (and stocks, but that’s another story) on a daily basis, and not some free market principle, I started out trying to figure out what connects dark oil inventory and shadow housing inventory.
Michael Olenick, founder and CEO of Legalprise, and creator of FindtheFraud, has – extensively- looked at the latter:
“Shadow inventory,” the number of homes that are either in foreclosure or are likely to end up in foreclosure, creates substantial but hidden pressure on housing prices and potential losses to banks and investors.
This is a critical figure for policymakers and financial services industry executives, since if the number is manageable, that means waiting for the market to digest the overhang might not be such a terrible option. But if shadow inventory is large, housing prices have a good bit further to go before they hit bottom, which has dire consequences for communities, homeowners, and the broader economy.
Yet estimates of shadow inventory, and even the definition of what constitutes shadow inventory property, vary widely. For example, the Wall Street Journal published a Nov. 11, 2011 article, “How Many Homes Are In Trouble?” where values varied from 1.6 million (CoreLogic), [..] to between 8.2 million and 10.3 million (Laurie Goodman, Amherst Securities). [..]
…. things are actually worse than any of the prevailing estimates indicate, although Goodman is very close to the mark. Current loss experience suggests that this figure is staggering, easily in the $1 trillion range.
Why aren’t those losses more visible yet? Well, evidence suggests that servicers are stalling the foreclosure process, not taking title to and selling these houses. For the lenders, such delay likely allows them avoid the write-offs of both the negative equity as well as the worthless second liens. More generally, it keeps the trillion dollar losses hidden.
Lenders aren’t acknowledging their stall tactics, however. When people notice how slowly foreclosures are progressing from initial steps to resale, lenders point at their foreclosure fraud related dysfunction. Lenders conveniently don’t mention that such dysfunction was self-induced, instead blaming borrowers and courts. [..]
…. there are 9,800,000 houses in shadow inventory.
If these loans were taken out for the median value of a state-by-state home price, using data from the FHFA, for Q2, 2006, there is $2.3 trillion of home values at near the market peak. The mortgage balances are going to be lower than that, but given how widespread equity extraction came to be (and it is probably that the most levered homes are hitting the wall), it is not unreasonable to assume LTV ratios relative to peak values of 80%.
Loss severities on prime mortgages are running at roughly 50% and are 70% on subprime (note that with more borrowers fighting foreclosures, and given that loss severities on a contested foreclosure can come in at 200% or even higher, so using these assumption is certain to understate actual results). $2.3 trillion x 80% x 50% = $900 billion.
These losses will be distributed across the GSEs (meaning taxpayers), banks that have second liens (with the biggest losers being Bank of America, Citibank, JP Morgan, and Wells Fargo), investors in private label (non GSE) mortgage securities, and other US and foreign banks.
Balanced against this liability is some amount figure for the underlying asset, the house. Given that servicer advances, foreclosure costs and servicer fees come close to and even exceed the value of the property, comparatively little of this $2.3 trillion will be recovered in property liquidations. [..]
In support of the conclusion that banks cannot afford to recognize this shadow liability is the sharp decrease of foreclosure filings in 2011 and the seeming unwillingness of banks to move foreclosures through the system.
They file foreclosures, then let them linger, not taking homes even when every possible borrower defense is exhausted. Some of this slowdown may be due to more scrutiny of foreclosure documentation, particularly in judicial foreclosure states, but there is clearly more at work. [..]
There is other anecdotal evidence suggesting banks do not want these houses or, more accurately, do not want the write-offs that actually taking the houses would force:
• Foreclosure defense lawyers have clients who have not paid their mortgage in years, but face neither a foreclosure nor even a negative mark on their credit report. I recently received a call from a man who said he had not paid his $1.6 million mortgage in two years but his servicer has not foreclosed, and he faces no derogatory information on his credit report; he was frustrated because he is retired and just wants to move to a cottage.
This phenomenon, which apparently isn’t rare, might explain why shadow inventory reports that rely on credit reports to extrapolate shadow inventory are often dramatically lower than these calculations. [..]
• It is common for foreclosure mill lawyers to argue for delays in selling a home when nobody is representing a borrower. Judges, who want to clear their dockets, will rail at bank lawyers about the age of the case even while bank lawyers argue for yet another delay, while the other table — where the borrower, the defendant, is supposed to sit — is empty. [..]
Yes, servicers continue to prey upon ordinary Americans. But evidence suggests that they’re also preying on investors. Individual American families do not deserve to suffer these behaviors, that increase the losses while delaying the uncertainty, and neither do pension funds, European villages, municipalities, or other unsuspecting entities who actually funded these loans.
