Common investor mistake: it can't happen to MY stock...

"Hey, Cap'n, my company is kicking ass.  How can it possibly go down like you keep saying it has to?  Production is up.  Earnings are skyrocketing.  And the stock has been a winner for years now."

I was recently told this by a friend who pointed me to Continental Resources as proof that he was invested in good solid companies which could withstand almost any economic circumstance I could dream up.  Continental pulls shale oil out of the ground in the northern USA.  Everyone needs oil, right?  Energy will never go out of style, blah blah blah.

So far, the chart has been agreeing with him (but only since early 2009 which should be a hint since that's when Bernanke started dropping cash out of his money chopper).  First off, what do EW tell us?  It looks like it just finished 3 of C.  So now we should expect a nice pull back into 4 of C.  The two most common paths for this would be in blue and in red.  In red is the 38 or possibly the 50% fib.  The blue is both the 61.8% fib and the level of the prior 4th.  The bottom of blue or red should be 4.  Then we should expect one more wave up to either a new high or to form a failed 5th (i.e. declining double top).

But after that 5th wave is in I expect a massive collapse in the shares (in other words, C and not 3).  This is what the waves are saying.  So how could this ever happen?  In a word: deflation.  Deflation literally changes all the rules.  Things that used to be obvious simply do not play out as expected.  Models fail.  In the case of Continental:

• CLR has $5 billion in debt and $50 million in cash.  The debt doesn't mature for a couple years and so for now people are acting like it doesn't matter.  But what happens if oil usage slows down due to a collapsing economy?  What happens if it remains slow past the time that the debt repayment is due?  What happens if interest rates have risen dramatically when they need to roll it over?  What happens if banks simply stop lending because they themselves are capital impaired?  Continental could be left to twist in the wind.
• It is an easy target for government to steal from.  Fracking is controversial.  Some say it poisons our aquifers.  Others say it provides lubricant between otherwise stable plates that can cause earthquakes.  A company with only $50 million in cash is ill-suited to respond to a significant lawsuit.  Just the cost of fighting it could deplete their capital.
• PE contraction.  When the credit is flowing, Price to Earnings multiples become more generous.  When the credit crashes, they become stingy.  With a current P/S of 7.16, P/B of 6.6, reverse PE of 33 and forward (fantasy/imaginary) PE of 18 all of these "fundamental" metrics could easily be cut by 75% or more.  In other words, fundamentals are not fundamental at all.  They are relative.  Relative to what?  Relative to the size of the credit based portion of the money supply.

So this is the big mistake that people make: they extrapolate current conditions forever.  Trees will grow to reach the sky, etc.  They forget that during periods of significant credit crises, PEs dip to 5 and that P/B can dip to 1.  They forget that when there is demand for oil in the economy that government tends to look the other way on environmental issues but government is always watching, always waiting for its opportunity to swoop in with lawsuits and fines "for the protection of the people" as soon as it is politically possible to do so.  You know what the government calls 1 million barrels of oil sitting on the ground ready to be shipped while the economy is still growing?  They call it "fat profits from taxation".    You know what those same barrels of oil are called when nobody wants them?  "An environmental disaster which requires the careless owners to be fined and punished".

The valuation of assets is all relative to the mood of the herd and the herd is giving off lots of signs that it is ready to head south on its cyclic migration.