Planet Yelnick

Recession Ahead, Yield Curve Flattening

While we have focused on the stock market, there has been telling activity in the bond markets. A month ago a loyal Yelnick reader submitted a guest post on Prechter calling interest rates wrong. He called it right - the Fed has raised short term rates but paradoxically the long term rates are dropping, tightening the spread between short and long rates - flattening the yield curve. Normally when the yield curve flattens, it indicates a softening of demand for long term money and hence less business spending. A recession ahead! This seems to be what is happening now.

Now another loyal Yelnick reader wishes to weigh in on what international bond markets are presaging for the US.

Does Japan in the '90s Presage the US in the '00s?

Smith Barney has overlaid US and Japanese stock and bond markets with a ten year lag, and found an eerie match. This suggests the US interest rates will continue to drop, not rise as Greenspan and many inflation-watchers believe; and the stock market is at a ten-year high this year. The slide down would not be as dramatic as the 2000 bubble bursting, but a slow grind into 2014. The Daily Reckoning gives more on this analysis:

The consensus view is that the economy is on the mend, profits are climbing, and Alan Greenspan has finished his financial rescue,” says our anonymous portfolio manager from Smith Barney. “I disagree with this assessment.” The research note explains: “After every primary bull market, there comes a primary bear market. The greatest bull market in history ended in 2000. This bull market was eerily similar to the Japanese bull market, which ended 10 years earlier. I believe there are many lessons to be learned from the Japan experience, and I am heavily overweight bonds with a gold hedge in my portfolios. This is a long-term position.

There are profound differences between the two markets, particularly in the banking system and the entrepreneurial sector, and any comparison such as this is too much of a simplistic pattern fitting to be predictive. It is nonetheless useful to compare historical patterns of asset manias and their aftermath. The most telling difference between 1929 and 2000 is the introduction of modern economic management by the government (Keynesian economics, as it were). Accordingly, the comparison of this boom/bust cycle to 1929, 1906, 1873 or 1837 may have misled the Elliott community as to the shape and timing of this wave pattern. The modern management of the economy will tend to prolong cycles - for example, the business cycle has lengthened from a 3.3 year cycle first identified early in this century by Kitchen and Juglar to a 4 year cycle that matches Presidential election manipulation - and smooth out downturns. The Japanese bubble in 1989 and its aftermath is the first such boom/bust cycle in a modern managed economy, and hence needs to be seriously considered in spite of the differences in the two economies. The Japanese experience informs us that this deflationary K-Wave winter will be drawn out and may look like a slow slide in a decade of low interest rates and modest-to-flat growth.

If so, this will accentuate the global scramble for yield.

Break Point Today?

Many of the Elliott Wavers had a turn window on Mon/Tues this week, hence were seeing Wed (today) as the last chance for a decisive break down signaling the start of the real wave 3 down, a sickening slide into the election. It may have happened as today's drop looks impulsive. Zoran cautions that usually the Bifurcation Point occurs after the third high or third low, and so far the Dow has only double-topped; hence this might be a false break with one more top to go.

If this is the break point, or it occurs within a few days after a brief false breakout, this might also reflect the high-water mark of Bush. He is riding high right now, and some of the more interesting election sites - electoral-vote.com and Iowa Presidential Election Winner-Takes-All electronic market - both show a surge in Bush's direction over the past two weeks. Kerry may be unable to recover if he does not break Bush's momentum soon. A stock market breakdown will likely also coincide with a change in attitude towards the incumbent.

Either way, watch the next few days in this market.

Bush is All Keynesian Now

As the politicians sort out whether Bush got a post-convention pop or not, watch to see if the stock market pops or not. It is on a cusp, and the way it breaks will point to whether Bush gets re-elected. Normally stock markets do ok in the two months leading to an election, whereas in the other three years they tend to dive in Sep/Oct. This year it is still unclear which way it will go. The consensus Elliott Wave position is that the Dow has retraced all it should, so at best it should hover around its current level and then take a dive. Specifically, it should at most touch Dow10407, then dive. If it rushes through to higher levels, something else is going on - a bull market? This would mean that the Bush/Greenspan economic policies have successfully bridged us through the potential disaster following the dot-com bubble of 2000.

Approaching the Break Point

The Dow is approaching the 61% retracement from its Feb04 high. It is also right at 78% retrace from the Jun04 high. We have therefore satisfied the normal retracement levels of the market - although, as has been noted, the Dow has often retraced as much 78% rather than the normal 61% since the manic peak in 2000. Watch to see if we blow past Dow 10400, or if the market stalls this week.

Will the Bush Rally Carry W to V in Nov?

The general Elliott Wave view has been that a serious market slide would doom Bush's re-election. As the election approaches, the Elliott Wave analysts are refining their view and hedging their prediction. The Bush Rally over the past two weeks has stalled at a level which makes the next month hard to call. Prechter, Zoran and others are all at the moment waiting for clarity when the traders come back from summer (either this week, a week later after the US Open tennis match in NYC). Walter Bressert has come out first announcing that we are in an uptick that should peak just before the election, and support W's re-election. Best position to take right now is wait and see.