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They posted an exclusive exposé that Google was going nuclear. Right. So TechCrunch is trying to get their silly story out before GreenBeat does.
I would have rather seen them post tomorrow that ClimateGate has convinced Obama to abandon the upcoming EPA regs on carbon and really go whole hog on "drill, baby, drill!" Then they could have scooped the indisputable leader in scooping stuff off the shoes of the blogosphere, Iowahawk.
This is an update to a post on PE ratios. Last year we had for the first time the earnings of the S&P go negative, which drove the PE ratio to absurd levels, as you can see from this chart by Hans Wagner.
As we got the final results in from Q4, we have an overall $51.15 per share for the trailing twelve months, putting the current PE at 23. Future projected earnings across the S&P are:
2010: $75 (BofA) and $76-79 (GS)
2011: $85 (BofA) and $90-95 (GS)
2012: $90 (BofA)
Hans discusses past behavior after a recession, and finds that PEs tend to drift down towards 15 as an economy normalizes. If the PE drops into a normal range of 15, as is shown in his first chart, the 2010 projections would target a year-end S&P at 1200, essentially flat for the rest of the year. He sees the trailing EPS rising to just under $60 after Q1, putting a fair value at Sp1200 if we drift down to a 20 PE, but at a bullish 1350 if we remain around 22-23 PE. Given the drift downward of PE from 23 to 20 and then to 15, he projects a range of 900-1250 through the end of the year. This is not far off my January predictions for a rolling market in 2010, not a break below the Mar09 lows nor a rise to new highs.
Barron's roundtable on this topic in January focused on the economy. It is well worth the read. The closest analogy discussed is Japan, which bodes poorly for the US. The biggest wildcard is whether we recover in the 4-4.5% GDP range, which should enable the Fed to completely end QE and other stimulative measures. Overall the group was gloomy, pinning their minimal optimism on a liquidity-driven market, and expecting the Fed to continue easy credit. At best their S&P range was 1250-1300 at the end of the year.
The NYT also ran a piece on fair value, and expressed the concern that interest rates are rising, putting a damper on the Fed's easy money policy. More on that topic in this post: Did ObamaCare Spook the Bond Market? The WSJ weighed in on this topic, suggesting first that a massive increase incorporate debt offerings may have pushed the swap rates with 10-yr Treasuries to negative, and second that funds were caught off guard by the negative rates, and dumped Treasuries, making last week's debt offerings unusually weak. In other words, the weakness might be a blip.
Barry Ritzholz asks rhetorically, when was the market last under-valued? He is of the camp that since the Greenspan Put after the 1987 crash, stocks have floated at much higher PE levels than in the past. We dipped briefly back into an historical level last year at the Ma09 low, then have popped back up to bubblicious levels again.
Barry may not realize he is making the opposite point of his post: that as long as the Fed's extraordinary easy credit continues, stocks will float at ahistorical PE levels, rather than drift down. Thus the bond market holds the key to stocks: if long rates drift up despite the Fed's best efforts to hold them do this is the warning signal that the excessive easing is losing its grip.
MERU and SSNC both priced at the top of their range, a good sign. Last week's tech darlin', CALX, is kind of a bust, fading after the opening and now up only 5%. Growth is modest, revenues dipped in 2009, and it still throws off losses. Such a deal! SSNC is similarly sized with slowish growth. Meru is a growing quite fast, albeit off a smaller base.
Meru will send the best signal to the market of the receptivity of venture-backed growth companies. 
Disney announces it is looking for women with all natural treasure chests for the next Pirates movie. The indubitable NY Post reports that the filmmakers sent out a casting call last week seeking:Real Woman Jiggle
- bumper sticker seen on Sunset Blvd
beautiful female fit models. Must be 5ft7in-5ft8in, size 4 or 6, no bigger or smaller. Age 18-25. Must have a lean dancer body. Must have real breasts. Do not submit if you have implants.
The report adds: To make sure LA talent scouts don't get caught in a "booby trap," potential lassies will have to undergo a Hollywood-style jiggle-your-jugs test and jog for judges. If there's nothing moving from the waist up, they're saying, it's a dead giveaway that you're not all flesh and bones -- and you're out.
Thanks to Mish for this important set of nuggets.
We are in the heart of the good season of IPOs, and it is looking a bit more promising than it started. Two weeks ago a retirement plan management service, Financial Engines, priced above its range and shot up 44%. This improves on a prior financial-services play, QuinStreet, which priced below its range and sits only 10% above the issue price six weeks later.
Last week a telecom technology firm, Calix, priced at the top of the range, went up about 15% on the first day, and has settled back 5% above issue price. A fabless chip company, MaxLinear, priced above the range and shot up 33%.
This week five more are expected to go out, including Meru Networks, an enterprise wireless LAN provider, and another financial-services play, SS&C Technologies. A lot of these IPOs were started in the '90s (and some like SS&C in the '80s), but Meru was started more recently, in 2002, and MaxLinear in 2003. For the VC industry, it is heartening to see 2000-era core technology firms get out. (SS&C is of more interest to private equity firms, which took it private in 2005 and are now taking it public again.)
The IPO market is still tentative. Only four of the seven expected issues got out last week. Some of the laggards, like Redgate, are trying to roll forward and price day-to-day. It is selling bus advertising space in China, so it casts a bit of a damper on the China-is-a-field-of-dreams story.
Looking forward to the heart of Silicon Valley VC dreams, Nexsan, a data storage play, is expected to go out in early April. After that ReachLocal hopes to get out. Reach is a the leader in local online advertising, and will be a great indicator of the robustness of appetite for Internet ad-based IPOs. (Disclosure - I have an indirect VC interest on both of these.)
The old adage is buy in Nov and sell in May, and maybe that is what we should now expect. The seasonal pattern is quite dependable, and Sy Harding reports that it is seen not only in the US but globally, and goes as far back as 1694. Still, it doesn't always happen. He also notes that we would be just as well off mathematically to sell 5% from the top as selling 5% after the peak, but often we are psychologically much worse off selling in a downside panic. Better to be wary near a top, and prepare to short. With this in mind, here are some weekend speculations.
Thursday's Special STU noted an exhaustion gap, and as expected today was weak. Next week we should see a deeper pullback. Friday's STU stated that "there is no satisfying way to label the move up from the February 5 low, or the even shorter-term swings over the past several days, without compromising some of Elliott's guidelines." As I have been saying, the market has been at a moment of entropy (in a Chaos Theory sense) where it could go either way - hence hard to label. Still, we can always play around with what we do know, or think we know:
The 33 day turn pattern suggests a turn now, and another one in mid-May. The prior ones have been low to low; maybe this is high to high? We might see a pullback that lasts several weeks, then a final run up into May.
Our challenge is to guesstimate the wave structure. Since Feb 5 the market has sallied forth up a tight channel, and so far has broken in three waves, suggesting either a zigzag or an impulse. A pullback now and a final surge later would fit a wave 4 correction and then a final fifth wave up into May. That makes this a five-waver up, which either kicks off something bigger (eg a much larger zigzag), or finishes wave C of a correction. One model is as follows:
This "ending flat" pattern has been shown by several ewave sites, including this Wave Principle chart. updated from when first suggested, a week ago:
My prior weekend speculative count had been a top in the 1158-1170 range, which we have busted a bit above, but still close enough, so it could have topped a few days ago - and perhaps enough negative events are swirling around to drop the market, including passing ObamaCare, the jitters in bonds, the possible conflict in Korea, and the seeming bubble bursting in China, but too early to tell.
The old one is still on, but tenuously. If we blow by it, the next stop is the 62% retrace of the whole Hope Rally at Sp1229, which turns out to be close to the 1240 level where wave C of this flat = 1.6x A, a common enough relationship. Let me propose a new one based on this speculative wave count of an "ending flat" to end a triple correction from Mar9:
Sp1225-50 by the end of May.
The wave structure that supports a top at this time is Kenny's ending diagonal, which I updated in the broadening top discussion.
There was a debate in the comments to those posts as to whether the expanding diagonal triangle is a recognized form to end a move, and a few days ago Kenny came back with an update himself supporting the expanding ED. He shows this chart, which is from Prechter's Elliott Wave Principle (10th Ed., 2005), p 39. It shows an expanding ED ending a pattern, and (note to Vipul) shows the swings of the expanding ED largers than the prior wave 4 of higher degree.
Kenny's discussion of this topic is well worth the time. He also points to a resource that I had mentioned in my longer treatment, A Slight Excursion into Ending Diagonals and Other Terminal Patterns that should be studied as well.
A footnote on terminology: what Prechter calls an ending diagonal, Neely calls a Terminal Triangle. As is his wont, Neely adds more restrictive rules onto his Terminals. He doesn't label an expanding ending diagonal as an expanding terminal triangle, but he has a form called wave-5 extended which fits. It would give a target of Sp1275 by June. Neely also allows for an expanding triangle to end a complex correction, a form which may fit the Kenny pattern and would support an end last week.
Orthodox wave theory teaches that triangles are almost always penultimate waves, typically in waves 4 and B, so it may surprise to hear of triangles ending complex corrections, but the concept is also there in Prechter's EWP. He also thought complex corrections would be sideways, whereas this Hope Rally is elongated upwards, yet he has been counting it as a complex correction with multiple X waves, not an impulse. Orthodox theory also says that ending diagonals are rare, but Kenny and others have seen an increasing prevalence of ending diagonals/terminals lately. Orthodox theory also expects expanding triangles in fourth waves, but Neely says he never sees them; instead some other wave pattern is happening, likely a terminal fifth wave which looks like a triangle. All of these points suggest an update of wave theory is overdue.
Besides spooking bonds, ObamaCare may be about to trash stocks. And its costs are supposed to be years away! Karl Denninger notes how Obama said there would be no financial impact until 2014, but already it is causing reduced earnings for major US companies.
AT&T's charge is 8% for this quarter. Caterpillar's was 11%, and Deere's 16%. These are against retiree costs - the WSJ explains that the bill removes a deduction for providing drugs, hence the charge. An excerpt here. We should expect this percent to increase as employee healthcare costs themselves are driven up.
This charge is non-cash today, but indicates higher taxes in the future. One estimate is $4.5B of charges. As this spreads across US companies, expect charges around 10-15% of quarterly earnings, which is 3-4% of annual earnings. Actual future cash losses will be about half of that due to higher State and Federal taxes. This suggests that the S&P became a 4% over-valued on earnings and 2% on cash flow when Obama signed the bill, not the 10-15% that Karl Denninger feared.
The WSJ provides a handy chart to explain the changes.
