Sunday, May 09, 2010

The Case for DOW 4500 Watch It Unfold

Given the recent events unhinging the capital markets, public and shadow... I will shift my focus to cover the likely decline of the equities market to DOW 4500.  Privately I have been anticipating this decline since October of 2009.  It was only when the market's reaction on 4/29/2010 -- in response to the Goldman allegation's -- that I believed that a top had been put in.  Given now there is heightened awareness due to the "Flash Crash" and the rapid rate that the market is unraveling there is no time to waste.  Knowing this will help protect yourself and protect your assets.

Ok so I've been watching this right shoulder (this is a market technical term Head and Sholders pattern which usually signals a significant decline is in process or is about to occur) form since October of 2009, and I have been patiently waiting for it to develop. Being that it was an election year I thought that it would take on the aspect of a rounded top and that it would likely move into a trading range until after the election. I also considered that the decline would happen much quicker than the left shoulder top in 2000 and the head top in 2007.  However, based on the action since the Goldman civil suit was announced I have concluded that it is failing harder and faster than envisioned.  In fact we are seeing the first throes of the downside now.  Given the recent spate of the recent geo-political, geo-financial and geo-environmental issues it is adding lubricant to the already slippery slope of a mega downtrend.

From a techinical aspect this never looked very good, from a fundemental aspect it is starting to reinforce the dire technical aspect.

Check out NBC Anchor Brian Williams on Letterman... He's certainly right regarding the fact the world has no money... but this isn't a joke.  As you can see from the chart above we've been working on a twenty year head and shoulders. Technically the right shoulder will drop somewhere below 6500.  Utilizing Fibinacci analysis using tick data -- Thanks to Prophet Charts and Think or Swim -- the absolute support level for the DOW is 4500.  Even I was surprised by the velocity and ferocity of the sell off, which seemed to appear out of no where, but in point of fact this was inevitable as this is restoring balance to a market mechanisms that have been out of balance for some time.  The fact that the selling continued very strongly into the weekend is decidely ominous. What's more.  This is not even a market to stay short for too long either as the snap backs will be breakneck events. Wait till everyone starts pulling their money out of 401k plans -- mutual and hedgefunds -- after this weekend. Europe's attempt to prop up the Euro will likely prove futile, as this ball has started to roll and has too much momentum. In addition, with so much mis-trust of the capital markets both Shadow and Public we are likely to see credit and the bond markets freeze precipitously once again. In other words here we go again. The Greece populace is decidely fed up and since they invented democracy they have the right to uninvent it.

Here is a more expansive view of the $DJI using tick data from the 1900's utilizing Fibonacci retracement lines I was able to identify specific levels of support and resistance for the DOW, notice that the in the Thursday "Flash Crash" it broke through a Fib line at 10,210 and bounced right back up, remember prior support (11,086) is now resistance. Another item that I would like to point out to you is the period from 1978 to currently, what would I attribute to this rise? Two things, the "Rise of the Machines" and "Rise of the 401k" Plans. I will be writing more expansively on these topics in the next few weeks, but both play a big role in the the market proclivities of the last 10 years.

Here is another view from another perspective the S&P 500 During the same 20 year period this also shows a head and shoulder, but it also shows an enormous double top two decidely bearish patterns the weight of which will be too heavy to hold back.  Notice the FIB Confluence "two Fib retracement lines at different time frames laying on top of each other" at 1050, this represents a sticky support level if we wipe this out this week which would be a break of the February low this will result in a drop to 900 in short order.

People are going to be crushed by this, because stocks on the snap backs will appear to be cheap, but they will fall once again only to crush them again. 

This is where my theory of the "Rise of the Machines" and "Rise of the 401k Plans" comes into the mix.  Both in my view have contributed since 1980 to pushing the markets to an un-realistic level of value.  The evolution of accounting methodology has contributed by enabling these assets to be accounted for differently so that it captures and adjusts to the artificial environment created, 1. By the ability to move, manage and track large quantities of assets via electronic means and 2. Create an artificial floor and steady demand for assets via the advent and widespread adoption of the 401k plan.  The levels of which we are at right now are so lofty that we will see the floor drop out like a ride at Coney Island with many people stuck to the wall as the ride keeps spinning.  As the ride slows we will start to see institutions start dropping to the floor as the force of macro economic gravity takes over.

In 1978, Congress amended the Internal Revenue Code by adding section 401(k), whereby employees are not taxed on income they choose to receive as deferred compensation rather than direct compensation.[4] The law went into effect on January 1, 1980,[4] and by 1983 almost half of large firms were either offering a 401(k) plan or considering doing so.[4] By 1984 there were 17,303 companies offering 401(k) plans.[4] Also in 1984, Congress passed legislation requiring nondiscrimination testing, to make sure that the plans did not discriminate in favor of highly paid employees more than a certain allowable amount.[4] In 1998, Congress passed legislation that allowed employers to have all employees contribute a certain amount into a 401(k) plan unless the employee expressly elects not to contribute.[4]

In the mid-1980s, there were fewer than 8 million participants with less than $100 billion of assets in 401(k) plans.[5] By 2006, there were seventy-million participants with more than $3 trillion of assets in 401(k) plans.[5] There were 438,000 companies sponsoring 401(k) plans in 2003.[4]
Originally intended for executives, the section 401(k) plan proved popular with workers at all levels because it had higher yearly contribution limits than the Individual Retirement Account (IRA); it usually came with a company match, and in some ways provided greater flexibility than the IRA, often providing loans and, if applicable, offered the employer's stock as an investment choice. Several major corporations amended existing defined contribution plans immediately following the publication of IRS proposed regulations in 1981.
A primary reason for the explosion of 401(k) plans is that such plans are cheaper for employers to maintain than a defined benefit pension for every retired worker. With a 401(k) plan, instead of required pension contributions, the employer only has to pay plan administration and support costs if they elect not to match employee contributions or make profit sharing contributions. In addition, some or all of the plan administration costs can be passed on to plan participants. In years with strong profits employers can make matching or profit-sharing contributions, and reduce or eliminate them in poor years. Thus 401(k) plans create a predictable cost for employers, while the cost of defined benefit plans can vary unpredictably from year to year.
One danger of the 401(k) plan is if the contributions are not diversified, particularly if the company had strongly encouraged its workers to invest their plans in their employer itself. This practice violates primary investment guidelines about diversification. In the case of Enron, where the accounting scandal and bankruptcy caused the share price to collapse, there was no PBGC insurance and employees lost the money they invested in Enron stock. Congress inserted trust law fiduciary liability upon employers who did not prudently diversify plan assets to avoid the chance of large losses inside Section 404 of ERISA, but it is unclear whether such fiduciary liability applies to trustees of plans in which participants direct the investment of their own accounts. (Wikipedia)
The inception and adoption of the 401k plan has been the single best asset enhancer known to man.  In a way the proposal to change the social security system to private accounts could have kept the monster abated, by continuing to feed and lift the floor of all mainstream asset classes.  So with it's demise it was only a matter of short time before the pace of ascent in assets started to slow and trend down.

And what better tool to keep track of all these millions, ahem er... billions upon billions of steadily rising assets...  the computer.

And here is where the current downtrend started...  4/29/2010 the singular event that set this reaction in motion.  I now dub this the "Gold Shoulder" precipitating the "Flash Crash" that set the hook.  Just be fair to GS it could have been anything as the primer it just turned out to be Goldman instead of Greece, although one could argue that the Goldman allegations created a suspicious enough atmoshphere amongst investors that resulted in a hair trigger instead of a squeeze trigger.




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