H/T Zero Hedge Submitted by Gordon T Long of Tipping Points

Preserve and Protect: Mapping The Tipping Points

The economic news has turned decidedly negative globally and a sense of ‘quiet before the storm’ permeates the financial headlines. Arcane subjects such as a Hindenburg Omen now make mainline news. The retail investor continues to flee the equity markets and in concert with the institutional players relentlessly pile into the perceived safety of yield instruments, though they are outrageously expensive by any proven measure. Like trying to buy a pump during a storm flood, people are apparently willing to pay any price.  As a sailor, it feels like the ominous period where the crew is fastening down the hatches and preparing for the squall that is clearly on the horizon. Few crew mates are talking as everyone is checking preparations for any eventuality. Are you prepared?

What if this is not a squall but a tropical storm, or even a hurricane? Unlike sailors, the financial markets do not have the forecasting technology for protection against such a possibility. Good sailors before today’s technology advancements avoided this possibility through the use of almanacs, shrewd observation of the climate and common sense. It appears to this old salt that all three are missing in today’s financial community.

Looking through the misty haze though, I can see the following clearly looming on the horizon.

Since President Nixon took the US off the Gold standard in 1971, the increase in global fiat currency has been nothing short of breath taking. It has grown unchecked and inevitably has become unhinged from world industrial production and the historical creators of real tangible wealth.

Do you believe trees grow to the sky?
Or, is it you believe you are smart enough to get out before this graph crashes?

Apparent synthetic wealth has artificially and temporarily been created through the production of paper. Whether Federal Reserve IOU notes (the dollar) or guaranteed certificates of confiscation (treasury notes & bonds), it needs to never be forgotten that these are paper. It is not wealth. It is someone else’s obligation to deliver that wealth to the holder of the paper based on what that paper is felt to be worth when the obligation is required to be surrendered. It must never be forgotten that fiat paper is only a counter party obligation to deliver. Will they? Unfortunately, since fiat paper is no longer a store of value, it is recklessly being created to solve political problems. What you will inevitably receive will be only be a fraction of the value of what you originally surrendered.

In the chart above, we see that just when the exponential expansion seemed to have run its course during the dotcom bubble implosion, we subsequently accelerated even faster. Cheap central bank money; the unregulated, off-shore, off-balance sheet increase in securitization products; a $617T derivatives market; and the domination of the credit producing Shadow Banking system then took us to even greater levels. Bubble after bubble continues to propel us, as more recently the Bond Bubble replaced the Real Estate bubble.  Similar to trees not growing to the sky, something always happens which creates a tipping point, a moment of instability or a critical phase transition. Suddenly what worked no longer works.

I have written extensively in a series entitled “Sultans of Swap” and another series entitled “Extend & Pretend” the growing and clearly evident tipping points that are unquestionably now on the horizon. You can ignore them at your peril, but when the storm swells hit, don’t say you were never warned and no one saw this coming.

Consolidating the trends and distortions outlined in these two series, we arrive at the following ‘large brush’ death spiral leading to a failure of fiat based currency regimes.

The above cycle is well supported by recent and still unfolding developments. These have been mapped onto the cycle.

MAPPING THE TIPPING POINTS

Let’s now list the Tipping Points which have become abundantly evident over the last few years and which are continuously expanded on our web site Tipping Points.  We track each of these on a daily basis on the site.  The rankings shown below, though they do shift, we have found to stay relatively stable on a quarterly basis.  Each Tipping Point has the capability of individually being a catalyst to advance the sector marked in red above.

SEQUENCE & TIMEFRAMES

We can never be sure of the sequence and time frame of any particular Tipping Point. Like a house of cards you never know which one, or what movement will precisely bring the house of cards down. What you know however, is that it will happen – you just need to be patient and prepared. Unfortunately few have the patience or think they can time it for even more profit. The greatest trader of all time, Jesse Livermore, wrote after a life time of trading, that his best gains were made when “he bought right and sat tight!”

Our current analysis on Tipping Points reflects the following:

DETERMINING MORE GRANULARITY – We are in the 2010-2011 Transition Phase

In my articles EXTEND & PRETEND: A Guide to the Road Ahead and EXTEND & PRETEND: A Matter of National Security I outlined even more granularity to the virtuous cycle turning vicious spiral.

We can now overlay the Tipping Points onto this map. We arrive at the following.