While financial pundits have been watching stocks rise, bonds have fallen sharply with yields spiking up. We have just had three bad Treasury auctions in a row - demand was weak for 2-yr notes on Tues, 5-yrs on Wed and 7-yrs on Thurs. The signature 10-yr is rising towards 4% (see chart). As the Fed is now ending QE for mortgages, rates for a 30-yr mortgage have risen above 5%.
The most inexplicable moment this week came when interest-rate swaps priced corporates BELOW Treasuries, a first. Treasuries are supposed to be the safest bet around, and should price below corporates. No one is sure if this is a blip or a trend. It may be just a blip due to a lot of corporates being issued right now. (Instead of bank borrowing, US companies are issuing debt - which means a lot of moaning of lack of bank borrowing is missing this alternative path to credit). Morgan Stanley takes it as a signal that Treasury rates are about to spike up to their target of 5.5% in the 10-yr. ZH has a long treatment, worth reading.
Technically, Treasuries are breaking out of a channel/triangle since December, and fairly sharply. How far they will run is unclear. Triangles often end with thrusts. The STU expects this thrust to go above the prior highs, which is only 4bps higher on the 10-yr, and a bit more on the on the 30-yr (4.84%). This suggests the break could be fast, followed by a reversal. It is noteworthy that the triangle in Treasuries is also seen in other markets, like Shanghai equities and certain currency pairs, such as the AUD/CAD, so this sharp spike & reversal may be mimicked across other markets. More on currencies below.
The next chart shows a heads & shoulders pattern, which would suggest a run up from the neckline as far as the dip below the neckline - or to above 5% in the 10-yr, and 6% in the 30-yr. Head & Shoulders are often seen and seldom fulfilled, so be cautious on this projection.
Yields are NOT rising due to inflation, and hence the real rate is rising as well, which should slow the economy - double dip coming? There are no particular economic woes which should push rates higher. Could the rise be a return to normalcy, with a 3-4% GDP expectation ahead? Perhaps, but that view would not explain why the bad Treasury auctions this week, nor the sudden spike upwards. David Rosenberg notes how a similar rise (90bp) happened from March to June 2007, right before the big credit crunch hit. Have we started that again, in March again? Are we seeing a shot across the bow, a warning shot of the coming second wave of the crisis?
Another explanation is that Bill Gross of PIMCO caused a rotation out of bonds by saying that the three-decade bull market in bonds is over. Real rates are expected to rise, especially after the Fed begins raising short-term rates. PIMCO is now moving into low-deficit sovereign debt (Germany, Canada - but not the US) and stocks. No surprise, the spread between the 10-yr Treasury and the German bonds have widened this week. So if this turns out to be a blip, blame Bill.
Related to this is the continued Greek Tragedy. A deal was announced, or maybe not; but the critical fact is that Germany decided not to bail out Greece. The best analysis of this I have read comes from STRAFOR's Mitteleuropa Redux report. Germany is going to strengthen its position and let the profligate Club Med economies fade. No surprise that the bonds of the PIGS are sinking. Greek problems first spilled over to Portugal, and now Spain. These are all countries whose debt-to-GDP is way too high.
With the Dollar strengthening, why are Treasuries weakening? We need to ask the question of whether ObamaCare is a straw that is breaking the camel's back. Its deficit impact is years away (although tax increases come first), and it is easy political hay to claim it is spooking the markets. Yet the sum of the indicators above is that US Treasuries are beginning to lose their pre-eminence as the lowest risk, best quality place to park money. ZH did an analysis which observed as many others have that "the US is on a collision course with an unmitigated funding disaster" then added "with recently passed healthcare reform, look for the redline indicating total debt to go increasingly exponential". Here is their chart with that red line, showing how fast it has risen over the past 18 months:
Their most interesting insight is the Fed has been pushing the lengthen the maturities of this debt. They can continue to sell short-term bills at essentially zero rates, but want to push buyers into longer maturities. As they do this, they begin to lose control over rates. Simply put, they can keep short term rates low, but the market determines mid- and long-term rates.
Perhaps the market is digesting this revised deficit chart, which was quietly let out on March 5, a few weeks before the ObamaCare passage. It shows the structural deficit is much worse than imagined, and we will hit ZH's collision with funding disaster faster. Now adding ObamaCare and its full-ten-year cost of $2.4T, these numbers would be dramatically worse than even the higher revisions. Of course, it is really difficult to truly assess the impact of ObamaCare, but every program like it since Medicare has come in grossly worse than estimated, not better.
Even without ObamaCare, the CBO estimates the "deficit held by the public", which excludes intra-government holdings like social security, increases from 53% today to over 90% of GDP by 2020, putting us into the PIGS arena. The book by Rogoff and Reinhart, This Time is Different: Eight Centuries of Financial Folly (2009), which looked systematically at these sorts of crises, found that the 90% level was the tipping point to lower growth, making it near impossible to grow out of the debt burden - and hence instead fall into sovereign debt default.
A series of gaps today indicate a near term top. SlopeofHope noted with a hint of sadness a bear blogger gap: a number of bearish blogger sites have gone dark, giving up against the seemingly relentless rise of the Hope Rally. He wonders if this is some sort of contrarian indicator - maybe when the last bear site goes dark, the final top is in.
A special STU noted an exhaustion gap, a classic technical analysis (TA) topping indicator: we gapped up at the open then covered the gap by the close. Daneric's chart shows it, and adds that we had a huge volume spike in the gap, a confirming indication of exhaustion.
You can also see it in this chart by Carl Futia: the gap up then the sharp and deep drop to the close. Carl thinks we drop to the bottom of his box (Sp1155) and then back up, stair-stepping towards 1200.
EWP spots a bearish reversal candlestick with a long wick at the top (see chart), which went higher than yesterday's intraday high and closed lower than yesterday's intraday low.
Carl, Daneric, the STU and EWP are in agreement that at least a near term high is in, with continued weakness tomorrow and maybe into Monday.
"Mercantilism works" - Paul Krugman
Krugman's call for 25% tariffs on China are based on a profound misunderstanding of how the Great Recession will transform US manufacturing. The US is rapidly moving to a higher-value and sustainable position in global production from an older model of unskilled labor gaining a middle class salary on the assembly line. The greatest threat to this repositioning comes not from China but from within, from policies that hinder innovation and burden production.
I have written how the Great Recession will transform the West by accelerating a drop in core manufacturing and replacing it with high-value jobs in the layer of design, software and services that I call the IP layer (for Intellectual Property). A simple look at how value flows to Apple for the iPhone should convince you. Click on the sidebar thumbnail of a chart of value in the iPhone (courtesy GigaOm, sourced from Column Five Media). In sum:
The assembly line manufacturing component is about 1c on the $. Apple gets about 70c, and that does not include the service income from downloadable apps and music. Most the rest of the cost to build it is IP frozen into chips and software. The mobile operator subsidizes the purchase by $351 and gets about twice that in data fees, even before including voice minutes and sms fees. A similar model applies to the new iPad.
The IP and Services layer is where the value is. Traditional manufacturing of the sort Krugman wrings his hands over is no longer what "manufacturing" is all about.
You could argue that Apple is an outlier, but there are a myriad of similar companies in Silicon Valley, Redmond, San Diego, and elsewhere across the US. The web industry is largely centered in the US. The smartphone industry is almost wholly in Silicon Valley (Apple, Android, Microsoft's Danger division, Palm). The social networking winners are largely here as well. And of course the US and Europe have huge bio-tech and pharma industries.
It is passing strange indeed, then, that what passes for industrial policy in the US is to bailout car companies, enable huge profits in financial services, empower increased public sector union jobs, jawbone about green jobs - and continue to pluck the golden goose of innovation with:
Certainly China is catching up, but a look at history shows that China is still a paper dragon. When the US went through its period of remarkable growth to become the China of its day back in 1900, US companies were the world innovators in both technology (telegraph, telephone, lightbulb, electric generation and transmission) and process (ruthless efficiency in oil, steel, transportation and retail). When Japan emerged as a world power, it too showed innovation, particularly in commercialization (VCR, walkman) and process (just-in time manufacturing, quality). As China has emerged, it shows neither. Instead, it is a story of cheap labor and rapid flow of capital.
This is all too apparent looking at Chinese profitability. The Chinese exporters are hanging on by a thread,with a profit margin of less than 2%. They are at huge risk of failure if the Chinsese currency rises. As an equity analyst noted:
2% margins on export-oriented businesses is not representative of any sort of real competitive advantage. A real competitive advantage when it comes to exporting would show double-digits profit margins.
If Krugman gets his way, the sort of assembly line manufacturing of China would not come back to the US. If the Chinese currency goes up 25%, or we throw on a tariff, the rise is from $6.50 on an iPhone to $8. Instead, it would go to Vietnam or other low cost areas.
The bigger threat to the US is a continuation of bad industrial policy that hinders US innovation, while China makes great strides to move beyond cheap manufacturing to the IP layer. Already we see R&D moving to China out of the US. Several Chinese companies are gaining world scale and competitiveness with Western companies, such as ZTE in cellphones, Haier in telecom infrastructure, Lenovo in computers, and Baidu in search.
An encapsulation of the problem with the path we are on is that government workers now surpass goods-producing workers in the US.
The last time a transformation of this magnitude occurred in the 1930s when workers left the farms and went to the assembly lines. Farming dropped from 40% of the workforce to a few percent, and yet farm production kept increasing. We had huge gains in productivity, and after WWII were able to absorb those new workers into manufacturing.
We have gotten to the point where the number of public employees in the Agriculture Dept is said to rival the number of core farmer workers. I don't know if this is quite accurate, but the joke is, why was the Agriculture employee crying? His farmer had died.
Yet that old saw misses a deeper and more important observation: while the number of core farmers has decreased, the workforce in the layer above farming - call it Food Processing - has grown dramatically, and adds a lot more value than farming itself. Food processing and the food service industry to deliver it to supermarkets and restaurants has proliferated an incredible assortment of food products. In many respects this is equivalent to the IP layer above the assembly line, and has its own intellectual property in genetic engineering, flavor enhancement, organic products, preservation, packaging and distribution. Sadly, it too is being starved of innovation, and hampered by fears of genetic modification of seeds, while China is moving ahead.
