The Beautiful Thing About Bubbles…
Is Bubbles Are Beautiful Things… For a While…

Posted by mturner on November 4, 2009 under Bull/Bear, Investing, Stock Market Update |

by Mike Turner

Despite the Fed’s announcement today that the ‘mother-of-all-carry-trades’ can continue indefinitely (see more on this, below), I am wary this market could move lower for at least another week or maybe two.

Below is the current CycleProphet chart on the S&P 500. The model is forecasting a correction (see drop between Circle A and Circle B). The forecast bottom of the current correction has moved up a week from last week’s forecast. This may well mean that the depth of this correction will not be as severe. Based on this updated chart, I am not quite as bearish today as I was a week ago. The S&P 500 could bottom anywhere between where it closed today and roughly 980 (see Circle C). Since the bottom has moved closer to us in the time-line, I would not be surprised if the bottom occurs sooner than 11/16.

Looking further into the future, the cycle data are now forecasting that once the market bottoms in this current correction, the next major market top could be in early February. December and January look to be very volatile.

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CycleProphet Update:
For those of you in the CycleProphet beta group… I will be sending out an update next week. I am meeting with the design group this weekend and will have more to tell you after that meeting.

If you are not in this “IPO” (Initial Product Offering) beta group and want to be a part of the design and testing effort, we have not quite reached our 500 limit yet. We will be attending the National AAII meeting next week where I will be presenting the new CycleProphet product concept. There is no doubt that there will be more people wanting to participate in this project than we will have slots available. If you want to be involved, click on the above chart, which will take you to a landing page that describes the product and gives you an opportunity to get in the beta group.

There is no obligation to participate in the group and no obligation to subscribe to the final product. However, only the beta group will be given a 50% discount on an annual subscription when CycleProphet is launched later this year. You do not want to miss out on this innovative financial forecasting tool. Also, as a beta group member, you get to provide our development team with suggestions on the product’s final look-and-feel, what charts should be included, and how the website should be designed. Click Here or click on the chart above to get more details and how to get into the beta group member.

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The Turner CrossOver Oscillator (below) data support that the market will move lower, but that support is beginning to weaken. As the Composite Index (black line indicating severity of overbought condition) moves back below zero (Circle A), it means the market is becoming less and less overbought. At the same time, the Short Sell Index (red line) is moving higher, which is indicative of an increasing level of an oversold condition. Both of these trends could continue for quite some time, depending on the severity of the correction. With both the Composite Index and the Short Sell Index so close together, a state of ‘fairly priced’ condition could exist in the market. A lot will depend on whether either of the indexes continue, directionally, in a trend. Regardless, this could be interpreted as supporting the likelihood that the market does not have a lot of downward pressure on it right now.

The Turner CrossOver Oscillator provides an indication of the over-bought or over-sold condition of the market. The red line (New Short Sell Index) shows a technical direction and strength (or lack thereof) of investors to push stock prices lower, triggering new Short Sell Signals. The higher the Short Sell Signals line, the more Bearish the market. The black line (Composite Index) is the combined impact of both the new Short Sell Signals and the new Buy Signals and is an indication of the degree of oversold or overbought condition of the market. Buying opportunities exist when the Composite Index is moving higher. The higher this line moves, the more Bullish the market. Market bottoms are represented by a change in direction of the Composite Index from moving lower to moving higher. Market corrections become much more likely the Composite Index crosses the Short Sell Index from above the Short Sell Index to below the Short Sell Index. The market is represented by the green shaded area.

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My Current Trading Strategy…

While we are waiting on the markets to come in line with the forecasts (or… if the forecasts are wrong… when the forecasts come in line with the markets), I plan to be very careful about where I put money. As such, all but EQUITY IV is mostly cash, with the exception of some CANROY stocks in EQUITY I, II and IV. These Canadian royalty oil-related stocks are exhibiting a very tradable pattern.

