Stock Market Crash! Blog

Bubble Charts

I'd like to create a post showcasing the most rudimentary aspects of the housing bubble, in the form of simple housing price charts. I'm sure this has been done 1,000 times, but I feel the charts tell the whole story better than any other statistics. A picture is worth a thousand words.

Its obvious from the first glance at the charts that we are in a speculative mania, at least in the coastal regions:

The US average price of houses sold has increased 50% since 2000, with a 33% rise since 2003:



The average selling price of houses in the Northeast US has increased 63% since 2000 and a staggering 50% since 2003 alone:



The average selling price in the Western US soared 73% since 2000 and 45% since 2003.



These levels of appreciation would be respectable coming from more volatile investments such as stocks and commodities, but is absolutely outrageous coming from the sleepy and staid real estate markets. While stocks have been slowly rising since 2003, many investors have been chasing more exciting investment returns, which they've certainly found by creating a self-fulfilled prophecy that is the housing bubble.

Strangely enough, the housing bubble might keep inflating another 50%, based on the action of other historic bubbles. In a speculative episode, all common sense is thrown to the wind, setting the stage for drastically unrealistic asset valuations. Read through this site's historic market crash articles to get an idea of this process.

As a bubble inflates, there are often pundits warning of overheated prices, only to get ignored as prices leap up exponentially. Speculators then see that the pundits have been wrong (actually, too early) and take it as a confirmation of their overly high expectations for the markets' ascent, serving to push the market even higher. At the height of a bubble, most skeptical ideas are quickly dismissed by the investing public, saying "the market won't crash, but it may level off for a while" and "skepticism isn't profitable" and other variations on this theme.

It should be interesting to watch such a classic bubble unfold before our eyes.

Oil Taking a Pause

The last few weeks have seen crude oil skyrocket from $68, to its all-time high over $75 per barrel on geopolitical concerns. Unsurprisingly, the market took a pause on profit taking Monday and Tuesday, easing from $75 to $72.88.

Does this drop mean the rally is over? Most likely not, however, some sideways consolidation is to be expected after such an explosive run-up. Even the strongest bull markets take occasional pauses before resuming their previous trend. This type of market action is the most healthy and sustainable as it prevents a meltdown from the market moving too far, too fast.

In my view, oil is still in a bullish trend as long as the price is over $70 per barrel. Oil may even retrace to this point before resuming upwards. If it goes below this point, all bets are off. Here is the chart:



The consolidation may take the form of a rising pennant formation, which is fairly common in a strong bullish move.

There are several strong potential catalysts for oil to resume its uptrend:

1)Wednesday's Department of Energy inventory report is expected to show that crude stocks likely fell on average by 137,500 barrels in the week ended April 21. Closely watched gasoline stocks are picked to fall by 2.4 million barrels. Source.

2)Iran is ratcheting up its defiance ahead of the April 28th U.N. Security Council deadline to suspend uranium enrichment, while threatening to drop out of the Nuclear Nonproliferation Treaty. Source.

3)U.N. Nuclear Chief Mohamed ElBaradei's report on Iran's cooperation with U.N. Security Council is due to reach the Security Council and the IAEA's 35-nation board of governors by Friday. The report is widely expected to be negative, showing Iran's noncompliance. Source.

There are certainly more variables, but these are the main stories which will cause some volatile oil trading.

Dow at Major Crossroad: 11,400

We're approaching a very exciting and crucial time in the US equity markets. The Dow is less than 100 points away from 11,400, the level that stopped the 1990's bull market right in its tracks, resulting in a terrible bear market that ended at 7,200.

From 1999 to 2001, the Dow attempted to break 11,400 four different times, only to come crashing down again. Another time, in early 2000, the Dow briefly passed 11,400 for a few weeks, then dropped 2,000 points. Click on the chart below for a larger version:



Clearly, Dow 11,400 is THE most important resistance level in this index, and we're closing in on it. Depending on how the market treats the resistance, we can either enter a bull market or a bear market.