Similar to what happened in the '30s, as core manufacturing has declined, manufacturing output has not, and the jobs have shifted to the "manufacturing processing" layer above, the IP layer:
As with farming, we can promote innovation, or starve it. Right now the punditry seems intent on starving it. The most astounding fount of bad policy is the Economist Who Wants To Be Taken Seriously but says really dumb things - Paul Krugman. In a recent post in his NYT blog, he actually said that "mercantilism works". Adam Smith wrote Wealth of Nations to show the mercantilist fallacy, that the "beggar thy neighbor" policy lowers overall trade and hurts the mercantilists' citizens. The victory of Capitalism over Mercantilism was decisive, to say the least. The errors in Krugman's argument are dissected here and here. He wants us to become China. He says things this dumb:
A much more sophisticated discussion of the topic comes from Professor McKinnon of Stanford, who points out that as long as the Chinese currency is not accepted as a widely-tradeable reserve currency (like the Yen, Dollar or Euro), it cannot be floated without severe internal consequences to China. Simply put, it would rise without much to limit it, as the Chinese themselves would be loathe to recycle their savings by investing in Dollar assets since the rising RMB means their Dollar investments drop. It should come as no surprise then that mercantilist economies tend to force their citizens into huge savings while restricting their ability to spend outside the home market, since that spending would unwind the beggar-thy-neighbor cheap currency. All of this means that the clumsy Krugmanian solution (of the US becoming a mercantilist like China) would fail to change China and would lower global trade whole hurting the US consumer.
In spite of poor US policies, I see a tremendously exciting and lucrative future for the US in remaining the leader in the IP layer above manufacturing. We have already vastly increased the size and scope of our college-educated workforce, and the IP layer can absorb college graduates just as the assembly line absorbed unskilled labor off the farms. The speed of change and innovation in engineering, design and marketing mean that training for specific jobs is less valuable than being broadly skilled in learning, creativity and adaptation, all areas in which the US culturally excels.
We need the patience to ride out the Great Recession, the forebearance to let the transformation work its way across industry, and the wisdom to accept the Creative Destruction of Capitalism, rather than fall into the politically expedient trap of intervening to forestall the change.
We are beginning to see some "brown shoots", early signs of a coming double dip:
Thornberg should be listened to: he predicted the real estate bubble, the disastrous downturn in California and the high probability of recession in 200. You can download his presentation here. He says the economic recovery is mostly government induced and could lead to a double dip as the government steps aside and attempts to hand over the baton to the private sector.
Here is the China leading indicators chart heading south:
WSJ ran a story today of how the one-time darling of solar energy, First Solar, is hurting as solar subsidies subside. Key point:
Solar power relies almost completely on subsidies, and those are being slashed in Germany, where First Solar made 65% of its sales last year
The stock is down 40% and is likely to continue dropping. Its core business is suffering due to cheap solar panels coming in from China and the difficulties of transitioning to a systems provider for solar farms. The WSJ thinks it could drop another third.
Anthony Cherniawski has been on the broadening top formation for a bit, and today asks whether it has crested. I have been on this theme in a number of posts, most recently here and in more depth here, translating it into an ending diagonal or terminal triangle formation, a more precise description. Here is Tony's latest chart. As he puts it:
The whipsaw pattern indicates a market that is out of control and about to end badly
There is discussion in the blogosphere about how the market might be waiting for resolution of the healthcare bill. Maybe, but whether it passes or not should have only a temporary impact. In the short run, outside of momentary reactions, the market is always driven by technical factors.
Let's look at a few TA items that go beyond pattern. The relative strength index (RSI) is showing overbought. Here is a chart from Doug Short's site with commentary from Serge Perreault:
The charts also shows the rate of change index (ROC), which has been dropping since March, although recently has turned up. Normally if a market is going up while the ROC is dropping, it indicates a decline coming.
Contrarian Advisor noted that stocks above their 30 DMA hit 95%, meaning very overbought, but the % above their 10 DMA is slipping, suggesting the buying pressure is getting selective - an indication of nearing a top, although not necessarily topping. He says the market looks like 2004, where we went sideways for two years after the initial surge off the Mar2003 bottom.
This Friday's STU had a discussion of another cluster of technical indicators, which also signal a decline ahead:
The simultaneous move of the Daily Sentiment Index to 84% bulls and the CBOE Equity put/call ratio down to .46 (or below) has preceded the start of short-term market declines in August, September and October. The declines usually start shortly after the p/c ratio turns up, which it has now done.
The newsletter goes on to urge a bit of caution, since a decline would quickly alleviate the overbought condition. We need a sharp break down coupled with momentum (down on increased volume) to confirm a change of trend.
Friday's issue also clarifies a huge problem in the EWI count. They had considered the sharp drop down to the Nov2 low as a second X wave, and thought the market in a third zigzag up. Complex corrections like this don't go beyond a triple zigzag, so the latest carfuffle (the drop off Jan and then the new high) blew their count. They now change the prior X to a smaller degree wave inside the second zigzag, and place the recent Jan-Feb drop as the second X.
I had earlier given Kenny credit for the big ED count, and he returns to it with a complex and elliptical discussion of the count carfuffle. He also has modified his ED close to the way I suggested to start it at a later dip. An occasional reader of this site, vipul, thinks the new ED count doesn't work - I encourage him to comment and explain. Until then, it provides one framework for analysis. It allows for a new high around Sp1200-1230. Here is the chart:
Another perspective comes from EWTrader. It picks up on a pattern that I suggested back in October just as the purported second X wave was starting: a terminal triangle as the third corrective pattern. This pattern would be relatively flat and hit a triple top across the tips of the triangle. Often this sort of pattern ends with a wave that fails to exceed the tops of the triangle, or briefly breaks above then falls fast - a false break. At the time I first suggested this, October, I would have pegged Kenny's ED as that pattern, but in shifting the second X wave to the recent drop, a second possibility is that the terminal triangle unfolds over the next few months. One EW Trader has a conceptual version of how it might break:
My primary issue with this chart is that this triangle IS the ending pattern, and does not need a Z wave to finish. Instead, I would count the wave labelled (a) as X, and the rest get reduced back so (b) is T1, (c) is T2, etc. up to Z which is T5 (Tx meaning the xth wave of the terminal pattern) and should end along the top line, not above (indeed, often would end below in a final wave failure). This sort of terminal would produce a quad top beginning with the wave labelled Y, or a triple top if the T5 leg truncates. Likely range is the Sp1158-70 level.
To summarize the technical analysis options discussed:
The next few trading days will help sort this out.
Interesting analysis today on SeekingAlpha: market has been relentlessly up since Feb8 and VIX has fallen to a two-year low. Healthcare bill may pass this weekend (lots of tennis elbow syndrome in DC these days) which the author thinks will be a sell signal primarily because the benefits are years off but the increased taxes come quickly. Tomorrow is options day, so market could swing sharply. If the bill does not make it through, you can buy back in Monday.
Our newest über bull, Tony Caldaro, also expects a pullback: "It appears we could be getting close to an Intermediate wave one top. Possibly another new high in the SPX along with another negative divergence might do it. The daily RSI, as noted yesterday, continues to be extremely overbought." He goes on to add this:
We checked the wave structure in Sept 95, which is the last time this type of overbought level occurred. It was during Micro 3 of Minute iii of Minor 3 of Intermediate iii of Major 3 of Primary III of Cycle [5] from the 1974 Cycle [4] low. For this type of overbought condition to appear during this uptrend helps to confirm the Major wave 3 of Primary III scenario.
If we really are in a 3 of a 3 of a 3 etc. of the beginnings of a bubble, maybe rather than lighten up, shouldn't one pile on? In a bubble, we can get overbought, and get even more overbought. If Tony is right, best to wait through the weekend, then roll up the dump truck of cash and go long! Ok, a bit premature to make that call.
Carl Futia thinks we have already entered a downdraft to around Sp1152 +/-. After that we head towards his Sp1200 target. This also suggests to lighten up, or wait until Monday to pile on.
Given that the Fed has been attempting to reflate, but inflation today came in scratch to down, the first time since 1982 that the core rate had a meaningful decline, and the smallest YoY rise since 2004. This suggests a relative benign interest rate environment, and should be bullish for stocks since a low rate environment supports a higher PE market (higher PE means lower rate of return, but relative to bonds, a high enough rate of return).
My take on all this is caution. The rise in stocks has been anything but impulsive, and is likely the result of excessive Fed reflation spilling over into speculation. Mish had a good discourse on the velocity of money, criticizing John Mauldin's recent newsletter on that subject, where he quoted from the great Austrian economist Murray Rothbard and explained what happens when the central bank tries to reflate while the velocity of money drops:
Falling velocity is a result of an increased demand to hold money as opposed to a desire to expand productive capacity or borrow to make purchases. In other words, banks do not want to lend and consumers and businesses do not want to borrow.
The Fed can print, but it cannot determine where the money goes, or indeed if it goes anywhere at all.
If the Fed increased money supply by 10%, the most likely consequence would be for money to sit or perhaps make its way into non-GDP producing financial speculation.
This appears to be what we are seeing: the Fed's attempt to reflate has led to a bubble echo across commodities, equities and bonds. Significantly, however, not in real estate or commercial lending, nor in the USD. The Fed has now ended its Quantative Easing (QE), and hence that reflation. Rumors are floating that it might raise the discount rate again, in a surprise move. Point is the reflation that has gone into speculation is ending, and with it the force driving this market relentlessly up.
If the pullback comes, and picks up momentum, we might have topped in the Sp1158-70 range. If instead we turn back up, the next target remains the 62% retrace at Sp1229.
A third view is that we might be inside a large triangle, and are too focused on either a wave 2 that is about to end, or a new bull market, to see the bigger picture. That triangle could put us into a sideways motion for years, between the 2007 top and the 2009 bottom.
Zoran's view of the larger market trend (before he passed away) was that the Dow had completed 82W4 from 2000-03 and then had run up in 82W5 to the top in 2007. In this he was an outlier among TA pundits, although Dent also had this count. He expected the aftermath of 82W5 to be a multi-year larger fourth wave, 50W4. (Zoran, like Neely, Bronson, and likely Elliott himself, thought the correction off 1929 was a triangle that didn't end until 1949/50.) Since fourth waves are often triangles, and we had major fourth wave triangles from 1929-49 and 1987-94 (Zoran's count, a running triangle), he expected 50W4 to be a larger triangle too. If so, the 2007-09 drop is leg A, or part of leg A, and the Hope Rally is the start of leg B, or a big b wave inside of leg A. Leg B (or b) could punch through the 62% retracement at Sp1129 with impunity. His chart with a conceptual wave 50W4:
Food for thought. Enjoy options Friday!
I try to report the ebbs and flows of market opinion, occasionally tossing in some thoughts as guidance amidst confusion. Right now as I have been commenting the market is at the maximum point of entropy, where it could go either way. Difficult point to take a position with confidence - might be easier to bet on March Madness.