Few people are going to complain when they’re not paying their mortgage that there is no mark on their credit-report nor a foreclosure; a few of the more perplexed ones — or those that want to bring a bad mortgage to resolution — may speak out, but most remain silent.
Similarly, many investors, and surely the banks themselves, know about these figures. But as both sides spin their wheels, the problem continues to spiral out of control.
Ilargi: I think perhaps the best way to make the connection between dark inventory in commodities and shadow inventory in real estate is to look at, no surprise, what pays for it. And that leads me to what I have long since coined “zombie money”.
Zombie money is the money that seems, but only seems, to exist because of unrecognized losses. QE measures, for instance, basically serve to keep those losses unrecognized. That’s what they’re for. To make markets, and ordinary people, believe that banks are still solvent when in reality they’re not.
Funny thing is, even with all the accounting tricks that hide those losses, the entire system is still, and already, on the verge of collapse. And when it goes, the loser will be you, not the gamblers that lost fair and square. If dark inventory shows you anything, it’s that fair and square is a thing of some mythical fairy tale past. The reality for you and me is, and this is not the first time I put it like this: heads you lose, tails you die.
Zombie money pays for dark oil inventory; this is for instance why tar sands can look profitable, even as their EROEI is very low. If there’s sufficient difference between spot prices and forward prices for natural gas and oil, it makes sense to turn the former into the latter (which is all that tar sands are about). Nothing to do with energy efficiency, everything to do with market manipulation. The same goes for shale gas, and for oil shale. It will all soon give a whole new meaning to the term “unsustainable”. Promise.
Zombie money also allows, and causes, lenders, aided and abetted by governments all over, who want no part of a crashing real estate market, to keep millions of homes off the market, which in turn allows them to keep billions, if not trillions of dollars, in losses off their books. This results in hundreds of millions of people, throughout the western world, who think their homes are worth much more than they are. And then they wake up.
Dark inventory and shadow inventory keep us all from having a realistic picture of what is actually out there, what anything at all is worth. Prices are not set in any sort of “free” market; they are set in “shadow markets”, “dark markets”, in which – derivative – financial instruments rule, not the actual assets they are based on. Until they don’t.
Today’s prices are set by bets on expectations of tomorrow’s prices, and these expectations in turn are manipulated by parties that have a vested interest in making investors – and the general public – think a certain expectation is realistic; all it takes is to make that expectation sufficiently opaque, to make sure investors have access to far less information than the parties that deal and/or hold the derivative instruments.
That’s all it takes to create, out of thin air, a whole new generation of suckers and greater fools.
This creates a tremendous cognitive dissonance, a picture of the world that is entirely delusional. And that, of course, can and will not last. Even if a majority of people still wishes to think that it can. What do they know about what’s going on behind the curtain? Hardly anything at all.
And then they wake up.
- Peak oil leaves the spotlight as global economic uncertainty rules oil prices (mb50.wordpress.com)
- Seaway pipeline creates contango with oil glut (mb50.wordpress.com)
- Oil mixed (nation.com.pk)
- Naked Oil (theoildrum.com)
- The Rise Of Dark Inventory In Housing And Oil (businessinsider.com)
On Thursday, the head of the International Monetary Fund, Christine Lagarde, urged members to approve an agreement reached last year that would double the funds available to the global organization and give currently under-represented nations like China increased voting power, Reuters reported.
If approved, the plan would make China the international lender’s third-largest member of the IMF:
The IMF said Lagarde “called on members to use their best efforts to make the 2010 reform package effective before the 2012 annual meetings.” The meetings take place in Tokyo in mid-October.
An IMF staff paper said “efforts to meet the 2012 deadline should not be spared.”
As of December 12, just 53 countries, holding 36 percent of total IMF quotas, had approved the increases. Approval by members holding about 70 percent of quotas is needed to implement the changes. Some countries require their legislatures to authorize the changes.
Lagarde’s push for approval of the measures comes as the Euro-zone crisis underscored the shift in global economic power away from traditional post-war leaders and and popular opposition to the government in China appeared to demonstrate the internal challenges faced by the world’s fastest growing large economy.
