Planet Yelnick

Computerizing Wave Theory

Request to my readers: I am looking for examples of past attempts to automate elliott wave or similar approaches. I understand from a friend formerly at the Foundation for the Study of Cycles that attempts to do this go back to the '70s. There are several services that purport to have done this in some fashion, such as Fractal Finance and BAM Investor. Any examples of success or failure, and any insight into lessons learned, would be extremely helpful to the Zoran Project. Please either comment or pop me an email, thanks!

Last Chance to Get Out Comes Again

The last chance to get out before a much deeper fall is likely next week. The drop has spooked even the uber bullish CNBC, which trucked out a series of bears today after the close. This is the biggest and fastest drop since the fall off the Jun11 top, and now expectations have grown that we at least drop another 5% or so to Sp980. Before buying into the CNBC view, let's look at the underlying investor behavior and likely market moves next week.

First, we bifurcated down last Wed, confirming a major change of trend.  Hence the minimal view that we replicate the type of drop we saw after Jun11 is sound. Whether it is much worse has not yet been confirmed by market waves (which reflect underlying psychology of market participants).

Second, the rally back over the trendlines and then second break is very bearish. What had been a support line - the trendline connecting the Mar9 start of the rally with the Jul8 bottom - should now become resistance. The psychology of hope broke when we crushed back down today. A break of a trendline is often a false break if it reverses quickly. Instead this break got reconfirmed.

Third, we should now be prepared to see the proverbial Kiss Goodbye: a final retrace up to the trendline that kisses it and then fades. Doesn't always happen but is a great indicator of a serious change of trend. The six-month trendline will no longer define the rate and direction of the market's move. The drop will.

The wave structure in the Naz and S&P seem fairly clear: we have concluded a five-wave down move and now should have a wave 2 bounce. We might see a gap down Monday morning as the retail investor panics a bit this weekend and puts in sell orders; but either that day or Tues should show a sharp reversal. The STU notes that Wed is FOMC day, and the market may appear to rally into that day waiting for the FOMC report (and any interest rate changes) before fading after. 

That rally is your last chance to get out. It should go back at least 50%, and that means it should kiss the trendline goodbye at around the Sp1061 pivot level one more time. (Math works simplest if we have a 15 or so pt drop Monday before the reversal: 1101 top to 1020 then 50% rally gets back to 1061.)Then a wave 3 down with higher intensity and a greater fall.

The wildcard is the Dow, which has not yet confirmed the break. Its lower trendline runs around 9600 on Tuesday and is rising about 20 pts a day. Interesting is that the STU has an alt count for the Dow which is much more treacherous and bearish. The implication is a minor bounce and then a deeper fall without the kiss goobye moment, A fickle mistress, that Dow! No more last chances!

You may wish to check out their reports next week, as I think it will be a free week. You can click on the flashing buttons on the right when they change to Free Week!  I will also give a post to make it easy. Of course, if you click through from this site, I might eventually get paid a referral fee, so decide to reward me or not as you feel fit.

Neely is advising to stay out, meaning not take a position; and his count remains ambiguous as to structure and direction. Simply put, the bifurcation signals the change but needs to sustain the move down at a faster pace (sharper angle down) than the prior up move (measured by the slope of the lower trendline).

The USD should be on a rally for months, and commodities and commodity currencies like the Loonie or the AUD are expected to fall.

Bonds are still hard to call. A return of risk aversion likely means a widening of spreads - junk bonds have even higher yields (so they fall) and the Treasuries may drop.  Yet over the first phase of this downturn we might see the long bond continue to higher rates, noting that the US Treasury still has huge amounts of debt to raise to cover the burgeoning deficit, and the Fed has tapped out its QE purchasing of Treasuries. I am watching the FOMC meeting for an indication that the Fed may continue QE, which should depress yields and be bullish for bonds.

Cash4GDP Updated

Market reaction to better-than-expected GDP report (3.5% vs 3.3% consensus) is the expected retest of yesterday's break of key trendlines. A common technical pattern is to close a gap down; today the S&P e-mini at 1159 (at the time of this posting) is getting close to covering a gap at 1161. The Naz has a bit more to rebound to close its equivalent gap at 2116, so watch for continued strength today. It was bit surprising that markets were down yesterday before the GDP report, as more typical behavior is to rally into the news and fade it after.  It shows the strength of the four-day down-move 

 

We remain with clear signals of bifurcation yesterday in all but the Dow, which confirms the trend change: Dollar up, everything else down.

The strongish GDP report was based on gimmicks: Cash4Clunkers and the first-time buyer's credit. Edmund's noted that the C4C payments of $4k per car are really much higher at $24K per car when the trendline for sales without C4C is compared with the incremental sales from it. (They also note today that there are clear signs of a recovery in car sales from the October data.) A similar analysis of the $8K housing credit would estimate a $43K actual cost for incremental sales. Whatever the validity of those methods, they raise the question of whether this GDP bump will sustain. We should see estimates for Q4 be adjusted upwards as economists tends to extrapolate the present, probably from a pre-report range of 2.5% to a past report range of 4%. 

In past history the GDP turnaround following a bad patch - and we have been in the worst patch since the 1930s - would be much more robust. We grew well over 10% a year in 1934-36 coming out of the first phase of the Great Depression: 17%, 11% and 14%.  Today's annualized GDP reading at 3.5 and a Q4 performance at 4% are quite disappointing in comparison.

Updates: a number of sites have done a deeper dive this morning:

1. Almost the whole increase is due to government stimulus and gimmicks. Karl Denninger adds the auto component of 1.66% to the increase in government spending of 2.4% (the 7.9% increase times the 30% share of GDP from government) to show that the 3.5% would turn into -0.5% if those are removed.  Now, not all the auto component was due to C4C so his calculation is a bit aggressive, but the point is sound that absent stimulus we would likely have been flat or negative GDP again.
2. The consumer component is worsening. From Karl and also Mish, personal income decreased in Q3 when it had increased in Q2; taxes increased in Q3 when they had decreased in Q2; and most concerning disposable income dropped in Q3 (and dropped a lot in constant-Dollar terms) whereas it had risen in Q2. Ouch.
3. Savings dropped in Q3 vs Q2 even though disposable income dropped more; this is probably the result of C4C gimmicks, and is likely to reverse in Q1 if not Q4 due to Holiday spending.

The next report to watch is unemployment. We might crest 10%. Jobless recovery is an oxymoron, but note that unemployment is a lagging indicator. The key indicator to watch is real estate - it almost always leads out of a recession. The Case-Shiller report has good news - a fairly widespread price uptick. Whether this is mostly due to the another government gimmick, the first-time buyer credit, will be more clear when that program lapses.

Bifurcation!

Clear signals of bifurcation Wed in all but the Dow comfirms the trend change: Dollar up, everything else down. Dollar Index broke above both the wave 5 'wedge' trendline and the trendline for the whole wave down. While the STU wants to see it break the DX77.50 level (the wave I of 5 level), the break of the trendlines is sufficient for a bifurcation to confirm a change of trend. The DX should now shoot up above 90.  The sharp movement off the low has been steeper than the fall, and has broken as a five-wave impulse. S&P has also broken the 0-B trendline from Mar9 (through Jul8) indicating it has confirmed a trend change to down. The Naz has had an even steeper fall below its trendlines and seems poised to lead the charge down at a faster clip. Downside volume (9:1) suggests a relatively deep drop to come, albeit with sharp reversals along the way. Perhaps most surprising is the sharp fall happened on the eve of what was assumed to be a relatively positive GDP report; usually the market will rise into such a news item and fade after.

Reflate This Book! Conquer the Crash (2nd Ed)

EWI sent me an advanced copy of the third edition of Conquer The Crash. The first edition was striking in the early call for a crash and deflationary period. It was largely ignored. Yet we have had the crash, and have had deflation for over the past year. This may be the time to take it a lot more seriously. 

The new edition has a fairly lengthy back end of appendices which augment and update the text. Most immediately useful are recommended places to invest in a deflationary depression, with updated contact information. 

The book also has a "best of" collection of EWI's reports over the past decade, especially around the top in 2007. For those of you who are not subscribers, this book and those excerpts provide a great way to get up to speed before considering a subscription. Of course, the excerpts will be cherry-picked to show the best predictions; but EWI was all over the top in 2007 and expected the crash that followed a year later. They have reason to crow about it. You can see what they wrote and their reasoning. 

It also has a deeper discussion on deflation. With EWI's permission I have earlier discussed and provided a copy of Chapter 13 entitled Can the Fed Stop Deflation? As I said at the time, I was blown away by it. The public still holds enormous faith in the Fed, and expects it to be able to wave its magic wand and forestall the deflationary depression that inevitably follows a credit bubble of this magnitude. This analysis says otherwise. And the new Appendix D (aptly named) gives a lot more analysis of deflation, Greenspan and Bernanke.

If you already have the book and have subscribed to the EWI services - at least the EWT - this book is not necessary. If you have not read the book, and particularly if you have not been reading the EWT for the past four or five years, this book will be a real eye-opener of where we are in the unfolding drama of the economy. Strongly recommended to those new to the thinking & analysis of Prechter. 

Note: The FTC wants me to let you know that I have an affiliate relationship with EWI such that I get paid a varying amount on success, meaning a click-thru from this site to their site that results in a subscription or other transaction. It at least covers the cost of my subscriptions to their services. 

Dollar May Have Bottomed - Let the Melt-up Begin!

Breaking above $1.50 to the Euro was huge - today the Euro fell hard below that level. See chart. Dollar down means almost all other currencies up - and lots of nations have been trying to stop that appreciation by intervening in forex markets to drive their currencies down. China changed policy a year ago July of letting the Yuan have a controlled float, sparking the commodities sell-off last year, and since then has taken advantage of the dropping USD by dropping with it, to the consternation of the surrounding Asian Tigers. It made their currencies relatively uncompetitive with China. They have been active intervenors to support he USD but to minor effect. Intervention to get the Euro down below $1.50 is quite a different matter of scale and impact. 

The sharpness of the Dollar rise in the Dollar Index (DX) and fall against the Euro signals a likely change of trend to up. In a few trading days the DX has gone from 74.9 to over 76 - a huge move.  It is very close to breaking a recent wedge trendline, which would confirm a bifurcation has occurred. See chart courtesy tonight's STU. The STU is watching a break of DX77.5 to confirm the this change of trend os over a major degree. If it occurs, it signals a strong rise in the Dollar to above DX90. A reversal back to DX75.20 means this is a false break, not the bottom yet.

I have been writing that the markets are running inverse to the Dollar. This not at all surprising or profound to the ewave universe, but is against conventional wisdom which still surfs along the surface of things to make market calls. What it means is crystal clear:

    A bottom in the Dollar signals a top in everything else

Major bottoms or tops are often not coincident but sloppy, so it does not necessitate all markets turning together. Indeed, that would be unusual; but we are in unusual times, once-in-a-lifetime times of the deflationary depression that follows a huge credit bubble. We had them in 1929, 1873 and 1837, and although many have read about the Great Crash in 1929, few remain who really experienced it. The rules-of-thimb in the investing world have really grown out of the experiences post WWII, indeed post the 1949 end to the trading range of the Great Depression and the beginnings of great bull runs of 1950-66 and 1982-00 that mark the American Century. 

We have been in a rare Currency Market since 2002, a market driven primarily by the Greenspan Indian Summer of reflation to stave off the deflation of Kondratieff WInter (which he explicitly acknowledged in a paean to Kondratieff). The reflation policy of the Greenspan Put has been continued by "Helicopter" Ben Bernanke. Hence, we should see almost all markets turn on the Dollar. 

This means lighten up on gold, get out of oil (quickly, it is a volatile market), back off those Carry Trade perennials like the AUD and Loonie, and get out of equities. Bonds may be on a spike to higher rates, which is bearish; more on that as it unfolds. If we are truly in a return of risk aversion, after the spike Treasuries should rise (and rates fall) as money rushes there in the vacuum of a fall in everything else. 

