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The Confidence Game


...when the powers that be attempt to forestall the inevitable ebb and flow of cycles of confidence and the business cycle, all they accomplish is stretching out the inevitable.

Have you seen the bigger piggies in their starched white shirts?
You will find the bigger piggies stirring up the dirt
Always have clean shirts to play around in
In their styes with all their backing they don't care what goes on around

--Piggies (George Harrison)

More then anything, what has taken down credit markets in the past is confidence – or I should say a lack of confidence. You might say, appropriately enough, that it's a confidence game.

It seems reasonable enough to conclude that when the powers that be attempt to forestall the inevitable ebb and flow of cycles of confidence and the business cycle, all they accomplish is stretching out the inevitable. Like a slingshot that is stretched too far, it can snap back in your face. Like the kid in the school yard who can blow the biggest bubble – until it covers his face. And it seems the powers that be have been acting like school yard kids blowing up one asset bubble after another.

Economist Ludwig von Mises pointed out how central banking acts as an accomplice to government money expansion. In his business cycle theory, he explains that the market economy could not generate by itself a series of booms and busts and blamed an outside factor – the habitual expansion of money and credit. Ludwig von Mises argued that a credit induced boom must eventually "lead to a crack-up boom." He wrote "The boom can last only as long as the credit expansion progresses at an ever – accelerated pace."

The temptation when you're a consumer driven economy is to pump up the credit markets in order to paper over problems or use credit as an economic band-aid. However, this practice fuels excess speculation and borrowing. When borrowers and speculators don't need to be responsible – when they are paid, literally – to be irresponsible and price risk out of the equation, financial markets permeate an air of invincibility. Such has been the case – especially this year when the market got off the mat in March when it looked like Boo had thrown a haymaker. An air of invincibility exuded from the market this year so thick that you could cut it with a knife. A thick, creamy, exuberant invincibility – like Camembert. Wait a minute! That's not Camembert - Hoofy, you didn't?

Until last Tuesday it looked like the bulls had it together. Since then it's been all indigestion. Three out of the last four days, the S&P saw bids evaporate as an air of panic hit the tape leaving the S&P to close at/near the lows of the sessions.

Moreover, the S&P now shows two consecutive closes below the key 50 day moving average.

Although a move in the S&P that undercuts the June 8th low of 1487.40 could theoretically trace out a "C-Wave" and bullish fractal of the pattern in March - in my experience one of the most dangerous positions of the market – one of the most dangerous times to be a buyer of pullbacks is to buy theoretical support and retracements if a buying climax, a blow-off, an exhaustion move has already crescendoed. And that is a distinct possibility.

In the current consolidation (B) the S&P may carve out a fractal of the March W, (A) and stage a rally, but the character and nature of any such rally will be critical to observe. Trade below the May low (C) will trigger and outside down month. February was also an outside down month.

A ninety degree retracement from the 1540/1541 June high is 1501. The S&P is now in a vulnerable position closing below 1501 after having tested 1540 last week.

Led by Bear Stearns (BSC), the little piggies were the pork that chopped Monday's green to red. The DJIA went from up 130 points to close at a loss of eight points.

BSC slid below its March low. If Goldman (GS) is the Tell of Tell, then it is sending a bearish signal. Why? The stock broke out above a first quarter high of 220 in April, pulled back to test that breakout point on June 8, but with Monday's action, GS has relinquished the 220 level closing at 216.74.

Bearishly the BKX is tracing out a series of lower highs and lower lows below its 200 DMA and its 50 DMA.

Below 1501 the S&P remains in a weak position. The BKX is the albatross around the market's neck. It will be interesting to see the behavior in the BKX if it tags its March low of 109 at the same time the S&P potentially undercuts its June low. If that occurs the S&P may be magnetized to a turndown of its monthly chart – i.e. a trade below its May low of 1476.70. Trade below that level will carve out a bearish outside down month. Bearishly this will occur in the timeframe where I've been looking for a significant peak.

The behavior from an outside month down will be key. Typically, in keeping with the Principle of Reflexivity, a snapback rally should unfold. If it does not, it will indicate serious selling pressure. If a rally does develop on a turndown of the monthly chart, the nature and character of that rally will be critical to watch.
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