Friday, July 31, 2009

Martin Armstrong cycle hypothesis

Love him or hate him, you should at least be aware of the Martin Armstrong Economic Confidence Model and its major cycle turn dates. There are major and intermediate turn dates and the major cyclical peak turn date of 2/27/07 came within a few days of nailing the high in the financial sector (using the Philadelphia Banking Index [$BKX], the Philadelphia Regional Banking Index [$KRX], or the Dow Jones US Financials Index [$DJUSFN] as a proxy). Now the cycle turn dates do not tell you which sector or major market is going to turn at the major date, so it is only clearly evident in retrospect which market the cycle is predicting.

It is now unequivocally clear, with the benefit of hindsight, that the current bear market for the ages is a financial and debt crisis. The financial sector in the US peaked 8 months before the general markets but gave a clear warning sign of the pending disaster for those who chose to listen and had enough knowledge and foresight to know what the financials were telling market participants. While CNBC talked about Goldilocks and Bernanke talked about subprime "containment," the charts of the financial sector were screaming the opposite.

An intermediate term cycle peak date in the Armstrong cycle recently passed on 4/23/09. Now, the intermediate term turn dates are sloppier than the "big" turn dates, but the financial sector peaked a few weeks after this turn date (i.e., again using the $BKX, $KRX and $DJUSFN as proxies) and this sector has yet to make new highs along with the general stock markets. The $DJUSFN index is close to making new highs but the $BKX and $KRX are not.

I am guessing that these indices will fail to make new highs and will respect the cycle turn dates, irrespective of the general market indices, which have already made new highs. This hypothesis is easy to test and watch for, as the $DJUSFN is already in the process of potentially double-topping. If the $BKX and $KRX fail to make new highs along with the general markets this summer, this will fit with my Armstrong cycle theory and confirm in my mind that another wicked bear market leg this way comes.

If the $BKX, $KRX and $DJUSFN make nominal new highs this summer and follow the general stock market higher, then I would have to start to questioning the strength of this bear market rally. What I mean is that I am uber-bearish right now (what's new, right?) and don't buy into this last gasp rally one bit. However, if the $BKX, $KRX and $DJUSFN can make higher highs than their early May peaks, this bear market rally has some serious legs and Prechter will be proven right that this counter-trend rally may have a ways to go. Either way it is a bear market rally and nothing more, but timing is everything when trading.

This stock market has already failed to do what I told it to do - damn these markets sure don't listen, do they?


Following are the 6 month daily charts of the $BKX, $KRX and $DJUSFN to demonstrate the current lack of new highs in these sectors. I decided to test my theory with a little money and placed a debit calendar spread option trade using puts on the FAS (triple levered bullish financial secor ETF) to take advantage of the decay in this instrument over time.

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