I plan to do some ‘month-trading’… as opposed to ‘day-trading’… with these CANROY’s. Here is how this trading strategy works:

These stocks pay a monthly dividend that ranges from 5.4% to almost 11%, annually. But, the interesting thing about these stocks is they have a nicely defined share price movement cycle; somewhat, but not entirely, related to their dividend declarations. This cycle is slightly different for each stock, but a very tradable pattern exists where they tend to sell off at certain times of the month and then move back higher… only to sell off again.

My strategy for these stocks, is to buy these stocks at or near the bottom of their monthly cycle, then set an exit price for each, using a limit sell order. If the stock reaches the sell order, we are out with a very healthy profit. Then, I will put us back in those equities as near as I can to the next month’s bottom, to run the cycle again. If a stock fails to trigger the sell order, we collect the very attractive dividend. Either way, it tends to be a great trading pattern. Of course, if the bottom falls out of the price of oil, these stocks will be hurt. This is why we have a stop loss set for each position, as well.

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The Massively Building Global Equity Bubble

There are very few economic pundits that I like to follow, but one that I have a lot of respect for is Nouriel Roubini (Professor at New York University’s Stern School of Business and chairman of Roubini Global Economics). I will paraphrase an article of his I read recently (here’s the link to it in the Financial Times website: Roubini article).

Since the low in March of this year, a huge global bubble in certain asset classes (stock, bonds, currencies) has been building. This expanding bubble has occurred, to a significant degree, on the weakening US dollar (USD), the Fed monetary policy (as being replicated around the world in many other countries) and how investors are using that weakness and cheap dollars to buy these asset classes.

The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold, and is expected to keep those rates at 0% percent for a long time, as stated in today’s Fed meeting.

Investors are shorting the US dollar to buy, on a highly leveraged basis, higher-yielding assets and other global assets. These investors are not just borrowing money at zero interest rates… they are, actually borrowing dollars at an effective negative annual interest rate of up to -20%, as the fall in the US dollar leads to very significant capital gains on short dollar positions.

Investors who play this game (and it is being played on a massive global scale) are just riding a huge bubble financed by a large negative cost of borrowing.

“So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe … for now … for the mother of all carry trades and mother of all highly leveraged global asset bubbles.”

As with all bubbles… this one will burst sooner or later. Roubini believes this will become the biggest coordinated asset bust in history.

What will make the bubble burst? If the USD is to suddenly strengthen and appreciate in value, the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a market price collapse of all those risky asset classes.

The current administration keeps saying it wants a strong dollar. Really? If the above scenario is anywhere close to accurate, that is the last thing we need right now.

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Do we ride the building bubble?

There is a very frightening and, yet wonderful thing about bubbles… while they are building, they are truly beautiful things to ride. Euphoria exists and risk seems nonexistent. I believe we are in such a condition. When they burst, the crash can be truly mind and pocketbook numbing.

I agree with Roubini that we are in a global asset bubble that is growing daily. But, even in the midst of bubbles, there can be short lived corrections. Have you noticed, over the past several months that each time the market looks to move a lot lower, a bottom is quickly reached and the market moves higher? This is the effect, I believe, of the global asset bubble. So, I expect the market will soon bottom and then move higher between now and early February of 2010, if the cycle data forecast model is accurate.

This current market correction is not the bursting of the bubble that will surely happen sooner or later. Once the interim bottom is set, we’ll jump back in to the building and ever expanding global asset bubble. We want to ride this bubble right up to the bursting point… kind of like playing chicken.

This bubble will likely not burst until we see the USD stop weakening and really start to appreciate. The Fed will need to start raising rates. Odds are they will signal that event long before it happens. But, when both of these bubble-bursting events occur… we need to hang on tight and either be solidly in cash or, where possible, seriously short the equity market. That time is not now; nor do I expect to see the global asset bubble burst for quite some time… perhaps several months. The USD is not appreciating in value. Interest rates continue to be, effectively, well below zero. As long as that condition continues, the bubble will continue to build.

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Your bubble-watching money manager…

Mike Turner, President
Sabinal Capital Investments, LLC.
www.sabinalcapital.com