Sunday, July 26, 2009

A Wild Speculation: the Stock Market and the Economy

Here's a wild speculation on the stock market and the real economy: the Powers That Be have engaged in a covert but easily visible wild speculation.

Bear with me while I speculate wildly about an unprecendented campaign of wild speculation by The Powers That Be.

The U.S. economy is at a cross-roads. Either it is exiting the recession and about to resume its glorious path of "growth" or it is teetering on the abyss.

If you were the Powers That Be--those holding the reins of political power and those making hundreds of millions in Wall Street bonuses--which alternative would you prefer? Which one would you throw your weight behind?

Duh--you'd be working every covert and PR lever possible, and inventing many new ones, to push the idea that the recession is over so spend, spend, spend.

Now here's the first thing we have to understand: borrowing $200 billion at zero-interest and dumping it into the $12 trillion U.S. economy is akin to spitting in the wind. The Bush-era "stimulus" of around that size just vanished sight unseen, barely registering in the economy at all.

But $200 billion dumped into stock market futures and churned in program trading and high-frequency trading has enormous leverage. While the total value of the U.S. stock market is in the $10 trillion range (down from $15 trillion at its 2007 height), only a few percent of the total outstanding shares trade hands each day.

But by buying futures contracts and churning via program and high-frequency trading--essentially buying from oneself or others in your manipulation game until other traders join in the bogus rally--the leverage is greatly increased. Thus a mere $10 billion thrown in relentless buying of futures contracts can spark a huge rally.

Before the Internet era, technical analysis was a black art of charting done by hand. Now every punter and middle-class owner of a 401K or IRA has access to thousands of charts displaying dozens of indicators and models. Everyone has access to data which was once limited to the exchanges and large brokerage houses.

Now that everyone see the same indicators and data, guess what becomes much easier: manipulating the market. Just two weeks ago, the mainstream financial media was filled with stories about the supposedly ominous "head and shoulders" chart pattern. In the past, H&S patterns were never mentioned in the MSM except in commentaries by market technicians. For Technical Analysis to have spread to the headlines is noteworthy.

Why? If you set out to manipulate the market higher, this makes your job much easier. Now that everyone "knows what to look for," then all you have to do is engineer a rise to certain levels which triggers "buy signals" that will be screamed and trumpeted in one media venue after another.

Want to engineer a rally behind the scenes? It's easy:

1. Kick-start a rally with massive buying at the open of the market day. Counter every bout of selling with massive buying of futures, and then "paint the tape" with more buying in the last 15 minutes. Then buy thousands of futures contracts at higher bids in the after market to set expectations that the rally will continue the following day.

2. As everyone who holds bets that the market would decline (shorts) has to buy back the stock they shorted, then this adds buyers (albeit reluctant ones) which further boosts the "Bull rally."

3. Do this for 10 days in a row, so the MSM can make fawning comparisons to previous "bull runs" in previous "Bull markets."

4. Identify key "technical signals" and then trigger them so the MSM can pump up this "proof that the Bear is dead and the recession is over." Recently, there was a frenzy of MSM coverage of the "bullish cross" in which (on at least some charts) the moving averages crossed in a "we're going higher" signal.

Other "buy" signals which have recently been triggered include "a new yearly high" for all the indices and a "Dow Theory Buy" as the Dow Transports and the Dow Industrials both logged new annual highs.

Seen in this light, sparking a Bullish frenzy is like taking candy from a baby.And most amazingly, it doesn't take much money to do so because the leverage offered by futures contracts and high-frequency trading is so extreme.

Take a look at this chart of the DJIA. Note that every indicator is bullish except for one: volume.

To market insiders this fly in the Bull-market ointment is critical, because "volume is the weapon of the Bull." If there's declining volume, that is extremely suspicious because volume is the one metric insiders can only pump so high on their own.

If you follow the market, you've seen the charts which depict that over half the trading done every day is program ("black box," "algorithmic," "computer," "quant," etc.) trading by Goldman Sach and other large broker-dealers, large hedge funds and other insiders. Trading by so-called "retail" investors (like me and you) and other investors below the level of top-tenth of one-percent make up only 17% of the trading. The other 83% is all in the hands of the 1/10th of 1%.

Despite their tremendous leverage, the insiders (and the Fed and Treasury, which announced last year that they would do anything to goose the markets higher, including buying equities and Treasuries, an unprecedented confession of open market manipulation by the Federal government) cannot force others to participate in the rally.

All they can do is drive the markets so relentlessly that anyone who wants to make money has to buy into the rally. And that includes, well, just about everyone.

