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July 11, 2011

A short-seller’s Market similar to 1907 & 1929

Jesse Livermore “Ace short seller”

The identical market conditions which allowed Jesse Livermore to lever up a small stake

to a $3m fortune in 1907, and $100m in 1929, exist today. In constant dollars, these

amounts have the purchasing power today in excess of $80m and $13.9bn. Jesse

Livermore started from nothing. What follows is a brief synopsis of the highlights of his

life excerpted from Wikipedia.

Born Jesse Lauriston Livermore on July 26, 1877, in Shrewbury, MA, Livermore started

his trading career at the age of fourteen. He ran away from home with his mother's

blessing, to escape a life of farming his father intended for him. He then began his

career by posting stock quotes at the Paine Webber brokerage in Boston. He was

known as the Great Bear of Wall Street. Famed for making and losing several multi-

million dollar fortunes, and short selling during the stock market crashes in 1907 and

1929. He was worth $3 million and $100 million after the 1907 and 1929 market

crashes, respectively.

Livermore first became famous after the Panic of 1907 when he sold the market short

as it crashed. He noticed conditions where a lack of capital (a credit crunch) existed to

buy anything including stock or Real Estate. Accordingly, he predicted that there would

be a sharp drop in prices when many “long” speculators were simultaneously forced to

sell by margin calls and a lack of credit. With the cash crunch, there would be no buyers

to absorb the stock being sold, further driving down prices. In the aftermath of the

Crash, he was worth $3m in 1907, and $100m in 1929, roughly equivalent to $13.9bn

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today. In the interim he went deeply into debt $1m trading commodities, before he

declared bankruptcy in 1912.

From $1m in debt, Livermore proceeded to regain his fortune and repay his creditors

during the World War I bull market and resulting downtrend. Livermore continued to

make money in the 1920s Bear Market Rally. In 1929, he noticed market conditions

similar to those of the 1907 market. He began shorting various stocks and adding to his

positions, and they kept declining in price. When just about everyone in the markets

lost money in the Wall Street Crash of 1929, Livermore was worth $100 million from

short-selling profits.

Conditions today are strikingly similar. The 1907 Crash is analogous to the 2000 dot-

com bubble bust, and the start of Supercycle Wave (II), ended in 1932. In essence, he

caught both the beginning and tail-end of a Supercycle Bear Market, you have a similar

opportunity here and now. A credit crunch, as the one in 2008, is endemic to market

free-falls, but you cannot wait until you see it on the evening news. By then, the lion’s

share of the profit will have vanished. Anticipate or you’ll be shut out.

The absence of Fear in Myth & actuality

In Wagner’s Ring auf die Niebelungen, only Siegfried’s total absence of fear, empowers

him to slay the dragon Fafner, and claim the magical Ring with the power to generate

unlimited riches, along with the Niebelung’s hoard of gold.

The cursed Ring represents unbridled greed, the same which lures today’s fortune-

seekers with the promise of great wealth. As in the Ring sourced in Nordic Mythology,

the riches are always short-lived, but the associated curse extracts lifelong loss of love.

To rapidly accumulate wealth with a high degree of certainty, follow my lead legendary

Jesse Livermore made two fortunes, under the identical Market conditions which exist

today.

Unbridled greed

Nowadays fearless greed is ubiquitous. Just as in the Ring, this Bear Market Rally has

lured investors with delusions of riches, only to humiliate them with lifelong serial

downsizing. Today’s irrationally fearless investors will soon rue the day they ever

lusted for more.

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The benefits of Inverse Exchange-Traded Funds

Inverse funds, are synthetic short sales, which allow you to short an entire asset class by

buying a single Exchange-Traded Fund, as you would a stock, without having to borrow

the stock or become liable for interim dividends. In a market collapse, as I learned in

2008, stock available for shorting is in very short supply, and often totally unavailable.

What’s more, inverse ETFs uniquely allow retirement accounts to profit from a

market collapse, otherwise tax-deferred accounts would be entirely excluded. Outright

short-selling requires a margin account, and tax-deferred accounts are prohibited

from margin by law. What’s more, inverse funds allow you to “short” without the price

uptick, required of conventional “short sales”. The other exception of course is the $VIX

volatility index and its analogues: VXX and TVIX. For most investors today, the $VIX

trade will become the single best investment of a lifetime. This does not mean you can

concentrate all your capital on the $VIX. Prudence requires we protect ourselves the

Fed’s unsavory attempts to save face, when their “big guns” prove totally inept.

Although the Fed can no longer prevent a market collapse, yet we can expect the

institution will go down fighting.

Why the comfortable retirements expected can never be fulfilled

The actuarial assumptions under which retirees were promised generous, lifelong

pensions, no longer exist. Such payouts can never be fulfilled. After a decade of

artificially-low interest rates, most Pension Funds face enormous pension liabilities.

