The American economy is in the deepest economic depression since man started keeping track of artificially created economic events. I am pretty sure that I am not the first to tell you that the economy is not getting any better for your average person. Consequently, there are not enough retail investors who are both ready and able to prop up the markets. These same retail investors are the ones who took a hit in their retirement accounts on the way down to the print-of-the-beast: 666 on the SP500. So where is the money Lebowski?
One word, seven letters, two syllables: Bailout
I am a strong believer in the notion that the bailout money has been put to good use by propping up the markets since early March. The sad fact is that the bailout money is our money, yet it has gone to the banksters. It’s a pretty simple racket if you ask me. A bank such as Goldman Sachs, JP Morgan, Bank of America, or Wells Fargo goes to The Fed, trades some worthless collateral (mortgages, toxic assets, business cards, legal pads, office supplies) for dollars to shore up their reserves, and also uses the money to invest directly into the stock market. First they dial in some leverage at some ridiculous level…maybe 30:1 or higher like Lehman or Bear? Next, they buy low, tell all their analysts to lower their estimates, create a blitz of earnings that outperform said estimates, and then they sell high. The same stocks. Again and again. Maybe they use vector-vest for their investment advice, but I doubt it. So who are they selling the stocks to? Gullible retail investors who finally feel like the market is safe again, that’s who, and maybe some lucky foreigners too, although I think the world is waking up to the charade.
Well folks, this trend is unsustainable. In an era of throwing around buzzwords like “sustainability,” the financial industry knows not the definition of such a word. Let’s examine our trusty long-term chart of the Spider ETF (SPY) and see exactly why we’re in for some puzzling times. Ladies and Gentlemen, may I present to you: “Bernanke’s Conundrum”
Bernanke's Conundrum
We begin our charting adventure in 1994. Something happened and the market took off. They call this something “the tech bubble,” and what a bubble it was. The Spider (SPY) went from roughly 50 points to 150 points in the span of six years. Not bad, eh? A meager 200% gain in under a decade. A glance at the chart below will show you a clear picture of the tech bubble, AKA the first economic top.
SPY 1993-2009 First Top
If you will also notice, I have drawn a line from the start of the bubble to the top. The cool thing about my charting application is that it will draw these really neat little “fibonacci fans,” and sometimes they can be downright scary.
You can see that the second uptrend, which began in 2003 and topped out in 2007, coincided perfectly with the 61.8% fibonacci fan-line. It’s not really much of anything in retrospect, but it is pretty uncanny how the market oscillates along very natural and predictable patterns.
SPY 1993-2009 Second Top
We all know and love this second bubble. We love it the same way we love redheaded stepchildren. Apparently the dotcom crash was too much for The Fed to deal with and they decided it would be best to peddle adjustable-rate-mortgages to people with no prospects of ever repaying the banks who originated these loans. What a great idea that happened to be. Housing Crrrrrrrrrrash!
So here we are. We have come full circle, so let’s talk about what has happened in the last three years and try to understand what lies in store for the future. Have a gander at the chart below:
SPY 1993-2009 Support and Resistance
This final chart is Bernanke’s Conundrum. Interest rates are Bernanke’s conundrum. Inflation, Stagflation, and Deflation are Bernanke’s conundrum. This man is between a rock and a hard place that can be summed up with a Sheakspearian question that I have translated into financial-speak:
To inflate, or not to inflate: that is the question.
Whether ’tis nobler in the mind to suffer
The slings and arrows of outrageous inflation,
Or to take arms against a sea of deflation,
And by opposing end them? To go into bernankruptcy.
Based on history, The Fed has let the dollar weaken for something along the lines of 97 years. To no surprise, this also happens to be the entire history of The Fed’s existence. That’s not a bad track record for an organization whose mandate is to control inflation and maintain price stability. In essence, they are doing a wonderful job. Inflation is always there, but it’s a controlled incline, so all is well. Additionally, prices are quite stable too. As long as stable means constantly increasing over time, then yeah, The Fed is a winner. They have always chosen inflation. They live, eat, sleep, and breathe inflation. Inflation is the lifeblood of the Federal Reserve.
With that being said, if you have been reading my blog for any amount of time, you will know that I absolutely love support and resistance studies. As I have mentioned before, you do not really need much more than a good support and resistance study to come to any kind of conclusion about the state of a given security and/or market. The beauty of support and resistance is that it tells the entire story in a few simple lines on a chart, so let’s examine Bernanke’s Conundrum via the SPY ETF:
I have chosen the SP500 for this study because it is a fantastic representation of the American economy. First look at the red line. That is a visual representation of the upper limit of the American economy over the last 15+ years. We hit a peak in 2000 and we crashed to the green line (around 800 on the SP500). In 2007 we hit the economic top yet again, and we collapsed to the previously established major support zone, albeit with a tiny (and scary) breakdown to 666.
Between the red and the green lies an orange line of uncertainty. This line is the neckline of the greatest double-top the world has ever seen, and it is the defining line in Bernanke’s conundrum with regards to inflation. If Bernanke decides to continue to inflate our way out of this, and the economy picks up, we will see the SPY go up-to, and possibly past this resistance line as the market breaks out above the 200 day moving average (the wide gray channel in the chart). I personally believe that if we see the kind of inflation that pushes the market higher than the orange line, it will be hyperinflation, and nobody likes that. There is no way that the Dollar can get stronger and the market go any higher. They are inversely correlated at this point in time, and when one gets weaker, the other gets stronger, and vice versa.
On the other hand, if Bernanke decides to land his helicopter and casually deflate this mess, look to the green line for support. Should he choose the deflationary route, the market will collapse to the lows at the $80.00 price level. Should the $80.00 level break down, you better put your head in the sand because the next major support level is slightly under $50.00
In addition to the inflation and deflation outcomes, Ben Bernanke can also keep the markets deadlocked between the green and orange zone ($80-110). This could happen considering he has only one real weapon left in his inflation-assisted-arsenal: rate hikes. I would venture to guess that he will not hike rates until the market surpasses the neckline in the chart.
In conclusion, the key issue here is not if we will test these support/resistance levels, but rather, when we will test them. It’s all a matter of time. I personally believe that this scenario will pan out at some point in the next 3 years. With a long-term strategy in mind, I prefer to simply pick a side and hedge it with an inverse ETF. I generally like to hedge 50% of my investment at the bare minimum. As the market changes, I can dynamically add-to or subtract-from either side of the trade and skew my bias towards one trend or another and take advantage of profit-generating opportunities as I see fit. How would you trade this? What do you think is going to happen? Leave a comment.