A – EXIT FROM ECONOMIC CRISIS STAGE

• Commercial Real Estate – Finally forced to account properly for mark-to market valuations.
• Housing Real Estate – Option ARMS come due and FHA / FNM / FDE / FDIC are seen as insolvent.
• Corporate Bankruptcies – Unfunded Pension impacts and debt loads (gearing) on reduced revenues.
• State, City & Local Government Financial Implosion – Non Accrued Pension Obligations, falling tax revenue and years of accounting gimmicks come home to roost.
• Central & Eastern Europe – The ‘sub-prime’ of Europe will soon erupt on the EU banking network as evidenced recently by Hungary and the Baltic States.

TRANSITION:

HIGHER INTEREST RATES
Significantly Increasing Interest Rates – A Major Global News Focus

A $5T Quantitative Easing (QE II) Emergency Action
It will likely be triggered by a geo-political event or false flag operation.

B – ENTER POLITICAL CRISIS STAGE

• Entitlement Crisis -  The unfunded and underfunded Pension charade ends
• Credit Contraction II – Credit Shrinks Violently
• Banking Crisis II – Banking Insolvency no longer able to be hidden through Extend & Pretend.
• Reduced Rating Levels - Falling Asset Values and Collateral Calls on $430T Interest Rate Swaps
• Government Back-Stopped Programs -  FHA, Fannie Mae, Freddie MA, FDIC go bust

C – HITTING ‘MATURITY WALL’ STAGE

Lending ‘Roll-Over’ – Game Ends

CONCLUSION

A recent Zero Hedge contributing author summarized the current environment nicely:

“There is an entrenched insolvency problem in the United States, and a picture is worth a thousand words. Insolvency is not illiquidity; insolvency is about income that can’t service debt burden. Notice where things fall off the cliff: I believe we are getting close to this point. Just need a catalyst. Sequential bond auction failures here, a sovereign default there, massive liquidity drain all around, worse… whatever. The fumes running the engine (QE, or credit easing) are dwindling.”

There is an old sailor’s saying:

Red sky at night, sailors delight.
Red sky in the morning, sailors take warning!

Every morning the next batch of economic numbers is released and the indications are consistently red. Of course the market initially drops, and then miraculously rises on no volume. Since 2007 we have potentially constructed the largest head and shoulders topping formation we have ever seen.

This doesn’t mean the markets are imminently headed down. What it does mean is you should be meticulously battening down your financial hatches and checking your options for every eventuality.

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain

Gordon T Long
Tipping Points

What IF we’re headed toward another market crash?

What IF the economy is headed toward a deflationary depression?

We at Elliott Wave International urge you to prepare for the worse. And we believe holding cash is a great way to prepare. Cash will serve as a bridge over “troubled financial waters”. And if the worse doesn’t happen? Well, you will not have lost anything!

No matter what happens, you’ll be financially safe. But IF financial seas become troubled again, you’ll be in a great position to take advantage of investment opportunities once those seas settle down.
Yes, Robert Prechter says actual greenbacks will have an advantage even over T-bills. He explains in the January issue of the Elliott Wave Theorist:

“Treasury bill yields go negative when the demand for T-bills outstrips supply at a time when nominal interest rates are near zero. Many people have trouble understanding why investors would be willing to pay more than face value for a T-bill. The answer is that the word ‘pay’ is less than meets the eye in a credit-based monetary system. Nobody pays cash for T-bills. They pay with something potentially worth far less: a bank balance, which today is a very precarious IOU. Between 2010 and 2015, most banks will close, and few people who kept their money in banks will be able to buy T-bills. Those who have them already will have value. That’s why some investors recently bid T-bills up past their face value.

“Now think about this: Negative yields make T-bills worth less than cash. In 2010, as deflation returns and accelerates, T-bill yields are likely to become quite significantly negative. Can you imagine a 5% negative yield on T-bills? I can. Rather than join that rush to lose money, a smart investor will instead convert his bank balances to greenback cash and keep it in safe places.”

Where can you keep your wealth safe? If your first thought is the bank, keep in mind: Many banks will likely close during a deflationary depression, and the Federal Deposit Insurance Corporation may become overwhelmed.

Submitted by RCS Investments

The Bull/Bear Weekly Recap

Bullish

+More signs surface that banks are beginning to loosen lending standards and is a critical element in sustaining and further boosting the economic recovery.  The demand-side is stabilizing as well after quarters of contraction.

+ Industrial Production shows a healthy rise led by auto production and was larger than expected.  The manufacturing recovery continues and has not fallen off a cliff by any stretch.  Coupled with last weeks report of the UCLA-Ceridian Pulse of Commerce (a leading indicator), we can be sure that this sector will continue to contribute to Q3 growth.

+Confidence in Europe continues to show as Irish and Spanish auctions go on without a hitch, while the German ZEW current conditions rose the most in its history in August.  Economic performance in the country continues to defy skeptics.

