Planet Yelnick

Secular Bull Market Confirmed

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!

Consensus 10 for '10 Predictions

For comparison to my predictions, here is a compendium of almost all major forecasts. The consensus forecasts and advice seem to be:

• S&P 500 rallies to 1250
• Emerging markets outperform developed
• U.S. outperforms other developed markets
• Earnings growth of 20% Plus
• U.S. economy grows at 3%
• Job growth turns positive early in the year but unemployment remains high
• Inflation remains low
• Rates to rise across the curve
• Stocks outperform cash and bonds
• Overweight health care, tech and telecom — Underweight financials, utilities and materials
• M&A picks up because of strong cash flow and slow growth
• GOP makes gains in House and Senate but Dems continue to control Congress

Investment Roadmap For Yasi

I have a colleague at work who is new the ways of the Force (technical analysis).  Freshly graduated and with a few shekels in her savings, she wants to explore the wonderful world of investing.  She is inundated with advice, all of it confusing and contradictory, and bless her good sense she wants to do her homework and work her way through it. I haven't yet had the heart to tell her it takes 10 years of dedication to begin to be a good investor, and even then the market will surprise more often than not. 

Instead I suggested she start with the easiest and one of the most effective investing system: the seasonal pattern promoted by Sy Harding.  His stats are on his blog, and he simply blows away the most common investing approach, buy and hold.  His system is perfect for Yasi.  She only has to make two decisions a year: when to buy in, in November; and when to get out, in May.  Sy even helps with his service, giving fairly tight windows for those decisions.  This year he called it right before the Nov21 bottom, and he hasn't given the 'go away in May' signal yet. 

Yasi is young, and eager, and has a full wallet; she doesn't want to wait until next November.  Instead she hungers for action, and is exploring what to do now.  Oh boy.  The best investment advice I ever heard was from Charlie Munger, partner to Warren Buffett.  He would tell young, eager investors to take out a postcard and fill in 20 lines.  Then he would explain that in their whole investment lifetime, they wouldn't fill out that postcard with good ideas worth investing in. 

But youth is impatient, and Yasi is not to be denied.  Now, as I have occasionally said about this blog, I do not give investment advice - especially not to a colleague at work, since she can find me when the advice goes wrong, as it usually will, or worse, her parents will find me.  Instead, I use this site to provide a perspective based on what other pundits are saying, plus what I can piece together from broader trends in the investor community and economy.

Thus, let me offer Yasi a perspective on major areas of investment, right now.  When you read this, Yasi, you should know that I have a number of very smart readers who have a deep and varied set of perspectives on the market.  They will be able to give you all sorts of advice.  I therefore would like to encourage readers to this blog to also give young Yasi their wisdom and perspective.

This is a long post, so you can read it all below, but for convenience I broke it up into sections, linked below.  Or, just go down the page.

Stocks

Bonds

Real Estate

Currencies

Commodities

Summary

Investment Roadmap: Summary

I wrote this for young Yasi.  I hope it helps. The overall message is to understand the broader economic and political climate you are investing in, and make decisions that fit the bigger picture.  Economies tend to go through four phases or seasons.  Let's call them Spring, Summer, Fall and Winter for convenience. 

In Spring, a new factor of production is driving strong fundamental growth.  A rising tide lifts all  boats. Almost any investment works. Think 1949-1966. 

In Summer, things heat up, and inflation emerges.  Usually the over-confidence of Spring has led to a foolish Imperial War, like Vietnam, or WWI.   Think 1966-1982. 

In Fall, the fever of inflation is broken, and the Ship of State righted.  Disinflation comes (inflation abates and interest rates drop).  Assets rise in value, and financial engineering reigns supreme.  This period ends in a blow off credit bubble, as over-confidence leads to excessive risk.  Think 1982-2007.

In Winter a Deflationary Depression sets in. Prices drop, interest rates go to absurdly low levels, governments intervene to stimulate. At the bottom we usually have a trough war, like WWII.  Debt is written off, excess capacity shuttered, unemployment rises, markets fall.  Think, 2008 - ??.

 In a nutshell, the advice is:

1. Spring: stocks and real estate do well
2. Summer: commodities, real estate, gold and art do very well
3. Fall: stocks and bonds do spectacularly; watch out for the bubble
4. Winter: cash is king. 

The Surge

In the short run, we have a bounce within the turn window.  It might be a short-lived counter-trend rally, as the STU believes; or it might be the start of a final runup into the 2008 elections.  Tech stocks led the weakness in the first few days of January, and despite predictions of record earnings in 2008, the market is waiting to see how their earnings results come out for the last quarter of 2007, when weakness due to real estate, credit crunch and Xmas disappointment will come through. 