My take is that we will top within the range of Sp1158-70, as I first suggested back on Jan10. We got into the lower range of that today. Often the market climbs into the FOMC announcement, so it may drop later this week, but I expect the Dow to also get to new highs, and it has about 50 pts to go, which means another or so S&P pts. Thus I am still looking to a turn around the Spring Equinox this weekend - meaning a possible final set of highs next week if we fade the rest of this week.
Some pundits had expected that the FOMC would signal of an impending rate change. No change in language. The market shot up after that, which led to the inevitable CNBS-like cheerleading stories. Of course, parsing the Fed's statements is sad place for the market to be. I still think we have about a three quarters to go on the rate increase, based on past Fed history. The Fed tends to raise a year after unemployment peaks. Another analysis suggests three years after a recession starts, which also puts it in Q4. We might be there then, but today Geithner threw cold water on the recovery, saying he expected unemployment to remain high and the recovery sluggish. Also, inflation may be lurking, especially in commodities, which might force the Fed's hand early. So if you are a Fed Watcher you can argue both ways.
UPDATE 3/17: The WSJ added to the Fed Rate Watch this morning, suggesting it is not so much a year out the Fed watches, but a point drop in the unemployment rate and a 500k rise in employment. Given how the unemployment rate is flattening due to a faster decrease in the workforce than any increase in employment, this might make for an extended rate wait. Combining this Fed history, the macro environment, and a projection of unemployment (see chart), suggests no rate increases before Q4, when unemployment rates would have dropped for a year and dropped about a point from the peak.
This chart is newly updated to show not just the actual unemployment rate vs the expected rate when the Porkulus Stimulus was passed, it also now shows the New Projection coming from Geithner's testimony:
BTW the commentary of the chart preparer is priceless:
Are you freaking kidding me? Do you see how high those numbers are, and how long they’re that high? And they actually have the temerity to tell the American people to suck it up for 2 more years while they pursue other legislation?
The last really good guru call was the STU on Jan15, where they called a top and voilà! we dropped hard on Jan19. Since then they have held to the topping position even as we retraced past the 62% level, which usually is it for a wave 2; and then crushed through the 78% level, which almost always is it. Yet because the Dow has not yet confirmed (it remains below the Jan top), they hang on to the top being in - they expect that "this week" a market decline will start. I can understand, then, why a commentator with an exquisite wit posted a link to this video as his view of gurus and their adherents (it is short, worth a click):
I have also tuned into Carl Futia since I like his "box" method, a variant on what Neely and Zoran have used (as well I am sure of others). He had expected a drop to Sp1125 +/- but backed off that yesterday. He remains worried, since the number of daily advances in the NYSE is fading, not advancing, as one would expect in a bullish breakout. Instead of a breakout we might be seeing climatic volume at a top, where distribution is occurring. I have commented how at a top or bottom, volume typically increases as players rotate out of positions.The market also looks like a broadening top. I discussed this a bit in my recent excursion into ending diagonal and terminal triangle formations. We seem to have two such tops forming: a short term one and a larger one. The short term one is consistent with an end by the end of March, and the long term one is consistent with third top sometime this summer. Here is a chart of the parent and child fractals, a concept promoted by Elliott Fractals; the accompanying analysis is here:
Also of note is how the Sp1150 level has been a key support or resistance level for over 12 years. This chart from Doug Short comes with an updated commentary today:
We had negative quarters in the S&P on 2008 which made the PE ratio skyrocket to ridiculous levels. The trailing-twelve-month (TTM) earnings had to deal with negative quarters, until now: the last negative quarter was 4Q08, and it is about to drop out of the TTM calculation. Since almost all S&P companies have reported (99%), we can pretty well estimate the new TTM PE ratio for the S&P: 22. This is still high historically.
The market is looking at estimated forward twelve month (FTM) numbers, which have the S&P at around a 14 FTM PE. Yardeni expects earnings to grow from around $75 to close to $100 per share across the S&P in 2011, which would push the market towards Sp1350 at year end 2010. Still, dividends are lower than normal, down almost 10% YoY. S&P companies are sitting on cash, which in normal times would depress future growth, and earnings. Instead, if we get a recovery, they may increase dividends, sprucing returns to investors.
The Pragmatic Capitalist gives us a handy chart to estimate the S&P at more normal PE ratios:
As we anticipate the pattern of a Monday Pump up at the open, consider that a lot of positive excitement last week came from a positive retail report on Friday. This led to gushing that consumer spending was now likely the fastest in three years, and upwards revisions in GDP forecasts for Q1 to 3.1% from 2.7%. The V is on! We're saved!
This premature exaggeration could lead to a flurry of buy orders over the weekend. Yet consider:
You wonder how a month of blizzards and bad Toyota news could lead to a good report. Although I am not a conspiracy guy, and tend to blame purported manipulations on incompetence, this report looks an awful like we have a rolling manipulation of data, with positive reports and later revisions. Expect Feb to be revised down - to make March look better!
The trend over the last three months is a 1.2% annual rate of growth (0.7% ex gasoline). Weak. Hard to see how that supports a 3% or higher annual GDP increase, let alone the close-to-6% from Q4.
Worse, in inflation-adjusted real terms, retail is down although trending as if bottoming: "[W]e are in the recovery phase, i.e. declines have stopped [but] this phase is very anemic, kind of like a patient on life support." This chart shows real retail (orange), a twelve-month moving average (black), and an extrapolation (blue) as if the Great Recession had not occurred:
A lot of retail experts gushed with excitement on Friday. Maybe the experts are out of touch with reality? Especially because Peak Stimulus is rolling over. if so, the downside surprise in a few months could be shocking. A "gap and crap", on Monday, as Mish predicts, might presage a gap & crap quarter in markets.
California is issuing more munis to bridge the state through a huge $20B deficit (on a $87B budget, which used to be an astounding $110B). The credit default swap rate of California has grown towards Greek levels - yet the offering sold out 25% more than expected. Floating $2B, Cal sold $2.5B at 5.65% for 30 year bonds. That interest rate is 1.2% higher than comparable munis elsewhere, a bigger spread than last time Cal did this (in Nov) where the spread was 'only' 90 bp. As the deficit in Cal has widened, the spreads have increased, but does this really indicate a risk of default?
My view is no. The last thing Cal will do is stop paying on these bonds. It needs them to manage through the ups and downs of tax revenues.
An analogy for muni bonds is to the dot-com era, where the dot-coms threw everything overboard to stay afloat - except their web hosting. Their web sites were their lifeblood. The leading hosting service, Exodus, was a huge short waiting to happen, since its stock held up past the bubble bursting, until finally the dot-coms had to shut their sites down.
You can see the behavior of the issuer in this over-subcribed issuance: rather than worry over the high interest rate (120 bp higher than other States), California issues even more, fearful of buyers at all. Hence the rates rise due to market noise, not the underlying risk. (Also note that the higher muni rates of Cal are still not anything like a junk bond rate - as long as Treasuries are still below historical norms, the bond market will keep munis relatively lowish). Don't believe an efficient market hypothesis for California Munis right now - rates are driven by fear and greed. Fear by the issuer, greed by the happy buyers of relatively high tax-free rates.
Historical Default Rates
Muni's historically have had low default rates, even when the issuer itself went bankrupt. In the Great Depression about 2000 cities defaulted, which led to Chapter 9 of the bankruptcy code, allowing them to go into restructuring - and save their bonds. Since this was passed in 1934, around 600 cities have had to file for Ch 9 - out of well over 40,000 municipal entities. A very low rate.
The big one to fall in 1994 was Orange County, California, which initially defaulted on part of its debt, but eventually the bondholders were made whole. Orange County led to a series of reviews of muni default risk. The studies concluded that general obligation bonds have a very low default rate of about 1/4 of 1%, especially if Orange County is taken out as an an outlier due to unusual circumstances. Much riskier are special districts and industrial-development finance that issue under the name of a municipality.
The lessons learned for munis are twofold:
On the last item, there were higher electric-power project defaults in 1982 coming from a court ruling, but very low since, especially after changes in the 1986 Tax Reform Act. This suggests two risks in buying industrial development bonds: the underlying project may fail, and laws may change. Consequently, be wary of muni bonds fronting:
The Union Stranglehold
Make no mistake of fear despite the low historical default rate, even back in the Great Depression. Bloomberg issues a "bankruptcy bloodbath" story about Vallejo, Calif, the most recent major city to go into Ch 9. Vallejo is in trouble due to excessive demands of city unions, and the worry is that bondholders may have a partial default as part of a packaged deal.
The new factor in munis is how laws have changed to advantage state unions. Still, Ch 9 would allow excessive union contracts and benefits to be voided. About half the States, however, prohibit by law their municipalities from using Ch 9, presumably to further entrench union contracts. Fortunately for California, it is not one of those States. (The list is in the Bloomberg story.)
A recent article, Plundering California: How Public-Sector Unions Brought The State To Its Knees, has now become the book Plunder!, discussing how public sector unions like Visigoths have sacked States across the nation. The author posted the Readers Digest version in the WSJ. Memorable anecdotes include:
It used to be public workers took lower pay but had better retirement. Now they get higher pay and much better retirement. Such a deal!
It used to be most of the spending on K12 education went to teachers, principals, buses and schools. Cal actually ranks low on support people at the school level, but I recall that in the '90s California spent only 60% of its education budget on actual education (teachers, principals, buses, schools) and the rest on an over-paid bureaucracy in Sacramento, the State capital. A decade later and that 60% is down to 50%, with half of the education budget now flowing into those nefarious bureaucrats. These percents are probably overblown for effect, but the impact is clear: unions and administration are bleeding the State budget dry while letting the vaunted California K12 system fall to the bottom of the heap. Something has to change.
What Happened to the Golden State?
Californians sigh thinking of how golden the State was in the '60s. On lower taxes and spending per capita, it had the best public schools in the country, new freeways that flowed, cheap housing, almost-free universities, cheap energy, heavy industry, and seemingly unlimited growth. Today on higher taxes, something like 2x the real spending per capita on education, and very high energy costs, it has the second worst K12 public schools in the country (thanks, Mississippi!), crumbling roads, riots over tuition in colleges, and a list of woes that overwhelms.
I went to a rally for Meg Whitman for Governor, and the first question she was asked was, why would you want such a hopeless job?