+ The Mortgage Bankers Association reports that their Refi-Index has reached the highest level since May 2009.  Increased refinancings will help in freeing up disposable income for increased consumption.

+ Abroad, the Shanghai and Sensex stock markets show improving prospects for economic growth in those regions.  Lower inflation gauges will support more stimulus measures in China, while India’s Sensex is near 30 month highs.

+ In Europe, Greece is surpassing expectations in controlling its budget deficit and has helped ease sovereign debt concerns, while the German Bundesbank raised its 2010 growth forecast. The global recovery continues with China and Germany leading the way.

Bearish

- Empire and Philly Manufacturing Indexes show a slowly fading recovery in this sector as both readings come in less than expected.  For the both indexes, New Orders move into negative territory for the first time in over a year.  End demand better come soon!

- Jobless Claims are strongly pointing to a double-dip on the horizon as job losses are increasing. The job market is not improving as the bulls state.  Looking at the details of the Philly Manufacturing index, the “Average Employee Workweek” sub-index fell from +1.7 to -17.1.  Demand for labor from this sector is decreasing as the inventory restocking phase is complete.

- NAHB Index fell to the lowest reading since the March of 2009, when the stock market was plunging to its lows.  Given that every recovery has been presaged by a rebound in this sector, can we be confident that this whole “recovery” is sustainable and that a double dip can be averted? While housing accounts for a smaller portion of GDP, home prices are still extremely important to consumer confidence.  A struggling sector, along with the huge glut of homes, will ensure that housing prices will take another leg down and with it, consumption and the banks. Need proof?  Check the latest Mortgage Applications report from the MBA as it seems that demand is showing stabilization after some increased readings in the past few weeks.  If this is where new demand is, prepare for the housing “ice age” this winter. (Link Courtesy of CalculatedRiskBlog)

- Consumer confidence remains in the doldrums as per the ABC and Gallup Polls.  No recovery is being seen on Main Street.  This is translating to weakening consumption trends as the second most important shopping period for retailers, back-to-school, is thus far turning out to be a dud.  Weekly consumption metrics, Goldman and Redbook, are showing renewed weakening in YoY consumption growth rates as well.  Earnings growth penciled in by analysts is too high given this metric.

- Leading indicators point to a slowing economy.  However, one must note that most of the positive impetus in the past months has been due to the “Interest Rate Spread”, which has been artificially maintained by the Fed’s ZIRP policy.  Subtracting this from the metric and you get an economy that is facing a higher probability of entering a double-dip recession with every passing month.

-  The ECRI leading indicator growth rate just declined back into double digit territory @ -10.0, while the prior week was revised from -9.8 to -10.2, so in reality we have no been in double digit negative growth for 3 weeks.  The signs of a double-dip continue to grow despite the consensus clearly not expecting one.

Observations/Thoughts

Looks like their will be little to no help coming from the fiscal side for a while.  That one last stimulus based on fear that I was expecting in my Q2 Outlook has come and gone (though I thought it would be bigger), meanwhile, …

…the warning flags are waving more aggressively: housing, treasury yields, jobless claims, manufacturing, and consumer confidence.   Is the other side of this hurricane upon us?

What I had harped about for months is now finally hitting the mainstream.  Structural issues have not been dealt with.

As an investor, these are the types of articles you do NOT want to see on Bloomberg.  It shows that consumers are still struggling and that the second most important period for retailers is turning out to be a dud.

An excellent synopsis of the impending protectionism that investors are failing to discount (only beginning to get slightly mentioned in the media). (Link Courtesy of Mish’ Global Economic Trend Analysis)

What you see here are countries that are dependent on exports.  China has the same problem as they have kept the Yuan from strengthening.  Speculation is that England may do another round of QE.  Obama is promising to double exports.  Not everyone can be an exporter ladies and gents.  The world economy will remain set back until emerging markets can formulate sustainable recoveries in their underdeveloped domestic economies.  That development would be a step in the right direction.

…our Fed continues to believe that QE is the best solution to our problems.  For a good analogy regarding stimulus and the economy, check this out.  I wrote it a while back.  Note: QE qualifies as monetary “stimulus”.

Here we go again.

It’s been a great run for Treasuries for quite a while.  My Bullish call on this asset class was spot on.  But the gains are unlikely to continue now that we are seeing “capitulation” from the most ardent Treasury bears and high levels of bullishness in general.  Everyone is now on the same side of the boat, which means that there’s little impetus for further considerable bullish moves for the time being.  I’m considering moving to a neutral stance…stay tuned.