The Bullish Case

If the market closes above this important psychological barrier, its possible to have a strong bull market, perhaps lasting several years. Some possible causes for this may be the rapid and healthy corporate earnings growth, low unemployment and the white-hot growth of China, India and other emerging markets. Collectively home to 1/3 of the world's people, China's experiencing +9% annual GDP growth, while India boasts +7% growth. The growth of these economies has helped lift hundreds of millions of people out of poverty in the last decade alone, while helping to foster an emerging middle class. This large middle class is an excellent potential consumer market for globally-produced goods and, consequentially, a boon for the global economy.

Additionally, Japan, the world's 2nd largest economy, is said to be emerging from the deflationary downward spiral that started with the pop of the Nikkei bubble in 1990. The combined effects of the current economic conditions can be summed-up with the saying, "a rising tide lifts all the boats." The IMF projected the global economy will expand by 4.9 percent this year and 4.7 percent in 2007, a very hearty growth rate, indeed.

If the Dow has a firm close above 11,400, I will likely take a long position in stocks. Yes, you've heard right. The owner of a bearish site MIGHT buy stocks. I'm not a permabear, but a capitalist who makes money on either side of the market. I will place a stop loss in my stock at a level corresponding with Dow 11,400. If it drops below this level, all bullish bets are off.

The Bearish Case

An alternative scenario (and equally plausible) is that the bull market could bump its head on the 11,400 ceiling, and embark on a bear market, in a 2001-like "deja vu all over again."

The impetus for a bear market is +$73 per barrel oil prices (and maybe higher soon), gasoline at over $3 per gallon, and higher interest rates which will pop the housing bubble. Once the housing bubble implodes, foreclosures will increase and consumers who use their homes as ATM machines will feel the pinch and curtail their spending. Now the housing wealth effect which has made home owners feel very wealthy, will run in reverse.

The homeowners who will be hurt the most, with the rise in mortage rates, are the ones who let themselves get duped into taking on adjustable rate mortgages or ARM's. With an ARM, monthly mortgage payments rise as interest rates rise. Homeowners who overleveraged themselves with jumbo-mortgages will face dramatic increases in monthly payments, forcing many to foreclose- especially if the job market weakens. According to the Mortgage Bankers Association, ARM's constituted 34 percent of mortgage applications in 2004, a staggering figure indicating many people who think interest rates will be low forever and housing "always goes up." Sounds alot like the other historic bubbles I wrote about for this site.

More worriesome is the statistic from the National Associations of Realtors, saying that 36 % of the home sales in 2004 were second home purchases, ie. mostly speculative buying and "flipping." As housing deflates, these speculators will add more fuel to the fire as they attempt to unload their houses.

Added to the bearish mix is Iran's lunatic President Mahmoud Ahmadinejad who threatens the stability of the world, due to his aspirations to bring about Armageddon and the "Coming of the Hidden Imam." The Western world MUST attack Iran- either kill or be killed. Death isn't exactly a fear of a nation thats on a suicide mission.

Inflation is also a casualty of the kind of rapid global economic growth of the past few years. The sheer demand for copper, cement, oil and other raw materials from China and India is evidenced by the 4 year commodity bull market, sending each commodity to record heights. The cooling of these economies may result in deflation, dragging the rest of the world down as well.

If the market fails to break 11,400 and drops, I would likely short housing stocks, because these will be among the worst performing groups.

A 20-Year Stagnation?

One interesting observation I'd like to share is that the current Dow MAY be experiencing a similar pattern to its sideways pattern that lasted from the mid-1960's until 1982, as the Dow repeatedly attempted to breach the 1,000 level, only to result in four different bear markets. A 20-year stagnation ensued as the Dow stayed flat. The market was more akin to a massive 20-year bear market, at least in real terms, as inflation reached dizzying levels.