Most Californians can point to the key forks on the road to perdition:The pattern in California is for the surpluses in good years to be doled out to political favorites. In 1999 the huge dot-com surpluses went to public-sector union benefits. In 1996 surpluses went to K12 by reducing class size. And so forth time and again. During the bad times, these constituencies buckle down in a fight to hold their benefits, and the State in desperation issues more bonds to bridge the difference. The legislature remains eternally in deadlock. It is a terrible political situation when state unions can use campaign finance and other muscle to shake-down the taxpayer for benefits. This is a whole different dynamic than normal bribery of the legislature, since the state pays for the union benefits, state laws make it hard to remove the benefits, and the taxpayer is stiffed without apparent recourse.
Clearly reform is necessary, but it is not clear the crisis is yet bad enough to cause the change that is required: to repeal Jerry Brown's 1977 law.
The potential risk to munis is that attempts to fix the budget run into a rock and a hard place: education has to remain at that 40% level (which has crept higher than that under the Prop 98 rules) while unions fight to maintain their inflated benefits. Are bond payments now a weaker political constituency than schools (by law) or unions (by force)? This will be tested in the Ch 9 settlement in Vallejo.
The Need for Tax Reform
The underlying cause of the boom/bust cycle is the highly progressive tax system in California. It in a sense is more profit based than income based. During good times, it provides too much revenue to the State, which spends it and ratchets up the budget. During bad times it provides too little, and as unions fight to maintain their ill-gotten benefits, the muni bond market fills the gap, putting the muni market through its periodic conniptions of fear and greed.
This is good for munis, since it drives rates up without materially affecting the risk of default. It is NOT good for the State.
There is a tax reform proposal floating through the halls of Sacramento which makes sense: flatten the tax rates by broadening the tax base, and change to a more stable system that collects about the same in good and bad times. Simplified, it changes the sales tax to a business gross receipts tax, and the income tax to a flat rate. The plundering would continue, but with less of a pool of excessive tax revenues to feed off of in good times.
My take is that the tax reform is more likely than the repeal of the 1977 union law. It would improve the climate for muni bonds, since it would make tax revenues more reliable. Also, after Orange County default, the muni market recovered quickly. Any mistake in Vallejo that partially effects bonds is likely to be met by even stronger support for avoiding bond default elsewhere. And momentarily higher rates, a great buying opportunity.
There still is gold in the Golden State, in muni bonds.
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note: this is the second in a multi-part series on bondsSomething similar seems to be going on with economic forecasts:
We stand at a point of confusion, where this could still go either way. Maybe we have a sharp V up from here, or maybe a flat to down patch.
The international picture is also mixed:
I hold with the view of a V first, then a rollover back down in Q4 or Q1 2011. Every W starts with a V. Here is the logic:
Inventory levels are quite thin. We have had declining inventory even thru Q4 - what seems like inventory rebalancing is really a smaller drop QoQ, which shows up as positive in GDP calculations. I suspect we have an inventory surprise in Q1 and maybe Q2, where we see a real increase for the first time in a while, adding to GDP and maybe making Q1 and Q2 better than the current modest expectations. Combine that with temp workers fro census, and we can seem to be well on the way to a V shaped recovery by this summer.
Then we have the inventory rebalancing the other way, the dramatic drop in Stimulus (QoQ) and the letting go of those temp census workers - a surprising change of GDP and unemployment to the worse. We hit the Summer of Disillusionment.
The impact of this scenario on stocks would be a flat or rising period into the summer, then a sharp break down. A lot of pundits marvel at how high the Hope Rally has bounced, but they seem to miss the broader context:
The rumblin' stumblin' rise in stocks fits this circumstance. Economic indicators remain mixed, but the trend is up. With continued concern over GDP in Q2 and a possible early double dip in Europe, stocks might just be flat more than up. I had mentioned in my prior post a possible triple top ending by late March or April, but this economic scenario suggest a slower, rolling triple top:
"The Dude Abides"
- Jeff Bridges, The Big Lebowski
The market hasn't made much progress since it touched Sp1120 over three months ago. This can indicate a slow topping process, which is consistent with declining volume, although volume should increase at the top. Sometimes the best move is patience. The Trader Abides.
Do our pundits abide?
Tony C has gone bullish: "This market is certainly not looking bearish at this time."
Neely has changed his count - a major change. He used to start the current wave from the Nov bottom in 2008, and now he moves it to the Mar low in 2009. He used to think we would crush through the Mar levels; now he indicates that level will hold fo a while. He made a brave call years ago that the 1987 low would not be revisited in our lifetimes, but is not yet that strong on this call. He still expects an imminent drop, and continues to short (and get stopped out), but not to test much more than the July low in the Hope Rally.
The STU sees divergences. The Dow remains below its Jan19 top, and has begun fading while the S&P continues to meander up. The Transports have exceeded their Jan high - a developing divergence under Dow Theory. The Naz has continued to rise, but they explain that away given recent history:
I remain unconvinced. If the Dow and S&P head above their Jan levels, which the S&P is a gnat's breath away from, the divergences abate, not abide.
Back in Nov 2009 a number of pundits including the STU claimed we were in a topping process, but it seemed premature to call it. At that time I thought we had more to go, and noted that usually at major turns volume increases as stocks rotate from bulls to bears (or the other way). We didn't see it then, nor now. I also remember back in 2006 seeing similar calls, right before we took off to all-time highs.
In other words, this corrective rally can continue to amble up on modest volume. As we really approach the top, volume and activity should increase, as stocks distribute.
I jumped down the Elliott Rabbit Hole right before the Jan top to try to figure out where the Hope Rally would end. My estimates were in the range of Sp1158-1170. In terms of time, I thought it would end in late Jan to early Feb, and it topped pretty much at the beginning of that range. Since we seem destined to exceed in all indexes (except maybe the Dow), here are a few timing considerations:
Carl Futia is using his box technique to give us another cut at timing and level. We hit the top of his box early (more than 25% before the end), and hence he expects some sort of drop before we shoot above the box, but comments that the emini may first run to 1156 before reversing. If you count his days, this drop then rebound is not more than a week and a bit out, putting the top (if at my 1158-1170 range, not the 1200 target of Carl) about 10-15 days out, or into the equinox again:
Paul Kedrosky made a wish for the new year: "Remember IPOs? Way back when your parents were messing about with
technology stocks in the late 1990s, pretty much every company that
could went public, mostly via Nasdaq IPOs.... I’m wagering
we’re about to enter a similar period in 2010."
He was hoping for a Walter Sobchak moment:
Has the whole world gone crazy? Am I the only one around here who gives a shit about the rules? Mark it zero!
- The Big Lebowski (1998)
The Next Netscape
The dot-com boom was sparked by Netscape's IPO, just as Apple's IPO launched the PC Bubble in the early '80s (complete with companies with goofy names like Kentucky Fried Computers).
Will we have our Netscape Moment this year? It is now looking less likely.
Today's Netscapes are companies like Skype, Twitter, Facebook, Zynga and (maybe) Yelp - winners in social media. TechCrunch's Erick Schonfeld gives his top 10 IPO candidates. Yet it seems rather than rush for glory in the public markets, these companies are inclined instead to take in private equity and stay private. Facebook for example took a big slug from a Russian PE firm, and took itself out of the IPO sweepstakes for now.
Instead of the hot new companies, we are seeing a lot of '90s retreads finally getting their chance to exit, such as the indomitable Force 10, which has more than $200M VC financing in it, and no buyers. Their only exit left is the unsuspecting public! We are also seeing cleantech names, like Tesla, line up to go out - companies which need tons of capital to grow. (Disclosure - I have an indirect VC interest in Tesla.)
Companies with hot growth prospects in a new sector can be a Netscape. Google got out, and at the time a lot of VCs thought it would be the new Netscape. No dice. Filings ratcheted up from 47 by Aug 2003 to 236 by Aug 2004, but few got out. Google was really a second generation search firm, a category hot in the prior IPO period, not the start of a new trend.
Retreads will not make an IPO craze. Cleantech may have the allure and cache to do so, but so many of them are long-term science projects which require huge capital to get going (think - solar farms in the desert). A bunch of solar firms went public in 2006, and a lithium-ion nanotech battery maker, A123, went public on late 2009 (cleantech and nanotech in one company!), but no huge wave of cleantech IPOs has emerged, yet.
Killing the Golden Goose
The VC industry funds around 1,000 new companies a year, and although many get bought and others fade away, the overhang of venture-backed companies is hovering around 10K and stretch back to companies started in the '90s. While most of them exit via m&a, IPOs drive up valuations and excitement for the whole industry.
Yesterday the WSJ ran a piece on the shakeout in VC Funds: funding is down from $41B in 2007 and $29B in 2008 to only $14B last year. The number of new funds is also down, from over 200 in 2007 and 2008 to 125 last year. The number of venture firms that mange these funds is down more than 20%, from over 1,000 in 2005 to fewer than 800 in 2009. Many of the still-extant funds are not going to raise again, and are simply working down their prior funds (a typical fund last 10 years).
Are we slowing starving the golden goose of US technological leadership? M&A without the price umbrella of IPOs simply will not sustain the VC industry. Nor will it sustain US innovation. VCs are beginning to switch to safer bets with quicker exits, while China still forges ahead! Is this what we want?
The prior two years were the worst for IPOs since 1974-5. There were only 5 venture-backed IPOs in Q4, and only 13 for the whole year. Even in 2007 we had 86, and back in the after-glow of Google in 2004 we had 94:
The VC industry has just had its worst decade since it really got going 30 years ago, after EIRSA allowed pension funds to flow some fiduciary money into alternative investment vehicles like VC and PE (private equity). The industry is bleeding, and needs the IPOs back.
This Time It Will Be Different
There was a lot of hope that things would change in 2010. The IPO seasons are Spring and Fall, as things tend to slow down over the Summer and during the Winter holidays. A few IPOs got out in the Spring of 2009, after the Hope Rally took off, and a few more got out in the Fall. They performed pretty well in the after-market, an indication of the attractiveness of the new public companies to investors, and hope was high as as recently as January for a much better 2010. Here is a list of how they did:
A123 Systems Inc. - Up 45% overall; up 38% vs. Nasdaq
SolarWinds Inc. - Up 76% overall; up 36% vs. Nasdaq
Fortinet Inc. - Up 38% overall; up 35% vs. Nasdaq
LogMeIn Inc. - Up 25% overall; up 2% vs. Nasdaq
OpenTable Inc. - Up 32% overall; up 0% vs. Nasdaq
Ancestry.com Inc. - Up 3% overall; down 5% vs. Nasdaq
Medidata Solutions Inc. - Up 8% overall; down 15% vs. Nasdaq
Echo Global Logistics Inc. - Down 11% overall; down 19% vs. Nasdaq
Omeros Corp. - Down 25% overall; down 29% vs. Nasdaq
Sadly, it is a pretty short list. A much longer list have lined up this year to go out - over 9x as many. There are a number of really good venture-backed companies - here is a list of the top 50. Not that many of these are lined up, however. Bankers went to the major VC firms last year and asked them to pony up their tired, their poor, and their hungry; and as a consequence many of the IPO candidates are like Force 10 or those capital-intensive cleantech deals: they need to get out in order to keep going.
