I THINK THAT WINTER HAS RETURNED

Not a weather discussion (although I will say that this summer sucks and I am a global warming skeptic).

On May 2nd (and S&P 877), I wrote the following:

I believe that we are nearing an inflection point here. A downleg is starting that should take us to approximately S&P 777ish over the four weeks. From there, we can either start a nice summer rally (back to current levels of S&P 877 or higher to 900-1000) or we can go right to a retest of the March lows. The real move lower will probably start in August 2009, but I am still not sure when. Ultimately, I believe the stock market is going to go a lot lower.

An inflection point did ensue on May 8th, when the S&P hit 930. From that day forward, the market stopped going straight up and basically stalled and entered a trading range between 878 and 956. Currently, we sit at 898 and tested the lower end of the range today.

I was wrong in that the market did not just roll over and sell off to S&P 777. I talked about a summer rally back to 877 or 1000. Obviously, that hasn't happened yet. Perhaps the two merged together? The bears (777 or lower) fought the bulls (summer rally to 1000) and we called it a draw for the past 2 months and we are now close to that 877 (we hit 886 this morning).

"The real move lower will probably start in August 2009, but I am still not sure when."

I now think that the real move lower started on June 11th when we hit S&P 956. I am not sure if we are going straight down from here or if we are going to rally a little bit first here and then go lower in August.

I do feel that a top is in. Why?

1) Lowry's Report. Basically, they are saying that the underlying demand and supply of the market is much worse than what the price action of the indexes is indicating. Their head Paul Desmond recently went on CNBC to say this and he expects a break of the March lows.

2) The gold/silver ratio is warning of trouble ahead (thanks Bob Hoye) by jumping to 70 from 61. A similar jump happened last August. We all know what happened in September 2008! This ratio often leads in a crisis.

3) The US dollar appears to have bottomed. Another nail in the coffin of the bulls if it is true.

4) Commodities appear to have peaked. Another nail.

5) Jeffrey Cooper from Minyanville.com, one of the best out there and a master of cycles analysis, has been warning of impending trouble from mid August onward. I agree.

6) The green shoots were a myth. The proof is overwhelming that all you had was a slower decline in GDP not a return to sustainable growth (ie underlying demand, not inventory building). You could conceivably have green shoots at some point. I just don't see them yet. The biggest green shoot is the stock market. Yeah, that worked out real nicely in October 2007, when the S&P hit a new high, a month before the recession started, didn't it? Also, last month's US unemployment figures were horrible (while better than earlier in 2009, they were worse than anything in the last recession, including the period after 9/11- remember all those airline layoffs!). Consumer spending has also been atrocious of late.

7) The history of monster bear markets is that they often have 40%+ rallies and then ultimately go to new lows. Look at the Nasdaq 2000-03. Ditto for Dow 1929-32 and Japan 1989-? Their purpose is to reset the shorts (by stopping them out or burying them) and suck in the bulls. Bear markets are as much a function of time as price. We have had a severe decline in price (although I think we need more). In terms of time, for a megabear market, this one has been quite short (20 months). More time is necessary to change psychology on a long term basis

8) Sentiment has become almost universally bullish. It always does in a bear market rally after a crash. There are no shortage of people who have claimed that the worst is over. I believe the worst is coming. Even some of the bears are only looking for a retest of the March lows (the bulls are looking to 1000 to 1300 and laugh at the thought of a retest; they are convinced that a 40% rally means that a new bull market has started). I am looking for a break of the March lows.

9) International problems are likely to rear their ugly head (North Korea, Iran, swine flu, Latvia, Ireland, Chinese smoke & mirrors- I am a China skeptic).

10) The recent spike in long term interest rates is a possible warning shot of problems ahead. Higher interest rates are sinking the economy and are likely to cause further problems as they spread to non-government bonds.

There are plenty of other confirmations, including my own gut. The one fly in the ointment is ECRI. If the recession is truly over, I suspect that the March lows are not going to be retested and that I will be wrong.

Where do we go from here?

I am positioning myself quite heavily on the short side for the first time this year (and the first time since last fall). I am targeting a move to S&P 600 as my conservative target sometime this fall/winter. A move to S&P 444 is possible if things really unravel although that may be a target for later in 2010.

I realize that these numbers sound crazy, but these targets are consistent with other major bubbles (remember that the Nasdaq-100 lost 83% and the Dow lost 90% in the 30s).

I also remember writing this back on September 5th, 2008 (S&P 1242):

If things got really ugly in October/November and we sunk to say 770 S&P with a few bank failures, you could even have the end to the bear in terms of price.

While I retract the "even have the end to the bear in terms of price" portion, the S&P 770 was 38% below the price of that day and 50% from the all-time high. A move to S&P 600 would be a similar 38% move. A move to S&P444 would be a full retracement of the entire bull market move from 1994/95.

I also warned of TSX 9,000 and $60 oil back on July 8, 2008, when oil just finished peaking at $147 and the TSX hit 15,000. Didn't that sound ridiculous?

I am bullish on USD and Japanese Yen and that's about it for the time being. There will be few places to hide for the rest of the year, I believe. I see the loonie going to new lows and oil going to $20 or $30 eventually. Gold is likely to get liquidated as well, but may present a fantastic buying opportunity in the fall (I am currently long a little gold but I suspect that I will get stopped out soon).

I may change my analysis tomorrow, so do your own homework, but I just wanted to update the reader (if I have any left?) on my thinking.

Disclosure: positions in USD, Yen, CAD, ultrashorts in oil & various equity indexes, selected equities, long gold.