Primary 3's initial moves

To me there is little doubt that Primary wave 3 has started. Where it will end is far to early to tell but S&P 500 could very well fall back to 500 or even more.

Over the past week and a half we have seen a fall wiping out the whole rise since October. Short term is a bit fuzzy but most likely are we past the worst fall in the initial (minor or minute) waves down. In other words, a correction is soon at hand if it has not already started. If that comes it is likely to retrace 50-61.8% of the decline accoridng to Elliott guidelines. My guess is that the retrace will be on the lower side since that will obstruct the bears from entering the market. The plot below shows the two alternatives I have at present. I have used NY opening hours for this plot. Often the low liquidity during off-hours distort the charts, and this is the case now, I think.

 

S&P 500 1 hour

One final option

Although my blog yesterday isn't entirely void, the likelihood that it will come true is significantly decreased by yesterday's surge. Before we scrap the present count altogether and start all over again there is one final possibility that I will present. As mentioned yesterday the ending diagonal was far from perfect. There is now strong evidence that no ending diagonal is tracing out in SP. Instead yesterday's rise is the first in the final rise up to Primary wave 2. As the percentage arrow points out in the plot, the upper bound on this rise is 1168, since wave <iii&gt; must nog be the smallest wave. This count is likely to be finished next week judging by the duration of waves <i> and <iii> which both lasted 9 days. However, any peak above wave <iii> must be considered as a candidate for Primary wave 2.

 

S&P 500

Peak of Primary Wave 2 in Stocks?

The currency and precious metals markets have already turned, and most likely the commidities markets too. From a year ago we know that copper and oil was ahead of stocks. Now there is some strong technical evidence that Primary wave 2 has peaked in stocks, at least from an Elliott Wave practitioner's perspective. Presented below are daily charts for both S&P 500 and SWE 30 and their count both says the same thing: Primary wave 2 is over. We have reached the end of the road in terms of subwave complexity for a corrective wave. This is by all means no bulletproof predicition, but sufficient enough to take a position.

S&P 500 daily

SWE 30 daily

Looking in more detail into S&P 500 it gives that the final rise from November until now is a triangle (orange) followed by an ending diagonal (yellow). Triangles are always the wave before the last, and ending diagonals are always the last wave. The ending diagonal is admittedly not ideal but accpetable. All in all it makes a pretty convincing signal that the direction of the stock market is down for some time. If it really is Primary wave 2, that period of time is more likely to be 2 years than 2 months. In time we'll know.

S&P 500 4h

Predictions for 2010

Based on the previous blog, I have made some predictions for what 2010 will bring about in the key instruments that I regularly follow. Updated sections about 30 Year Treasury Bonds and Gold.

S&P 500
SP500 is valued at P/E 23 regarding 2009 estimated reported earnings and 20 for the 2010 dito. In other words, a recovery is fully priced in already and there is little space for a further rise. However, the stock market does not always act rationally why it still may happen. Nevertheless, with its current pricing SP500 is very sensitive to any renewed credit problems which Dubai World clearly proved. Furthermore, sentiment is at its peak as showed by the Investor's Intelligence weekly surveys most recently showig 16% bears and 77% bulls. There simply are no more buyers to enter the market.

From an Elliott Wave perspective SP500 has reached the end of the road in terms of the maximum number of allowed sub-waves in Primary wave 2. Following is a most likely devastating Primary wave 3 downwards. In the chart above I present a somewhat ideal Elliott pattern, but it also gives us an appreciation about the stopping point. The initial Intermediary wave 1 will not necessarily be very dramatic, but in a Primary wave 3 any surprise that will occur will be directed downwards considering the distance it will travel. To summarise, the fundamental analysis says sell and Elliott Wave analysis gives us a Primary wave 3 target below the March 2009 bottom, possibly in the range 450-480 where the lower end represents 123.6% of Primary wave 1 and the higher level represents equality (in a relative scale) between Primary waves 1 and 3. The time frame for Primary wave 3 is most likely larger than Primary wave 1 which lasted for 1.5 years.

EUR/USD
Everybody knows that the USD is doomed due to the huge budget deficits and trade deficits that the US is running. What is less known is that all the other fiat currencies are equally doomed. It's like dividing zero with zero, you really don't know what you get. In the longer perspective the US will without doubt at some point in time inflate their debt away and may differ from Europe's path where in particular Germany is very reluctant to this approach, but we are far from that right now. At present deflation is the problem, not inflation and what counts in deflation is being able to pay your debt, and debt is predominantly issued in USDs.

