Seeing Through the Silent Crash

Seeing Through the Silent Crash

The following was first published on Elliottwave.com on 12/21/06

Bob Prechter has borrowed from a favorite Christmas carol title, Silent Night, to name what he sees happening in the markets. He calls it a Silent Crash, and he's put his thoughts down in his most recent Theorist as well as making a video that displays the accompanying charts. He calls it a silent crash, because the large amount of credit sloshing through the system is keeping the Dow up in nominal terms, while it's falling in real terms, if measured by gold or commodities. Here's an excerpt to give you a sense of what he's thinking.

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Excerpted from the December 2006 issue of The Elliott Wave Theorist

The Silent Crash—and What Happens Next
Well, is there anything else going on around the world? This time you can read the papers to get the real story in real estate. The S&P Composite Homebuilding Index has been cut in half since stock prices topped out last year, and that’s in nominal terms. I’m not even putting it in gold terms or in terms of the CRB.

So we’ve got a crash going on in real estate. The rate of change in the median price of homes in the United States has made its lowest low going back to the 1940s, so we know this is a serious turn. Most real estate analysts are saying, “Yes, it’s bad, but it’ll be temporary just like 1990 or 1974.” But the tremendous speculation and the dramatic reversal is much more like 1929 - ’26 to ’29 - than it is like those minor pullbacks. So we think this 50 percent decline is not a correction. It’s the beginning of a much larger retrenchment.

It was a stealth top in real estate. This is very important. I don’t think you can find an article from 2005 last year saying, “Oh, by the way, real estate is topping out.” They were all talking about the mania and rising prices. And if they were not rising any more in one area of the country, the articles changed their focus to another area of the country where it was rising. But overall, prices were topping out in the summer of 2005.

Like every good peak, it was a stealth top that people were not noticing. I think that’s going on in the stock market in a huge way, with the real prices falling and the nominal prices holding up. Of course, now we’re seeing the result of the real estate bubble that’s now burst. It’s in headlines all around the country. “Real Estate Bubble Bursting,” “Housing Slump Puts Drag on Growth,” etc. I think if you study this page of headlines and memorize it, you’ll soon see the same kind of headlines, but they’ll be relating to the stock market.

I’d like to read a couple of lines from an article. This was in The New York Times a month ago, talking about real estate in Arizona. The article says, “Until recently, people were camping overnight, begging to be the next number in the next lot in the next house. Not only are there few new customers to talk to, but many buyers who put down a deposit are not even bothering to come back for a walk-through.” It quotes a real estate agent who says, “All of the sudden they just don’t show up.”

I think that’s exactly the scenario that we’re approaching in the stock market. People right now are camping out every night so they can buy in the morning, but soon enough, they just won’t show up. We saw something like that happen in the NASDAQ after the big bubble there, but now we’ve got it across the board again in the blue chip areas and—if you understand Elliott—that’s what we call a bear market rally.

Have you read precthers conquer the crash, or in the crest of a tidal wave. Very interesting but somehow i feel that after following his thoughts for such a long time, he is very off in his timing. I think that he has a pretty accurate picture of a likely scenario when it comes to the big picture, however when it comes to Elliot wave, many different scenarios can always play out, he just always focuses 100% of his energy on predicting crashes. Sooner or later he will be right as nobody denys that they occur from time to time. However, if timing isn't spot on, prediction loses its value. I guess he's in a win win. If he is right, well everyone can say wow look at him. If wrong, we will be happy that he's wrong. Definitely a good angle to take.

I was a Prechter for the 1987 correction. He was certain that was the top. Glenn Neely, a 'neo-elliottician' was certain, it was a correction and the DOW would go to 10,000 at minimum before the bear could take hold.

What I can tell you here in SoCal is that, housing is still ridiculously overpriced though things have 'slowed down'. I would never pay what they say I can get for my modest home. All this craziness in an earthquake zone...

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January 15, 2007

Declining Commodity Prices Signify Weakening Economy
Some Thoughts on the Volatility in Commodities
Or Sell! Mortimer. Sell!

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I got a lot of mail as usual from readers about my annual forecast. It was about evenly divided between those who think I am too much of an optimist and those who think the economy will avoid a recession. There are a number of readers who think we have already seen the bottom, and that 2007 will be a banner growth year.

Let me be clear about one thing. My call for a mild recession/slowdown stems almost entirely from my thought that housing is going to be a real problem in the coming quarters. This will cause a slowdown in Mortgage Equity Withdrawals and put pressure on consumer spending. It will cause a rise in unemployment, which is also bad for consumer spending. If the housing market does not slow down a lot more than it already has, then my forecast is going to be wrong. It is as simple as that.

And as is typical of changes in the economy, there are a lot of mixed signals. Certainly the rather solid December consumer spending number we got today does not suggest there is much pressure on the US consumer. Retail sales account for almost half of all consumer spending, which in turn makes up more than two-thirds of gross domestic product. Today's government report provides a broader picture than industry figures, which showed a disappointing holiday shopping season.

Same-store sales rose an anemic 3.1% for December on an annual basis. But those figures are only 17% of retail sales. The government data shows consumers were busy elsewhere, either at restaurants, the internet, or buying health care, among a lot of places besides the mall to spend your money.

And certainly the stock market sees no problem, with another record close today for the Dow. On a technical basis, there are a lot of reasons to suggest this market may go higher in the short term. So if your forward looking view is six days or a month, you may have reason to be optimistic. If you are looking at a longer time period, and/or agree with me that a recession/slowdown is in our future, then the stock market may indeed pose more of a challenge.