As I've indicated on the chart above, there are basically three scenarios in play at this critical juncture:

1. The "melt-up" continues as the MSM announces (endlessly) that "the recession is over." In this scenario, the stock market continues its relentless ascent as everything gets better and better. The ultimate "top" has been touted as 15,000 on the Dow: a level which would top the 2007 high of 14,000+ by a wide margin. Go team, rah, rah, rah!

2. A school of technical analysis known as Elliott Wave Theory (EW or EWT to those in the know) forecasts a slightly less positive future: a brief dip in the coming days which will be followed by one last rise--and then a sharp drop to previous lows or even new lows.

3. Then there's the scenario which virtually no one even states, much less touts as plausible: the rally collapses right here, starting next week. Nobody is dumb enough, naive enough, foolish enough or uninformed enough to even timidly suggest that the open manipulation of the Powers That Be could actually fail because it's obviously so well funded, planned and executed that it can't possibly fail.

Well, there is one person foolish enough to voice it, I guess: me. This entire 10-day "rally" (or call it 12 days if you look only at the Nasdaq) simply doesn't pass the "sniff test." Technical analysts avoid confusing the charts with fundamental data like auto sales, unemployment, etc.--they look only at "the tape" (prices) and various indicators.

Techical analysis (TA) thus does not attempt to explain trends, it only seeks to identify and follow them. Thus a manipulated rally is just like an organic or "real" rally (that is, one driven by actual profitability, low price-earnings ratios, robust economic growth as measured by metrics which haven't been manipulated, etc.)

Nonetheless, TA practitioners should be wary that volume is declining during this "rally." Despite all the trickery, manipulation, tape-painting, propaganda and false "buy" signals, the market is showing very little participation as measured by volume.

This suggests to me a market in which every participant is anxiously eyeing the exit doors. That is, everyone is waiting to see how much higher their profits will rise before they exit (sell). The problem with this "wait to get the last dime" strategy is that when the selling begins, those exit doors will turn out to be awfully narrow and few will get their sells through before the declines turn into a waterfall.

Ironically, this "don't sell because the market's going higher" strategy is based on an implicit faith in the Powers That Be: this rally can't fail, Goldman Sachs is behind it!

In a manipulated rally, the market falls once the spigot of insider buying is turned off. And when everyone has been holding on to the last moment to see just how high this puppy can run, then everyone will try to sell not on the way up but on the way down. That's how a low-volume rally turns into a rout.

Why would the Powers That Be gamble so heavily on creating a bogus rally here? Because it's the cheapest way to convince the American middle-class that "everything's fixed and the recession is over." It's also the easiest way to generate billions in trading profits which can distributed to the 1/10th of 1% playing the manipulation game.

(If you don't believe in manipulation, please start reading Zero Hedge.)

Anecdotally, I see evidence that this ploy--"proving" the "recession is over" by goosing the stock market to "new highs for the year"--is working. A friend of mine who rents vacation rental cabins in Virginia told me his phone started ringing two weeks ago (when the rally started) and he booked over $10,000 of business in the past two weeks--and this is after a very slow start to the summer season.

Granted, this flurry of summer-fun could have many causal factors, but it would be rather obtuse not to notice the alignment with the "recession is over" stock market rally.

It's really quite brilliant. Dump a few trillion dollars into "saving" the investment banking sector from any hardship (like well-deserved bankruptcy), spread another $787 billion around as mulch in the real economy ("stimulus") and then "buy" a blazing-hot stock market rally for a relatively paltry sum which forces every mutual fund and hedge fund manager to jump on board lest they "underperform" and consequently find themselves unemployed.

It's like paying people to stand in line at a new restuarant opening; passersby will assume the food is outstanding and join the line. It's only when the meal is served do they realize they've been conned.

But funny things can happen on the way to an economic "recovery" triggered by blatant, orchestrated stock market manipulation: reality can still stick its nose under the tent flap. While I cannot predict what sort of reality could penetrate the wall of manipulation which has bulldozed all doubts and all selling, I do see the declining volume as the Achilles' Heel of this manipulated rally. Once the players and punters and managers seeking alpha (outperformance) realize the game is over, the selling could overwhelm the dealers' card tricks.

Right now that seems impossible, but the very fact that literally no one anticipates that as even a remote possibility ironically makes it much more likely. When the consensus of Bulls and Bears alike is that we will get a brief, shallow "correction" which will inevitably be followed by another massive leg up, I start wondering if the market--as manipulated as it is--will do what 90% of the punters expect.

I hear the spirit of legendary trader Jess Livermore whspering in my ear that the market will take along the fewest possible participants. For more on Jesse, please read Reminiscences of a Stock Operator

Lastly, let's look at this long-term chart again. If the wheels of the "real" U.S. economy, the one dependent on exponential growth of credit/debt to survive, much less "grow," have indeed fallen off, then just how low do you reckon this market could fall?

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