Now, in 2006, is Dow 11,400 the same as Dow 1,000 in the 60's and 70's? Click on the chart below to see a larger version:



I'm not saying this scenario is a guarantee, but rather it is something to keep in the back of your mind. A similar stagnation also occurred in the early 1920's as the Dow struggled at the 100 level.

In my opinion, there are many potential reasons why the market might stagnate in the next 20 years. The end of cheap oil and the unuse of alternative energy sources is a great reason. Another is the Western world fighting against a relentless, decentralized terrorist enemy, causing society to live in constant fear. Policing the Iran and Iraq may reduce the US's economic vitality. Economic stagnation might also be caused by the astronomical debt loads that have become in vogue with governments around the globe. The graying of developed nations' populations will also contribute to the slower economic growth in the future. A nation of retirees simply can't have the innovation and rapid development of a nation with youthful workers.

Will the market break 11,400 or hit its head? I can honestly admit that I just don't know. I'm thoroughly confused as much as I'm amused. Then again, as a trader, I don't have to predict, I only have to react which in this case means seeing how the market reacts at this monumental psychological level. Very soon, I will make a post announcing which road the market decided to take, and how to use this information to your advantage.

Putting My Money Where My Mouth Is: Oil Stocks (Update 1)

Oil hit an all-time high of $72.49 on Wednesday after weekly data showed a drop in U.S. gasoline stocks, raising worries that refiners don't have an adequate inventory cushion ahead of the peak summer driving season. That, and an announcement by Iran's King Ahmadinejad saying that oil, even at $72.49 per barrel, is still underpriced. He knows exactly what to say to roil the oil markets, not that it takes much nowadays.

How did my foray into oil stocks fare? In less than 3 days, I made $504 on a $11,032 investment, for a 4.57% gain. I have a feeling this is only the beginning. Based on my earlier projections, oil has a target of $82 or more.

Its a strange feeling to profit handsomely on an issue that's causing everyone else such grief. Trust me, I'm not happy that oil might go to $82 per barrel. I'd much rather profit from shorting oil, making me the same profits, and having everyone rejoice with me. I am a realist, however, who realizes that the forces propelling oil ever upward are out of my control and that I might as well profit from them. This is the same turmoil experienced by a short seller in a bear market.

This logic leaves me with an answer to all those who complain about increased gas costs, etc: They can buy oil futures and oil stocks and hedge themselves. Big companies hedge against increased raw material costs all the time. Thats why the futures markets were created in the first place.

This leads me to an article written by Robert Kiyosaki, called The Coming Oil Crisis, in which he projects "oil at over $100 a barrel and gasoline at $5 to $12 a gallon at the pump."

I personally enjoyed the section where he talked about the "wealth equations" of most individuals and some companies versus that of oil companies and those investing in oil. He detailed how the former's wealth is negatively correlated with oil prices while the latter's wealth is positively correlated. Kiyosaki emphasized that the ordinary person has a CHOICE if they want to be the former or the latter. What will you choose?

Putting My Money Where My Mouth Is: Oil Stocks

A few posts back, I mentioned the possibility of oil reaching $82 per barrel and why it might be wise to purchase Chinese oil stocks. Since that post, oil has closed at an all-time high of $70.42 per barrel on increased geopolitical tension.

Well, I decided to put my money where my mouth is- $11,000 of it. I purchased 132 shares of CNOOC (China National Offshore Oil Corporation), symbol CEO, at $83.44.



Yes, its the same CNOOC that gained infamy in July 2005, when it made an all-cash $18.5 billion offer to buy American oil company Unocal Corporation, causing a political backlash. Many questions were raised regarding the jeopardy of American national security by having a bellwether oil company in Communist Chinese hands. Eventually, CNOOC retracted its bid to avoid the months of controversy. If anything, the affair symbolized the coming of age of China's economic might, in a manner akin to Japan's rise in the 1980's- and all the fears associated with it.

