Sunday, March 31, 2013

The First Crack in the Dam (of Confidence)

The bailout drama in Cyprus had created an atmosphere of uneasiness and suspense in Europe for the last two weeks. The significance of the events has been dismissed by most people, even economists and political pundits, all pointing out the fact that because Cyprus makes up just 0.2% of the European Union's GDP, that the damage to the larger Eurozone would be minimal. However, the economy is global with a lot of working parts integrated together (and has been that way since the 1400s, but society is more connected now than back then), meaning that when one part sustains damage or goes down, a chain reaction can happen.

As will be demonstrated here, the drama in Cyprus is much more serious than many would think. What happens in Cyprus affects the European Union, and eventually, the entire Western World. The next phase of the "Crisis of the Western World" is approaching. The drama in Cyprus started when the two largest Cypriot banks became insolvent and needed a 10 billion euro bailout.

The stage for the Cypriot financial crisis was set with excessive exposure to the Greek debt crisis (through investment in Greek treasury bonds, which have been considered junk bonds) and the downgrading of the Cyprus economy to junk status. Moody's had downgraded the credit rating of Cyprus to junk status on March 2012, citing the need for the Cyprus government to inject more capital into the banks. In June 2012, Fitch downgraded Cyprus bonds to BB+, no longer qualifying as investment grade as far as acceptance as collateral by the ECB is concerned. A short time later, Cyprus requested a bailout from the European Union's Eurpean Financial Stability Facility or European Stability Mechanism.

The drama started on March 16, 2013 when the European Union agreed to a 10 billion euro deal with Cyprus. In the first action of its kind, the part of the terms of the bailout is a so-called "wealth tax" that takes up to 10% of deposits for all domestic bank accounts.

1 -- News of the "wealth tax" sparked a mini-bank run in which people attempted to pull their money out of the banks as fast as they can. Many local ATMs ran out of cash in a matter of hours. With the sudden scarcity of cash in Cyprus due to the bank closures, many businesses have stopped accepting credit card payments.

2 -- The Cypriot government rejected the terms of the bailout on March 19, 2013. In the aftermath of the failed vote, The Cypriot government declared a bank holiday that would eventually last over a week. When the banks re-opened on March 28, 2013, capital controls were were already in place setting limits on how much money can be withdrawn along with the deployment of police in the streets amid the fears of a bank run.

3 -- When the bank holiday ended in Cyprus, the damage was already done. Many businesses and aging retirees saw their savings wiped out by the "wealth tax", losing as much as 80% of their life savings overnight.

Many politicians, economists, financial analysts, and news pundits have shrugged off the drama in Cyprus as "not a big deal".  The significance of the events in Cyprus is not recognized by most people. Confidence is an ironic thing --- it takes decades to build, but it takes only a few days to tear it down. Confidence is a very important part of keeping the banks fully functional. With the "wealth tax" genie now out of the bottle, the first crack in the dam (of confidence) has formed. The "wealth tax" has already caused some real damage to people in Cyprus and it has also caused many people in southern Europe to question whether their savings accounts and checking accounts are truly safe.

When people no longer feel that the money they have in the banks is safe, they become more likely to pull it all out. There is a reason why people stuffed their money under their matress in the 1930s during and shortly after the Great Depression (hint -- over 9000 banks imploded from 1929 to 1932).
There are very strong indications that the people at the top of the pyramid are oblivious to the cracks in the dam of confidence (see above). When a dam develops a crack, it becomes weakened and the cracks get larger over time. Eventually, the entire dam gives way and bursts.

There are already indications of more cracks in the dam of confidence that could form in the future:

1 -- Banks in Slovenia are in need of billions of euros of fresh capital and are struggling with bad loans that equal a fifth of the country's economic output.

2 -- There is already discussion of depositor haircut provisions for systemically important banks in Canada as part of the 2013 budget.

The first crack in the dam of confidence has formed. Over time, the cracks are expected to get larger, weakening the dam over time. When the dam bursting event takes place, the result is a full scale bank run throughout the Western World. The dam bursting event is most likely to take place in 2015 or 2016 and will start in Europe before spilling into the United States and Canada. The "tax wealth" genie is out of the bottle and it is going to be very difficult for people in high places to put it back in.

Sunday, March 10, 2013

The Mother of All Bubbles

It is very obvious that the credit bubble is still expanding even as it already exceeds the South Sea and Mississippi bubbles in size, magnitude, and duration. The credit bubble that is in play throughout the Western World (not just the United States) is literally the mother of all bubbles. The credit bubble did not burst during the "Panic of 2008", in fact, the bubble is over 40% larger than it was in 2007.

The credit bubble formed in 1974, at the start of Cycle wave V (1974 - 2000) up and continued to expand in size and area of influence. As we approached the peak of Grand Supercycle wave [III] (1784 - 2000), a series of smaller bubbles started to form. With a very long topping process in play, we have seen a series of smaller bubbles form and pop in succession even as the mother of all bubbles, the credit bubble, continues to relentlessly expand.