The USD has plunged while stocks have surged since March. A significant reason, I believe, is that it was the cheapest currency to finance carry trade in. Another reason may have been that focus was on the US deficits and quantitative easing that all other government's problems were largely ignored. as I stated in a blog yesterday, QE has been relatively moderate in the US, contrary to e.g., the UK. Europe is faced with significant problems mainly in the west, south and east (leaving the north and center fairly stable). How these problems will be solved will decide the fate of the Euro, but my belief is that politicians don't have the willpower to do the morally right thing which is to let individual countries handle their own problems even though that means defaulting on debt. With the uncertainty this implies, and risk aversion about to grow stronger, I believe that the USD is in for a strong comeback in the short term (< 1 years).

Elliott Waves supports the above argument by identifying the the EURUSD has peaked in Primary wave B and that Primary wave C down has started. By using common wave relationships the likely target interval for this wave is in the interval 1.09-1.15. Ideally, combining fundamental and TA, the end of Primary wave C would coincide with an obvious money printing decision in the US but that is jumping ahead of things a bit.

30 Year US Treasury Bonds (updated chart and EW)

As stated in the SP500 section risk aversion is increasing which will short term work to the benefit of long sovereign bonds, in particular US Treasury Bonds mainly for traditional reasons. Counteracting this effect is the increased indebtedness and related risk of bankruptcy for governments.

Elliott Wave analysis implies that 30YUSTB is tracing out the final wave in a Primary wave 1 downwards after which it will turn upwards again. Ideally, Primary wave 1 will end within the interval 105-112 but given the possible immediate change in stocks, a shorter or even truncated Primary wave 5 has to be taken into consideration. Primary wave 2 in turn cannot exceed the previous top at 140'30.5 for the present count. A more narrow range based on likely Elliott Wave relations would be 124-131. Identifying the end of Primary wave 1 will allow us to narrow down this range even further. A previous blog deals with the relation between SP500 and 30YUSTB in more detail.

Gold (XAUUSD) (updated chart and EW)

Gold is the ultimate store of value, however, it does not help when loans are defaulting. Hence, during deflation gold is suffering as any other asset relative to legal tender. For this reason, and being true to our conviction that deflationary pressure is building, gold should fall. In the longer perspective though, when the US starts to inflate itself out of debt gold will shine as bright as ever, but we are not there yet. In addition to the above the sentiment for gold is longer term severely overbought why a pull-back can be expected. Hence, the fundamental picture for gold is short term downwards, and long term upwards.

Elliott wave analysis provides estimates on the above argued pull-back. Corrective Cycle wave 2 has just recently started which will bring gold down 50 to 61.8% of its entire rise from 2001. This brings us to a likely range between 620-720. Furthermore, a common corrective stop is within fourth waves of smaller magnitudes which there are two of in the plot. Both of them partly fit into the speciffied range but also partly fall outslide of it. Following the pull-back, and analogous to the first deflation then inflation assumption that we are working with, Elliott Wave analysis allows gold to take off rocket style.

Input parameters entering 2010

2009 went to history as the best recovery of all times. At the end of the year common knowledge is that the crisis is over and the politicians and central bankers are heroes saving the world from a depression. I don't share that view and I think the future will prove me right. As for the crisis being over there are substantial evidence that we have not left the troubled waters behind us:

1. Unemployment is still increasing. At best the rate of increase is reduced, but I don't see how an an increased unemployment rate could not be bearish for the world economy. The official US unemployment for November is 10.0%, including marginally attached workers and part time workers that figure increases to 17.2%. Two other interesting statistics are the labor force rate at 65.1% and the employment population ratio at 58.5%. The corresponding official EU27 unemployment rate for October is 9.3% and the EU27 employment rate for Q2 is 64.8%. 20% are employed only part time.
2. GDP is not rising. The US GDP figures for Q3 were initially 3.5% but has lately been revised down to 2.2% of which Cash for Clunkers is estimated to be 1.45% and a dominant part of the remainder being government spending. Imports and exports also rise, but they cancel each other out. Remains, well, nothing really.
3. Transportation is slumping as presented in a previous blog.
4. Debt is not falling but again growing, in particular sovereign debt. On Christmas Eve, the US senate voted for allowing the Fed to use up to $4 trillions to prevent the next crisis. (What do they know that we don't?) This is on top of the already existing deficit of $12 trillions. There is also convincing evidence that this debt is nothing more than a giant Ponzi scheme, in the sense that an entirely new and unknown group of investors seems to have entered the market when the Chinese exits. For details, go to Zero Hedge's link.
5. The housing market is being manipulated severely with the US government now being the sole lender for housing purchases via Freddie Mac, Fannie Mae and Ginnie Mae. Furthermore, the US government has guaranteed all of the outstanding obligations from these companies. This is in a time when nearly one in four homes are now worth less than the loan from which they were paid for.
6. Banks are still not required to mark to market why a large bit of their balances are pure fiction.
7. Monetary inflation is nowhere to be seen. Fed's decision to introduce quantitative easing by buying treasuries on the open market has not succeeded in what it was intended to do. The banks that sold the bonds have been given a free lunch by keeping the money at the Fed and thus earning interest. But by doing that and not lending the money is not multiplied and hence no inflation is created.