Now that I'm finished with that aside, let me brag that CNOOC gained about 1% since my afternoon purchase, earning me a cool $100. My buying decision was influenced by my bullish view on oil, but I saw a particularily good opportunity in CNOOC. Since February, CNOOC has been in a downward trending channel, which it has now broken out of, coinciding with oil's breakout of its ascending triangle.

My preferred method of trading, at this time, consists of trading breakouts from sideways consolidation areas. I like to analogize these consolidation areas to a compressed spring- full of potential energy, and ready to blow at any minute. Some of the most explosive moves I've seen started as breakouts from boring range-bound action. Another reason for this trading style is that it offers a good risk versus reward ratio compared to investing in a market that is already trending. You can never know if the market will correct or consolidate right after your purchase. In a breakout, however, the support line is often just below the price, meaning a correction to this level won't cause a large loss of your trading capital.

In the case of CNOOC, I have my stop loss order set at 81.70, which is the resistance line (now support) of the upper channel that was just breached.

Supporting my bullish views on oil stocks is a research segment by BCA Research, an economic forecasting firm which has been highly accurate in the past. BCA posits that "oil & gas stock valuation multiples are low—a metric which adjusts the trailing P/E ratio for the level of interest rates is significantly below its historical average."

We'll see how it goes. I will certainly profit if Iran's Mahmoud Ahmadinejad decides to stop oil tankers from transiting the Strait of Hormuz and/or the US decides to attack, a possibility that is growing by the hour. At least my profits will help offset my increased gas costs ;)

How To Profit From the Interest Rate Ascent (Pt. 3- Utility Stocks)

For the final part of this series, we recommend utility stocks as good short sale candidates as interest rates continue to rise. Utility stocks have been in a virtually unstoppable bull market over the last five years, benefiting from low interest rates like their REIT and homebuilder counterparts. Utilities and other companies with high debt loads are more sensitive to interest rates because of the higher cost of borrowing.

Here's a chart of the Dow Jones Utility Average ($UTIL):



In October 2005, the Utility Index broke below an important trendline, marking a new, weaker phase in the bull market. A short sale of utility stocks might be in order IF (and only IF) the Average breaks below the support line at 380.

I make a big emphasis upon a strong close beneath supports, because without such confirmation, there really isn't a way to tell if the support will mark the low before a stock embarks on another leg upwards. You really can't predict the market, only react to it after seeing important trendlines being broken. Once again, place a buy stop-loss just above 380.

Just like REITs, you can short utility ETF's, such as iShares Dow Jones US Utilities (IDU) and Utilities Holders (UTH).

For a list of individual utility stocks, check here.

Click here to check the updated Dow Jones Utility ($UTIL) index chart at StockCharts.com

How To Profit From the Interest Rate Ascent (Pt. 2- REITs)

Real Estate Investment Trust (REITs) stocks are the next eligible short-sale candidate, as interest rates rise. Take a look at the Dow Jones REIT Index chart ($REIT):



In a little over 2 years, the REIT index nearly doubled as it rocketed from 450 to 850, creating 2 important uptrendlines in the process. Even the slight corrections were the paragon of a healthy bull market, because the reaction low at point 3 never closed below the last rally high at point 1.

The economic climate has changed a bit since then, however, and interest rates seem to be reverting to their more familiar (higher) levels. This Investopedia article offers a cogent explanation of the negative correlation between REITS vs. rates.

A short sale in REIT stocks might be a wise choice, but only IF the Dow Jones REIT index closes below the rally high at point 2 and then below the uptrendline which started in May 2004. A close beneath point 2 would be a strong indicator of the declining health of this bull market.

Shorting REIT exchange traded funds are the most simple way to gain exposure to this market. The Vanguard REIT Index Fund (VGSNX) or Vanguard REIT Index VIPERs (VNQ) are good candidates.