In the long run, however this bounce turns out, I expect stocks to make a final run to new highs.  If I am right, it will be driven by tech stocks.  Call it The Surge.  The leader of the last bubble drives the final run of this one.  The Surge should last well into 2009.  Tech IPOs will come back, and the venture industry will get a needed reprieve after suffering the worst five-year stretch in its history.  For the first time since the Bush Administration, capital will flow back into innovation and growth, away from real estate, takeovers and Old Time Industries like oil and food.   The case for The Surge is below the fold.      

Dollar Blues and the Bush Imperial Adventure

The Dollar is in a world of woe.  Canadian Dollar hit parity.  Euro at $1.40.  Drudge reports the Saudi's may go off the Dollar in the oil trade.  Since our Dollar is essentially backed by oil, not gold, this would hurt.  Is it time for a bounce?  The STU charts how the Dollar has been in a declining wedge, and has spike below the lower trendline.  Final little burst before a sudden reverse? 

Mother of All Margin Calls

Prechter Explains All today in a his July EWT.  I have previously posted that he would have to modify his long-standing count of the Big One down, and he has:  the next major bottom is either 2010 or more likely 2014.  You can read the EWT to see the historical patterns that lead to those dates, but they are consistent with many previous posts here - and astute comments from readers, several of whom have shown themselves to be better wave analysts than the commercial services.  We now are entering the set-up for what a recent pundit (I have unfortunately lost the link) has called the Mother of All Margin Calls.

Election Correction is On!

We expected an Election Correction once the Demo's won Congress - the reverse of what happened in 1994 when the Repub's took Congress.  It is now occurring, but with a marvelous twist: it is first occurring in the Dollar in a reaction to Bush, not the Democrats.  The 'good' Republicans in 1994 and the 'bad' Bush in 2006 may turn out to bookend the period of growth and bubbles in the US.  We have undergone a great monetary experiment by the Fed during this period, and have seen the Chinese emerge on the world economic stage through 'vendor financing' of the US trade deficit.   Let's take a look at this story and project out what happens next.

Currency Market

Years ago a pundit (I believe it was James Dines) described the 1980s as a rare currency market, meaning it was reacting to changes in monetary policy, not fundamentals.  At the end of an inflationary Kondratieff Summer, someone finally breaks the back of inflation, and we enter the 'false plateau' of the Kondratieff Fall. In 1980, Volcker broke its back.  In 1982, we entered the false plateau - the "decade of greed."  Once inflationary expectations were flattened, all financial assets were undervalued, since their future cash flows would have been heavily discounted against inflation.  Once their discount rate is lowered, they immediately are of higher value.  With the magnitude of Volcker's success the re-marking to market was quite a spread.  It took a while for markets to catch up to the new reality, but they did, faltering only in 1987 with a new Fed chairman and a change in US monetary policy, to cheapen the Dollar against the Yen.  Today, with markets in lockstep - a very unusual circumstance - are we in another Currency Market?

Good Deflation and the Greenspan Indian Summer

The recent stock drop worldwide is a warning shot across the bow of the Fed, to come to grips with the growing imbalances in the world economy.  The borrowing of 8% of US GDP from the rest of the world is not a sign of strength of the US economy but a transfer of wealth to the rising economies in Asia.  What we are seeing is the coming to an end for the Greenspan Indian Summer, this period of unexpected growth and prosperity that the Fed created by flooding the economy with liquidity after the stock market crash from 2000-2002.  Greenspan is fairly clear (for a central banker) that he was attempting to stave off the deflationary depression that normally follows the bursting of an asset bubble - the so-called Kondratieff Winter, which is a bit obscure in mainstream economics but was mentioned by name by Greenspan.  The latest Fed chairman is a self-acclaimed expert in deflationary depressions, and got the nickname Helicopter Ben for a speech he gave in which he said the Fed could always prevent a Kondratieff Winter by helicoptering in money and dropping it on the economy.  But did their inordinate fear of deflation, and misreading of the current situation, cause them to over do it?  Let's take a deeper look.

The Greenspan Put and the Global Scramble for Yield

Many pundits have noted the Greenspan Put, meaning, every time we have a potential financial meltdown, Greenspan floods liquidity into the markets, bailing out the overextended investors.  This sets up the moral risk that investors will be inclined towards speculation over investment, since the Greenspan Put socializes the downside while privatizing the upside.  The last time this happened was around the time of the 1987 crash, and was one of the causal factors of the crash.  We deregulated the S&L industry but maintained the government guarantee on deposits.  This socialized the downside - if the S&L went under, the government would make good on the deposits - and privatized the upside - no longer did S&L's have to engage in safe banking practices.  Very quickly they got into the junk bond game, and were one of the instruments of takeovers of major US corporations.  You can read about it in dozens of books on the Decade of Greed.  Later the US government bailed out the S&L's, an early version of the Greenspan Put. 