If the bankers push the dogs of the bunch, a promising reopening of the IPO window could close shut, fast.
As the Spring IPO season was about to open, the signs pointed to an IPO thaw. You can see the optimism in this live discussion transcript. We have now had the first bunch go on the road and get out. So far the first ones out do not look that encouraging:
If we have to make excuses for weak performance, the IPO market is not there yet. While the bankers are forging ahead, some IPOs are being postponed, and others decide to sell out instead. Maybe the IPO groundhog saw his shadow, and we have to wait for another six more weeks of Winter before the market thaws.
The Next IPO Boom
IPOs can happen all the time, but the happy days come about every decade. We had tech IPO blips in the early '60s, early '70s, early '80s, and late '90s. The PC Bubble of 1980-83 and the Internet Bubble of 1995-2000 were particularly powerful, and made the modern VC industry what it is - or was.
I had two companies in registration in 1983, during my first stint in venture capital, and one got out in June but the other failed to go in July. The IPO window shut real fast after Fortune Systems went out in a big offering, and promptly fizzled.
I pitched a company on the road in October 1999 at the height of dot-com fever, and did a secondary for it in April 2000 just as the Nasdaq fell 500 points in one day - and came all the way back. We were lucky to get it out. I was on the board of the last large IPO of the era, Genuity, a $1.9B offering in June 2000. In July 2000, you couldn't get anything out. The window had closed just as fast as in '83.
We had a small IPO bubblet in 1986, when a number of quality offerings got out (Microsoft, Oracle, Sun), and a few more got out such as Dell as late as 1988 before interest in IPOs flagged. Until Netscape, a 12- year hiatus measured from bubble-end ('83) to bubble start ('95). Does this put the next IPO window out to 2012? Or after?
Tech stocks tend to lead out of a recession. When the market returns to risk, it will seek high yields. Fast growing tech stocks promising much higher yields than Treasuries. We had double-digit interest rates and inflation in 1980, and went through a double-dip recession, and yet the PC IPOs were hot. When Netscape went out in 1995, we were coming off a perceived slow patch.
Perhaps when we finally emerge from the Great Recession, tech IPOs will lead the way. We have signs of recovery right now, but not the rush into higher risk investments, at least not in the US. Capital continues to flow out, to emerging markets, and Chinese tech stocks. This indicates to me that we need to return to a more normal investment environment in the US before tech IPOs can return in force. Right now we still have continued reflation in monetary policy (ZIRP - the zero interest rate policy) and fiscal stimulus, but still falling private investment and commercial loans.
Put simply, we need rates to rise and stimulus to abate before the IPOs return in a new Springtime for Venture. I would say 2012 at the earliest, if not 2014.
I hope I am wrong and it comes back sooner.
A good place to track the IPO market is Renaissance Capital's IPO Watch site.
The smart way to trade is to look for high probability moves and place bets. When markets confound as they often do, traders tend to fall back on trying to arbitrage the small moves - but that is a game so covered by the quants it is hard to see how the day trader can gain an advantage. Often then we hear cries of insider manipulation, front-running, and the invisible Plunge Protection Team (PPT) skewing the results. Isn't winning better than whining? Wouldn't you rather be able to count cards against the house and double down when the odds stack in your favor?
When a pattern is clear, one can make a high-odds move. Moves in the direction of a trend, impulses, are often easy to identify and run with, particularly in the middle third wave, the strongest move. This leads to a rule of thumb to place a bet after the 2d wave, and get out when the impulse stalls (usually the fourth wave). In a counter-trend move, however, the opposite is true. The middle of a wave structure is the most unclear, and can hit the point of maximum entropy where the market could go either way.
This is where triangles come in handy: a corrective triangle always comes as the penultimate wave, the next to last, and is a marker of a change of trend coming.
This is also where diagonals come in handy, since the ending diagonal (ED) always marks the end of a move.
A diagonal is a triangle-like wave that runs in the direction of trend, not counter to it. They sometimes start a new trend, but they are most useful as an ED. One of Neely's great improvements of wave theory is to emphasize the "Terminal Triangle" (his term for an ending diagonal) as relatively common to end a wave. Orthodox wave theory in contrast tends to characterize EDs as "unusual", typically occurring after a move has been too vigorous, run "too far too fast." Download Elliott Wave Lesson 3 for the orthodox explanation, or click here.
Interesting is that recently Prechter and the STU have found a number of EDs since 2007, including leading into the Bear Stearns interim bottom in Mar 2008, and also leading into the end of the huge drop in Sep/Oct 2008. Maybe not so unusual after all.
As with many aspects of NEoWave, Neely's Terminal Triangle is fairly precisely defined, and both encompasses EDs as well as other formations that orthodox wave theory counts differently. His first-cut set of rules are:
I just posted Kenny's view that the Hope Rally is terminating in a large ED. If this turns out to be correct, it would give a high-confidence shorting opportunity. Some comments to the Kenny Chart criticize it, but with one change it is relatively easy to remove the most important criticism, that it begins with an ED: shift where Kenny has a green [b] ending to the next low point, and the ED starts from there with a corrective 3 waver that runs from Sp990 to 1101, drops to 1029, runs to 1150, and then drops to Sp1045. Still, to confirm this, we need to see a sharp reversal that retraces the rise in half the time.
Kenny's ED is an expanding type. Oddly enough while normal triangles come in both contracting (meaning converge towards an apex) and expanding (meaning the the waves open up from an apex), Elliott in his original work never mentioned an expanding diagonal. Yet the expanding ED is a common form in Technical Analysis:
Neely actually has rarely if ever found an expanding triangle in a fourth wave, and instead sees it as a Terminal final wave. Anthony Cherniawski looked into a number of fourth wave expanding triangles and found that counting them as fifth wave Terminals worked better. A recent assessment also found the expanding ED relatively common. You can download the report here: Download Elliott Wave - Diagonal Ending Expanding Report. Zoran combined Elliott, Prechter, Neely and Gann with classic TA, and also found the Terminal a very useful construct. Here is an example of his analysis during the Iraqi War Triangle.
My take is that Neely's Terminal is a better approach than trying to find nested 4-5 and 1-2 waves in a complex overlapping end to a move. The most important indicator for a trader is the sharp reversal of trend, what Zoran called the Bifurcation Point. Typically Terminals (and triangles in general) end with a sharp thrust. This signals that the choppy, sloppy, overlapping and very annoying market behavior is changing. This is the moment to sit up and be prepared to lay a position down. A very useful tool.
I scan a lot of sites and like to highlight insights. Tonight Kenny gets the prize. To recapitulate where we are, the prime pundits had called the end of the Hope Rally (primary wave 2, or P2) right before the the Jan19 highs. Sometimes the wave approach is really useful! At first it looked like a good call, as we fell sharply, but we broke in a corrective 3 wave pattern, and retraced back more than 62%, making it unlikely the top was in. Confusion broke out - what was the count?
Kenny to the rescue! His chart explains: P2 is in the final throes of an ending diagonal (ED) of the final wave of a zigzag that goes back to Jul8 when the second leg of the Hope Rally took off:
(Note to Kenny, WAGS called my attention to this.)
This explains the unusual five wave rise, which is hard to count as an impulse:
Kenny gives a target of Sp1159, but watch for a truncation. In an ED it is ok for leg 1 to be the longest, but leg 3 still should not be the shortest. This puts a limit on leg 5: leg 3 went from Sp1129 to 1150, and leg 5 took off from Sp1145, hence has an outside limit of Sp1166.
The STU continues to see this as a minor wave 2 with the top on Jan19. They see a completed wave structure in the minor wave 2, so a reversal right away is possible. They also discuss the alternative of a new high, noting that any such new high would not be a signal of a new bull, but a continuation of P2 for a bit longer. If this happens they might have to switch to Kenny's count!
And the Academy Award for Best Picture goes to ...
If justice were served, James Cameron would get Best Director for Avatar, since he has pushed the state of the art in CGI to make 3G a breakthrough, and The Hurt Locker would get Best Picture, for being a small indie film with a big character study. The insider read is the opposite, a rare spit where Avatar gets Best Picture and Cameron's ex gets Best Director. You'll likely know by the time you read this. Whichever wins, or a dark horse, Avatar is a huge step forward towards a new trend in film making, Cinemé Sensation, where CGI and 3D create an experience which can only be truly enjoyed in large theaters. Even a relative dud like Wonderland draws in huge crowds.
We are seeing a rapid transformation of video under the impact of technology across time, space and depth:
The real 3D revolution is how technology will soon allow anything to be seen anywhere at anytime. The interesting question is where to invest.
Cinemé Sensation
I rushed out to see Wonderland, and although the story is slow, the acting disconnected and the action listless, the experience achieves a new sense of depth where it is difficult to tell what is real and what is artificial. I knew this was a step forward when Alice stepped into Underland (the real name) and dust came up around her feet.
Avatar and Wonderland represent depth coming to video. Our kids have been seeing this coming, with the latest console games approaching a striking realism. With the budgets for big pictures, the CGI of Pixar and the new 3G technology developed by James Cameron, we are rapidly approaching the moment when virtually any imaginable story and landscape can be realized with stunning realism and depth.
As with any new technology hitting Hollywood, the rush to amaze can get way ahead of the tenets of film-making. At least in Wonderland they improved the story, creating a plot and motion forward that was lacking from the source material. (Go read the original Alice - she just wanders around.) The woodiness probably comes from the incessant green screens needed as backdrops for CGI to later fill. How to have a relationship on screen with an imaginary cheshire cat? At times the whole film seemed to disappear into effect, until only the grin of the animator remained.
They key to the Cinema of Sensation is to make a great film, not just a great sensation.
Film is about story. Much has been made of how derivative the story was in Avatar, a remake of Ferngulley down to the glowing forest, the magic tree and the evil white people:
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Yet it had a story and a compelling set of characters. Compare that to George Lucas's three prequels to Star Wars, where George forgot all those tenets of film-making that he learned in Film School.CGI killed the movie star:
This is part 1 of 7. The rest are here.