For those who'd prefer shorting individual stocks, take a look here for a comprehensive list.

The best place for a buy-stop loss order is right at the 755/760 mark of the support level. You must always leave room for your trading ideas to go wrong. The best traders often take small losses while in pursuit of "the big one." All it takes, however, is a few very successful trades to win big in the markets.

Click here to check the updated $REIT index chart at StockCharts.com

How To Profit From the Interest Rate Ascent (Pt. 1)

In the preceding post, I promised to show how to profit from the collapse of bonds and consequent rise in interest rates. Not surprisingly, I recommend shorting interest rate sensitive stocks. I will detail 3 stock classes that are great short candidates, in a mini-series of blog posts, with one post for each of the 3 classes.

1)Homebuilder Stocks

The housing bubble of last six years has been fueled largely due to mortgage rates being at multi-decade lows. Homebuilding stocks have greatly benefited from the overheated real estate market. A homebuilder stock, Hovanian Enterprises, has risen a remarkable 2,233%, Beazer Homes rose a respectable 1,066%, and Lennar Corp a "measly" 650%.

Now, interest rates are heading back up, reversing the process which caused homebuilders good fortunes.

A look at the Dow Jones Home Construction Index ($DJUSHB) shows a bearish head and shoulders top reversal, which is looks earily like an upside down chart of the 30-Year Treasury Bond yield chart, from my last post. Mere coincidence? I think not. Interest rates are inversely correlated with housing stocks. See here:

$DJUSHB:



30-Year Treasury Bond yield. Notice how well the right & left shoulders and head corresponds with those of $DJUSHB:





Our previous post detailed the profit target measuring technique as applied to a head and shoulders bottom reversal, and the same applies for $DJUSHB's head and shoulders top, albeit in an upside-down manner. You must subtract the vertical distance of the widest point of the pattern from the price where the market breaks below the neckline support level. This gives us a price target of 530 from the current 866. The market is likely to drop to this point, form a flat trading range, and embark on a continuation of the previous trend.

Before entering a trade, the most prudent move is to wait for a strong break below the 850 necline support. This confirmation is necessary to see if the head and shoulders is indeed valid. What I find notable is how 30-Year T-Bond yields already broke above their neckline resistance, possibly foreshadowing what's to come for the $DJUSHB.

Upon a confirmed break below 850, the best bet is to short sell one of the stock components of the $DJUSHB index. These include Beazer Homes, Hovanian Enterprises, Lennar Corp., Centex Corp., Pulte Homes., and D.R. Horton Inc., to name a few.

The risk-management approach I would take is a buy stop-loss order placed at a point in the underlying stock that corresponds with the neckline support of the parent $DJUSHB index. A failure would be if the $DJUSHB rose above the neckline.

Have patience- part 2 and 3 of this series is coming soon!

Click here to check the updated $DJUSHB index chart at StockCharts.com

How High Can Treasury Yields Go?

In the spirit of the last post, I'd like to bring attention to another bearish chart pattern, this time in interest rates, more specifically the 30-year US Treasury Bond yield. This pattern is called a head and shoulders bottom reversal, which you can learn more about at StockCharts.Com. This pattern provides a minimum target of 5.5%, from the current 5.1%. The market has already broken out of the pattern and will likely continue rising.



Our measurement technique is derived from adding the vertical distance of the widest point of the pattern to the price where the market breaks above the neckline resistance level.

Its very possible for the yield to hit 5.5% and enter a sideways consolidation pattern before resuming its upward trend.

Such a rise in yields would entail a corresponding collapse of bond prices, as yields and bonds are inversely correlated. If yields hit 5.5%, 30-year Treasury Bonds will drop to a price of 100, from the current price of 107. See the 30-year Treasury Bond chart. Obviously, bonds aren't the best investment to be holding at the moment.

