A Heart Disease Metaphor

"Cutting rates and granting tax breaks may be good for the market's heart, but the long-term prognosis is poor if the financial system's arteries remain damaged."
Jim McTague, Barron's.

Letter to a Bitter Bull

Toro of the Running of the Bulls Market Blog has this excellent reply to an angry, bitter and deluded bull in the following post. To give you a hint, the bull in question, Don Luskin, addresses the mean permabears (responsible, according to him, for the recent market ugliness) by saying:
"ARE YOU SATIFIED?".

Truth be said, Don Luskin is at least saying something even if it's only a bitter rant. Other bulls have grown utterly silent. Bears of all stripes, on the other hand, are coming out of the woodwork and having a blast sharing their ursine views. Case in point, this from Associated Press:
Billionaire George Soros called Wednesday for a massive injection of regulation and oversight over financial markets whose excessive freedoms have caused "not a normal crisis but the end of an era."
Granted George Soros, a man I highly respect and admire, is not the most apolitical person you'll ever meet but at least his sense of timing is impeccable.

I'll leave the last words to the always insightful Arthur Hill from the John Murphy Market Message:

"Lower interest rates are supposed to be positive for stocks, but both the S&P 500 and the 10-Year Note Yield (interest rates) have been falling together for three months. Because stocks have yet to respond to lower interest rates, more rate cuts may not be the panacea for the stock market. Not immediately at least. Chart 8 shows the Dow Industrials and the five rate cuts. It all started with a surprise ½% cut in the discount rate on 17 Aug. Despite four more cuts since then, the Dow Industrials is over 1000 point below its 17 August close. The Fed, the Congress and the President are doing their best to stimulate economy, but let's see some stimulus in the charts before getting excited."

Ursus Americanus: this time it's for real

As I indicated in a previous post, a decisive break of the August lows was a necessary condition for a bear market prognosis. The line in the sand was a nice round number, 12,500 for the Dow. We needed: a clean break, on a daily close basis, on high volume. What happened today, as shown in the chart above (click to enlarge), fully qualifies...in spades and I'm trying to stay calm and understated here.
The next logical support for the Dow would be around another nice round number, 12,000, right above the March 14, 2007 low, established after the nasty February 2007 spill. Does anybody remember that one? It seems so long ago now and yet it was a harbinger of things to come. But I digress.
Guess what? We're already two thirds of the way to support. That's what's called the path of least resistance: why do in a week what you can do in a day? But Dow 12,000 can be but a quick stop on the way down. I'm not much for patterns but that Head and Shoulder pattern on the chart above is literally jumping out of the monitor. A quick calculation gives us a target of around 10,500. Like the title says, this time, it's for real.

P.S. I feel compelled to add a cautionary note here, lest I come across as overly bearish. What happened today is undeniably very bearish but the market, as we all know, has a way of behaving in the strangest and most unexpected manner. And now, after a huge down day on huge volume and with the VIX exploding 17%, would be a great time to catch many traders wrong-footed. So watch out for those nasty bear market rallies, they can be stronger than those of the bovine variety.

The (Mis)education of BB

Very interesting article on the New York Times web site titled "The Education of Ben Bernanke". It gives a nice timeline of all the salient financial events of the past 6 months starting with the speech Bernanke gave last May in which he uttered the following sentence:
“the effect of the troubles in the subprime sector on the broader housing market will likely be limited.” These words might one day rival these other fateful words: "Prosperity is just around the corner" (President Hoover, 1932) for what could be euphemistically called otherworldly lack of prescience.
For other gems from the Great Depression era, check this out. One from a very respected economist in his day: "There may be a recession in stock prices, but not anything in the nature of a crash." (Irving Fisher, September 5, 1929) but this one by same takes the prize considering it was delivered the day before the Crash: "Stock prices have reached what looks like a permanently high plateau." (Irving Fisher, October 17, 1929).

Ursus Americanus

The Accrued Interest blog, an expert blog mainly dedicated to the fixed-income markets, offers this very cogent analysis of the stock market and its future from an intermarket point of view. Oddly enough, he is of the opinion that the stock market is in for a very big selloff as usually happens within a year or so after corporate bond spreads explode. The big question is: has the meltdown already started? Even though we've seen some pretty big down days already this nascent year, I believe we need to see the August lows taken out decisively (on a weekly basis and/or on respectable volume) to start waxing poetic about bears. Positioning oneself for just such an event (if one isn't already) would be prudent.

Goldman Sachs in a descending triangle

If my eyes are not lying, this chart above (click to enlarge) is tracing out a descending triangle, a bearish formation. Its base, as it happens, is also where GS gapped up on high volume on 9/19/07, when people were starting to think (hope against hope is more like it in retrospect) that the whole subprime implosion was just a bad summer nightmare after all, that everything would be OK and that in any case Goldman was immune to all that nonsense.
From what the chart is telling us, should this base give way for good (conveniently, the base is a round number: 200), we would be expecting at least a 50 point drop (the height of the triangle) and a test of the August low at 157.

Are markets random?

The question above should be more specific and say: Are markets totally random? Obviously, there is a lot of randomness in financial markets but is it all random?
If the answer to that very big question were a resounding yes, that would mean anybody trying to use charts (or more generally past data) to trade is doomed to failure. That's what proponents of the efficient market theory and its relative, the random walk theory believe.
So I think that, far from merely being a rhetorical question, it is of existential importance to any practitioner of technical analysis.
A lot of evidence has turned up in the past 20 years that seemed to disprove or at least seriously damage the random walk and the efficient market theories, none more potent than the crash of October 1987. As any self-respecting statistician will tell you, if the markets actually followed a random walk, that crash would have never happened.
For more background information about this most interesting of subjects, I found this on that most hated (but most useful) of sources, Wikipedia:

"The mathematical characterisation of stock market movements has been a subject of intense interest. The conventional assumption that stock markets behave according to a random Gaussian or normal distribution is incorrect. Large movements in prices (i.e. crashes) are much more common than would be predicted in a normal distribution. Research at the Massachusetts Institute of Technology shows that there is evidence that the frequency of stock market crashes follow an inverse cubic power law.[6] This and other studies suggest that stock market crashes are a sign of self-organized criticality in financial markets. In 1963, Benoît Mandelbrot proposed that instead of following a strict random walk, stock price variations executed a Lévy flight.[7] A Lévy flight is a random walk which is occasionally disrupted by large movements. In 1995, Rosario Mantegna and Gene Stanley analyzed a million records of the S&P 500 market index, calculating the returns over a five year period.[8] Their conclusion was that stock market returns are more volatile than a Gaussian distribution but less volatile than a Lévy flight.
Researchers continue to study this theory, particularly using computer simulation of crowd behaviour, and the applicability of models to reproduce crash-like phenomena...."

I actually found the article they're mentioning about markets and power-laws.

For what appears (to my untrained eyes) to be an impressively conclusive proof of the non-randomness of markets, you can check out this paper titled, oddly enough:
Stock Market Prices Do Not Follow Random Walks: Evidence from a Simple Specification Test. Be warned: it is math-heavy.

Despite all the new recent research, followers of the Random Walk Theory have been, so far, impervious to self-doubt. Their argument goes something like this: outliers, nothing but outliers!

My wish for 2008

Boy am I glad I waited until after the first trading day of the year to blog about my wishes for 2008 as pertains to trading. Now my task is easy:

May the year 2008 be as exciting trading wise as January 2, 2008, official first trading day of the year, was. May we have monster sell-offs (SPY, SMH, QQQQ, FNM, JCP) and monster rallies (USO, GLD, GDX, FXY) all on the same day, every day.