The new Fed Chairman is known as Helicopter Ben for remarks he made to the effect that the Fed could avoid a Kondratieff Winter by helicoptering in new cash and dumping it on the problem.  So far all this new liquidity has sloshed around in financial assets, and not led to any overall inflation.  The US Dollar is the world's reserve currency, and as world trade grows, demand for reserves grow.  The seniorage of the world currency allows the Fed to dump Dollars and avoid inflation. 

What a trick!   Print money, no inflation.  Hahaha!!  Alchemy!  The Sorcerer's Stone has been found, finally!   Hahaha!!

Yelnick has previously noted that in a low return environment - the Kondratieff Winter - there will come a global scramble for yield.   It has started, and it should last for at least a decade. 

Where does this money go?  In a world with a Greenspan Put, it should go into speculation.  Currently we are seeing froth in venture markets, and a rise in m&a activity. 

A lot of the recent activity can be called Google Envy.  Is it now the fastest growing company in history?  Clearly there is a sea change in advertising, and the Lion's share of it is going to Google and Yahoo.  Simple story:  online browsing time is now equal to TV viewing time, yet in the US TV gets $60B of ads and Internet only $10B - last year.  This year, Internet ads have doubled, to $20B, while TV ad spending is flat.  No reason why Internet ads couldn't keep going, and even surpass TV ads.  This leads to the view that much of the speculation will go to what is sometimes called Web 2.0 or more broadly Digital Media.   

The game is afoot.  Let loose the dogs of finance!  Rupert wants to spend $2B to buy into the Internet.  He already spent $1B, buying among other properties MySpace, which has now grown to an astounding 34M members.  eBay paid $4B for Skype, a company with almost no revenues!  Free phone calls!  What a deal!  Microsoft wants to buy AOL.  Everyone wants to buy Chinese search companies like Baidu.  It used to be venture firms only made real returns with a frothy IPO market.  Maybe a frothy m&a market can work as well? 

Stay tuned - another tech bubble lies ahead.  Thank you Alan!  Hahaha!! We'll take it.

Beyond the Planet of the Wolf! Wolf!

I do not normally drop in personal notes but after all the comments recently on Prechter I feel it is time to give a perspective. 

I encourage readers to also read and contribute to the comments. We have some readers who follow Elliott Waves fairly closely, and others new to it, and others just out to have a bit of fun; but there is a lot to be learned by following the comments and in particular the more astute commentators. I read the comments and incorporate their analysis & questions into subsequent posts.

As an aside, I do not do Elliott Wave analysis. Doing it right takes rigor and discipline - and interpretation.  Even The Elliottician with their Refined Elliott Trader software need to interpret the possible wave patterns. Instead I report it, and try to suss out a consensus. Having watched Prechter and others going back to the '80s, I have developed a certain feel for the pattern, and can more easily see the miscalls than the correct calls. I started the Wolf! Wolf! series because I thought Prechter's initial Wolf call was off the mark. So far, way off.

That said, at the end of this post I will give my current view of where we are with wolves (or bears or bulls), but first wanted to discuss Prechter.

Digital Media and the Global Scramble for Yield

We are in an inevitable and extended period of low yields. The bubble's legacy is global over-capacity in manufacturing. The opening up of India and China has dumped an incredible over-capacity of workers. Why are we surprised about a 'jobless recovery'?  The US is borrowing the world's savings and spending it, rather than investing it. This is living on borrowed time, and will soon end, reducing the engine of global demand. The West is suffering declining birth rates, and the predictable demographic demise of the young in Western economies will depress growth rates - it is the 20-somethings who buy new stuff; the 30-somethings and up tend to trade up - further depressing demand. All this has already resulted in low returns in almost any asset class worldwide, and this condition is expected to last for decades, until global demand catches up with supply of workers. The only high-yielding asset class is real estate. Where will hot money go after real estate cools?

The quick answer is back to tech stocks, in particular digital media, but not quite yet.  Read on for more detail on why tech.  In the Technik blog I will run a series on digital media opportunities, and encourage your comments and guestblogs.

Kondratieff Winter and the Greenspan Indian Summer

When Greenspan made his recent remark that he knew how to beat the Kondratieff Winter, it brought to the forefront what had been an obscure problem in economics.  The Kondratieff Winter is the deflationary depression that follows a speculative bubble.  Every major bubble in US history has led to Kondratieff Winter: 1837, 1873, and of course 1929.  Fortunately, they don't happen very often - about once a generation.  Unfortunately, it is our time.  Greenspan's prescription is to provide massive liquidity, which he certainly has done since the dot-com bubble popped in 2000.  Has he staved it off?