Declining Commodity Prices Signify Weakening Economy

I am not the only analyst expecting a recession, of course. I ran across this note from those smart guys at Comstock Partners (www.comstockfunds.com). It will give us a nice segue into some thoughts on the volatility in commodity prices and speculation about the price of oil. Quoting:
"The idea that falling crude oil prices will boost the economy and overcome the plunge in housing is yet another instance of hope replacing reality. Despite its great importance, oil is just another commodity that goes up and down with the business cycle. When the economy begins to weaken commodity prices go down; when the economy is strong commodity prices go up.

"Since its May high the CRB commodity index has dropped 22%, only the 7th time this has happened since 1974. According to ISI, since 1974 every decline in the index of 20% or more has been associated with either a recession, a significant slowdown or a financial crisis. Each of these periods has also occurred following a period of tight money and an inverted yield curve. In this regard it is also noteworthy that oil has not been the only commodity declining in price. Recent months have featured significant declines in a wide assortment of commodities such as copper, gold, sugar, hogs, wheat and corn. It is therefore likely that the oil price decline is itself a result of economic softening rather than an impetus to growth.

"ISI also points out a number of other factors historically associated with significant economic slowdowns including the lagged effect of 17 rate hikes; the decline of house prices; the plunge in mortgage equity withdrawals (MEW); the inverted yield curve; significant slowing in the leading indicators; tightening by foreign central banks; and nominal DP growth under the fed funds rate. [All factors I have written about in the past few months - JM]

"In addition our own studies indicate that a serious economic slowdown in the period ahead is more likely to end in recession rather than a soft landing. Not only have soft landings been extremely rare in U.S. financial history, but expansionary cycles featuring a series of fed rate hikes, an inverted yield curve and a sharp drop in the growth rate of the leading indicators have almost always been followed by a recession and bear market. Note that the soft landing in 1995 was not associated with an inverted yield curve or a 20% drop in commodity prices, while the soft landing in 1985 was not preceded by a series of fed tightening moves. Every recession starts out looking like a soft landing in the period of transition between economic expansion and contraction that we are probably in today. In the current instance the unusual housing boom and subsequent collapse make the prospects for recession seem even more likely."

The Technical Characteristics of the Real Estate Mania
By Susan Barretta

A look back at the May 1997 Elliott Wave Theorist essay “Bulls, Bears, and Manias” reminds us that normal markets propel themselves via a chaotic feedback system. Price movements are driven by behavior, which in turn drives behavior. The market inhales and exhales, moves up, then moves down, retracing part of its gain. We see this in the progress and regress of Elliott Waves.

Yet this price “respiration” vanishes when markets are not normal, as is clear from a study of the chart of asset manias. You notice fewer and briefer setbacks. The usual tools of analysis don't work -- in a stock market mania, for instance, prices blow through calculated levels of resistance that the former bull market would have respected. In some markets, technicians might characterize the final move of a mania as parabolic -- a period when the price graph becomes considerably steeper toward the peak. Technically, a mania arises out of a long-term bull market that once exhibited the normal pattern of ebb and flow, but changes into virtually a non-stop rise that appears as a steep line on a graph.

Manias have duration. Some famous manias that “Bulls, Bears, and Manias” cites lasted two years, the 1920’s run-up was about eight years, the Japanese market experience was 15 years, and the U.S. stock market’s mania covered 1982-2000, about 18 years.

Manias have extent. Manias raise asset prices by multiples. From its low in 1982 until its 2000 high, the Dow's price multiplied by 15x. The multiple for tulip bulbs in the 1630’s was considerably more.

U.S. house prices have been ascending at least since the start of this data series in 1963. Are any of the technical characteristics of a mania evident in this chart?

http://www.elliottwave.com/images/ez...01-17-07-1.GIF


Figure 2. Median U.S. House Price, 1963-2006.


The national housing market has certainly been in a long bull run. The arrows point to the most protracted flat-to-down periods of the long-term upward trend. Some regions of the country endured substantially longer and more painful housing bear markets during the time range in this graph, thus contributing amplitude to these national-scale corrections. But on that national level, the recovery times from these corrections have been relatively quick. There are a few down times in very recent years, but the dips are brief.
Note the three red trend lines. Prices broke away from the first trend line in 1992. The second trend line highlights the slightly steeper slope that started around 1994 and terminated in 2002. Finally, the third even steeper trend line started in 2002 and lasts until it was decisively broken in the first half of 2006. Thus another of the technical conditions that characterize this market as a mania is clear, namely increasingly steeper trends. Manias accelerate in arithmetic terms.


The graph shows duration. If one counts the start of the mania from 1982, it includes 25 years; from 1971 includes 36 years. When we examine the behavioral aspects of a mania and the steps that turn a bull market into a mania, we could make a case that some aspects go back to the Great Depression -- over 70 years -- and even longer than that.


And then there is extent. In nominal terms, the median house price was $25,000 in 1971, and poked through $250,000 in 2006, a 10-fold multiple.


http://www.elliottwave.com/images/ez...01-17-07-2.GIF


“Bulls, Bears, and Manias” notes that it is practically impossible to call the top of a mania, but other measures of the asset market potentially flag when a decline is imminent. With stocks, for example, the Advance/Decline line typically falls, so the final advance rests on fewer and fewer stocks. In the housing market, existing home sales seasonally adjusted topped out June 2005, and inventory, described in terms of the number of months it takes to sell it, has been climbing since January 2005.


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So by some other measures of housing market strength, the jig is up. These weakening indicators do not guarantee a decline of course, but these indicators would need to weaken before a price decline develops.


Relatively quick recovery from setbacks, shallow quick dips in very recent years; increasingly steeper trend lines; duration; extent, other measures that have warned of a weakening trend -- it looks like our national housing market has been in a mania from a technical perspective, and that the mania is in the process of unwinding.


In the next article, we’ll talk about the psychological pattern in the progression from a bull market to a mania.