A Dollar Bottom also signifies an over-turning of the assumptions that have fueled the Obama Hope Rally, and a return to risk aversion after a summer of hope. Watch the DX closely. Until it bifurcates above the wedge trendline, it could be a false break. The sharpness of today's move suggests a short squeeze is on, against those who have been betting on the Dollar going excessively lower. 

In equities watch for a break of the trendline from Mar9 through Jul8, the 0-B line. A break of that confirms the bifurcation of equities. Right now it is running between Sp1050-55, and Dow9500-9550.  

GDP Report May Drive a Sideways Market

A word on where this market could go this week: sideways. The Q3 GDP report is expected Thurs. Consensus is for around a 3% rise, the first rise since the Greater Recession started in Q407. Christina Romer of the President's Council of Economic Advisors discussed how the Stimulus pushed up GDP in Q2 by 2-3% and should push Q3 up by 3-4% and into positive territory. I have previously shown an alternative analysis that the impact was less than this, but no matter; that analysis and her comments both come to the same conclusion: we are at Peak Stimulus right now, and the impact will be smaller going forward, down to negligible by next summer and a drag by end of next year. 

Given peak stimulus right now, the key is whether the private sector is showing signs of life beyond government life support. This report should give some insight into that. Hence the market may stay in a spiky range through the report, and then bifurcate, meaning pick the direction for the next few months.

The wave structure is complex. It has broken as a double zigzag since the July bottom, and now may be breaking into a third corrective period, an ending triangle. When a complex correction goes into its third corrective structure, it often ends in a sideways move in the form of a triangle. While triangles are called the penultimate wave, typically in the second to last position (waves 4 or B), they also tend to be the last wave in a complex correction. I suppose this could also be termed an ending diagonal or a Neely terminal; if it emerges it suggests the corrective wave is over and we bifurcate down. This chart from Prechter's wave tutorial is illustrative (you may have to be a Club EWI member to see the tutorial). 

The Financial Panic Necklace and the 1987 Historical Analogy

I have been following the many historical crash analogies that pop up. In my post The Japan 1989 Analogy I link to many other posts on these analogies in case you want to check this meme out. 1938 is the perennial favorite because it involved government stimulus that kept the economy on life support for a while, much as now; but 1987 keeps popping up. 

Here is a fascinating comparison of the Dow Transports overlaid on the Nasdaq in 1987 (see chart). I like this comment:

Keep in mind that the role of a bull market is to keep you out all the way up until the top, whereas the role of a bear market is to keep you in all the way down until the bottom. 

The other intriguing crash call is still alive: the Spiral Crash discussed in the post Another Crash Call: Is 2009 Like 1929 and 1987?  Chris Carolan of the book The Spiral Calendar had shown how similar 1929 and 1987 were when the dates were compared to the lunar calendar. Jim Ross, whose handle is VirginiaJim, had overlayed 2009 and found that we had hit the first of four key dates leading to the crashes in '29 and '87. If the high on Monday holds, we will have hit two key dates. 

The comparison points to:

• a downtrend into Nov13
• a final lower top on Nov23
• the crash starting around Dec10

The crash might not just drop as in 1987; it might have 2 -4 weeks of slip-sliding away. More a swan dive arc than a drop. Either way, bad joss for equities. 

I am not a fan of astrological patterns for investors. I note that in the book Passages the author found that at around age 28 Americans tend to shirk the career that thought they "should" be pursuing (based usually on parental biases) and turn to the careers that want to be pursuing. Saturn takes 28.5 years to transit the Zodiac, and so no surprise that the astrologers think Saturn influences that 28 year old. I simply think it is timing coincidence enshrined into pseudo science. 

Yet there may be something causal to lunar cycles. Chris Carolan has found a Financial Panic Necklace (see chart). Chris does NOT buy into VirginiaJim's 2009 crash; he thinks the next Necklace Panic is not until 2023. 2009 does not sit as a gem inside his Panic Necklace. His chart captures lunar cycles and solar cycles as well as eclipses, which would tie it to the Puetz Window. (Puetz found that eight major crashes from tulip bulbs to Tokyo all occurred after a solar eclipse that is followed by lunar eclipses.) 

In my prior post of astrological skepticism I discussed Puetz's analysis with VirginiaJim. A Puetz Window came this summer, and nothing happened, at least not over here. Despite my skepticism I note that the solar eclipse ran across China, and the Shanghai Index has been down ever since. Hmm. But not quite a crash of the sort Puetz had looked at. 

Puetz speculated that the eclipses and full moons do not cause the crashes but spook the market participants. Chris Carolan's neckline does include many but not all panics, just as many Puetz Windows come and go without market fireworks. Causality is obscure at best, and yet the multiple examples are intriguing of some psychological remnant buried in the reptilian brain (where fear and greed reside). 

Crashes are rare. Many are called and few happen. We already had one last year. So follow these calls at your own risk. Yet they remain entertaining to contemplate. 

More Real Estate Nonsense UPDATED

The Natl Association of Realtors gushes Big Rebound in Existing-Home Sales Shows First-Time Buyer Momentum. In fact, sales DROPPED in September despite the rush to cash in on Clash4McMansions (the home buyer credit that expires shortly). Chart from Calculated Risk, as modified by The Big Picture. Barry Ritzhold says this of NAR:

I am honestly unsure of whether the folks at the NAR are dumb as lawn furniture and make these misrepresentations honestly — or whether are just another group of disgusting spin doctors, willfully peddling lies because it helps their own agenda.

The NAR report relies on seasonally-adjusted data. Actual sales dropped 5% from the prior month. This is less than the normal drop from August to Sept, hence the gushy headline, but then again normally there aren't Cash4Gimmicks incentives skewing things. Distressed sales also made up 29% of the results. In a followup at Calculated Risk, Existing Home Sales: More Activity, Little Achievement, the distressed sales are distorting the results but are a necessary step forward - getting rid of the past overhang. As I noted in a recent post, however, that overhang is increasing pretty fast for Prime loans even as we work through the subprime disaster from the last few years. 

UPDATE 10/24: Barry Ritholz dives into why this year's seasonal adjustment is so misleading: for the past ten years the seasonal drop ranges broadly from 10% to 29%, and this year's fall was 5%. Adjusting by the average drop (17%) to say this was actually 10% growth and calling it a "surge" in home sales without taking into account the aberrations such as the incentives for first time buyers is simply knowingly misleading. As he puts it, "this was not an ordinary seasonal adjustment - it was highly misrepresentative."

Mark Hanson does a pretty devastating analysis of the gimmickry. When the first-time buyer incentive expires in a month, the same sort of drop-off we are seeing in auto sales after Cash4Clunkers should shock & awe. 

UPDATE 10/24: Mark's deeper update notes that inventory declined for three reasons that are not baked into seasonal adjustments, and hence caused the spurious NAR adjusted growth number: 

1. HAMP kept foreclosure inventory off the market even though foreclosure-ready inventory is way up
2. Poor market kept at start of school year led more-than-normal for-sale houses to be unlisted
3. Negative equity kept many trade-up buyers out of listing their homes

Rather than declare premature victory and rely on short-term gimmicks, we need to let the market work through the overhang. Only after that can housing return to normal. Sadly, pushing gimmicks to incent new purchases by people of marginal credit only sets in motion a new overhang when they get into trouble. 

We May Have Just Topped

The bears come out at any downturn, and they are out tonight. One of my favorite pictures from the Slopester captures the sentiment. Why the joy? Surely not just the last hour drop. Yet it was a classic Bifurcation moment, at least of the recent trend: it fell faster than the uptrend, and broke below the trading range of the past 10 days, since a gap up.  The general feeling is captured by Evil Speculator: "We Topped."

The STU may have pushed social mood towards giddy bearishness. The downward reversal pretty well signals continued weakness. A break of their 0-X lower trendline (now around Sp1046 or Dow9455) would confirm. They found a "quadruple outside-down" day in the Wilshire 5000/Trannies/S&P500/S&P100. All the main levels have been hit: 

• the Sp1099 gap was filled
• the Dow10122 "4th of the prior 3rd" was hit close enough (within 3 pts) 
• the Naz2183 gap was filled

On top of this, Tony Caldero has continued his precise ewaving with a post tonight on the Sp1080.77 low breaking below a recent wave iv 1082 level, and very very close to the Sp1080.15 level of what once seemed the top on Sep23. The break of the just prior wave iv indicates this is no longer a small jink and jove of a subdividing wave up, but a larger degree correction. Whether it is the end is not yet confirmed but at least it points to serious weakness over the next few trading days. 

About the only non-confirmation was over in the Dollar Index. The DX hit the lower trendline today at just below DX75, but the STU has been watching for a throw-under and sharp reversal at DX74.50. The great thing about the pattern the DX is in, the ending diagonal, is it is clearly a terminal pattern and will be followed by a reversal up. The only question is when. The throw-under and reversal would be a classic indicator of when, but is hasn't happened, and need not to end the pattern. The closing wedge shape is clear, albeit could run for a while before still. 

Gold has formed a triangle, the penultimate pattern, indicating another (and final) thrust up is about to occur in gold. Probably the spike down in the Dollar and run-up in gold occur around the same time. So watch gold first to give advance warning of the Dollar Bottom.

I will post shortly on bonds, but suffice to say right now that the wave pattern is ambiguous. Best to wait for clarity before taking a position.

By far the most interesting discussion in the STU was around the banking index, which shows a fairly clear top. This would be huge as the bank stocks have been like the Nifty Fifty, or in this case the High Five: a small number of stocks = a major part of the rise. This sort of situation is bearish: a bull market runs up on a broadening base while a bear rally runs out of steam on a narrowing base. Their sudden weakness presages more than a drop in the Dow; it signals a return of the credit crisis. 

The Zoran Project

Notice to Oz readers: I will be in Sydney the first week of November, and am arranging to meet some of the followers of Zoran Gayer's work. I think it is possible to computerize a lot of the advanced Elliott Wave thinking of Neely and Zoran, and will be there to start an effort to do so. If you would like to join a group discussion of how to carry on his work and take advantage of a computerized Zoran predictor, please contact the Sydneyite who is helping me, Charlie Weress: charlie_weress(at)hotmail.com 

Prechter Says The Top Is Close

Late Sunday he put out his monthly EWT and it had much the same type of message as his EWT in late Feb 2009, calling a bottom right before the Mar6 bottom, and June 2007, calling a top right before we began topping from July-Oct 2007: the turn is close enough it is time to switch positions. This call has a special resonance since his June call was right before the greatest shorting opportunity in our lifetime: the 800 pt drop in the S&P. Sell the E-Mini S&P futures with stops and $800K at risk would have become $4M. He thinks primary wave 3 (P3) is about to begin, and should drop a similar percentage as P1.  Translated, that means 700 S&P pts, or the second greatest shorting opportunity. 

Now, he made a similar recommendation around the Aug23 top, and you could scold him for premature bearish exuberance. Yet as his EWT points out, the market is not much higher now than then (50 pts at the moment), and the rise has slowed greatly from the sharp rise in March and April, and the half-fast rise since Yasi went in in May. And he had remained bullish from late Feb until late Aug despite his reputation as a permabear despite others calling a top in June. 

Yves Says Bonds May Be Calling a Top

Yves sent me an email commenting that if he is correct in the bond count of a wave 3 up unfolding, then stocks may be at the end of their corrective move since last March. He notes that being long the Long Bond with leverage has been a better idea than shorting stocks, even if the top is in.  

The chart shows his count. He has been on this theme since last June and it has been working. 

More Investment Thoughts for Yasi

Yasi went long in May after I set out an investment roadmap despite my cautioning her (since much of the runup had already occurred). If she has stayed long, she is in pretty good position. Yet, the wave count I put out last Friday seems to be on: we are in the final wave 5 up, and should top soon. So, should she lighten up? My thoughts follow, but readers, please add yours in the comments.