All in all this hardly makes a convincing case for a sustained recovery. Instead, to me it looks like temporary life support, which, when terminated, will bring back the deflationary forces and cause the markets to plunge once again.

Risk vs safety

The stock market is the market which takes on the highest level of risk, derivatives excluded. the simple reason for this is that stock owners are the last ones to recover any assets in the event of a bankruptcy. I usually use S&P 500 to represent the stock market since it is comprised of a huge number of companies but also is the most liquid futures index existing.

S&P 500

In the other end of the spectrum we have the bond market and in particular the sovereign long bonds. For the same reason or liquidity, and the long time frame resulting in a large leverage, I use the 30 Year US Treasury Bond (30YUSTB). One could argue that there is safer sovereign bonds such as the Japanese Bonds (which definitely not are safer) or German Bunds (which maybe are safer, but the Germans could face the need to bail out some of its European colleagues e.g., Greece, Spain, Portugal and Italy, in which case they most likely are not) but that is to be weighed against the less homogenous European market and smaller German market. Hence, I stick to the 30YUSTB.

30 Year US Treasury Bonds

Both the SP500 and 30YUSTB are in their final phases of a Primary wave. However they are not exactly synchronized according to my Elliott Wave analysis which is why there are a few options considering the near future Smaller Picture. The Big Picture is that stocks will fall in 2010 due to the credit crunch which will gain steam in turn due to falling government stimulus. As an effect risk aversion will increase and thus Bonds will rise. This I am fairly confident will happen, it is the timing that is the question mark, and for timing I use Elliott Wave analysis. The way I see it according to Elliott Waves there are a few options.

1. Assuming SP500 and 30YUSTB synchronize their respective high and low, and assuming the SP500 count to dominate then we have that Primary wave 2 may be in or will be in in the near future. However, this option makes the count in 30YUSTB incomplete which is why I am reluctant that it will happen.
2. Again, assuming synchronization, but instead assuming the 30YUSTB count to dominate gives that Primary wave 2 can last for another couple of months considering the duration of  Intermediary waves 1 and 2 in 30YUSTB. This option is possible and would require that stocks continue upwards without significant interruptions. This is actually a big deal from an Elliott Wave perspective since we have reached the end of the road in terms of complexity of Primary wave 2. It is already is a triple combination which is the most complex Elliott Wave pattern in a reactionary wave. In other words, this is not a very likely scenario.
3. Now I assume an unsynchronized chain of events. here, Primary wave 2 in SP500 finish in the near future while at the same time 30YUSTB finishes off Intermediary wave 3. The initial fall in stocks would be met with a similar, but smaller rise in long bonds. It makes good sense since right now the market is convinced that the crisis is over. and thus will take some conviction in order to change its mind again. This conviction will not happen overnight which is why I think that it is possible that 30YUSTB can continue its downward journey a bit further before the market starts appreciating lower risk investments again. Especially in the light of the conventional wisdom that the US dollar and budget deficit is beyond salvation. I too think that it is, but I think that it will not prevent 30YUSTB from experiencing a final grande finale before it turns in for a very long time if not for good.

Baltic Dry Index Update

The Baltic Dry Index (BDI) has nothing with the Baltics to do whatsoever, the name is taken from the Baltic Exchange located in London. Nevertheless, BDI shows a clear slump beginning middle of November.

Data courtesey of Bloomberg.

One might ask oneself the amount of recovery taking place anywhere if transportation is slumping. What goes for both China, Eurpoe and the US is that any recovery not derived from increased government spending would result in an increase in trade and transportations.

Another very interesting item to consider is the traditional relationship with Dow Jones Transportation Index (DJT) and Dow Jones Industrial Average (DJIA). According to classical Dow Theory, the DJT is ahead of DJIA since transportation is where both growth and stagnation hits first. In analogy with this, and considering the BDI's importance to world trade, it is likely that falling BDI also results in a falling stock market some time ahead. BDI's recent history supports this assumption, when considering its peaks in November 2007 and May 2008.

Happy New Year!

A very brief blog looking back at the year that has been and welcoming the year that is.

I started this blog in October with the belief that the surge from March was ending.
That proved not to be the case and the rise since then has been 8.2% in both S&P 500 and SWE 30. Slightly disappointing I must confess, but no-one ever expected that this would be easy. It is also important to rememberthe purpose with wave 2 -- to remove the pessimism among the investor collective, including even the most stubborn of bears. However, my conviction that the rally will come to an end is as firm as ever. While waiting for that to happen I take the opportunity to wish my readers a very

Happy and Prosperous New Year!!!