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The Locusts of Liquidity


These locusts are feeding on a field of equity dreams where the only P/E that matters is Private Equity.

Well I won't back down, no I won't back down.
You can stand me up at the gates of hell,
But I won't back down.

-Tom Petty and Jeff Lynne

"On my command unleash hell."
-Maximus Decimus Meridius, the Gladiator

It is at new highs slightly above prior significant resistance (or vice a versa, at new lows slightly below significant support) that we find out what the market is made of.

It is this lost motion upon overthrowing old highs and undercutting new lows and the dissipation of momentum where the market many times reveals its true nature.

For example, after the dramatic waterfall decline into the late July 2002 low at 776 S&P, the index ran up 24% - a substantial advance. However the index then started a new leg down to 768 S&P into early October 2002 overshooting the prior low by approximately 1%. Maybe it is because the art of deception is the mother of speculation – maybe it is because the Big Dogs drive the market to a new low (as occurred in October 2002) in order to flush out the weak hands. This makes for ease of movement when the reversal occurs. Let's face it, the penthouses of Wall Street aren't lined with choirboys. Let's face it, the gamesmanship of Bang 'em to Buy 'em and Buy 'em to Bang 'em is the favorite pastime on the Street.

Let's just say that the break below the prior low stops out many longs, and generates new shorts by "trend-followers." When the market reverses back up through the prior low the new shorts are squeezed. Many times these short covering rallies are exactly what establish a Bear market low. After all, the advance has to start somewhere, and many times it starts with a short covering rally.

Currently the S&P scored an important high on February 22 (1461.55 S&P), declining sharply into March 14 (1364 S&P). In the process the move up from the July 2006 low was overbalanced as the break traced out the largest correction since last summer's lows.

April saw the S&P 500 overthrow its prior February high by approximately 2%. There is an adage that the market usually (not always) gives a graceful exit. In other words after a break from a high, a return rally to test the high plays out. In keeping with this notion, and according to the Principle of Tests, the market staged a return rally into the end of August 2000 to test the break from the March 2000 all time high. In March 2000 I wrote that the inmates were running the asylum. I received a few emails suggesting that I keep my opinions to myself and simply report on the accumulation distribution. At the end of August 2000 I wrote that the market was in its most vulnerable position since 1929. The Naz crashed and the S&P shed 50%. Into the March 2000 high it was all virtual reality and new paradigm. Seven years later it's all basic materials and cyclicals. US Steel (X) has gone up more than tenfold since 2003. It's really rather Biblical, the first shall be last, and the last, first. Steel becomes Amazon (AMZN).

As shown above, the Principle of Tests played out in July and October 2002. This occurred on the twenty-year anniversary of the birth of the Bull in the summer of 1982. There is another adage: as above, so below. This may sound like a cliché, but cliches are so called because many times they are true. Is the current picture a mirror image of the 2002 low as the S&P exceeds its February high by 2% following a substantial decline?

This is a question worth asking on the twenty year anniversary of the1987 break (given this cycle's performance in 2002). This is a question worth pondering, as there has never been a period with years ending in seven when the market was able to avoid a substantial sell-off. This is a question worthy of any disciplined investor with at least one eye on risk to reward, especially when you consider that the market has avoided a 10% correction for four years running now. It is important to remember that a "normal year" gives two 10% corrections and one 20% correction. The market won't back down.

The Bull/Bear debate should be decided on any violation of the February high that sticks and stays below that high. It is important to note that the Russell 2000 has already knifed back below its February high. Ditto the big Tell, Goldman Sachs (GS).

On the heels of the burst of the technology bubble, 9/11, and corporate scandals, interest rates were not so much cut as they were chopped to historic low levels. Then, on the heels of the real estate bubble imploding and the sub-prime mortgage issue, money supply has exploded in recent months. This money creation, this Bernanke Bid, synchronous with the Yen Carry Trade is the wind beneath the wings of the locusts of liquidity. These locusts are feeding on a field of equity dreams where the only P/E that matters is Private Equity.
Socrates said that when the Muses first brought song to the world, the beauty so captivated some that they forgot to eat and drink until they died. The Muses turned these souls into locusts.

From my ledge it looks and sounds like once again the music of momentum for momentum's sake is being chanted from the caverns of Wall Street by capitalist Hare Krishnas swarming before the sun like locusts of liquidity. Same asylum, different inmates.
No positions in stocks mentioned.

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