One view of this wave is from Tony Caldero, and it puts a limit on the final run up at Sp1112 for reasons set forth in my Friday post. The wave action today pretty well confirms that little wave 4 is over and 5 is on. The S&P closed its gap from last year today, so could be done; but the wave structure begs for a run up to at least Sp1107, where A=C of the second zigzag since the July bottom, as explained last Sunday.

Another view is from Walter Murphy, that we are still in a wave 3 up. What Tony calls the end of 3 he thinks is the end of the third wave inside of 3. A reasonable position given that otherwise wave 1 is pretty long compared to 3; within the rules but rare. If so we should see a pop to Sp1107, a fade (in the real wave 4), and then a final runup towards Sp1121, the 50% retrace (Dow10334).

My proposed count from Friday would have ended wave 1 lower than Tony, created a longer wave 3 (which could still be on) and hence allowed a higher end to wave 5 than Sp1112.

Let's pull up without getting so hung up on minor count differences. As a general rule of interpretation, as corrections meander on in ever more complex structures, it is better not to play Ptolemy and construct epicycles of ever increasing complexity; instead simplify (or compact in Neely's terminology) the count. In doing so the whole move off Mar9 looks like a large ABC, and we would be in the final waves of C. The attached chart (courtesy the STU) shows the simplified count, with now 7 waves up - an ABC-X-ABC compacted without being hung up on where to draw the X. By doing so we see the wave can continue to subdivide up and we should not try to project the top by looking at the minor wave structures.

What gives further support for more subdivision higher are the other major indexes. The STU tonight noted that the Dow is is near the "4th of the prior 3rd" level, a very common maximum retrace level for a wave 2. The S&P has gone a little past that, but the Dow needs to get to 10122. In addition, the Nasdaq has its gap to close from last year at 2183, just a smidge higher; and then 2252 is the 61.8% retrace. Given how AAPL blew away earnings, and the Naz futures after hours, the Naz should jump tomorrow, closing the gap and heading to 61.8%. Both indexes point higher.

The other consideration is the USD, which is continuing down. It is likely to spike down at the end of its fall, typical of its formation, an ending diagonal. It hasn't yet, so Dollar down, Dow up. That spike may touch the long-time target of EWI of DX74.50.

For those of you wondering what might spike to Dollar down then turn into a surprising reversal, read How The Fed Bailed Out The World from Zerohedge. The Fed has provided liquidity for central banks globally to the tune of $6.5T, and it now sits as a huge liability that needs to be covered by them. But how? Consider this conclusion:

As the DXY continues tumbling ever lower to fresh 2009 lows, the trade de jour is once again the dollar funding one, although unlike before when the Yen was the carry currency of choice, this time it is the dollar itself, positioning banks for the double whammy of not just a dollar funding shock, but one coupled with a potential massive and historic short squeeze. If and when an exogenous event occurs, not even $6.5 trillion in Fed swap lines will be sufficient to bail out the world economy.

Such a short squeeze would send the USD skyrocketing upwards. Where would they find the Dollars to cover the short? From the Fed? How funny would that be! You owe the Fed $6.5T and need to cover, so you borrow another $6.5T! What happens next time, when it is $13T? Or the time after that??

This is one of the conundrums Bernanke has to handle to exit gracefully from his bailout last year.

Instead of another bailout, what would happen is a recovery of the USD from vastly oversold levels. If you look closely at US equities, their rise has been on decreasing volume. It seems to be largely a manifestation of hedging against the USD. (Yes, for overseas investors, buying US equities hedges a falling Dollar.) Hence any spike in the Dollar would crush the stock market.

Now there is no indication that these events are about to occur. Absent them, Yasi should probably let it run. Even a drop right now should not spook her, as it merely may be a minor wave pullback within the upwards trend.

The key is to watch is the lower trendline in the chart above - the so-called 0-B line (or in this case 0-X). A break below would indicate a major degree trend change and the likely end of the whole Obama Hope Rally. Absent a crash, she has latitude to lighten up if it occurs, and should be in the money. Right now that line runs around Sp1041. Since it is rising a few points a day, watch for a break of Sp1050 by the end of this week, or 1060 by the end of next week. 

One last thing, Yasi. This site does not hand out investment advice, but comments on the opinions of those who do. So take any thoughts in this at your own risk. Happy trading!

The New Normal

The bond fund PIMCO popularized the term New Normal to explain the investment environment for the next five years: low growth, high unemployment, slow banking, slower securities, and steady erosion of productive capital stock. In their words:   

Global growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors; the core of the global system will be less cohesive and, with the magnet of the Anglo-Saxon model in retreat, finance will no longer be accorded a preeminent role in post-industrial economies. Moreover, the balance of risk will tilt over time toward higher sovereign risk, growing inflationary expectations and stagflation. ...

The result is a prolonged pause, or in some cases, a violent reversal in certain concepts that markets had taken for granted. 

McKinsey and others had also used the phrase The New Normal to describe the next few years: less leverage, more government, new protectionism, less consumption and a focus on Asia. They think innovation will continue, and investment in human capital. 

Now John Mauldin in his weekly newsletter takes issue with these projections as too optimistic, dismal though they may seem. He had been a proponent of the Muddle Through economy, one of slack growth (1-2%) and slack employment - kind of like the New Normal. He developed his Muddle Through concept before we had $1T deficits as far as the eye can see. He is even more worried that the optimistic projections underlying the White House estimates (see chart) are unrealistic: they assume 3% growth and a return to 5% unemployment, much better than expected in the New Normal. Hence $2T deficits may be the real New Normal. 

The problem he sees is that deficits of this magnitude crowd out private investment, and will continue to suppress consumption in favor of savings (in this case buying Treasuries mostly!). GDP is measured as:

 GDP = C + I + G + X

or Consumption + Investment + Government Spending + Net Exports (exports in excess of imports). 

The Keynesian plan is for an increase in G to make up for a drop in C. But if that G is funded by huge deficits, it crowds out private investment, and I drops. In order for GDP to continue to grow, we must have an increase in I to fund the private sector. It would have to come from the outside, measured as a positive X (net exports); but for a long time we have run a trade deficit and have had negative X. Will that change? One of the common themes of the New Normal is for capital to leave the US for Asia. This will not create a positive X.

You could take issue with the chart above, as the worst case deficit projections come from the Heritage Organization, a conservative group opposed to Obama. But Société Générale came up with a similar analysis, concluding that we will quickly have a Trillion Dollar Gap with no clear way to fill it. See chart, courtesy The Big Picture. 

Now, heretofore the overseas US investments have had returns back in higher than the trade deficits have bled out. This seems likely to change, and also puts pressure on X and how to fund the huge deficits. Right now the US banks are getting deposits at very low rates and buying Treasuries at 2% or higher - such a deal! It enhances the Fed's QE but does nothing for investment in the private economy. 

Picking up on my theme from yesterday, as we starve private investment and send capital overseas, we starve the Golden Goose.

Prognosis: after the inevitable dead-cat bounce in GDP, we should see slow growth with periods of negative growth: The New Normal. Taxes should go up first in 2011 with the Bush cuts expiring and then in 2012 and beyond if any of the bills get passed (the healthcare bills all raise taxes, as does Cap&Trade). Tax increases will further suppress GDP. 

In this environment, hard assets and bonds should do better than stocks. 

Our Golden Goose is Dying

The golden goose of the US economy has been venture capital, where a surprising percent of jobs (11%) and revenue (21% of GDP) come from venture-backed companies (at least, according to the VC lobbying association). It has been dying for a decade. Sarbanes-Oxley, demonization of options, tax changes to advantage old-line companies, and much more has plucked it almost dry. The number of Billion Dollar exits in the last decade is a handfull, and most VCs can recite them (let's see, Salesforce, Google, YouTube, Skype, First Solar, and a couple of Chinese ones with some US backing; MySpace was under $1B, and Facebook hasn't exited yet).  The first quarter was really bad (down 80%) but that may have been shell shock from the crash last year.

The second quarter looked promising, but now the third quarter stats are in: down 6% from Q2 and 38% from Q3 last year. Worse, m&a is also down: 10% down from Q2 and 49% down from Q3 last year.

It is well known in Silicon Valley how bad it is. After the slump in 1991 (due to the so-called war dividend at the end of the Cold War), a community-wide effort called Joint Venture:Silicon Valley helped recharge the community. (I played a small part, particularly around Smart Valley, wiring it for the Internet.) JV:SV is still around but the effort is not. This may be *merely* a Great Recession, but around here unemployment is higher than it was in 1991 and the malaise that accompanies a Depression is palpable. 

CleanTech was expected to revitalize the place, and for a while it seemed to help. Michael Arrington of TechCrunch wrote a very perceptive piece a month ago called What Cleantech Should Learn from Nanotech (Before It Is Too Late). Nano was the Next Big Thing until it turned out not to be. Cleantech investors had great hopes in Obama, and give him a fair amount of support and money, but so far it is not turning out to be the Next Big Thing either. Simply put, energy generation deals seem stillborn due to their high cost (solar plants for example are still 3-4x more costly than coal or natural gas) whereas energy management deals seem to have legs. The whole biofuel bubble is long burst. One of the most noteworthy solar facilities in the Mojave Desert has run afoul of NIMBY - the green movement shooting itself in the foot by blocking it. Time and scale may cure the cost problem - if these plants get off the ground. In the meantime China is using excess capacity of semiconductors to dump PV cells into the US and Germany, making it even harder for alternatives to gain a foothold. 

Right now the venture industry is watching to see if the IPO window has really re-opened. A few deals got out last Spring, including Open Table and Solarwinds (which is not a solar company). A bunch are lined up to go out about now or in Q1. A123 (a battery company - energy management!) and LogMeIn (which competes with Solarwinds) both went out in Sept, plus a biotech company. Now, to get excited about 3 IPOs a quarter is pathetic, but that is a measure of how far we have fallen. Maybe another six can get out before Thanksgiving, if this market holds up. 

The whole of Silicon Valley is waiting to see if a few more IPOs can alleviate the constipation of the VC firms.

Doubling Down on My Lost Bets: We Are Not There Yet

Now that I have lost two bets - Dow10K by Aug31 (it was Oct14 - close but no cigar) and the top was in on Sep23 - time to go double or nothing: we did not top yesterday, and the gap down today is not the start of P3 or whatever down. We still have a gap to close between Sp1097 and Sp1099, and we appear to be in a fourth wave with one more shot up to go. It may go to Sp1111 next week and we are done, or it might extend. I can fill out the bet with a target (time/level) possibly by Tuesday.

Neither of the main pundits (the STU or Neely) were much help today. Both think there is more upside to go, and Neely expects a lot more than the STU. In scanning the many ewave sites I thought this chart from Kenny was most instructive. It shows the wave 4 count and need for a final thrust up. A concern I have is that it has really wimpy waves 1 and 2 off Oct2. 

Tony Caldero has a similar count but a different wave form where he ends wave 1 where Kenny had his black iii. This makes 1 longer than 3 and puts a cap on 5: no more than 30 pts, or Sp1112. Now, usually one leg extends, and in this case it would be wave 1, which is rare but within the rules. Sp1112 is the max, and usually when one wave extends the other two match or one is 61.8% of the other. This gives targets of 1112 or 1100 if today's bottom was the end of wave 4. 

Wave structure of 4 would allow almost no room to go lower on Tony's count, or it would cross into wave 1 which topped at Sp1080. This pretty well assures a continuation up Monday, either of wave 4 breaking as a flat (where wave B must retrace 61.8% of A under Neely's more detailed rules) or a start of wave 5. Wave 4 would be stressed to be a zigzag, which under Neely's rules should not retrace more than 61.8% of A, and wave C would have to be a shorty; but as long as C goes even a smidge more than A, it is within the rules. And a smidge of 2 pts is all that sits between the Sp1079.6 top of wave 3 and the wave A of 4 bottom today at Sp1081.5. But let's not sweat that possibility; under Tony''s count, wave 2 was a zigzag, and the Rule of Alternation would rule out another one in his count. (The third possibility, a triangle would not break the leg a bottom either.) 