Accelerated corporate contributions are out of the question, given contracting earnings

which threaten existence as going concerns. Despite its illegality, corporations faced

with a cash crunch tap into their pension funds for much needed working capital.

Entities which go bankrupt, become absolved of pension liabilities by their inability to

pay. Most investors trust that the Fed to remain firmly in control of markets and the

implied safety net of the infamous Bernanke “put”.

In attempts to play catch-up, many Pension administrators have opted for lower quality

debt, in return for higher yield. Still others have increased their allocations to riskier

equities. When the Market Crashes, catastrophic losses in both equities and low-quality

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debt will devastate Pensions. As a result, the Pension payouts formerly promised will

become no longer be possible.

Retirees will be shocked to learn they have little more than Social Security to live on in

their golden years. Others will wake-up to find they’ve handed-over control of their

financial futures to an inept drone at a bank, only to learn they have been totally wiped-

out. By default, talent migrates to the highest bidder. Such personal bankers command

relatively low compensation. That’s why bank investment departments become

bastions of concentrated mediocrity. If you are one of these trusting souls, Get out!

For those who take back control of their savings, inverse ETFs are a Godsend. Since

they involve a maverick, unconventional mindset, few banks will touch these. If these

individuals were capable of thinking outside the box, they would be earning 4-5 times as

much working for a private money manager. Meanwhile, these accounts, currently

invested according to the “prudent man rule” will wipe-out the retirement Nest Eggs of

an entire generation. Other than cash & inverse ETFs, there are no longer-term

choices.

Complacency - of epidemic proportions

What’s more, we know the Fed’s edicts are not to be relied upon. …according to Allan

Greenspan, “residential real estate could not collapse” & while Ben Bernanke claimed

the “subprime mortgage problems were well under control”. So when Ms Yellen

assures us that “investor complacency is not a threat”, we know very well that

complacency has reached epidemic proportions, - the tried & true sign of the irrational

euphoria which precedes every Market Crash. Similarly, when Portugal’s Central Bank

reiterates that the “Banco Espiritu Santo’s solvency is solid”, we can surmise a bail-out

will soon be required, & the run on Euro debt will spread to the entire periphery,

concurrent with the global pendulum swing back to risk-off, quality bonds.

Low volatility is this Market’s Siren

– Markets are priced too high for Volatility

Low volatility is behind us, on Wednesday & Thursday of last week, the $VIX, reared its

head like a Cobra, positioned to venomously strike fearless investors! Low volatility is

this Market’s Siren, luring-in investors, right at the top. Those who succumb will get

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killed! All major storms are presaged by an eerie calm, like the recent ultra-low volatility.

Not only do investors project such anomalies into infinity, but gullibly-duped by the Fed’s

assurances, they also leverage themselves up to the eye balls, expecting to make a

killing. Instead they’re the ones who will get killed!

The Fed’s placebo effect - guidance is a hoax

The Fed’s “forward guidance” has a temporary placebo effect –analogous to the emperor

with no clothes, the Fed’s guidance is a hoax. We are told, the economy is approaching

full employment, as its fault lines warn of impending catastrophe. The illusion of an

improving economy gives businesses the green light to jack-up prices. However, this

economy cannot withstand price increases without a substantial, time-delayed backlash.

Fewer transactions of lower average value are highly consistent with shrinking GDP.

In the current deflationary environment, price hikes backfire to result in lower income and

plunging profits. In the month or two it takes to modify consumer behavior, consumers

continue to temporarily put up with higher prices, while planning for lower cost

substitutes, and modifying their purchasing habits. These result in price hikes being

subsequently rolled back of necessity. When prices are finally rolled-back, the

consumer has already settled into his new, thrifty habits, resulting in a permanent loss

of revenue for those businesses who dared to raise prices without a feel for market

acceptance. Meanwhile those who reduced prices gain by attrition, & continue to win

customer loyalty. Because of higher turnover, their bottom line profits inch-up.

The Fed remains under the illusion that the economy can reach price stability,

concurrent with maximum employment. All this while avoiding the unpleasant jolts which

aggravated, rather than provoked, the financial market’s 2008 plunge. While these

mandates are possible in Bull Markets, they are totally unfeasible in Bear Markets.

The Market’s tippy-top is behind us, while the

Volatility Spike which precedes every Major Market Top is on the way

With the $VIX at a seven year low, the volatility which precedes a market top is already

in the process of materializing, as traders become confused by mixed signals, such

indecision creates volatility via the old Wall Street maxim: “when in doubt, get out”. The

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S&P has closed above its 200 day moving average for more than 400 consecutive days,

the second longest streak in the last 50 years.