Some reasons for rising rates are inflation fears stemming from strong global GDP and employment growth, record borrowing by the US Government and rates' reversion to their mean after spending years at historically low levels.

Though we use 30-year Treasury Bonds as our example, the analysis applies to all interest rates over 5 year maturities, including mortgage rates. The accelerating rise of mortgage rates will only to serve to hasten the unwinding of the once white-hot housing market. So far, mortgage rates have only gently meandered downward, allowing housing to cool slowly. Could the coming development cause housing to implode? I think it will, but only in the overvalued East and West Coast markets which are awash in speculative activity.

Between the rise in rates and the cooling of the housing market (which will dampen consumer spending), you can expect economic growth to be stifled. My hope is that this scenario doesn't entail a recession, which is may certainly be in the cards.

The good news is that you can profit handsomely from the coming rise in rates, so stay tuned for the next post ;)

Click here to check the updated 30-year Treasury Bond yield chart at StockCharts.com

Is Oil Approaching $82??!!!

There appears to be a potentially bullish chart pattern formed in crude oil since its Katrina-induced high in September 2005. Ominously, the pattern suggests a minimum price target of $82 - a harrowing $12 advance from the current price of $70 per barrel.



The pattern is called an ascending triangle, a type of continuation pattern. Such a pattern represents a pause or consolidation before the market resumes in its previous direction. Read this excellent StockCharts.Com article to learn more.

The beauty of the ascending triangle pattern lies in its ability to provide an accurate price target for the markets' rally, upon a successful breakout from consolidation. You can find the minimum price target by measuring the triangle's vertical distance(in $) at its widest point. This dollar distance is then added to the price where the market breaks out from the triangle. If the market rallies past this minimum price target, you can find a second price target by adding the vertical dollar distance of the previous uptrend to the breakout price of the triangle.

A price target is very helpful as it allows you to assess the risk versus reward ratio for a trade and it indicates a potential exit price, as well. When the market is trading at the price target, one strategy is to place a stop-loss order a few points below the target, helping you to mazimize profits if the market embarks on another leg up. If the target becomes a ceiling, however, the stop-loss order will help you preserve much of the trade's profit.

The vertical distance of oil's triangle is approximately $14, making for a minimum price target of $82 from its breakout at $68. If the market rallies past $82, the next possible target is $92, which was found by adding the previous $24 uptrend to the recent $68 breakout point.

Either one of these afforementioned scenarios will greatly impede the global economy's powerful ascent, the severity of which will be determined by the price target and the length of time oil stays at such a lofty height. There are plenty of catalysts which could cause such a disaster in the next few months:

1) Escalation of the Iran crisis: Can consist of either UN economic sanctions on Iran and/or the West launching military strikes. Either scenario will likely result in Iran shutting off its oil pumps to the West, easily sending oil skyrocketing.

2) Continued strife in Nigeria's oil producing delta.

3) Increased gasoline demand for the summer driving season.

4) Lowered US oil reserves.

Despite the gloomy prediction, there are several ways to profit from oil's rise to $82 or $92. One great option is to purchase shares in Amex's brand-new Oil Fund exchange traded fund. This ETF directly tracks oil prices and is revolutionary because it lets retail investors gain oil exposure without dealing directly in futures or physical commodities.

Another excellent way to profit is to invest in Chinese oil companies, such as CNOOC and PetroChina. Chinese oil companies will rise in lockstep with oil's increase, while benefiting China's astounding 9%-plus GDP growth. Even the world's most successful investor, Warren Buffett's Berkshire Hathaway owns 659,000 shares of PetroChina.

Caveat: This trade COULD go wrong, its just a simple fact of trading life. The best solution is to use a stop-loss order a few percentage points below your initial purchase price. There's no reason to marry a losing position. Simply get out at a small loss, and find another trade. If it's successful, let your winner run by ratcheting-up your stop loss a few percent underneath the price.

Click here to check the updated crude oil chart at StockCharts.com