- Either Berlusconi Or Lagarde Is Lying About What Happened Between The IMF And Italy (businessinsider.com)
- IMF Chief Lagarde Pushes the Panic Button (247wallst.com)
- VIDEO: IMF chief warns of ‘lost decade’ (bbc.co.uk)
- No country will be spared, says IMF head Christine Lagarde | The Australian (livingstrongandhappy.blogspot.com)
- IMF chief Christine Lagarde warns that global economic outlook is ‘gloomy’ (telegraph.co.uk)
CONGRESS INSIDER TRADING RUN AMOK: When They’re Not Trading On Private Information, They’re Selling It!
To wit: In addition to trading for their own accounts with private information gleaned from their jobs, our Senators and Representatives regularly meet privately with hedge funds who then use what they learn about impending legislation to cash in.
No, no, protests Congress. There’s no scandal. It’s just business as usual.
And of course that’s the point.
If this were happening in the private sector, Congress would be screaming bloody murder about corruption and greed.
Because its Washington, however, it’s just the way things are done.
- Lawmakers Give Inside Info to Big Investors – Legally (newser.com)
- Palin On Insider Trading: Congress, It’s Time To Stop Lining Your Pockets (tarpon.wordpress.com)
- Hedge Funds Pay For Early Congressional News (politicalwire.com)
- Tonight on AC360: Congressional insider trading bill (ac360.blogs.cnn.com)
- Cantor Says House GOP Will Push Insider Congressional Trading Ban Next Year (businessinsider.com)
- FBI Runs ‘Perfect Hedge’ to Nab Inside Traders (wallstreetpit.com)
- The Twitter campaign for the STOCK act (truthonthemarket.com)
- End Capitol Hill insider trading (mysanantonio.com)
DURBAN | Sat Dec 10, 2011 6:11pm EST
(Reuters) – The chairwoman of U.N. climate talks urged delegates to approve a compromise deal on fighting global warming in the interests of the planet, but an accord remained elusive on Sunday and rich and poor states traded barbs over the limited scope of the package.
“I think we all realize they are not perfect. But we should not let the perfect become the enemy of the good and the possible,” she told the conference.
Much of the discussion has focused on an EU plan designed to push major polluters — from developed and fast-growing emerging economies like China and India — to accept legally binding cuts in their greenhouse gas emissions.
EU negotiators had accepted “legal instrument” in one draft as a phrase implying a more binding commitment. But the latest version spoke of a “protocol, another legal instrument or a legal outcome,” the sort of weak phrasing that almost collapsed the talks on Friday.
Asked if the latest language was acceptable, Karl Hood, who represents an alliance of 43 small island states, said: “No it’s not. Never was and never will be. It’s too broad a statement.”
His alliance colleague MJ Mace, added: “You need a legally binding instrument. You have legal outcomes all the time. A decision is an outcome. You need something treaty like.”
The discussions took an increasingly bitter turn as they headed into Sunday, a second extra day that made the negotiations the longest in two decades of U.N. climate talks.
Venezuela’s climate envoy Claudia Salerno said she had received threats because of her objections to the draft texts.
“In the corridor, I have received two threats. One, that if Venezuela do not adopt the text, they will not give us the second commitment period,” she said, referring to an extension of the Kyoto Protocol, the only global pact enforcing carbon cuts.
“The most pathetic and the most lowest threat… we are not going to have the Green Climate Fund,” which is designed to help poor nations tackle global warming and nudge them towards a new global effort to fight climate change.
She did not say who had made the threat and delegates heard her allegation in silence.
Among the sticking points holding up a deal were an extension of the Kyoto Protocol. The draft text says the second Kyoto phase should end in 2017, but that clashes with the EU’s own binding goal to cut carbon emissions by 20 percent by 2020.
U.S. VS CHINA AND INDIA
But behind the back and forth over language and technical details, the talks have boiled down to a tussle between the United States, which wants all polluters to be held to the same legal standard on emissions cuts, and China and India who want to ensure their fast growing economies are not shackled.
The fractious late night exchanges punctured the earlier mood of cautious optimism which had suggested agreement on the four separate accord in the package was possible.
Should the talks collapse on Sunday, that would represent a major setback for host South Africa and raise the prospect that the Kyoto Protocol could expire at the end of 2012 with no successor treaty in place.
Scientists warn that time is running out to close the gap between current pledges on cutting greenhouse gases and avoiding a catastrophic rise in average global temperatures.
U.N. reports released in the last month warned delays on a global agreement to cut greenhouse gas emissions will make it harder to keep the average temperature rise to within 2 Celsius over the next century.
A warming planet has already intensified droughts and floods, increased crop failures and sea levels could rise to levels that would submerge several small island nations, who are holding out for more ambitious targets in emissions cuts.