The Market’s tippy-top is behind us

Meanwhile, the late-cycle, tip of the 5th wave sectors, such as utilities, which were

outperforming in lock-step with bonds until recently, have since reversed, to indicate

the Market’s tippy-top is behind us, while previously lagging consumer discretionary

stocks & financials have entered into the transition to bearish.

In the chart below from a Barron’s template, you get a glimpse of non-confirmation

between the Dow Industrials & the Utilities averages. From a cursory view, you see the

maximum three Diag >s of the same relative magnitude in series, to indicate its

maximum iterations. Leading up from the final Diag > are the five waves required to

cap off wave D, of an A-B-C-D-E Diag II. In aggregate it comprises Wave (A) of a (A)-

(B)-(C) Supercycle (IV). Below it the Dow Utilities Average, which until this month,

matched the performance of T-bonds. Match the June-July of industrials & utilities to

see the previewing divergence clearly.

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Utilities outperform near the end of market advance, to indicate investors are becoming

more cautious, while reaching for yield. The Utilities chart shows the attractiveness of

yield is no longer sufficient to keep investors hanging-on. A bearish sequence began

with wave i, while wave ii is its upside correction within the now larger, bearish trend.

The industrial and transports will follow in short order.

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The Bear Market Extended 16 years courtesy of Fed manipulation

Until recently, I assumed Elliott had simply erred in his alternation guideline, the likely

result of magnitude confusion from a short-sighted, long wave count. However,

regardless of his big picture miscalculation, the same alternation guideline should

prove true at all degrees of magnitude, and appears accurate in other instances down

three degrees in magnitude lower. The 5 & 13 years duration of Cycle Waves II & IV in

principle should be doubled to 10 and 26 years duration in Supercycle Waves (II) & (IV).

At Primary and Intermediate degrees, duration must be measured in months to

approximate the Fibonacci ratio of 1: 1.618 corresponding with simple & complex waves

2 & 4 of the same degree. When Robert Prechter ridiculed Elliott regarding the A-B

“Base”, he not only made a fool of himself, but also persists in demonstrating his lack of

pattern recognition genius. I certainly want to avoid such hubris.

As I showed you last week, this monster Bear Market was inadvertently magnified by

Fed manipulation. The blanket Futures buying surreptitiously purchased by the NY

Fed’s primary Bond dealers force-fed the Bear on steroids between 2008-2009. Like

Frankenstein’s monster, this Giant Bear will no longer heel to Fed manipulation - the

day of reckoning is the first of two troughs is rapidly approaching.

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Market Manipulation extended the Bear Market by ~16 years

to magnify the severity & duration of the second Great Depression

Market Manipulation’s ephemeral “wealth effect”, like the short-lived riches derived

Wagner’s magical Ring, merely compound the misery of a far greater, persistent

economic malaise, of the Fed’s own making. Such short-term fixes, take their toll as

enduring economic Depression. Mal-investments remain frozen which might otherwise

be re-deployed into more productive ventures, while the supply overhang in becomes

very slowly absorbed. In the process, the misery inflicted perpetrates learned

helplessness, destroys risk-taking element required of private enterprise & GDP growth.

Like a ball & chain, depression weighs heavily to undermine the self-esteem of an entire

generation.

In the absence of Fed manipulation, a relatively short, severe Depression would already

be behind us, and sustainable economic recovery in process. As Carmen Reinhart

concluded, the entirety of Fed stimulus must be withdrawn before a viable recovery

can begin.

Conclusion: rather than saving us from Depression, Bernanke’s messianic

megalomania merely extended and magnified the duration & severity of economic

Depression. The differential between simple & complex Supercycle Bear Markets

amounts to a 16-years of incremental misery. Like all organic structures, the Market can

be manipulated to extend a maximum of three times. So far, we have had two, under

Greenspan & Bernanke. The third will undoubtedly take effect soon, likely after the initial

plunge to Dow 10,570.

Bull Markets ignore warnings to selectively focus on the favorable news

Why most investors never make any money

In a Bull Market, negative news, like the 1stQ 3% GDP contraction, is discarded as

aberration, while better-than-expected statistics like the rear-view employment data,

spur euphoric, mindless herding to bid up prices. Once the Market gets killed, the

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collective perception swings to the opposite, highly pessimistic extreme, and remains

there long after the larger trend reverts back to Bullish. That’s why most investors never

make any money: they buy high and sell low, always projecting the previous war on the

current battle. Because of Nature’s alternation, the last will be first, and the first will be

last in each subsequent itineration.

Contrived bursts of investor confidence simulate Bull Markets

In an intentionally deceptive tactic, the Fed plays into this “selective awareness” by

magnifying buoyant statistics, while concurrently downplaying reality. This tactic

employed by Ben Bernanke, is a page right out of Goebbels, Hitler’s Propaganda

minister. Even as the German army was being crushed on the Eastern front, enormous

victories were synchronously being broadcast in carefully-crafted propaganda news

reels. It was Ben Bernanke who instituted the Fed’s corporate-style press conferences.