Investing in Cinemé Sensation is fraught with all the risks of investing in media properties. It is a hits business, and even the insiders get it wrong more than right. Right now every 3D flick will get an enthusiast audience, waiting for the next Avatar, but they will have to slog through a lot of Phantom Menaces to get there. Instead of creating compelling new stories, Hollywood is throwing old remakes at the unsuspecting audience. Even Spiderman, only eight years in the can, is being remade in 3D. As an investor, stay away. The audience can get tired of this very quickly, and go back to the Hurt Lockers.
Yet if the industry is up to the challenge, the content can improve to levels not yet imagined, where CGI can create landscapes and scenes not economic or even possible with traditional technology. In the development of the Cinema of Sensation, the first breakthrough might have been Titanic, but the innovation that amazed for what the art could become was The Matrix. Unfortunately the sequels squandered an impressive start.
The last time we had such a flowering of innovation and pushing the envelope of a medium was right on the cusp of the breakup of the studio system and the rise of television. Back then theater audiences had a wide acceptance and indeed anticipation of seeing a cartoon with a film. We ultimately saw innovation in content that led to masterpieces like this, which I see as the ultimate cartoon:
What about catching the 3D sensations on TV? CES 2010 was all about 3DTV, but I think it premature. They very elements that make Wonderland work on the big screen will make it a bust on the boob tube. The weaknesses in story and character will loom large, and the 3D wonders will seem small. Television is a social medium, and hiding behind goofy glasses will rapidly diminish the enjoyment. You can read more of my impressions from CES in this companion piece on 3 Things to know about 3D.
On-Demand
The Internet is causing a change in television that will overturn the current order.
The revolution will be televised. It will not just be on TV, it will be TV:
The broadcast medium is the massage, the way the business is done. Commercials come in pods, shows follow shows, programming is all about how to place the lineup within set time and counter-programming constraints. A whole industry of Mad Men has arisen over how to handle two issues: how to turn a show into a hit, and how to target ads to audience.
Tivo started the change, with time-shifting of shows. A baby step until Cablevision won its case to put a network DVR layer between the shows and the viewers. Other than live events, viewers prefer to control the time of watching. The power of the Season Pass to seamlessly record all versions of a show needs to be experienced.
The change is accelerating with over-the-top TV, the moniker for Internet-connected TVs and blu-ray players. Now the TV can bypass broadcast and access the vast library of content (legal and illegal) going online.
This can play havoc with the windows and various roll-out schedules of studios to release content. Recently Warner negotiated with Netflix and Redbox (the $1 a day DVD kiosk) to give a 28 day window between DVD release and rental. Disney in particular has been very careful with its evergreen titles, those movies that appeal to kids and can roll out Mickey fresh every 7 years to a new generation of lovable rug rats. Yet expect these attempts by the studios to manage their library to come against resistance. The Internet will try to find a way around any blockage. Consider this cartoon from SNL:
Yet the revolution is not to be denied. The major change on-demand will have on TV is to change how programming and advertising are done. How to promote a new show when you can't simply have the audience stay on the same channel when one show ends and the new one starts? How to get them to watch ads when they can flip away once the title ends? These questions have not been answered.
For investors the revolution will create opportunities to invest in the marketing-media complex, that vast enterprise between broadcast TV and ad agencies that is well over a $60B business today. For disclosure, I have investments in Aggregate Knowledge, which supplies a realtime ad engine to ad agencies; in Verismo, which has an over-the-top TV box, and Widevine, the leading DRM supplier to CE devices to enable OTT TV. This is an area to watch.
The Internet Everywhere
The Internet is not a new medium. This has confused investors over the past decade. Gobs of time and money have gone into new studios and web video outlets like Veoh, which had the help of Michael Eisner, and recently went under, or BitTorrent, with has flopped back and forth trying to turn itself into a new video service. Occasionally a breakout happens, like the Fred Channel over on YouTube or LonelyGirl15. What makes these work is they follow the tenets of storytelling in short form. Does this make for a new medium, a place for new forms of content to emerge, the home of short-form video?
Radio is a medium, where the distribution and device are entwined. Television is a medium, ditto. We have all heard how Film started as theater with a camera, and TV as radio with pictures, until the unique characteristics of the medium were learned and exploited.
The Internet in a sense is an anti-medium, where the distribution and device are now divorced. The Internet can distribute anything, and does: education, information, short-form vids, TV, stolen movies, and porn of such depravity and awfulness it boggles.
Cable started as mere distribution. For those on their high horses about piracy in the Internet, just reflect on how cable started: taking over-the-air broadcast for free and re-distributing it to the edges of broadcast coverage. Cable took off when networks began to realize they could create new programming to compete with the broadcasters. HBO, MTV and ESPN led the revolution back then.
In this same sense as the Internet, cable did not create a new medium, but vastly expanded the distribution of video to an old medium, TV. This expansion led to innovation, such as MTV and the Music Video. Again, get off your hihh-horse and think of how something given for free let MTV create a franchise for pay. Even early on the creativity of music videos sparkled:
SImilarly the Internet is going to expand video, especially to new venues. How to create growth in entertainment? Movies are trying via high-priced tickets for 3D, but it does not appear to effect overall viewing time in theaters. Television has ever more channels and a growing library of on-demand movies, yet this has barely budged the needle on TV viewing. Instead, viewing is going to other times and places: PCs, mobile devices, out-of-home venues.
Rather than thinking of the Internet as a new medium, think of the PC as one. It enables short-from videos, has spawned YouTube, and seems to love music videos. It thrives on social media. It is solving the problem of promoting new shows on on-demand TV: use social networks! It is smashing the economics of advertising, and may turn the TV industry from ad-supported to paid-for.
Now fast forward to mobile TV, and tablet TV. A new slate of social media, a new set of venues, and expand TV viewing across time and space.
I will continue to expand on these points by elevating this post to a persistent page. Let me just leave you with this: the vast expansion of video into the library can enable new delights. It can also enable this, which I saw in a post entitled This is What You See Right Before You Die. With all respect to the artist, it looks like a cyborg has taken over a singer on Russian TV, as if the machine is now inside its human avatar, trying to be Frank Sinatra. Is this the future bequeathed by James Cameron?
In theory, theory and practice are the same. In practice, they're not. - Yogi Berra
Karl Popper, well-known philosopher, defined a real science as one that makes falsifiable predictions. In my companion blog I discuss how the ever-expanding alarmist views of Al Gore turn Global Warming into a pseudo science. The WSJ ran an editorial asking the same question of economics: is the dismal science really a science? You can see where this leads: does the lack of discipline among elliott wavers turn a promising predictive theory into fulsome noise?
Technical analysis in theory can provide high-probability insights into market moves. When practitioners lose discipline and are all over the map, in practice it provides confusion. While more ewavers flip from bears to bulls, the bears hang on with more pugnaciousness in their calls. I wish instead they would look at what their analysis is saying, not what they wish it to be.
I have noted how the market has hit the zone of maximum entropy, the point it could go either way. It is now flipping the other way, from bear to bull. The ewaverers are actually following their discipline, not breaking from it. Here is a short summary of the markers of the flip:
Now, this still could be a wave 2, and could be about to reverse down - indeed may have at the end Friday already. But what we want is a high-probability call. Pundits can get carried away with a low-probability but gloriously contrarian call, because if they are right, then can preach their Cassandra-like foresight for years. If they are wrong, they hope it gets lost in all that fulsome noise. If they are wrong a lot, they simply lose credibility, or should.
Fine for the pundit to do this, but it breaks discipline with the purported science. The Global Warmists insisted a little over a year ago that snows would begin to lighten up or disappear from DC, and then when the Big One hit this year, the head Warmist, Al Gore, comes back and says Global Warming causes more heavy snowfalls! Well, which is it? A science which expands to cover any exigency is a false science.
We could also simply say that TA is a tool, nothing more, and not try to make it a Science with a capital S. Yet I applaud Prechter for trying to find the science in the tool, in his work on Socioeconomics. Without an underlying causation, elliott wave is but a complex pattern recognition system, a modern-day astrology, with no real predictive value. Once he set forth in the journey towards a Science, however, he needs to heed the requirements of Karl Popper.
For those of you who are prepared to place bearish bets, you really should read the top pundits' Friday reports. The STU continues to say the end is nigh, that this wave 2 is about to end. Neely also thinks we are about to reverse down, especially as more and more latter-day ewave bulls pop up.
In terms of Science and Discipline, the STU is at the limit of their rules. Sure, a wave 2 can go back 99%, but that is extremely rare; and an impulse down can break as three big waves with minuscule waves 1-2 and still be arguably impulsive, but that is a huge stretch. Why not instead lay out that the odds have shifted and explore alt counts?
Prechter made a dramatic call on Jan15, of a 200% short, and this time (unlike his first call of a top in Aug, or his 200% short call back in Nov) he was proven right within a few trading days. Is the STU now committed to supporting that call? As I explored last weekend, the drop did not really break as a five-waver down, and that means this is not really a wave 2, yet they stay on that count.
Sentiment has gotten quite bullish, and yet volume has dropped, which does not point to the start of a new bull market. I still find Tony Caldaros' dramatic bullish flip premature exuberance.
Carl Futia and now Hank Wernicki of Ellott Fractals think we head to Sp1200 in a continuation of the Hope Rally. Hank has dropped several fractal charts into comments which show a thrust up is due.
Neely counts the current wave as yet another triangle, not a wave 2 off an impulsive drop, and hence is not bound by the discipline of a wave 2 outlined in the bullets above. He thinks a drop is due, but not the dreaded and deep P3 down of the STU.
So where are we then?
I wish our ewavers would odds-adjust their calls. I conjecture that #3 would win, but not by much over #4. Zoran used to find a triple top or triple bottom as marking a top, and any TA specialist would also see that as a broadening top or bottom marker.
A classic triple bottom happened in 2002 with bottoms in July, October and then March 2003. Zoran called that the Iraqi War Triangle, the uncertainty before we actually sent troops in. Orthodox wave counts had July a wave 3 bottom, October a wave 5 bottom, and March a wave 2 bottom of a deep retracement of the new wave up that eventually got to the highs in 2007. That wave 2 is an odd duck and wasn't seen as a wave 2 at the time. Zoran's triple-bottom triangle (a terminal triangle in Neely parlance) gave a bit better guidance. Take a look back and the triangle becomes clear. Here is Zoran's chart:
His analysis and a discussion of triangles, terminals and broadening tops is this pdf, called 041303gayer.
