Paul Krugman

Paul Krugman, one of the most informed, rational and reasonable (hard qualities to find in one person lately) economists out there has just been awarded the Nobel Prize in Economics. I know some people fault him for his pronounced liberal bias but you have to admit he has been right about a lot of things. Plus he seems like a real nice guy. His blog has been one of the rare beacons of sanity these past few weeks.

Price Insensitive Selling

In times of intense short-term moves and I would think this past week qualifies, it's good to step back and take a look at the bigger picture i.e. a longer time frame. So let's consider the monthly chart for the S&P 500 index since 1998 shown above (click to enlarge).

A few things jump out:

1. The double-top, obviously.
2. The sheer velocity and ferociousness of the selling that make the 2000-2002 bear market seem gentle in comparison. The selling we've witnessed the past 2 months is equivalent to 2 years of selling then (2001 and 2002). The 14-month RSI, a good measure of selling momentum, has plunged from overbought to oversold a lot faster than 7 years ago and is more oversold now than at any moment then.
3. All Fibonacci retracement levels were blown through as if the Italian mathematician had never existed. The last stand, a full retracement to 768 is so tantalizingly close and the downside momentum so strong that we might break it without even noticing.

Covert Helicopter Money

(picture courtesy of businessweek.com)

For anybody wanting to never look at the bailout plan the same way again, I suggest the Wikipedia entry for Liquidity trap.

In the paragraph summarizing Milton Friedman's view, we learn that:

"A monetary authority can escape a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses. This is referred to as a money gift or as helicopter money. The term helicopter money is meant to portray the image of a central banker dropping money on people from a helicopter. Political considerations make it difficult for a monetary authority to grant the money gift, because individuals and firms not receiving free money will exert political pressure. The monetary authority must act covertly to give gift money to specific individuals or firms without appearing to give money away." (Emphasis mine)

There you have it, the bailout plan as the ultimate covert financial operation. When one knows Helicopter Ben Bernanke's devotion to all things Miltonian, one is excused for thinking that at least part of the reasoning behind the plan is to overpay for bad assets (giving money away to banks) and hope it somehow shocks the system back into action. Which is not to say that it's a bad plan and that it won't work (the odds are kind of long though), just that the covert part might be what some people are rebelling against, if only subconsciously.

Interestingly enough, this is one situation where Friedman advocates government intervention in and interference with the market. The Austrian school on the other hand would embrace the current bust as the only effective cure for the excesses of the boom and would strongly advise against any kind of government intervention as that would only make the bust last longer and delay any type of recovery (see Japan).

One point I think was not made forcefully enough if at all is how unaware all the Wall Street firms (including supposedly supernaturally aware Goldman) were of their dire predicament. Cognitive impairment of the highest order.

As always, one of the best analyses out there comes from those "crazy liberals" over at the New Yorker (best weekly mag bar none in my opinion). James Surowiecki notes that "Considering that Wall Street firms spend all day dealing with the market, they have been slow to understand just how vulnerable they were to it. Companies like Lehman and, earlier, Bear Stearns saw going public as an excuse to take on more risk and act more recklessly, when in fact becoming a public company makes caution more important, since the margin for error is smaller, and the punishment for failure swifter."

I remember fairly well the whole debate in the late 90s about Goldman going public. Resistance from the older partners and particularly the retired ones was fierce and while most of it might have had some not so noble motives (fear of change, fear of losing control and influence, etc...), some of it was spurred by the old timers' well-founded fear that just what happened the past few months would happen.

The Ban

It seems to me banning short-selling would only delay the bottoming process if not derail it altogether. One bottoming scenario I can think of is the kind where we stay in a range for a while with false breakouts and false breakdowns and people playing the range. Enough shorts get trapped that a final attempt forces them to cover and spurs a rally that completes the bottoming process. That kind of scenario can't happen if there are no shorts.

Gold

So many historical things are happening this week that gold's historical move yesterday was not given proper attention. This monster one-day 11% rise in GLD, the gold ETF, on 5 times the average daily volume speaks to the pure panic gripping the financial markets right now.

On a very much related note, this is Barney Frank sharing a conversation he'd apparently just had with Ben Bernanke:

“I asked the chairman if he had $85 billion to bestow in this way. He said ‘I have $800 billion.’ ”
“No one in a democracy unelected should have $800 billion to dispense as he sees fit,” Mr. Frank said. (New York Times Online 09/18/2008)

This boast by Bernanke makes me (and apparently all those gold buyers) a little nervous.

Now That's Engulfing!

As I've probably mentioned in a previous post, the engulfing pattern is one of the most powerful candlestick patterns.

What we have here is a massive bullish engulfing pattern on XLF, the financial ETF. It happened on extremely high volume and we're still comfortably above the low (16.77) established in July so this could be what I would call a tradable bottom for now. Show we break last week's intermediate high just below 24 and the 200-day moving average (now at 24.83), we could start calling it something else.

Miners Anyone?

This is one ugly-looking chart (for longs, that is).
GDX, the gold miners ETF, has been destroyed 52% from an intraday high of 56.87 reached on 03/14/2008 to an intraday low of 27.35 witnessed yesterday. Obviously, trying to call a bottom here would be akin to catching the proverbial falling knife (or falling safe depending on which version you prefer).

However, the adventurous soul could do much worse than start building a long-term position, add to one or simply go for a quick rebound at these price levels. Why? Well, just because, as incredible as it may seem and as wrong as I might be proven, I am seeing a few bullish signs in this chart.

First, GDX has seen some monster relative volume the past few days, potentially indicating some type of capitulation.

Second, we have a classic RSI bullish divergence, i.e. a new low in the stock that does not lead to a new low in the 14-day RSI.

Third, and purists could fault me for mixing my Technical Analysis schools as one mixes their metaphors, from an Elliott Wave viewpoint, it looks to me like we've completed wave 5 of an ABC correction.