The Stock Market Battle Rages as the Chickens come Home to Roost

By: Tim_Wood

The battle between the natural forces of the market and the desire to prevent these natural forces from occurring has now moved to a new level. Up until recently, these efforts were more subtle and more traditional. We are now seeing an outright campaign to keep the market afloat. As I see it, these efforts do not instill confidence, but rather go to show just how desperate the situation with the market truly is.

Back in 2000 when that market top occurred the Dow theory had confirmed that a Primary Trend change had occurred. In addition, my cyclical quantifications surrounding the 4-year cycle called for a decline that would at minimum take the Industrials down below the 1998 4-year cycle low, which did in fact occur. As the market moved into that 4-year cycle low in 2002, the cyclical bias of the market began turning up as the new 4-year cycle low was made. By June 2003 both the Transports and the Industrials had moved above their previous Secondary High Points, which told us that the Primary Trend had then turned up. So, at that time there was an intermediate-term positive bias to the market. Longer-term, all indications were that this was a giant rally that would serve to separate Phase I from Phase II of a much longer-term bear market and the threat of deflation, which the Fed is deathly afraid of, was staring us in the face.

However, back in 2001 the natural long-term cycles in the entire commodity complex had bottomed. By the time the stock market hit bottom in 2002 and began moving up in 2003 the long-term cyclical advance in commodities was well underway. As the stock market continued to advance we continued to see more and more interest rate cuts and massive increases in the money supply, which of course were all efforts to hold the market up and to kill the deflationary threat. The efforts were made because the Fed, too, knew the threat and the critical state of the market. As a result of their efforts along with the fact that both stocks and commodities had made major long-term cycle lows, the unprecedented liquidity campaign served to stretch the commodity cycles and set off the inflationary environment that began in late 2001. For those of you that don't remember, in November 2001 gold was 271 dollars per ounce. Crude oil was 18 dollars per barrel and the spot price for gasoline was 48 cents per gallon. In my area gasoline sells for about 60 cents a gallon over the spot, which would have put the price at the pump just over a buck.

Another by-product of this massive re-inflation effort was the housing bubble, which at the time I specifically remember that no one wanted to admit existed, much less that there was a problem. In any event, most everyone with so much as a pulse was buying houses. It was a building and refinance frenzy. People were “taking advantage” of low interest rates and rising housing prices to refinance their homes and/or to take out home equity loans for luxury items that they normally would not have been able to “afford.” People were also taking “advantage” of variable rate mortgages and balloon payments.

There were commercials on TV advertising loans in which you could refinance your house at up to 125% of its value. Home appraisals were being inflated and loans based on those appraisals were common place. I asked then and I still ask today, what were people thinking? What were the banks thinking and why were they caught up in such madness to allow themselves to make such loans in the first place?

The level of this frenzy continues to amaze me. I was talking to a friend just this week, who was telling me a story about the Branch Manager of his bank. This person was telling him that she was having to refinance her house because even she had fallen for a variable rate mortgage and her payment had doubled. This same person was also trying to talk him into “putting some money to work in the market” through some of the bank's many wonderful programs. Again, seemingly intelligent people were caught up in the housing bubble. I guess most everyone believed that rates would stay low forever and that prices would continue to increase forever.

In any event, the re-inflation efforts to promote and spend the US economy out of the hole it was in was successful. These efforts sent commodity prices higher and served to stretch the natural cycle further than normal. The housing bubble was ignited and the stock market was literally resurrected from the grip of a massive bear market. I have absolutely no doubt about that as by all historical measures, the market was in serious trouble and had indeed slipped into a major bear market.

Well, things are different now and as the old saying goes, “The chickens are now coming home to roost.” I first reported on October 28, 2005 that based on the cyclical structure of the hosing indexes we were very close to having a confirmed long-term top in housing. That confirmation soon followed. I have more recently in the July 14, 2007 article, on this website, shown you how the housing market typically leads the stock market at 4-year cycle tops. At present, I now see indications that most commodities have now topped. Plus, as anyone who has been reading my articles on the stock market know, I have been saying that the 4-year cycle has not bottomed and that the re-inflation efforts have simply served to stretch the 4-year cycle advance well beyond the historical norms.

As I see things we are now at the exact opposite end of the spectrum from where we were in 2002. First, the housing market has no doubt topped just as I first said nearly two years ago. But, it was not until more recently this year that we began to see the problems surrounding the housing bubble begin to surface. Everyone is now aware of the sub-prime mortgage issues. But there are also other issues with people with variable rate mortgages, declining housing prices and many people that used there homes as banks to finance their life style are now left sitting with larger mortgages and in many cases higher payments to boot.

Secondly, the cyclical environment for commodities has run its course as these long-term cycles are now rolling over and in many cases have already begun moving down. Third, the stock market now sits at or near the top of one of the longest extended 4-year cycle advances in stock market history.

So, at this point, as I see it, we now have an even worse problem than we did back in 2001 and 2002. Who is left to buy a house? The mortgage problems are all over the news and foreclosures and defaults are escalating nation wide. Long-term commodity cycles are rolling over and the stock market is extremely over extended with the pressures of the 4-year cycle bearing down. This is not good. Not good at all and the Fed knows it. Proof of the seriousness of this situation is seen simply by the increasingly drastic measures that we are now seeing. As soon as the market began to decline in late July they took their efforts to another level by publicly announcing their efforts. This was all occurring before the market had even fallen 5%.

In the last month we have seen bank repos, we saw the Discount window extended from overnight to 30 days with an option to extend it out to 60 days and the propaganda surrounding this is that it's now considered a sign of strength. What? Last Friday we saw an engineered cut of the Discount rate conveniently occur on option expiration day. On August 22 nd we saw J.P Morgan, Citigroup, Bank of America and Wachovia borrow $2 billion dollars from the Federal reserve. Later that night it was reported that Bank of America, coincidentally, made a $2 billion dollar purchase in the struggling mortgage company Countrywide. Hummm! Seems that the monetization of the debt has begun.

The commodity cycles have topped, the housing market and the credit markets are in shambles. The average consumer is now saturated with debt and the forces of the over stretched 4-year cycle in the stock market is pressuring the market in a big way. But, perhaps, just perhaps, the Fed can engineer another gasp for the market. But, at this point I really have my doubts and even if they can, it won't last and it certainly won't make the issues go away. The 4-year cycle low that most people believed occurred last summer never occurred and that evidence is now beginning to present itself.

Just as I have said all along, this cycle has been stretched, the low still lies ahead and we are now only just beginning to see the unwinding into this very overdue low. For anyone who still has doubts about this, then I have to ask, why do you think we are seeing such drastic measures to save the market? Guy's we are truly sitting on a house of cards and when the masters of the financial universe are afraid to even see the market correct 5%, it should tell you something. There is an awakening coming and you have been warned.

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By Tim Wood
Cyclesman.com

© 2007 Cycles News & Views; All Rights Reserved
Tim Wood specialises in Dow Theory and Cycles Analysis - Should you be interested in analysis that provides intermediate-term turn points utilizing the Cycle Turn Indicator as well as coverage on the Dow theory, other price quantification methods and all the statistical data surrounding the 4-year cycle, then please visit www.cyclesman.com for more details. A subscription includes access to the monthly issues of Cycles News & Views covering the stock market, the dollar, bonds and gold. I also cover other areas of interest at important turn points such as gasoline, oil, silver, the XAU and recently I have even covered corn. I also provide updates 3 times a week plus additional weekend updates on the Cycle Turn Indicator on most all areas of concern. I also give specific expectations for turn points of the short, intermediate and longer-term cycles based on historical quantification.

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