- UN climate talk delegates urged to approve draft accords (news.nationalpost.com)
- States imperiled by warming rebel at climate talks – Reuters (reuters.com)
- As Durban Deadline Draws Near, the Big Carbon Emitters Should Cut a Deal (thinkprogress.org)
- UN Envoys Debate Climate Pact Amid Divisions on Legal Outcome (businessweek.com)
- U.N. climate talks near collapse over gulf between rich and poor nations (news.nationalpost.com)
- Climate talks near end as draft deal printed (cbc.ca)
- Durban climate conference stalemate pushes talks into extra time (guardian.co.uk)
- Climate deal up for approval at U.N. conference (seattletimes.nwsource.com)
- UN Climate Conference In Overtime On Future Of Talks – Huffington Post (huffingtonpost.com)
Every other pension system was rated as unsound, jeopardizing the future of the elderly population. The U.S. earned a C grade, signifying “some major risks and/or shortcomings.”
- Why pension changes mean you should start saving now (blogs.confused.com)
- Portugal raiding pension funds could be sign of things to come in U.S (destructionist.wordpress.com)
- Prison Planet.com ” Portugal raiding pension funds could be sign of things to come in U.S (gunnyg.wordpress.com)
- Public Pensions: What’s with It? (socyberty.com)
- The Netherlands’ pensions top the league table – again (taure77.wordpress.com)
In Part 1 of this series, Is This The Best Stock Market Indicator Ever?, I examined the technical indicator known as $OEXA200R, that is, the percentage of S&P 100 stocks above their 200 day moving average, found on StockCharts.com.
The $OEXA200R can be thought of as a valuable early yellow light flashing ‘bears ahead’ or a confirmatory green light that we’re really back in a bull market after a bear. It is an extremely accurate market timing and short term predictive tool for any investor.
But what of the long term trends in the market? What does the future hold over the next 2 or 5 or 20 years? Is there a predictive tool for that?
I believe there is.
In this article we will analyze the long term S&P chart developed by Doug Short (Figure 1), using it as a reference to “tease out” some very specific predictions of future trends. The estimates and scenarios are based on an unbiased interpretation of data derived from this chart.
By following the cold data where it leads us, we arrive at some unnerving predictions which I will collectively refer to as The Great Repression.
Figure 1 illustrates the long term trend of the S&P from 1870 to present. It is inflation-adjusted and set on a log scale for clarity. Notice the red trend line and how the market regresses from bull and bear periods back to the historical trend.
Below the S&P graphic on Figure 1 is an illustration of S&P variance from trend. That is, the percentage the S&P skewed above or below the trend line at corresponding time points. For example, at the 1929 bull peak the S&P was at 82% variance above the trend line. In 1982, the S&P had fallen to minus 55% variance below the trend line.”
An analysis of the chart (Figure 2) revels that the slopes from each bull top measured at the highest variance points in 1901, 1929 and 1965 to the beginning of the next bulls in 1920, 1949 and 1982 all measure exactly 34 degrees. Again, the start and end points for the slopes are determined by the variance tops indicated on the “Variance from trend” graphic, not the actual S&P tops.
Assuming the slopes could theoretically measure anywhere from 1 to 44 degrees (excluding the 45 degree vertical and 0 degree horizontal orientations), the probability of all three equaling 34 degrees is less than 1 in 79,000.
Based on that data, one could make a reasonable statistical assumption that the slope for the current secular bear market beginning in 2000 would also follow the same 34 degree angle as the previous three bears. Overlaying that slope on the 2000 bull top would suggest that we are not yet half way through the present bear cycle.
But how much more “bear”is left?
To answer that question, we add an additional green line to the S&P chart corresponding to -50% variance from the trend (Figure 3). All three bears in 1920, 1949 and 1982 have touched that line before rebounding. In fact, all three have actually exceeded -50%: 1920 at -59%, 1949 at -57%, 1982 at -55%.
If we follow the 34 degree bear slope line to the -50% green variance line, we arrive at a very conservative end point for the current bear in 2022 – 2023 with the S&P at approximately 540. That, I wish to emphasize, is the conservative scenario.
A more mathematically realistic scenario is illustrated in Figure 4. Here, a blue variance line has been added at the -65% level, below the green -50% line. This would take the end of the secular bear out to 2025 – 2026 at S&P 450.
