Thursday, March 05, 2009

Toxic Tape (any price is possible)

No doubt, it's ugly out there. People are reeling, grim about the mouth. I know they don't need me to make light of all this, but why cherry-coat it instead? This has become the most orderly devastation of wealth since before any of us were in diapers. We have that in common now. East, West, elders, youngers; as people, as nations.

We're all wearing diapers now friend.

Today was another blistering day for the markets. The universal sucking-thumb sound was heard around the world. Selling was again broad and severe, but still there was no bona fide panic. There was no tremendous surge in volume. There was no extraordinary put-to-call ratios or other extremes in sentiment. There was no sign in the least that any of this has ended.

But there are signs we are close. Not close to a better and brighter financial future or anything stupid like that. But close to turning the worm, even if momentarily, in terms of trend. Nothing goes straight down forever.

That said, I'm not going to get into all the positive divergences right here and now and make any bullish arguments. The reason for that is I think there is a much bigger issue to deal with first. And that is because it is uncomfortably possible that we will see panic selling begin to emerge, right now; into something like a one-to-two day elevator drop.

I'm not saying this is likely, but frankly the table is set. There is nothing under us resembling technical support (if the Nasdaq were to gap to new lows, the next support for the major indices does not exist because there is none and BS pencil pushers on CNBC and elsewhere who have been extending straight-edges further and further - all the way back to Shakespeare's funeral, can stick support lines up their asses, because that is where they are talking from).

The market is a dynamic and when the dynamic shifts, it can happen slowly (quite common in up-trends), but if in a perfect storm it can happen all too quickly. For crashes to occur, there must be several factors at hand. One of these is absolute negative sentiment (and the investor psyche is painfully primed now for free-falling sentiment). Note that this is contrary to a more normal market, when extreme negative sentiment is a bullish indicator. When the market is crashing (1987 for example) there is a universal ABUNDANCE of negative sentiment, on that day especially. That is one of the key drivers intensifying the sell-off, virtually everyone is negative and jamming for the same exits at the same time. Short-sellers aside, for the moment at least no one is willing to take the other side and buy (don't forget to factor in margin calls, forced liquidations/distributions, hedge funds blowing-up, etc.).

Those short-selling bastards are the market's best friend in that situation and it will be one of the reasons why a crash, if it happens from this deeply oversold level, will be brief in duration though potentially quite steep; even the shoe-shine boys are talking shorts now.

If you think the market cannot crash because it is too oversold just now, then you need to study crashes - they occur when the market is extremely oversold. Oversold is never a bullish indicator (fill in the blank if you've read this column before) UNTIL the market is rallying.

Indeed, we may not crash (again, this is not a crash-call). The abundant number of shorts being one reason and subsequently I suspect we'll need a fresh negative catalyst here to push us into a panic. There may or may not be one in the cards just yet (something I don't want to bet against given the extreme distress in the environment right now and the domino-effect evolution these stresses have been breeding).

If we can get through another day without panic and the (yet unmentioned) positive divergences prevail, we will likely have started upward instead (at that point you can call it an oversold rally). It may advance quickly and violently (in which case it would smack of bear-market rally and it will not last) or it could develop more slowly, which is more bullish for the prospects of a longer, sustained rally. A slow, constructive start upward, with fits, starts and successful retests would begin to relieve certain pressures and create fresh buying (shorts cover, charts improve, value hunters come into the fray, money flows stop free-falling, money managers, corporations, individual investors and unified minors alike begin to come off of life support and breathe on their own.

A rally like that would manage a retracement anywhere from ~28 to 66%, depending, from the lowest-lows to the peak of hopeful-highs, and the timeframe would last some months.

If we can do all that without the blood and panic beforehand - I will be rather surprised.

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