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Monday, December 21, 2009

Y2K Pent-Up Selling Demand Model for E-minis at Onset of 2010


The stock market rescue operations of 2009 have created pent-up selling demand. We should all anticipate
profit-taking on the first two or three trading days of 2010. Previous examples of pent-up selling demand that
led to sharp stock market declines in the first two or three trading days of the New Year were 2005 and Y2K.
This report examines the Y2K pent-up selling demand model.

As soon as the Y2K risk passed, the Fed mopped up the excess liquidity that it had injected into the system in
Q4 1999. The injection fueled an impressive Q4 99 ramp-up in equity prices. A short term high was set on
Dec 30th 1999. And on the 1st trading day of the New Year, the SP500 sold off sharply for three trading days
until it tagged its Nov 30 1999 low. The equivalent of the Nov 30 1999 low would be the Nov 27 2009 Dubai
low at 1067. Mkt participants should note the Jan 6 2000 jobs report must have been wildly favorable for
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equities, because the market rallied strongly from that day into Thursday Jan 20, 2000, which was the peak
earnings season for the financials.

Well, the US jobs reports as we close out 2010 are trending in a favorable direction, so we would not be
surprised to see another stable jobs report begin to ramp up equity prices into the peak earnings season for the
banks who will all be reporting glowing year over year earnings comps without the nefarious writedowns that
accompanied their earnings in Q4 2008.

Another equity profit-taking selloff beginning around Thursday January 21 2010 should not be a surprise to
anyone. But the two day Fed meeting on Jan 27-28 2010 might well be supportive of equity prices. My
visibility of trading rhythms and market behavior begins to dim beyond Jan 21, 2010. My visibility will
increase as we get there.

I underlined the Nov 4 2009 FOMC low at 1039 as the next tier of support below November 27 Dubai World
1067 low. But remember, 1067 is also the Oct 14 2008 two-day 27% rally high. The Oct 14 2008 high at 1067
is a demarcation of investor confidence going forward. Above 1067, and all is well, below 1067, not so much
so.

That Oct 13-14 2008 two-day rally was sparked by the “weekend warriors” efforts to reassure market
participant that the “Gods were still in their Temples,” and that everything was under control. On Oct 14,
officials announced the creation of three new Federal programs (the Treasury’s Capital Purchase Program ~
CPP, the Commercial Paper Funding Facility ~ CPFF, and the FDIC Liquidity Guaranty Program). The aim
of these new programs was to “enhance market liquidity and bank lending.” Belief in the Myth of Organized
Support from the Federal Reserve and US Treasury peaked on those two days and died promptly thereafter.
Within a matter of weeks, the Federal Reserve and US Treasury attempt at organized support failed as the
stock market spiraled to new bear market lows in November 2008.

The big banks however were ecstatic on Monday Oct 13 and Tuesday Oct 14, for them, these new programs
to enhance liquidity were like a get out of jail free card. The animal spirits unleashed those two days were at
their fiercest, bested only by subsequent two-day 32% rally that followed the washout of animal spirits on
Black Tuesday, October 29 1929. Black Tuesday was accompanied by rumors that Hoover would not veto the
Hawley-Smoot Tarriff, depressing stock prices even further than the preceding Black Monday and that the
banks had been selling/shorting stocks. The bankers met twice that day, once at noon and again in the evening
according to John Kenneth Galbraith. JP Morgan’s Thomas Lamont met with the press that evening to deny
that the banks had been selling stocks or “participating in a bear raid.” Lamont went on to tell the press that
“The [bankers] group has continued and will continue in a cooperative way to support the market and has not
been a seller of stocks.”

Between Oct 24 and Oct 29, margin calls were solicited by out of town banks, and Galbraith says the “volume
of broker loans fell by over a billion.” To fill the billion dollar funding gap, the New York banks stepped in to
increase their loans by about a billion that same week, but their attempt at organized support failed. Only later
was it discovered that Chase’s Albert Wiggin was short the stock market during the crash. Presumably other
bankers were shorting the market too, curbing attempts at organized support. Goldman Sachs actively and
purposely driving AIG into oblivion in 2008 would be one of the far more deviant modern day equivalents of
the Albert Wiggins’ back in 1929.

http://www.citibank.com/transactionservices/home/oli/files/fedprog_1014.pdf
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