Why is that the more likely scenario? If one looks at the variance from trend graphic, we observe extreme positive variances in 1901 (84%) and 1929 (82%) followed by dramatic corresponding negative variances in 1920 (-59%) and 1932 (-67%). The relatively moderate 1965 peak (57%) was followed by a moderate 1982 dip (-55%).
Unfortunately, in this case there is no precise correlation as there was for the 34 degree bear slopes. However, the rule seems to be that the more extreme variance goes in one direction, the more extreme it corrects in the other.
In 2000, we had variance of an unprecedented 155% above trend. There is no way to forecast how deeply the upcoming negative correction will be other than to assume it will probably be severe, that -65% is a realistic estimate and that it could very possibly drop even lower.
This would result in a situation where by 2025 the S&P at 450 has lost 65% of its December 2011 value. The market downturn would be worse than the 2008 – 2009 correction, with the current recession growing more severe but not as catastrophic as the deflationary Great Depression of the 1930′s. In other words, a “Great Repression.”
Why wouldn’t there be a repeat of the Great Depression? One can only assume that Mr. Bernanke (a student of that event) or his successor would run the Treasury printing presses until they spewed smoke and flame in order to prevent another major deflationary event. What of the near term?
Upon close examination of the chart, one can see that during the past three secular bears there was always a small dip below the S&P trend line immediately preceding a sharp decline. Figures 5 through 7 illustrate when this occurred in 1915, 1930 and 1972.
Following these downward ‘blips’ there was brief rise in the market followed by a precipitous drop. I believe this phenomenon was repeated by the 2008 – 2009 drop (‘blip’) and 2009 – 2011 cyclical bull (Figure 8).
Note another striking coincidence: in each case, the S&P fell precipitously to the -40% variance level (blue line in Figure 9 above green line). If this trend repeats a fourth time, the S&P will experience another decline in 2012 – 2013 to 580, a 54% decline in its current value.
The S&P would then likely rebound to straddle the 34 degree slope line to the end of the secular bear in 2022 – 2025, as previously discussed.
The charts point to various long and short term scenarios for the market, several of which have a very high probability of coming to pass. Statistically, it is extremely unlikely that the mathematical patterns discussed here are simply due to random chance.
Taken as a group it would seem to be virtually impossible. Although the patterns are mathematically driven and not dependent upon world events it is fascinating how current events seem to be aligning with the near term pattern. In particular, the S&P decline indicated for 2012 – 2013 coinciding with the very likely disintegration of the Eurozone and euro.
Is there a silver lining for investors somewhere within this dark cloud? I believe there is, an extremely lucrative one that will make itself apparent in 2012 as the market tumbles.
It will be examined at that time in part 3 of this series.
- CHARTS: Is This The Best Stock Market Indicator Ever? (businessinsider.com)
- The Bull, Bear, And Secular Case From BofAML (zerohedge.com)
- 4 Reasons to be Bearish (zerohedge.com)
- Converging On The Horizon (ritholtz.com)
- How to Get Started in Chart Reading (forbes.com)
They argue that one euro will fall to just $1.20 within the next four months, compared to a current value around $1.34. What’s more, they think this estimate has downside risks.
Their analysis is predicated on a baseline scenario that EU leaders will put stop-gap measures in place in the near-term but will ultimately have to adopt large-scale QE to stave of the crisis in the medium term.
From their investor note:
In our central case, in which the ECB will be forced into a delayed and reactive large-scale QE, risk assets could trade better over time (assuming that the QE amount is sufficient). But it is likely to be seen as a change in the ECB reaction function, and hence we think EUR/USD would trade lower in the medium term. AUD, CAD and EM FX should perform quite well in this scenario.
We also expect ECB QE and although the immediate effect upon announcement of such measures may well be EUR bullish, large-scale monetization is likely to weigh negatively on the EUR in the medium term, hence providing an offsetting force to any USD negativity related to Fed QE3.
- NOMURA: The Euro Is Going To See A MASSIVE Drop In Value In The Next Four Months (businessinsider.com)
- Analysis: ECB’s Failure To Sterilize Bond Buys – Is It QE? (forexlive.com)
- The Pound rallied from a low just above 1.56 against the US Dollar Exchange Rate (torfx.com)
- Complete Summary Of What To Expect From Europe This Week (zerohedge.com)
- ForexLive European wrap: Euro shows a bit of backbone after S&P’s announcement…… (forexlive.com)
- S&P Threatens To Downgrade Euro Rescue Fund Amid Crisis Of ‘Governance’ In Euro Area (businessinsider.com)