Immediately following each press conference, the Fed’s primary Bond dealers were

strong-armed by to make massive purchases of blanket futures, funded by the Fed in

feigned arms-length transactions. Such contrived bursts of investor confidence, created

the illusion of a Bull Market, always in the final hour of trading, so that investors who

learned about the artificial surge would enthusiastically trend-follow the next day.

No mere correction!

Margins calls are just around the corner, and mass liquidations to follow will be forced

by short-covering, turning the once-placid market into a whirlwind storm. Market prices

are too high for the Volatility ahead, prices must plunge in order to compensate new

investors for the roller-coaster ride ahead. Rather than buying on dips, selling will

snowball to avalanche proportions. This is no mere correction in process, but rather a

crash in the making.

Employment - a lagging indicator

Employment is a lagging indicator. Employers optimistically hire at the peak of every

cycle, only to turn around & fire the new employees as the economic crunch squeezes

profits - last hired are the first to be fired. The incremental profit due in part from

inflationary expectations, becomes eroded by fewer transactions of lower-average

value. When hourly pay grows slower than the CPI, and labor force participation rate

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remains at a 35-year low, the underlying Bear Market is temporarily being masked by a

feigned recovery, consistent with Fed propaganda.

Economies addicted to Easy Money

The US Economy, like its larger, global analogue, is addicted to easy money. All across

the globe, markets have been artificially propped-up by Central Banks’ printing presses,

in attempts to counter the endemic deflation, through a rapidly-rising money supply. As

soon as foreign purchases of US Treasuries cease, long-bond rates will creep back up.

What’s more, the plunging value of the dollar will do much to diminish demand for US

denominated debt. While economists speculate on the arrival date of a Free Market,

setting the “price of money”, interest rates, at the intersection of the Supply & Demand,

rather than artificially inflated by the Fed. What’s more, the US economy is not strong

enough to withstand Fed tightening anytime soon. The taper cannot continue at the

current rate without substantial economic “cold turkey” repercussions akin to a hard core

addict deprived of his drug.

All asset classes, except cash, inverse funds & the VIX will eventually get killed

To gain a greater understanding of the Market, you need to realize that despite upside

corrections, once the trend goes Supercycle Bearish, all asset classes, with the

exception cash, inverse funds & the VIX will eventually get killed. Despite near-term

bounces in Gold, Emerging Markets, Commodities & T-Bonds, these are only short-term

upside corrections, within the Big Picture 5-wave bearish plunge. Concurrently a

deflationary spiral will trough with the dollar gaining is former glory, and vast purchasing

prowess. As shown in most of the Weekly & Monthly charts below, the Wave 2 at the

top right represents the upside correction of Wave 1, shown earlier on the bearish

timeline.

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In the yield chart above, wave 5 equates with wave 1 in others. The minimum upside in rates is

beyond the limits of this chart. However first a drop to at least 1.85% marked by the green

dashed line. Note the end of the Bull and the Beginning of the Bear have a transitory 3 years

in between. As in Classical architecture, crown molding analogous to the reversal transition is

proportional to the vertical upside.

Below are the corresponding bond prices, all Diag IIs are retraced to the first touchpoint at the

very minimum indicating a min upside of 122, or $1220 for a $1000 par T-bond. The capital

gains are tremendous, in addition to a little yield! Note here too a min 102 downside must

occur before the breakout begins. In the yield chart above, the Diag II is the analogous

minimum.

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Brent crude below displays the same Wave 2 upside correction in process.

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Similarly the CRB commodities index is just a smidgen above the green dashed line I

calculated as the most likely reversal, although negative sentiment could push the trough to

the area of 270, we are likely seeing the reversal in process…there are 2 lines not one in the

last frame, a likely “a” of and a-b reversal transition. Wave 2 at the right top.

Likewise the second Emerging market chart shows a striking resemblance in the wave 2 in

process as an E wave to indicate a transition to higher magnitude to produce an especially

long wave 2 approaching the tippy top. As you see wave 2 is an A-B-C

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The Euro likely dropping to 127 before continuing higher to the area of $1.58US /Euro

The dollar is almost identical to the yield chart, down to 72.65 then up to complete wave 2

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Above Financials mimic the structure of the Diag II Dow & SPX, waves 1-5 down ahead… Diag

II is integral to wave 1

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In the VIX above the left Margin gives the equivalent price in TVIX our ETF. $2000 in TVIX =

27.5 in the $VIX. From there it should drop back to the trough.

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The NAZ is ahead of the other indices having completed wave 2, wave 3, the likely longest and

strongest to the downside will kill tech and small stocks beyond the drop in 2000-2002

Below you see gold having completed a Diag > and in the process of the a-b transition to the

upside, again wave 2 bounce at the right top.

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