One other count, which my scan could not see charted, has a higher target. Go to the first chart and end wave 1 where Kenny has his back i and wave 2 where he has black ii. Then we would be still in wave 3 up, and Tony's top would be the end of 3. A bigger pullback and a final wave 5 to go. This would allow a 50% retrace to Sp1121 and Dow10334, and would also allow the Dow to shoot a bit higher to my original target (back to Jan1) of Dow10500, where it fills the Dow's gap back to the Lehman Moment over a year ago. There: all gaps filled, a normal 50% retrace, and better looking final wave pattern. 

This should be clarified Monday. Enjoy the weekend! 

Before You Jump Back Into Real Estate, Read This

Time for a little public service for those crazies buying back into housing. Amherst Securities did a report on the huge shadow overhang in the housing market. They count 7M units already delinquent, up from 1.3M in 2005 and more than the 5.2M annual home sales right now. They estimate an additional 300K go delinquent each month, or another 1M since this chart ended in Q2. 

The government's vaunted modification program doesn't seem to have much impact, as 70% of them go delinquent again within a year. Maybe 1M of the overhang could be modified if all went well, but then 700K would go back into the overhang a year later. In other words, best case the modifications would only save a month's accumulation of more overhang. 

They look a little deeper into Riverside CA, which has 1,372 units for sale out of 34,800 total properties. If you add to the listings the foreclosures not yet listed, houses about to be auctioned off, and houses with a notice of default, you find over 7,000 units are in the shadow inventory - 20% of all houses in the city! Now, Riverside like Vegas and places in Florida was at the center of the irresponsible government-backed no-money-down loans of the housing bubble, so this sort of shadow inventory of 5x the listings is at the extreme. But they sample other places, and find LA is a 3x overhang, Vegas is 4x and NYC over 1x. San Diego, where some of the crazy buying is going on, is at 3.4x overhang - the buyers are nuts! 

The problem right now is that defaults are happening much faster than liquidations, so the overhang is growing. See chart, which divides by loan type. Subprime are past their peak defaults, and the liquidation has caught up. AltA and OptionARMs are close. The problem is now in the Prime loans.

They conclude with an analysis why prices and sales seems to have bottomed: seasonal factors have given a temporary plateau.  But the seasonal buoyant period is over, and both prices and sales should now resume a slump. 

If you jumped back in and are now stuck, you have another option: sue! Bloomberg reports how condo buyers in Florida are suing for deposit refunds. Condos they put a deposit on in 2006 at $1000 sq ft are now down as much as 8x, and the worry is they will soon drop 10x or below $100 sq ft, the level in 1989! At those levels, maybe the crazies will jump back in and bottom fish ... 

The Psychology of This Market

Crazy stories of a feeding frenzy in housing are what we should expect to be seeing nearing the top. Imagine: multiple offers, selling in a "blink of an eye", all cash offers - what gives?

After a bubble bursts, the snap-back rally carries with it a snap-back psychology. The irrational behavior at the bubble peak comes back, and often is even more crazy. You can look at market history and see the same psychology in 1930, when the powers-that-be were convinced the recession was over; in 1938, which is the closest analog to today (see chart, courtesy SlopeofHope); in 1974; and on and on.

This is not surprising. If it weren't occurring, something would be wrong, and the Obama Hope Rally would not be nearing an end.

The Bubble Echo psychology should accelerate from here. JP Morgan put out a series of recommendations, which include going into emerging markets - another bubble-era theme which has returned. Sumitomo put out a projection of the Dollar going to 50 on the Dollar Index next year and fading as a reserve currency - weak Dollar being another bubble theme, and this an extreme projection. If you keep your eyes open, you will see these Bubble Echo craziness all around.

Real Estate Strikes Back

Oh boy, amidst the good earnings of Intel and Google we have a downer of a story on real estate. Foreclosures have hit an all-time high in Q3 of almost 1M homes. In Nevada, 1 out of 23 homes was in foreclosure last quarter.  Mish reports that foreclosures could top 3.5M homes this year, 50% higher than last year. Mish was a bundle of joy today, also reporting that rents have fallen for the first time in 17 years, and that new FHA rules make condos utterly worthless. 

Worse, real estate woes have run through subprime and are now increasing in prime housing. Prime loans are now 58% of foreclosures, and the chart shows that 65% of foreclosures are in the mid and upper tiers of prices. Video commentary here. 

OptionARMs are starting to bite. The 5 Min. Forecast reports that 46% of optionARMs are past due, even though only 12% have reset rates. 

What to make of this?  I have commented on this previously, including here and in a much more in depth post here. The next wave down is coming - see second chart. OptionARMs, HELOCs (home equity lines of credit) and commercial REITS are about to go through the same wringer that subprime did last year. 

That doesn't mean real estate couldn't be played. My comments from the in depth post still stand:

Seems like the only two sensible options (besides staying out) are: buy in places which avoided the egregious loans, like Palo Alto; or buy apartment buildings near distressed areas to pick up all those folks who are about to be kicked out of their homes.

Also, one bright spot globally is the land of Oz. Sydney real estate is still bouyant, pulled up by Chinese stockpiling. Of course, that could change if (when?) the China Bubble bursts. 

I would avoid China however - check out this Special Project: The China Files analysis of a growing bubble in Chinese real estate, sent around by John Mauldin today. Bottom line: China 2010 = Japan 1989.

Yves Updates His Bond Prediction

Yves sent me this updated chart. His last call was for a bond rally, and we have completed the first wave up. The recent weakness is a wave 2 correction. Stocks may give guidance as to bonds. If stocks get past fall off the Dow10K level (we continue to hover today) it suggests wave 3 in bonds is on. Yields should drop and bonds should skyrocket.If we hover, bonds may continue the wave 2 correction with a B up and C down before we get to wave 3 up. 

The STU has the opposite count, that we are still in a bond downtrend and the rise in bonds since Mar9 reflects a wave 4 correction with a wave 5 down to come. I suppose if bonds do a zigzag down as part of Yves' wave 2, it will match a short wave 5 as part of the STU count, and the two could converge. But a flat wave 2 or a start of wave 3 would contradict the STU count and show Yves as the Bond Guru du jour. 

ZZ Top

Among my 2009 predictions posted on Jan 1 was this one: "A Hope Rally to Dow10500 (SP1100) by this summer."  Well, summer has gone but Dow10500 seems to have come - maybe by this Friday's speculative top date. 

Kudos to Tony C as the EWI count has now joined his: the wave action since Jul8 has now broken into 7 waves (see chart, courtesy EWI) which count best as an ABC-X-ABC double zigzag (ZZ). I had expected this - see the discussion of the double ZZ count in this recent post. 

Dow10K is one of those wonderful levels like Dow1K and Dow100 that seem to be hard to put in the rear view mirror. We hit it 10 years ago and lo and behold are still there. That sure makes the buy & hold crowd look stupid. If we match the 1966-1983 experience we won't get past it until 2017. 

To the irrationally exuberant (aka CNBC), new highs are around the corner! Curious that they noted today that we had crossed 10K fifty times since 1999 on a closing basis. Jim Bianco at BiancoResearch counts 1859 times intraday (source: today's STU). 

What this may mean is we hover around here a bit. The next target level is Dow10125 on Friday to hit the upper trendline on the chart, and then Dow10334 to hit the 50% retrace, a common level for a ZZ top. 

If the S&P breaks 1100 it will cover a gap down from last year (Oct3). The hard core TA folk have noted this for a while. Gaps like that *need* to be closed. A different trendline off the Oct07 top and May08 secondary top is right at Sp1121 today, the 50% retrace level. So as the Dow goes towards 10.5K, watch the S&P go towards the 1120 level.  Again, a 50% retrace at Sp1121 is an expected level for a zigzag correction, and a good spot for the fat lady to sing at the ZZ Top.

Retail Sales Projection

Retail sales declined 1.5% in Sept. This report from Zerohedge shows how the Fed is trying to spin this as a 4% growth projection! Fed's comment:

Total retail sales slipped down 1.5 percent (nonannualized) in September, due in large part to an 11.8 percent drop in auto sales as the CARS incentives rolled-off. Excluding autos, retail sales rose 0.5 percent during the month. ... Over the past 3-months, the “core” series is trending at an annualized rate of 4.0 percent, a tentative sign that consumption may be starting to firm.

There is some additional good news in these results. Same store sales rose 0.6%, better than the expected decline of 1.1%. Now, September was an unusually warm month which helps retail, but October has started off as a record cold month with surprising snow coverage. By mid-month we had set 4500 new records for cold. This should hurt October sales if it continues. We shouldn't be overly stressed by a poor October report given that the sales may move forward into November. 

Moody's looked at same store sales and reached a more pessimistic conclusion:

We continue to feel that Holiday 2009 revenues will be modestly down, and profits will be up, from 2008s, with any surprises most likely to occur on the downside. There do not appear to be any macroeconomic forces at work that would lead us to conclude that the consumer will be better positioned to spend during the balance of 2009 than he/she was during the similar period of 2008.

My take is that we should be cautious with year over year comparisons. Last Fall was had terrible retail sales due to the economic climate and fear of a financial meltdown. Some normalization is to be expected. Reuters quotes some retail experts as projecting flat holiday sales year over year, which is not good news. Rather, I expect some growth, especially since the big guy, Wal-Mart, is not part of the same store reported numbers. After all, Wal-Mart is a huge part of retail. 

Also, during the past year the Four FoodGroups of the Apocalypse have done well:

1. Wal-Mart
2. McDonald's
3. Hersheys (cheap chocolate)
4. Hormel (spam)

Missed My Dow10K Bet By 6 Weeks

I had had a bet since last Nov that Dow would crest 10K by end of summer (Aug31). Darn! Six weeks off. Now we shall see if we get to the 50% retrace at Dow10334/Sp1121. 

Another Crash Call: Is 2009 Like 1929 and 1987?

The market in 1987 followed the pattern of 1929 very closely, which is an incredible coincidence. Extending this to 2009 shows the same pattern emerging and pointing to a top on Oct16 and a crash on Dec10. Oct16 is this Friday and options expiration, always a fun day. 

Now, so far we have one data point (Jul11) and a pattern match since, so don't make too much of this; but it is intriguing. Maybe the psychology around these moments is so self-similiar that this is more than serendipity.

This may just blow over but I thought I would elevate the comment to a post. You might also see the same story on other ewave sites, as VirginaJim spread this around in a comment blitz this morning. 

His commentary below the fold. 

Dollar Gets to YE$. Fed Gets in a Box

Today the YE$ currency (Yen Euro $Dollar as the reserve basket) hit a milestone: the past three months have seen the Yen/Euro get 63% of new reserves vs the Dollar at 31%, or below even one-third among the three. The US Peso is now down to its lowest level as a reserve currency since the break with gold in 1971 at 62%. While this is not quite the fancy headline "Dollar Loses Reserve Status" it does show that pressure is building on Bernanke to raise rates to support the Dollar. 

The Fed's conundrum can be simply explained (this is a quote from John Mauldin from Mish's site today):

You cannot continue to run deficits significantly larger than nominal GDP for too long without risking the demise of the economic system. But we are in a deflationary environment, so the Fed can monetize the debt far more than any of us suppose without risking immediate and spiraling inflation.

The mistake we are running is to have huge fiscal stimulus (deficits) alongside huge monetary stimulus. 

The concept of monetary stimulus to avoid serious deflation and ease the write-down of excessive debt comes from Irving Fisher's seminal Debt-Deflation Theory of the Great Depression paper of 1933. He gave a cogent explanation of the events that led to the debacle, and discussed how Hoover almost got it right in the summer of 1932 when he began reflating the currency - we began to emerge from the Depression between May32 and Sep32 - then lost heart during the election and let it come tumbling down. At the time Fisher was the pre-eminent US economist, the Keynes of the US so to speak. 