Here is a long term chart of the DJIA from 1997 - 2021 illustrating the topping process and the bubbles:

As the chart illustrates, the first of the smaller bubbles to form and go parabolic was the dot com bubble, also known as the tech bubble. The Nasdaq went parabolic in 1997 and shot up to a peak of 5132. More information on the dot com bubble is here. The bubble popped in 2000, ushering in the first stage of the Grand Supercycle degree bear market and associated major depression in the Western World. The DJIA and S&P 500 also peaked in terms of gold and PPI at the peak of the dot com bubble, and the peak has not been exceeded since. The aftermath of the bursting of the dot com bubble unfolded during Primary wave [A] of Cycle wave a and lasted roughly 34 months. The Nasdaq reached a low of 1108 on October 2002.

In 2003, The Bush 43 Administration and the Federal Reserve attempted to re-inflate the dot com bubble. With the credit bubble relentlessly expanding, the housing bubble started to go parabolic with the government taking part in the bubble. George W. Bush, during the 2003 state of the union address, said that "everyone should be able to afford a house". The parabolic phase of the housing bubble unfolded during Primary wave [B] of Cycle wave a in which the DJIA soared to over 14000 and the S&P 500 hit 1576. While the DJIA reached new highs in nominal terms (DJIA/$ ratio), it remained well below the 2000 high in real terms (DJIA/gold ratio and the DJIA/PPI ratio). The housing bubble popped during the 5 year rally. The popping of the housing bubble, and the sub-prime mortgage crisis that followed, would play a strong role in ushering in the "Panic of 2008", which unfolded during Primary wave [C] of Cycle wave a.

In 2009, the Obama Administration and the Federal Reserve started its attempt to re-inflate the housing bubble. The Obama Administration has thrown more than $7 trillion in cheap money into the economy, and the Federal Reserve has done a series of QE programs since March 2009. The money has pretty much stayed at the top of the pyramid, pumping up equity and commodity markets as well as causing the college bubble, the social media bubble, the Apple bubble, and the Google bubble to go parabolic. The current reflationary period, Primary wave [A] of Cycle wave b, is unfolding as a double zigzag with a projected peak in June 2014.

The rally off the March 2009 low is corrective and the rally has been unfolding with declining volume, with volume spikes during the Flash Crash and the large pullback in August 2011. The chart illustrates the bear market rally:

In bull markets, volume rises as the market rises, and falls during pullbacks. Volume is a very important momentum indicator. Even as the DJIA rose to new all-time highs in nominal terms, the DJIA is still far below the 2000 and 2007 peaks in real terms with the DJIA/gold ratio at 45.9 in 2000, ~16 in 2000 and it is at ~8 now.

Markets are expected to pull back for a few months, then soar again as the final stage of the Apple Bubble unfolds from July 2013 to June 2014. The chart of Apple illustrates the final stage of the bubble:

Apple's stock should fall to a low of $350 a share in July 2013. The structure is clearly corrective, unfolding as either a double zigzag or a triple zigzag. The final stage of the Apple Bubble is expected to unfold as an epic melt-up in the company's stock. Apple is a global corporate bellwether in the same way that the South Sea Company was a global corporate bellwether in the 1700s, so the influence of the bubble will be global. The melt-up is expected to have a very powerful influence, with many tech and social media companies taken along for the ride. The implication of the epic melt-up is a very powerful rally in equity markets with the DJIA hitting 17500 and the S&P 500 hitting 1900 at the peak of the Apple Bubble. It is worth noting that social media has morphed into a full blown bubble of its own, and Google has also turned into a bubble as well.

The Apple Bubble is expected to burst around June 2014 -- at a Kondratieff Cycle high point. The bursting of the Apple Bubble is expected to trigger the bursting of the Goggle bubble and the social media bubble, and the ripple effect will rip the job market apart throughout the Western World. The bursting of the Apple Bubble will usher in Primary wave [C] of Cycle wave w (2000 - 2019) in the Nasdaq and Primary wave [B] of Cycle wave b (2009 - 2021) in the DJIA and the S&P 500.

With a lot of three wave structures in the Nasdaq since the March 2009, the rally from the March 2009 low in the Nasdaq is very likely unfolding as an ending diagonal, as this chart shows:

The longer term chart of the Nasdaq shows a Cycle degree zigzag in progress, likely the first part of Supercycle wave (a) (2000 - 2042) in the index, which should unfold as a double zigzag:

The Nasdaq from 2000 clearly builds the case for the Apple bubble, the Google bubble, and the social media bubble bursting in 2014, while the college/student loan bubble and the credit bubble continues to expand all the way to the end of the "extend and pretend" phase of "The Great Deflation".

The mother of bubbles, the credit bubble, will continue to expand all the way to the end of Cycle wave b (2009 - 2021). Rising interest rates, combined with the continued addiction for debt throughout the Western World, will eventually cause the credit bubble to burst, which would also trigger the bursting of the college / student loan bubble. Just before the bursting occurs, the DJIA will reach 18750 and the S&P 500 will reach 2100. The bursting of the credit bubble will usher in the third phase of "The Great Deflation", Cycle wave c (2021 - 2042) of Supercycle wave (a) (2000 - 2042) in which a deflationary collapse of the economy throughout the Western World unfolds in full force.