I do not often comment on gold but as Hank Wernicki posted in a comment, "Gold is Going Nuts!" Even George Soros has jumped in, saying: "When I see a bubble, I buy that bubble, because that’s how I make money." Neely also jumped in today, with a wave structure that says gold is about to rush to a blow off top. Going back to 2005, Neely has gold in an expanding triangle, and says it has entered the final, most vigorous leg E. This indicates we will see gold go to new highs (it still remains below recent highs) and head towards $1300.
Here is a circumstance where technical analysis is way ahead of fundamentals. With inflation fears fading and deflation showing up in the most recent CPI, conventional wisdom is a bit surprised by the new gold rush. The CW fails to see that gold is a hedge not just against inflation, but a hedge against poor government policies. The Greek troubles in the Euro have spilled over into gold. Gold has surged to a six-week high in USD and record highs in the Euro and Sterling:
Pierre du Plessis notes that gold is gong up across all major currencies:
The CW is also surprised as the USD is now rising with gold, whereas they had been in an inverse relationship. With equities floating on speculation and stimulus, it should not surprise how they can float up with gold, but all markets had been in an inverse relationship with the USD. Most likely the change in this Dollar Down/Everything Up relationship is due to Euro and Sterling weakness overcoming Dollar strength.
My take:
The most entertaining and interesting chart of the day is this one from EW Trends, which comes with a picture of lighting a fire under the bull. Their chart (below) shows that volume is not cooperating with price: it is declining on rallies, increasing on drops. This is the opposite of what happened during the comparable drop from Jun11 to Jul9 last year. The S&P is also 10% above the 50 DMA, a condition many consider overbought. Is a short term pullback due tomorrow?
Of course the bears hope for more than a technical pullback. Often major turns come at a confluence of Fibonacci relationships (in time) to prior major turns. (Why this is so is that mass psychology like spirals in sunflowers and many other aspects of Nature often tend to Fibonacci numbers and ratios.) A reader sent me this sweet observation from a site called Sugarman (TD=trading day):
Today had very powerful fib numbers with the potential to have timed a top. It was 34 trading days from the January 11 high, 55 TD's from the December 9 low, & 89 TD's from the October 21 high. There were also 13 TD's from Jan 11 to Jan 29th. Today is the 13th TD from the Feb 10th secondary bottom of 1059. Today is also the 600th TD from the Oct 07 top. We will have to see if the gap holds and if there is enough impetus for one more push up.
This drop in volume on rallies indicates something is up other than a normal take off to new highs:
Sugarman is an old-fashioned technical analyst, who still does charts by hand. His chart below uses fan lines to predict movements. Note the red lines up from the Mar2009 bottom - the rise is very close to 45 degree line. If you reflect that angle down, you can quickly see that we have come above it, meaning the fall is no longer faster than the rise, a bullish sign (means this is a correction not a trend change), but only by a little; so a drop back below makes this a False Break. Watch for that during this pullback. It means we would remain at the maximum point of uncertainty of direction.
Sugarman's take on where this pullback may go is a rise to the 78% retrace level:
The monthly DT line from the Oct07-Jan09 tops is at 1118.92 this month. The weekly DT line is at 1127.99 this week. The daily is at 1028.83 today. The 78.6% retracement of the move from 1150.45 to 1044.50 is at 1127.77. There is also a hourly gap that the market made coming down & may try to close between 1126.95-1127.38. The market broke a major balance point on my weekly chart at 1126.79 coming up from the 666.69 bottom and I have always felt that the market might test this before wave C begins. (see attached charts)
Also note the convergence point he drew below Sp1000. He is suggesting a final thrust to 1127 to close a gap and hit the 78% level, then a sharp drop to Sp939 during the week ending Mar26.
We have seen the pattern of a Monday Pump begin to fade, yet today was also the first of the month. The S&P was up 1.0%, while the Dow lagged at 0.8% and the Naz led at 1.6%. How does that compare? Here is a chart from Bespoke Investment that shows how first days have done since the Hope Rally started:
While above average, today's 1% is below recent firsts, and notably below Tuesday Dec 1 where the Monday Pump pattern sat aside on the last day of Nov and returned with a vengeance on Tues.
So while today wasn't a surprise, it was a bit less than expected. In the S&P we hover at a gap at 1116 that could be considered closed. I nonetheless agree with the STU's point tonight that we have more upside to go, in part for the Dow to catch up to the S&P to erase a de-confirmation: the S&P got above their Feb16 high today, while the Dow still lags below. They see a five-wave pattern emerging, and think we just ended a wave 4 and are in the final 5.
As the EWP site notes, the pattern is far from perfect, and the more it meanders the less it has the right look. Instead, a three-wave pattern seems to be emerging:
Here is their five wave count for comparison. Note the relatively small wave 2 vs the long wave 4:
A bigger technical problem is we burst above the 50 DMA today. Normally this is bullish, but the volume was anemic. Maybe everyone is exhausted after that amazing USA vs Canada gold medal game? Or recovering from the kitschy Moose Stampede finale? Here is the cross the bears must bear:
My concern is the fan line off the Jan19 top, the Zoran Fall LIne I have mentioned recently. If it is drawn down at the same angle of the upper trendline of the Hope Rally, the slope is relatively shallow and we are still below it. The line is now around Sp1130, so we have a bit to go.
If it is drawn the way Zoran did, which is from one Bifurcation Point to the next, meaning reflecting off the angle from the Mar9 start of the Hope Rally to the beginning of the sharp drop off the Jan top, we have now broken above that fall line. If we don't quickly drop below, this looks like a correction not a trend change.
The guideline is that the drop has to be faster than the rise to confirm a change of trend. The fall line is the line that shows the speed of the rise applied to the drop. Below it, trend change. Above, mere correction. A momentary break is ok, as these tools are never perfect; if we fall below quickly, the break is a False Break and can be ignored. The implication is we cannot meander upwards very long before the odds shift to this being a correction.
We already have gone above the 61.8% retracement, which is Sp1110 if you count the bottom as Sp1045. We remain a little below that level if instead you count the bottom as Sp1072, and the break to 1045 as a B wave in an irregular flat. (This is explained in my weekend post.) A general rule is that waves 2 rarely go beyond 61.8%, and hence when they do, it is a high risk gamble to bet on a short position. Better to stand aside and see how the market develops.
Right now we remain at the moment of maximum entropy, where the market could go either way.
They drank a bit too much this weekend over at SlopeofHope. Rooting for the Canadians, eh? This comes from their PPPT (plunge protection protection team). Enjoy, and read to the very end:
All indicators, both technical and fundamentals have just confirmed a secular bull market.
The future has never been clearer to us. Forget every bearish analysis you have ever read - 1937, 2004, 1929. ... Great grand supercycle bull rally is upon us. Fundamentally the explantion is simple - money printing. Just like Zimbabwe's index went up 2000% when their currency devalued to nothing, the Dow is about to explode to the upside. Cross commodity correlation have also independently confirmed this uptrend. The market is at an inflection point, and the outcome is a burst higher. You will miss out if you are not loaded on the long side, and if you are short you should be very concern. As you can see from our very detailed charting using Prophet 5.0 charting software by Tom Night (contact us if you wish to buy a copy)
The inverse head and shoulder pattern has confirmed a secular bull market for at least the next 10 years. We are expecting a push higher as part of Wave C of 3. Fibonacci calculations are expecting at least a DJIA target of 21439 (ie 14150/21439 = 0.66).
We are going all in long!
Bulls and Bears, please post this on as many blogs as you can.
Note to bears, please highlight the rest of this post with your cursor:
We are NOT bullish, but as a contrarion we need to get the message out there that we bears have given up. If we keep telling everyone how bad the market is, Goldman and gang will continue to pump the markets higher. So lets all jump into a bull suit, and spread the bull propaganda! When you see the message above across Bloomberg, CNN, CNBC, etc, our mission is complete and the cataclysmic crash we expect is due.
Full cooperation is required especially from all webmasters (Tony Caldaro, Tim Knight, Guy Lerner, Corey Rosenbloom, Mish Shedlock). Do not forget to change the colour of the font of this section to blend in with the background so that it is completely invisible. If bulls are able to decipher this hidden message, our plan will fail and the Dow could go to 21439 with all the money printing!
AllAboutTrends continues with another guest post. Again, FTC point, I have no financial relationship with them. If you like their analysis, click on their link and find out more. They are offering a free newsletter and a free report on trading strategies.
So here we are, still in this B wave up, snapback rally, whatever you want to call it.
While the Full Stochastics are back to being overbought we have the general structure showing the potential of some more work to do on the upside next week.
A few weeks back we were talking about the 78.6% fib level. The drop off of the 1130 level down was so fast that one could say it's the equivalent of a gap. Lately a lot of gaps have been getting filled and should this one get filled it would not surprise us. In fact we'd prefer it to get filled to get it out of the way if we are going to get a lasting top that is.
The pink uptrend channel is still intact with Friday's action (albeit feebly) marking the start of a potential POH (Pullback Off Highs).
The wave structure whether you want to call it ABC or 12345 makes no difference to us as a potential wave C or 5 as shown in the chart above basically say the same thing. Of course they can truncate too you know (stall and fail).
Here is the 60 Minute OTC Comp chart to go along with the S&P 500 for your viewing pleasure:
For those of you who are not familiar with Elliott Wave remember it's all about trends as in trendlines. This is for you:
With the S&P 500, it's all about the Bottom PINK LINE. It's all you need to know. It's still intact and still the order of the day. We will not get any decisive break to the downside or the start of a C wave TILL WE BREAK THIS LINE.This is why it's imperative that we continue to monitor this line.
In Summary:
It's almost as if about the only thing that is going to get this market into gear is a news driven futures related computer program driven pop as manic Monday is upon us. And we all know what happens shortly there after that occurs right? Nothing. One can only imagine what the matrix will cook up.
Should we work higher next week we'll keep looking to add to the short side one step at a time -- a little bit here and a little bit there. It's called courage of conviction based upon chart pattern recognition.
Remember on the way up (while we were in a big picture clearly defined uptrend above the 50 day) the name of the game was to buy the dips and sell the rips, now? Short the rips after the computers pop it and cover the dips may be the flavor of the year.
Below is the big picture chart of the S&P 500.
As you can see in the chart above, we are struggling at the 50 day, we have the full stochastics in overbought territory and we are backtesting a clearly defined uptrend line break commonly referred to here as a KODR (Kiss Of Death Retracement). A KODR is a Kiss Of Death Retracement. This is when an issue or index breaks an uptrend to the downside and comes back up to kiss it from underneath and then fails.
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