His work is required reading, even with recent revisions. He explained as simply as I have seen why the Depressions of 1929, 1873 and 1837 were different in kind from deep Recessions in 1921, 1893, 1859 and 1820 (and 1981): the Recessions were due to over-production, while the Depressions were due to over-indebtedness. As now.

His remedy is now accepted wisdom: massive liquidity from the central bank is needed to ameliorate deflation and prevent money from being hoarded. Back in the 1930s people may have stuffed bills into mattresses, but today we stuff them into short-term Treasuries. Same effect - the money is not spent nor is it invested (which is also then spent, on new plants and new hires). Hence plopping savings in short-term low-interest notes is the same as taking it out of GDP and stuffing it in mattresses. As now.

Bernanke's Fed reacted too slowly, and drove US consumers to pay down debt and plunk their savings in safe instruments; but has heroically pumped liquidity since. The dilemma comes not from Bernanke but Obama: the massive Federal deficits to finance stimulus are creating a terribly negative dynamic. I have previously discussed the impotence of fiscal stimulus: rather than reinvigorate the private economy, it acts as short-run life-support. 

The worse position to be in is where the deficit grows faster than GDP. This creates a dynamic where the government simply digs a deeper and deeper hole. Right now economic projections even in the V-Shaped recovery have us growing the deficit faster than GDP. Only Obama's optimistic projections suggest otherwise, and they are not taken seriously. From Judy Shelton in a WSJ op-ed today: 

Even with the optimistic economic assumptions implicit in the Obama administration's budget, it's a mathematical impossibility to reduce debt if you continue to spend more than you take in. Mr. Obama promises to lower the deficit from its current 9.9% of gross domestic product to an average 4.8% of GDP for the years 2010-2014, and an average 4% of GDP for the years 2015-2019. All of this presupposes no unforeseen expenditures such as a second "stimulus" package or additional costs related to health-care reform. But even if the deficit shrinks as a percentage of GDP, it's still a deficit. ...

The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio ... .

Sadly, due to our fiscal quagmire, the Federal Reserve may be forced to raise interest rates as a sop to attract foreign capital even if it hurts our domestic economy. Unfortunately, that's the price of having already succumbed to symbiotic fiscal and monetary policy. If we could forge a genuine commitment to private-sector economic growth by reducing taxes, and at the same time significantly cut future spending, it might be possible to turn things around.

Worse, the maturity of Treasury debts is decreasing, from 6 years in 2000 to 4 years today, and dropping towards 2 years. As Karl Denninger comments, this places Treasury in an untenable position: it has to roll over the whole deficit every four years PLUS tack on new debt to cover the deficit. Why would the maturities decrease? Maybe that is all our trading partners will take, since they are rolling out of the Dollar into the YE$ basket. By reducing their exposure to long-term Treasuries they better prepare to get out if the US Peso continues to fall. 

When something cannot go on, it doesn't. Expect something to break, and soon, and the USD to begin to rise again.  

housekeeping notice

I have changed the comment policy to require a typepad signup & therefore create real posters not fakesters and imposters. I apologize for the inconvenience to real posters, and I encourage you to take the step to become official (which you can do under a handle not a real name). let me know what you think

Double Top With Divergences

Dow broke above its Sep23 intraday high and closed below, but the S&P and Naz (and Trannies) failed to confirm. The S&P got real close at 1079 then faded. Today was Columbus Day Fall Weekend Day and trading was a bit light. Bond markets were closed. Better not to extrapolate from holiday trading. Neely is standing aside until this upwards momentum dissipates. 

The STU remains optimistically bearish, noting that the Naz also failed to confirm at a double top in May 2008, which was also a wave 2 that retraced 99%. That top was followed by a hard decline that we all remember all too well. So watch the Naz for a key to the market over the next few days. Tomorrow Intel reports earnings after the close, and will be watched for a direction on earnings.

The Dollar as the Hot Potato

The Long Bond is way up in the past few days, with yields shooting from 3.95% on Oct2 to 4.2% Friday. The yield curve had been flattening, but is now going the other way. See chart from StockTiming. Bond markets are closed today for Columbus Day Fall Weekend Day. Tomorrow should be interesting. Does this sharp change in bond yields reflect local turmoil last week in forex markets, meaning it will settle back down this week, or is it presaging a trend change in the Dollar?  

Treasury had a surprisingly poor auction on Friday. Perhaps the CBO long term analyses are causing concern, since they point to fiscal doomsday. Curiously, despite last week's sneak attack on the Dollar, it came back on Friday. The Dollar is down today except for a collection of Asian Tigers who have been intervening to devalue their currencies (including Japan). My experience with bond markets is they don't look out that far; instead are driven by the trading environment. That may be about to worsen.

First, central banks are worried over holding the hot potato: too many Dollar holdings when the bottom drops out of it. While central banks are not decreasing USD holdings, they are shifting proportionately away. In effect, central banks are shorting the Dollar. Why?

No one wants to be caught holding too many dollars, and this rising reluctance is increasing pressure on the USD. This is an obvious USD negative, but it is also means that the ECB and the EUR are caught between a rock and a hard place. The capital flows into the EUR have very little to do with any euro area cyclical dynamism.. 

Second, we seem to be in a swirl of events that may soon change the current market dynamic. Besides Latvia having a failed auction and potentially defaulting, now Romania may collapse tomorrow. Fear of fiscal dominoes is bullish on the Dollar as a safer haven.

Third, the other shoe to soon drop may be China. The Shanghai exchange had been closed for over a week, opened strong Friday and faded today. Nw a report is out that lending in China hit a new low in September. From the report: "Yet the September decline was doubly ominous, as it comes in a time when banks traditionally let the spigot on full blast." 

A Look at the Dollar/Dow Relationship

The inverse Dollar/Dow relationship is widely recognized. Forkoholic Serge sent me this chart where he inverted the Dollar and laid it next to the SPX. Given the similarity, he asked: 

There's no consistency in EWI's count
if they count USD as impulsive down
should they count SPX as impulsive up?

EWI counts the Dollar Index (DX) in a 5 wave C down, and counts the SPX as having been in a double zigzag (ZZ) up. Both are corrective patterns at large scale. The C wave of the DX is an impulsive five-wave pattern within a larger correction. The double ZZ of the SPX contains impulsive waves within a larger correction. 

His question can be rephrased: is this wave sophistry rather than wave discipline? At first blush, the look of the two waves are similar on the attached chart. Both head up fairly steadily. 

But take a closer look. The inverse DX shows a fairly clear five-wave pattern, with a lengthy fifth wave ending diagonal (ED). It shoots up more than the SPX, then drops sharper, then shoots up again in wave 3, consolidates, and has meandered upwards in the ED since the July low in the SPX. In contrast, the SPX looks like a three-wave pattern, with a pronounced correction in June. 

Look closer. It is pretty hard to find a 5 wave from mar-jun in the SPX; instead it seems to count ok as a zigzag (ZZ) and initially the STU thought it a double ZZ. In a WXY pattern (double ZZ) the W and Y tend to look similar. That is why Tony C's count of a double ZZ from the July is interesting - you could count a dbl ZZ from mar6 to jun11, and now maybe a second dbl ZZ from Jul8 - now. Nice symmetry. If the 2d ZZ continues on into next week to slightly higher highs (Dow10k and change) then the two would be very similar in look and timing. If it doesn't go much higher it would be close to a 0.618 relationship of W to Y.

Tony counts us in wave 1 up of the C of the 2d ZZ, but the count also works as all of C if we have one more leg up. I think the reason he sees it as merely  wave 1 is the relationship of A to C. In a flat the C tends to be the sharpest wave; in a ZZ the A tends to be that. Hence not surprising to find the C of a ZZ to be less than A, often a 61.8% ratio of the A. But C=A is also fairly common. 

Here A of the 2d ZZ went from Sp992-1080, or 88 pts. The B went from 1080 down to 1019 at its low point. We might have a C ending around Sp1075, which means that C is about over. Under Tony's count, with C=A, then the target is Sp1107, and it is then more likely that C has more waves to go than one. This would suggest a sharp wave 2 (of C) drop early next week, then a good run up to above Sp1080 and maybe close to Sp1100, a sideways period, and a finally spurt up to Sp1107 or maybe even to Sp1121, the 50% retrace of the whole drop last year. 

The Fed is Causing a Continuing Credit Crunch

There can be no real recovery without the private sector, and credit is collapsing for consumers and business. These two charts show the businesses are not able to borrow and consumers are not able to get credit. On the consumer side, overall credit is declining at 5%/yr and revolving credit (credit cards) is declining even faster at 8%.  Business loans are down 12% yearly, and in the last three months a frightening drop of 19% annualized for total loans and a 28% annualized in commercial loans. This means the credit crunch is accelerating. 

One of my investments is living this nightmare. Their sales will triple this year in a bad market for retail products, but they have a difficult time getting a line of credit even when backed by real assets - receivables - and have to pay an effective rate of 15%. 

The public looks at the extremely low Treasury interest rates & deposit interest rates, and presumes that businesses can borrow close to them. Instead, normal everyday commercial credit is run up to usurious levels. And almost everyone knows someone who has faced seemingly rapid and arbitrary increases in credit card rates to a stunning 28%. New accounting rules which are supposed to enhance transparency may make consumer credit even harder to get. 

The reason for the worsening crisis is the way the Fed has handled the situation, as described the Run on the Dollar post: by burying the toxic debt inside the Fed, they have postponed the day of reckoning for the banks but have not cured it. 

You can see in the chart how much the Fed has buried, inside their Maiden Lane vehicle and using the TALF program. Total bank reserves have hit an all time high.A huge chunk of it (70%) are "non borrowed reserves" which as best as I can figure from the Fed's gobbleygook are the reserves burined int he Fed. They are not being used for active lending. 

This postponement has consequence. The banks have apparently taken their reprieve and used it to speculate in bonds and equities - the current Obama Hope Rally. Yet they are still tightening credit and pulling back on lending because the buried reserves lock up lending capacity. After all, at some point the Fed will swap them back! And then the banks will have a much harder time avoiding insolvency, since these assets will have to be marked down due to their lack of liquidity and the underlying distress of the assets lent against (primarily real estate). 

So far the Fed has postponed the necessary write-downs of the first phase of the crisis - primarily subprime and alt A mortgages to people of questionable credit who have since defaulted at very high rates. 

In the next two years the second phase will hit: optionARMs, HELOCs (home equity lines of credit) and commercial REITS, mortgages to borrowers of decent credit. The optionARMs and HELOCs are destined to reset to much higher rates. They were typically designed as a five-year balloon, with the expectation that they would get refinanced within that period. Since real estate values have dropped, this is now a fantasy, since many of these homes are underwater - the mortgage is more than the equity value. 

The expectation of course had been for continuing appreciation. HELOCs in particular are distressing, since they were taken out by people of good credit as second or sometimes third mortgages with every intent and capability of covering the payments and repaying the loans. Yet all around them the subprime and no-money-down mortgages drove up the price of housing, both inflating the size of the optionARMs and seducing homeowners into HELOCs. 

In effect we began using our homes as ATM machines, withdrawing to buy SUVs, HDTVs and vacation property. The MEWs or mortgage equity withdrawals drove the rising GDP during the Greenspan Bubble. This chart shows how different GDP would have looked without MEWs. 

The chart below it shows how the home ATM has run dry. 

With MEWs we borrowed beyond our means and spent it on stuff that pulled in future GDP to the present, meaning GDP that would have happened anyway after we earned more to afford it was pulled forward by a debt binge. Just as the mortgages that funded the MEWs have to be repaid or written off, the unearned GDP will have to be given back in the form of lower GDP or actual drops in GDP over the next five years. 

The piper has to be paid. 

