Don’t you think this whole bank stress test idea is a self-fulfilling prophecy? Let’s look at them for a minute.
For instance, the tests were applied to the trading book side of the banks and not the ‘hold to maturity.’ Simply put, none of these tests took the sovereign debt issue into consideration at all because they did not apply to whatever bond positions a bank may be holding. The main part of the test was to be sure a Tier 1 capital ratio is at least 6%. What this means is the core measure of a bank’s financial strength from a regulators point of view. It consists of common stock and reserves and in the case of the European tests be at least 6%.
One expert on CNBC explained that by keeping an emphasis on the Tier 1 ratio, banks were encouraged to keep lots of cash reserves on hand and that means not lending it out to the business community. This is where it becomes a self fulfilling prophecy. There are obviously 2 sides to this. In sports, certain teams take the field expecting to win. They visualize successful outcomes beforehand and it generally happens in the game. That’s also known as momentum and it was a way of building on itself. Then there’s the dark side. Downward spirals build on themselves as well.
If the motivation is to keep reserves high enough to be sure they’ll survive a crisis, they unintentionally set up the conditions that lead to crisis. This is the same thing as expecting to lose. That’s why it takes so long to kick a secular bear market. We’ve discussed the retest of the bottom scenario here many times. Why is that so important? Simply put, the crowd needs to realize doomsday isn’t coming to expect sunnier days ahead. It happens only when we survive the ‘here we go again’ sentiment.
If they are all waiting on the worst case scenario by not encouraging businesses to lend, the economy never gets going, unemployment never gets solved and governments never get the tax revenue they need to meet their own obligations. This gets us back to square one; these tests did not consider the sovereign debt crisis. If the government estimates are wrong about their revenue projections over the next 5 years, default risk rises exponentially. I don’t care if we are talking about Greece, Ireland or the State of California or the City of Phoenix. I’ve seen some rosy projections by the GAO especially when it pertains to their projections when it comes to the new health care laws. They are pretty optimistic and leave little margin for error. If they are off, it could set off a sovereign debt crisis right in this country.
In my estimation, the next crisis isn’t likely to come from a bank, its likely to be a country or one of the 50 states defaulting. These stress tests have done absolutely nothing to analyze the extent of the risk in case such a scenario develops. They are a waste of time in the big picture. In the near term, they announce this stuff on television, everyone feels good for a little while and people hope things get better. But it does play into the psychology of a bear market. When you sit and really pay attention to what is going on, this isn’t markets climbing a wall of worry; this is everyone on the slope of hope.
So we do have markets in a friendlier, giving mood and who can tell if it’s just a big illusion? Illusion or not, my scenario of markets going sideways for the dog days of summer is taking effect. The reason is largely a result of the SSE holding support and breaking back through the same polarity at 2500 it couldn’t get through just a couple of weeks back. There are profound implications given the commodity/reflation trade is tied to a better China. It’s so important that one important economic indicator; the Copper chart is now on the cusp of breaking out of the downtrend line that has contained the trend since April 12. Want to know if there will be a double dip recession? Look no further than the Copper chart. If we break through right here, we will have an overall sideways to bullish type market again. I won’t say nothing bad happens if Copper goes up but if the industrial metal does go up it means banks have a greater chance of not going down.
The BKX has been better the past few days but I’m still not convinced it has turned the corner. It still has stiff resistance back up at our 51.14 high where it stalled on the Gann calculation. But I won’t kid you; it has the potential to keep on rolling higher as evidenced by the median channel. The fact that last leg down only gave us a higher low has allowed me to add an ‘anticipatory pitchfork’ which you can see is already being validated with this low. What that means is there is potential up to the mid line and it can go to the mid line without even taking out the 51.14 resistance point.
But everything has the potential to go higher into the middle of the week. We have another key turn date coming up this week based on the Gann calendar which takes us to July 27/28. My line of thinking suggests that if the markets can survive this time window, they may be able to keep themselves afloat all the way to Labor Day.
The fact is China looks better which removes one dark cloud. Europe has looked better which removed another dark cloud. What can I tell you about the stress tests? All I know is the EUR-USD has done better and is well above crisis levels from May and June. But readings do appear on that chart which could put the pattern on ice for a little while. The problem is the Greenback which has serious technical damage against the Yen and is on the verge of reaching the point of no return if it falls further. If we go by the usual inverse relationships a weaker Dollar should lead to a stronger stock market. Right now we are at the major inflection point. The inflection point materializes in terms of price and time. The Dollar’s price and the equity market’s time. What likely is to happen is China takes a break here. It’s no longer in the danger zone of immediately failing because it has pierced into polarity but it hasn’t gone far enough to confirm a bottom. What that may do is send everything else into a consolidation as well. Certainly, at the end of July it makes sense. More market participants should be planning their August getaways at this point and we could start wasting time until the fireworks start in the fall.
Click chart to enlarge.
Jeff Greenblatt is the author of Breakthrough Strategies For Predicting Any Market, editor of the Fibonacci Forecaster, director of Lucas Wave International, LLC. and a private trader for the past eight years.
Lucas Wave International (https://www.lucaswaveinternational.com) provides forecasts of financial markets via the Fibonacci Forecaster and other reports. The company provides coaching/seminars to teach traders around the world about this cutting edge methodology.