This is what makes this situation so different from a normal recession. Normally when we get ahead of ourselves we have borrowed too much but did it against earnings power (or expected future earnings). In this case we borrowed too much based on asset (home) appreciation, and got way ahead of earnings power. As houses fall, the mortgages get written off, and consumer credit will have to wait until our earnings again catch up. 

The debt write-offs cause deflation, and as this chart shows we have been in a deflationary period for the past year. But we have had a relatively mild deflation compared with the scale of the excess debt. That is due of course to the Fed hiding the problem. When the second wave of the crisis rolls over, the Fed will be sorely stressed to continue to hide the hot potato. 

The Fed has an inordinate fear of deflation. So did Hoover in the 1930s, and his attempts to prop up wages and prices helped turn a bad recession into a long depression. 

Ironically they see the situation backwards. As the economy adjusts to excess debt and the pulling forward of GDP, debt write-downs reduce income and layoffs lower wages. With deflation, prices also drop, and less income goes a longer ways. It softens the blow.

Worse, the low interest rates devastate the return on capital. This gives capital an incentive to invest outside the US for higher returns - China? Australia? With a Dollar depreciation risk on top, it pushes investment away even faster. Deflation at least gives protection to the Dollar; but the deeper risk is as the Fed exits a round of deflation then gives way to inflation given the huge overhang of Fed liquidity created to bury the toxic debt. 

When might the chickens come home to roost? 

The second wave of mortgage problems crests in 2011, and can be postponed a bit. 

Fiscal policy in 2010, however, may create an additional set of stresses. The Bush tax cuts are set to expire, causing a huge tax increase in the face of a recession. The Stimulus will be past peak in 2010, and decreasing. The net impact will be a huge negative stimulus in 2010. This chart shows the Federal deficit in red and the change in it in grey; and the year after a stimulus it acts as a brake on the economy. 

Obama has room for a second stimulus. The deleveraging of total debt has been postponed by the Fed, but not avoided entirely. Private debt is still be written down faster than the increase in the Federal deficit. This gives room for a tax cut in 2010 to counter the expiration of the Bush cuts, and room for a second stimulus. 

We can debate the value of stimulus but it would have some short-term impact to at least ameliorate the potentially large negative stimulus next year. And maybe this time they can do a Stimulus bill that acts faster. 

The wildcard for the day of reckoning is a series of defaults come out of Europe. The mainline European banks are more over-leveraged than US banks, especially in Eastern Europe. Latvia just had a failed bond auction, and it is ratcheting Sweden. Other countries may follow. including Ireland. 

The bottom line remains: a continued if not accelerating decline in commercial and consumer credit. 

The longer the Fed tries to postpone the inevitable, the deeper the hole for the private economy to climb out of. All that is left is to try keeping the zombie banks at bay and the economy on some form of government life support until the US creditworthiness begins to seriously weaken. 

Last Chance Crash Calls

I don't see a crash coming - indeed, a new high seems more likely - but a growing number of ewavers have put out crash calls. "It's 1987!" No, it's not. Maybe this is because today is the anniversary of the peak in 2007?

Crashes are rare and calling them is risky punditry. Of course, if you get it right, you look prescient. If you miss, who remembers? Some of these calls are coming from pundits I respect, so here goes. 

Hank at Elliott Fractals sent me this chart and posted a crash call. He has gone "all in" - 100% short. You gotta respect someone who puts their money where their opinion is. (I hope he has stops!) 

His fractal approach is the next step in ewave, and although I don't know if he has yet created a multi-dimensional fractal (time/price plus momentum indicators) it is worth watching how predictive his approach turns out to be. 

Ned Bushong puts out a crash warning, not quite a call, comparing the setup now to the one a year (and a bunch of points) ago. 

JG Savoldi Of BAM Investor has been on a crash call for a while, and now says it is imminent. His chart is the second one. 

Even Carl Icahn put out a warning!

On the other hand, Neely has gone short term neutral to bullish today. He has moved his count to a developing triangle where Mar6 as the end of A and we are still in B. Under his system, the end of B is unpredictable (a truly honest pundit!!); stand aside!  Often the best advice. You can download it here. I plan to comment at greater length on it soon. 

Marty Chenard of StockTiming puts out this analysis today (the third chart) which shows institutional investors have been accumulating. As he points out:

When the Indicator moves above the zero line, day-traders should not be short because Institutional Investors are moving in the opposite direction. 

My take on this is the focus is on the wrong markets. Given the Dollar Demise stories of the past two days, something else seems to be about to happen: might the Fed be preparing to raise rates, and begin its exit? Bernanke's speech last night caused a Dollar rally. Yet the Fed went ahead with QE by buying a bunch of agency paper today. No exit yet. 

If not handled well, any such start would like spook the market and drive a serious break down. Crash? No. But swan dive, yes. Watch the forex and bond markets for clues. 

Aborted Run on the Dollar?

The Dollar's weakness this week seems to be due to an organized attack on it, shades of Soros shorting the Pound in the early '90s. The story on the secret cabal to replace the Dollar may have been a planned leak which was followed by an organized short and a surge in gold. Now the Financial Times reports of massive intervention in Asia to support the Dollar and slow the rise of Asian Tiger mercantilist currencies. The head of the Euro Central Bank has also been publicly bemoaning the weakness of the Dollar and a potential deal between the US and China to let the Dollar slide slowly while removing pressure from the US on forcing the Chinese to appreciate their currency. In other words, organized debasing of both currencies. In such a scenario, the Euro would continue to strengthen, threatening Euro exports. So now the Euro wants to join the race to devalue. Not really possible, is it? No one gets relative advantage. 

These manipulations can explain why equities have been spiky in the past week. They also support the ending diagonal formation the USD, a formation which can form as intervention emerges, and can reverse sharply. Tomorrow may be a bounce in the USD and a fall in gold and US equities. How sustained this will be remains to be seen. The USD forex market is absolutely huge. It is a treacherous moment, however, when the worlds reserve currency can suffer from mere rumors of secret cabals; it shows a pervasive lack of confidence in the management of the currency. 

The real secret cabal may be US leadership (Obama, Geithner, Bernanke) planning to continue to allow a slow fall of the Dollar in order to finance horrific deficits while lessening the burden of ever paying back the creditors. Two very interesting analyses of this in the last few days: 

1. Chris Martenson of The Crash Course argues that the Fed has postponed deflation by hiding the worthless debt for the banks. During the Greenspan Bubble from 2002-2007 the US doubled its Dollar denominated debt, from $26T to $52T. That increase is not supported by any concomitant increase in US productivity to support that level of debt, and hence can be expected to be written off to the tune of $20-25T. The write down of such magnitude would create a deep deflation. Some deflation is with us, but much of the worthless debt has been swapped into the Fed, where it sits without yet needing to be written off. 
2. Various commentators including here have noted how the Fed needs an exit strategy from their swaps of toxic debt: "Paradoxically, by buying and accepting bad assets, the central banks did not fix the solvency problem: they merely delayed the inevitable. The bad loans did not turn "good" by changing hands or being accepted as collateral by central banks." As the Fed swaps them back, they send the zombie banks back into insolvency, causing the financial crisis to re-emerge. The internal debates inside the Fed to begin the exit, which would start with raising rates, is beginning to leak out. 

The core rule of economics is TANSTAAFL, and in this case the consequence of the Fed hiding the hot potato of toxic debt is a crushing drop in credit availability that is continuing and maybe accelerating. Simply put, zombie banks don't lend. See chart. 

If this Dollar intervention gains scale, look for the USD to reverse up and US equities to reverse down. If it is short-lived, watch whether the Dollar shorts come back strongly and continue to hammer it down. In such an event the Fed may be forced to act to support the Dollar or risk a rapid devaluation. I had not expected this Dollar Crisis to emerge yet, and view this as merely a warning shot across the bow of the US Ship of State. Yet in the short term it ratchets markets and needs to be watched closely. 

Last Chance Stress Test

I haven't lost my bet yet, but I almost lost my appetite today: the bet is that the top was in on Sep23 at Sp1080 (Dow9918), and Mother Market ran almost back up to that level, then faded a bit. The fade mid-day today raises several interesting possibilities:

• We are in P3 down, but we just had an unusual but still within-the-rules large retracement - another last chance chance to get out! The STU counts us as ending a flat wave (ii) of the down move today. To get there they ended wave (i) at Dow9666 (see this post for a chart and discussion) and followed it with a huge irregular flat correction.
• We are in an X (or have ended it) and a serious up move is ahead, probably lasting three months and going towards Sp1100/Dow11K. If we are still in an X wave, it has broken in a complex fashion, and now should drop. This is the pattern that will confound both bulls and bears, since it looks like it is in P3 down then reverses and we have a third zigzag to a new high. 
• We are in the final C wave up of a zigzag, but a different zigzag than most have been counting. I credit this one to Tony Caldero, and recommend everyone review his special post from last night. More on this below.

The STU count is a bit of a stretch but often at serious market tops the market gets oddball, especially with spiky moves both ways and a lingering series of multiple retests. (Zoran used to wait for a third retest before calling a move as ended; if so, we have one more jink and jive to go.) The simplest count would be to call the drop off Sep23 a wave iv and the move up in the last week as an impulse first wave of the final wave v. The problem with this is we broke into the prior range of wave i (the Aug28 high in the Dow of 9630), at least in the Dow - see chart in this post. (This possibility is alive by a hair in the S&P.)

Hence something else is going on. Tony's count is a very adept way to explain what it might be. The first chart is from his site, and uses his counting method, where an ABC-X-ABC is ABabABC. He divides the second zigzag from Jul8 into a double zigzag, with the move from Aug28 down to Sep2 as the X wave linking the two. It means we had no fourth-wave overlap problem, and are in a final fifth wave up - elegant! His targets are:

Should this second zigzag, Intermediate wave C, also take on the same fibonacci 0.618 relationship as in Major wave A, then at SPX 1097 Int. C = 0.618 Int.A. Also, for Primary wave B, at SPX 1097 Major C = 0.786 Major A. Plus consider that we have two OEW pivots enclosing that level: SPX 1090 and SPX 1107. Finally a 50% retracement of the entire bear market is at SPX 1122, and at SPX 1125 Major C = 0.886 Major A, plus here we have another pivot SPX 1133. 

If Tony is right, we should find out pretty quickly. Targets in the Dow would be a little over 10K up to the 50% retrace at Dow10334. 

If the STU is right, we should also find out quickly - a drop within the next few days. Breaking below the Oct2 lows of Sp1020/Dow9430 pretty well confirms the STU story. 

We are entering a turn period, from tomorrow to Oct15, which would make the second zigzag in time equal the first, a common relationship (this weekend is the calendar day equality and Oct13 is the trading day equality.). 

There remains a third, more bullish possibility. If the drop off Sep23 were an X wave then the count suggests a third zigzag is ahead, and it should last around the same time as the first two zigzags, the one from Mar9-Jun11 and Jul8-Sep23. The X wave from Jun11-Jul8 went about a month, so this X would have been a bit short at a week and change on Oct2. Now, while there are no set rules for X waves, if it were still on even after today's stress test back to near the top, it would about equal the prior X if it meanders down another two weeks before the third zigzag begins and heads back to near the Oct2 lows.

This bullish scenario comports well with the broader market dynamic: we are still stimulating the economy, and it appears most of the spillage has gone into a bubble echo in stocks. The belief in green shoots might continue into Q1, so this rally could ride that belief at least another three months into Jan, or even to Feb/Mar 2010. The target becomes the 62% retrace level, which is above Sp1200. 

Which to choose? Mother Market will help us over the next few trading days. So might the USD. This chart from tonight's STU shows that the USD is still in a down move, which appears to be an ending diagonal. It seems destined to get to the DX74.50 level. The STU notes that a rally above its wave [iv] at 77.48 means the bottom is in. A strong rally off the bottom in the USD will probably somewhat coincide with a serious drop in stocks.  Timing looks more consistent with a bottom in weeks not months, supporting Tony's count.

Spiky Market Triangulating on a Direction

Mother Market is a non-linear chaotic system that runs most efficiently at the edge of chaos, which it is doing right now. In more prosaic terms, the recent spikes denote distribution - movements from one opinion to another - with short squeezes and rapid pops along the way. That is how the edge of chaos looks. At some point it will find order and pick a direction, and I think it did that this morning - up! Duh ... 

Later today I will get some insight from Prechter et al. but I want to share a perspective of Tony Cherniawski in an email he sent to his followers. The chart shows us in a triangle. Triangles are useful indicators of order out of chaos, since they always come as the penultimate (the next to last) wave pattern. This one will be followed by a final break up, which again happened today, so Tony's pre-marekt call was spot on. (Overnight the emini had also signaled a strong open today.)

His target for the break before the open was Dow9785, which we crushed through, with a secondary limit of 9834, which we slightly broke thru and faded off. One possible count had been nested waves 1-2, but breaking that level broke that count. (Yesterday the STU had dismissed that count as unlikely since the inside wave 2 - the last four days - was too large compared with the outside wave 2 candidate.) Nevertheless the triangle would say this move is the final one. 

The major alt count is the drop off the recent highs was an X wave, and we are or soon will be in the early stages of a third zigzag up. The wave count is ambiguous as to whether X has ended. It may be Tony's triangle (which he notes is not that visible in other indexes, making it a questionable count) denotes a B wave of an ABC inside that larger X wave, and we could fade below the recent highs after the C ends. I find this count curiously interesting because it means Mother Market will fool the maximum number of traders: the bulls will pile on thinking Dow10K is again in sights, and the bears will have backed off their short positions. 

Dollar Demise is Premature - A Discourse on a New Gold Standard

Lots of people sending around this story of a secret cabal working to get the oil trade off the US Dollar. The story seems to have engendered a lot of comment on the web; the mysterious Web Bot Project has called for a financial crisis on Oct25 that could lead to a Dollar Crisis. It apparently tracks web trends and attempts to make predictions. I wouldn't take this prediction to the bank but if it is widely crawling the web it may be showing the level of chatter on the demise of the Dollar is high.

I find this waaaay overblown. The cabal is not so secret and the timeline is not so fast (2018, not tomorrow). Mish does a good job of showing the impotence of the effort. Foreign Policy writes a really good piece on how hard it would be to push the US out of its hegemony.

The global reserve currency falls into the lap of the dominant power, and it does not leave easily. Even under the classic gold standard, it was the Bank of England that managed it, until 1914. After WWI the dominant power had moved to the US, and even then the global standard stayed in England. When the gold standard resumed in 1925, it was managed again by the Bank of England; but it had to create a bastardized standard, a gold exchange standard, where the Pound was backed by the US Dollar and the gold in the US. Only after WWII did the standard shift to the US, under Bretton Woods. Even when the US broke with the Bretton Woods gold exchange standard, the USD has continued to reign supreme against attempts to replace it as the reserve currency. 

Consider what is required to make the alternative work. The secret story says it will be based on gold. Now, a small amount of gold can go a long ways - global trade in 1913 was huge, and not matched until the mid-1990s. (I know that may seem hard to believe, but things fell a long ways down due to WWI and then the Great Depression). It was based on a 90-day instrument called a Real Bill, backed by gold held in the Bank of England. This Bills could be used to borrow against, and traded multiple times. A merchant in England contracted for cotton in the US to be shipped to a plant in China to be manufactured and shipped back to a store in London. The same, single Bill would be used at each step and often got traded or 'discounted' over 20 times. It all got cleared within 90 days and everyone paid off their debt - the many swaps down the chain simply paid off each other. (If you play with the math you can see it works.) As long as the balance of trade of the Bank of England was even, no net gold went in or out; it simply got shuffled in the vault from one bin to another. A small pile of gold could support a huge and growing trade system.

To make the new secret system work, the net gold flows in and out of whatever the bank or clearinghouse is have to balance. In the classic gold system, exchange rates were fixed and nations had to adjust their trade policy to make sure gold did not run in or out. Under a floating exchange system, the rates would adjust. Now in both systems nations could try to cheat, and did, much as the mercantilist countries like China today keep their exchange rates low by holding excessive Dollar reserves. So such a new system has to deal with the cheaters. (If you list who is behind it, you find them likely to want to cheat!)

Real Bills worked independently of such shenanigans. They were an emergent property of capitalism, arising early-on in the Italian city states, and hence were a very resilient system. Yet they died during WWI and have been largely lost to economic history. Instead we have commercial paper and other short-term instruments to finance trade, and are beholden to the whims and fancies of the banking sector.

To remain in balance, the secret system would need to handle much more than just oil purchases; it would have to set up some form of clearinghouse with relatively stable trade flows across a wide variety of trade. This is very hard to pull off. Perhaps if the cabal thinks it through, they will establish in effect a clearinghouse for a new form of Real Bill, and use it for only half of what banks do: the commercial supply chain trade, not investment or venture finance. The central authority might be called a bank but would function more like a clearinghouse.

As an aside, a lot of people do not appreciate the power of the Real Bill system. The Federal Reserve when created in 1913 was supposed to be a Real Bill clearinghouse. WWI threw a monkey wrench into that. The Austrians never got Real Bills, and have called for a 100% reserve banking system. This would be an utter disaster. Even the normally astute Mish went into a recent rant about fractional reserve banking being fraud. He got seriously slapped down by Karl Denninger's rebuttal. A 100% reserve system would lack sufficient capital to grow; fractional reserves are a marvelous way to leverage a small amount of cash-on-hand. Anyone serious about changing the global financial system must separate the trade finance system of the Real Bill (or its modern equivalent of commercial paper. factoring and A/R finance) from the investment system of bank loans, private equity and venture capital. A banking or trade system backed by real stuff (houses, cars, goods-in-transit) does not need to have much in the way of reserves, since the financed properties themselves are collateral.

While hard to pull off, it is not impossible for the USD to be replaced. Mish is too sanguine on this as well in his first article linked above, under-estimating the benefit for the US to power the oil trade. Other nations need to hold excessive Dollar reserves to finance the oil trade, and cannot easily convert out of it without impacting the value of the USD itself or of their own home currency. The US gets the benefit of seigniorage, and can run trade deficits much longer than possible under the classic gold standard.

I have a bet that by 2020 the US Dollar will be replaced or supplemented by some form of gold-backed reserve. It would take a much more serious Dollar Crisis to get there than anything going on right now, but if you look at the long term chart of the US Debt (see chart from CBO) you will see it is complete fantasy that the US can continue with the current policies - and this chart is from late 2008; the picture is much worse today. At some point we will face a huge Day of Reckoning. My 2020 bet looked far off when I made it a couple of years ago .. we shall see if it is far enough out.

The US can continue for a while with increasing deficits. Right now we are deleveraging faster than the Federal government is borrowing; see second chart. This is why we are in a fundamentally deflationary environment. And why the Dollar Demise is not imminent, nor is a new gold standard somehow imposed from our trading partners.

The Slope Of Hope's Monica Moment

Tim Knight at SlopeofHope got his wish today - Mother Market has set up one Sugar Daddy of a Bull Trap. He knows it, and yet he decries his excessive bearishness through the Obama Hope Rally. He calls it his Monica Moment - no matter how well he does from here on, that miss will dog him. 

Methinks he protests too much. If he plays the short tomorrow, he could make more than he lost on the way up. You can see from his Monica Chart how fast and far the market has come back since the fall (this is on a log scale), and how miniscule in comparison the recent drop has been. He wished on Friday for the Bull Trap Bounce today, and he got it. 

Yet Tim is a bit anxious. Monica Moments can throw you off your game. We bounced up about as far as we can for this to remain a wave (iv) with (v) down to come. The key levels to watch are Dow9666 / Sp1048 / Naz2094, the wave (i) bottoms. If we break those, then Scenario (2) is on. The drop from Sep23 to Oct2 will count as an X wave and we should expect a final zigzag ABC pattern to head over Dow10K and towards at least Sp1121 (50% retrace) if not Sp1228 (62% retrace). Tim will not like that, a second Monica Moment! Quite a bimbo eruption. And not deserved. Ah the travails of a trader!

But I think Tim can ease off his Wall of Worry. We should expect a top to become spiky, as this one has. The more troubling issue is that this pattern since Sp1080 is messy. Usually impulses down are more defined, and corrections messy, defined as over-lapping waves. Let me sort this out. 

I share a chart from Daneric to show the wave action in detail. He has adjusted his prior count of the drop off Sp1080 to get rid of an oddball ABABC pattern (a 3-3-3 is not orthodox) and replaced it with a flat (3-3-5), which starts at the right place, but I think he should have ended it and wave (ii) at Sp1070. In any event, his chart shows that the end of wave (i) down is Sp1048. This is my target to watch for, not Sp1046 as I have seen in comments to the last post. 

Two SP points should not make much of a difference tomorrow, but for you anxious shorts it may be huge. Tomorrow should gap down, especially because we closed right around a former support level which now is resistance (Sp1041), but the wave today may embolden enough latter-day bulls (day traders other than the likes of Tim, who is really good at what he does) to put in buy orders overnight, creating a pop at the open. So tomorrow may be a battle of optimistic day traders vs. skeptical institutions that plays havoc around the Sp1045-48 level. You cannot fool Mother Market, but she can sure fool you.

Looking at the chart, you can see how the wave pattern from Sep24 to Sep30 is complex and overlapping, and hard to count well. But don't be fooled by that. Here is my guidance:

• the two impulsive waves are easy to spot: the sharp drop off the Sep23 top, and the sharp drop on Oct1 (which started near the close on Sep30 and ended at the open on Oct2)
• the correction is also then clear: the messy annoying overlapping period in between is the wave (ii) correction, and is typical of a flat 

As a methodology, look for the clear patterns and ignore the messy transitions. Fill their count in after. 

It is critical to know when a clear pattern ends, especially if followed by a flat correction, since flats can have a B wave that goes farther than the prior end point, fooling chartists. Take a look at the period marked by Daneric as black v leading to the end of pink (i) down - it would be difficult to peg the endpoint any further out. The bounce after overlaps prior waves, which makes it corrective. In human terms, when the impulsive behavior abates, the wave wave has ended and something else started. When the pattern gets fuzzy, it has ended. 

This means that we will know if Tim got his bull trap tomorrow (or Wed) when the market impulses down.

Another possibility bandied about is the ending diagonal (ED) count. The final chart is from Tony Caldero and is his alt count for the Dow, not his prime count. It shows a possible ED forming since Aug17. An ED is a 3-3-3-3-3 structure with overlapping waves, and seems to violate a cardinal rule of Elliott Waves, that wave 4 cannot overlap 1. They only happen in final waves and are great news to traders like Tim, since he can take a contrary position with high confidence. They are rare, but we saw a couple last year just before two major interventions (Bear Stearns and AIG), suggesting they are creatures of intervention, much as fifth waves in triangles are often a spike caused momentarily by a news event. EDs can occur in fifth waves of impulses or in corrections as the final C wave. 

I respect Tony but think his ED is a stretch. It is expanding (see his blue trendlines) while an ED contracts as a wedge. The STU dismisses the ED in no uncertain terms: "none of the tenets of an ending diagonal are present (or were for that matter)." 

So let's drop that and fall back on two possibilities:

1. Scenario (3) or (4) is still on: wave (iv) is about to end and wave (v) is about to impulse down. Watch a break of Dow92523/Sp992 to confirm this scenario.
2. Scenario (2) is on: an X wave ended Friday and we are beginning a final zigzag up. Watch a break of Dow9666/Sp1048 to confirm this scenario. 

My bet rides on Dow9666 holding.  

Last Chance Chartfest

Now I have to take this Last Chance call real seriously - forget putting money at risk in the market, I have a bet for a dinner on whether the top really is in. As they said about Obama when he came back empty-handed on the Olympics: "The Ego Has Landed." So it is pride and reputation at risk. Let me lay out a few charts and comments to set the stage for the move on Monday.

Contrarian Advisor has a good summation of the major issues in this one chart: volume declining when it should increase in a bull market; USD weakness inverse to Dow strength; and a confluence of two trendlines we hit on Friday. His trendlines suggest a bounce Monday before breaking through. That bounce could be a little wave iv, as I discussed in the prior post, or maybe more.

Tony Caldero counts the drop as a big zigzag (5-3-5) A wave, and the counter-trend as a B. He was one of the few at the bottom who predicted a 50% retrace over five months (it wnet 7 months and 45%). BTW Prechter's EWI was another who made this call in late Feb, right before the Mar6 bottom. If this wave B has ended, his Objective Elliott Wave joins the P3 camp - in Tony's count, a C wave down at least to retest the March lows. As to my bet, his count leaves open a final wave up to new highs, preferably the Sp1121 50% retrace. He counts the recent wave as having a truncated fifth wave, a rare event which raises the spectre of a final run up still. To get his count to work, he saw a contracting ending diagonal, another rare pattern - a fifth wave which has overlapping five waves within it. A number of other ewavers have commented on this ending diagonal, and it caused the Friday STU to specifically diss that wave structure. 

The twitter feed of BAM Investor has been a veritable crashfest. They predict a gap down Monday. BAM claims to have a behavioral model. Worth taking a look at and following since their tweets are crisply bearish right now. We will all know pretty quickly how well their model is doing. Maybe I can hedge my dinner bet by asking them to cover the over in return for the plug. 

My favorite day trader sites are reveling in their putishness. Perversely, SlopeofHope wishes for a final wave up to set up a truly spectacular short as the bulls get stunned when it reverses. EvilSpeculator gives this chart with some guidance on levels to watch for either my scenario 1 and the Slope's perverse bull trap or my scenario 2, a drop that reverses and gets to new highs in the summer of 2010. 

Finally, check out these charts and how they match to a bigger picture model. His model shows we are in a cyclical downturn into early 2010, followed by a summer rally and then a deeper fall into 2011. Cannot vouch for the site or the model, but it does support my bet! Note that one of the blogroll links is to a site which discusses the mysterious Web Bot Project. Any reader care to share a perspective on this site, the charts and the Web Bot Project?

PS - despite my bet, my own views are captured in this comment to a prior post. 

Last Chance is Gone, Top is In

The market broke all prior levels to confirm in all major indexes that the top is in. How much of a top we shall see but for now expect at least a serious decline. The last chance to get out before the top is behind us but you have one or two more shots at it, at a lower level of escape. Wave structure *might* allow a small continuation up on Monday of the bounce off the intraday lows today (counted as a really small wave (iv) of the current down move). Regardless, the current down wave will soon plateau and a stronger counter-trend rally will give the last last chance to get out (or sell the e-mini futures, going short).

For those counting, we are in a wave 1 of a minor degree within P3 down - what degree of wave 1 is unclear. The last last chance will be to catch the wave 2 rally top before the stronger and deeper dive of wave 3. Note that the normal wave 2 top will be about where wave iv of (iii) down happened, or about the same level this wave (iv) will end if it continues up Monday - call it Dow9550 +/-. Note also that minor wave (v) down could run back to the Sep lows of Dow9250/Sp992. And wave 2 need not come back all that way.

After that wave 3 finishes we will have a better idea what degree we are in. if you buy that this is the STU primary wave [3] down (so-called P3), we are only in [i] of 1 of (1) of P3 - a LOT more downside.  But it may not be that bad - the various choices for which degree down are listed in yesterday's post.  The STU concludes their wave count this way:

The top wave structure is the one that we’ve been discussing: Primary wave 2 (circle) topped on September 23 at 9918.00 in the DJIA and 1080.15 in the S&P and Primary wave 3 (circle) down is now in its infancy. The alternate counts sport much lower odds at the current market juncture, so we won’t discuss them now. If the evidence changes, we’ll then delve into other potentials.

For you Neely fans, his confidence is growing as well that a major top is in, right where he called the end of his fractal a week ago.

Final note: the STU count on the long bond is different than Yves' count in the post earlier today. It is right at a level where one or the other will break. More as this unfolds. Similarly, the USD is moving up "in fits and starts" according to the STU, but its pattern is not definitively up. Watch for a break up next week. Point is the equities have confirmed a trend change; quite quickly we should see bonds and the USD also confirm their direction.

Flattening Yield Curve Points to Double-Dip Recession

Bob Pisani of CNBC (who I find their best source for real info) commented at the close today that the flattening yield curve is signaling a lack of belief in the recovery. Normally the yield curve steepens as a recovery gains strength; so a flattening curve indicates weakness. I commented on this several weeks ago and noted:

I would urge caution with the flattening yield curve. The learning from the Yield Curve really comes post WWII, in a period after the Great Depression when the propensity to save was giving way to an avarice for consuming. This has wholly flipped. Consumers are saving, not spending, and private business is still not borrowing to invest. The propensity to save lowers yields and flattens the curve.

  While I expect a W-Shaped recession, a double-dip, I would urge you to look through the pithy one-liners learned during the Great Moderation and double-click below the surface.

First, the Stimulus ain't working. Disappointing employment news today (see chart) and Mish thinks a revision of past periods is coming, indicating things are much worse than the government has been reporting. (I am shocked, shocked! they are dressing up the numbers.) Today the Big Gaffer, Joe Biden, spilled the truth as he is wont to do: the administration will not try for a new Stimulus but will try to fix the one they have - implying that they too admit it is not working.

Second, we are facing deflation not inflation. Yves' wave count for bonds (see prior post) suggests a pretty serious drop in the long bond yield, which rather than indicating a flight to quality like last year indicates deflationary expectations.

If you double-click below the surface of government CPI and PPI estimates, it is clear we have been in a deflationary period for over a year. Mish gave his take on Bill Gross's switch to deflationary investing (more on this in Yves bond post) and also has been arguing that the CPI number is misleading since years ago the govt swapped out housing prices for an imputed rental. Well, oddly enough, as housing collapses rents can actual go up! Hence the whole housing debacle is misrepresented in the CPI. Here is a chart from Mish with the CPI recalculated based on housing not rental. Mish argues for deflation over inflation based on the real stats.

Put this together: if deflation is worse than reported, the real yield on the long bond is quite high. if we actually have the -6% deflation of this revised chart, the long bond at 3.5% yield is at a horrific real rate of 9.5%. Time to buy! Deflation will drive that rate much lower to try to align real rates to a long-term 6% for the long bond. This supports Yves call to buy bonds, and PIMCO's big move back into govt bonds (but not mortgage backed agency paper). 

Third, the economy may be worse than reported. The Big Picture shows this depressing chart of unemployment compared with all other post Depression recessions. Trending out, it may not turn until 2011 and may not get back until 201.

More comments on this by Karl Denniger, including an analysis that actual losses were closer to 1M jobs, not the reported 263K, due to people dropping out of the labor force (giving up looking for a job).

Yves Calls the Bond Market - the New Bond Guru?

Yves predicted a bond rally and now seems to have caught it square on. He has been predicting this for a while - for example, in Sept when I posted Yankee Curse Day, and back in June when he posted on the Green-Shoot Fed Bull. Yesterday he posted a long analysis at Zerohedge as well as at Black Swan. This chart is his count, which he thought would come back in his June post.

Simply put, he expects bonds to outperform stocks. He now sees a 30-yr Long Bond rate as low as 2.5%, where it touched last Dec. Quite a round trip!

The Bond Guru heretofore has been Bill Gross of PIMCO. He was heavily in corporate debt and was pushing policies for the Fed to support a variety of debt markets. In the last three months he has rolled out of those positions and into government debt. He now expects deflation, not inflation, and a flattening yield curve. Maybe he read Yves post?

Spiky Dike Broken, Now Where To?

The divergences yesterday resolved to the downside. The top is in. Question is how much of a top, and how serious this drop will be.

The S&P joined the Dow in breaking Friday's low (Sp1041) and the Aug28 intraday high (Sp1039). The Naz has broken Friday but so far has only gotten within 10 pts from the Aug28 level (Naz2060). The Aug28 level is critical in that it represents the top of wave i in the count which would have allowed a final wave v up; but once we break into the range of wave i, this is no longer a wave iv and the top is in. 

Let's see how the next two trading days settle before picking a direction, but here are the main options:

1. The bullish count (yes there is one) is that we are in wave 4 off the Mar6 bottom. The correction from Jun11 to Jul8 is wave 2. That broke as a zigzag, so this one should be a triangle or flat - essentially a trading range not a serious drop. Now, it is very difficult to count the Mar9-Jun11 move as impulsive (5 waves); it counts quite easily as a zigzag (3 waves). So I think this count is a misdirection. But the move off Mar03 initially fooled a lot of ewavers, so keep your eyes open to this possibility.
2. The bear-rally count is that this is a second X wave, the first being Jun11-Jul8. The move so far is a double zigzag tied together by that X wave; it could certainly morph into a triple zigzag. If so, this X may look like that X - about a month long and relatively steep down. Then up we go in a third zigzag. The Obama Hope Rally lives!
3. The retest count is that we drop to retest at least the Nov08 lows if not the Mar6 lows, then bounce. The continuation is a long rolling wave into summer of 2010, and then another serious drop towards a major bottom in 2011. 
4. The P3 count is we crush through the Mar lows and head towards Sp400/Dow4K. If so this break should be a hope-crushing steady decline with occasional sharp and short rallies - like 1931.  

Let's look at the psychology of two periods to give guidance: the next two quarters, and next summer. Right now we are in a Grand Experiment (yes it deserves capital letters) to see whether massive global stimulation can get us out of the deflationary depression that inevitably follows a credit bubble. Greenspan successfully made this magic work in 2002-4 to create the Greenspan Indian Summer, a reflation that put off Kondratieff Winter but led to an even worse bubble than 2000. Indeed, it could be said Greenspan postponed Winter for 20 years, since 1987. Yet since 2007 the psychology has broken and the Bernanke Reflation is not working, at least not to change behavior in the private sector. At least not yet. It might change. As more green shoots pop up, the psychology could flip. Hence it has been rationale for market participants to push up on hope, and stay emboldened as more green shoots appear.

Over the next two quarters we should se a positive Q3 report (3% or so) and a somewhat positive Q4. Consequently the market could quite reasonably watch as economic news comes out, and stay buoyant hoping for upside surprise in Q4 and Q1. After all, economic growth often has the same starts and stops as market patterns. Hence option (2) above is quite reasonable. Some negative tea leaves recently have spooked the market; if more positive news begins to appear about the Xmas selling season, we could zip back up. This is not the market watching news so much as extrapolating future earnings.

Over the longer run a different psychology comes into play. In Hope and Disillusionment in Obama I described how he will inevitably disappoint his supporters who have dumped too broad a range of hope into his lap. Now, he has pushed hard for a more radical agenda than independents hoped, so he has already lost them. Next summer he is likely to lose his more radical supporters as he fails to get much more of his agenda passed. (Change freezes in an election year.) The dynamic of the election of 2010 is highly anti-Obama today, and while this could change (as they say, a year is a long time in politics), I expect the politic dynamic to ratchet the market dynamic. Hence scenario (3) is also quite likely.

I am not in the P3 camp. Serious economic chickens will come home to roost over the next two years, but not right away. Sure, option ARMs and HELOCs will be reset over the next two years - see chart. Various steps may be taken to delay this, but it is too large to put off. Also, the Fed needs to unwind its financial support for commercial paper, mortgages, and so on, and this will happen over the same period, but gradually. Hence it seems more likely markets meander for the next two years rather than drop precipitously.

In the short run, watch for whether we have a trading range off a shallow drop, or a sharp but relatively short month-long drop. Once past that we can see whether we stay in the relatively bullish scenarios (1) and (2) or the more bearish (3) and (4).