The mainstream business press is beginning to focus on this issue.  The Wall Street Journal ran a front page report at on the conundrum that Greenspan faces: by providing such liquidity, he may have staved off the Kondratieff Winter (for the moment), but he has created distortions elsewhere, in the real estate bubble, increasing trade deficit and massive US borrowing from overseas.  The New York Times Sunday Magazine ran two pieces the same week, perhaps unintentionally connected, one on Gold Bugs patiently waiting for a return to a gold standard following a Dollar collapse due to excessive debt, which is the cause of the Kondratieff Winter; and the other one about semi-luminaries in Silicon Valley still striving to make a killing, having not made enough during the bubble ("$10 million is but chump change") - they still believe another bubble awaits their good fortune. Since then we have had so many real estate bubble stories that one could say that there is a real-estate-bubble STORY bubble.

This is a high contrast issue for investors.  In a Kondratieff Winter, cash is king, and one needs to conserve it to survive the period.  In a Kondratieff Spring, a rising tide lifts all boats, and an investor should be "all in."

Muddying the issue is that every crash has a bounce, a wave 2 or wave B, before continuing to drop.  Investors who were confident at the prior top are even more convinced during the bounce that they caught the bottom. Normally the bounce comes quickly, and ends quickly; but this drama has unfolded in an unnerving slow-motion for the past five years.  This makes it even harder to discern the onset - or the end - of the Kondratieff Winter. Which is it?  Investors remain bullish, and the Cassandra's are dismissed. (As a living example, check all the comments to the recent Wolf! Wolf! posts; the uber-Cassandra, Prechter, has called the top prematurely so many times his opinion is now a contrarian indicator.)  Yet we must remain cautious about whether 2003 marked the bottom.  The normal markers of a bear bottom were not present - low P/E ratios, lack of interest in equities, and a burst of new investment based on fundamentals.  Instead, we have the disturbing trend of massive US borrowing to keep the economy afloat, a truly unprecedented occurrence.

Clearly Greenspan's efforts, combined with Bush's fiscal profligation and the expense of the war in Iraq, have all contributed to smooth over the brief recession after 2000 and pave the way for a slow-motion unwinding of the excesses of the bubble.  We have experienced few of the types of problems that we went through in the three prior K-Winters.  Even the mildest of them, from 1873-1896, was a worse deflation, and in the final three years, 1893-96, a much steeper recession (they called it a Great Depression at the time).  Are we past it?  Did Greenspan stave it off?  Or is it awaiting us in the next ten years?

In the middle of the Greenspan Indian Summer, it is time to consider this issue. 

The Bullish Case

The print edition of the WSJ on Friday had a number of articles which collectively built the bullish case, and represent the consensus view. The Ahead Of The Tape column calls this a Durable Recovery, and says: "The April Shower of powerful March data has turned around almost every last bear on the economy." The three most important indicators - employment, retail sales and CPI - scored a " 'triple double' " meaning all three were twice as high as expected. (Not sure why CPI increase is good news, but more on that below.) The front page ran an article called Companies Regain Pricing Power, suggesting that deflation is ending and predicting inflation ahead. The Money section had several articles on how to deal with the expected rate boost as the Fed heads off the now-anticipated inflation. The Heard On The Street column is entitled Bulls Argue Higher Rates Won't Hurt Techs and Financials. The bad news on inflation is said to be good news because it indicates that "the economy is heating up."

The key to the bullish case is business spending. The economy has stayed relatively bouyant due to increased government and consumer borrowing and spending. Government spending seems to have exceeded all bounds, and in a campaign year the pressure is on to constrain it. As the consumers' capacity to continue borrowing and spending abates, the economy needs business spending to pick up the slack. The key indicator to watch is durable goods orders. The consensus view was for a 1% rise in March - the reported number is 3.4%. Quite impressive. But not all bears went into hibernation. Bob Bronson reports in his private newsletter that the peak in these numbers actually occurred last December, indicating a slowing not accelerating economy. The reported number for March included revisions upwards for February; the impressive Mar numbers were actually lower than the revised Feb numbers, supporting Bronson's case.

The prudent bear would wait to see how these reports pan out over the next quarter. Even if we have begun a major drop, it will have its normal corrective reversal in late summer; and one can always get out (or short) then if need be. The imprudent bull should be buying on dips.

New Year's Predictions 2003 Revisited: The Case for the Bull

Last year in his private newsletter Yelnick outlined three options for the new year.  How did they turn out?

1) Prechter's meltdown.  Didn't happen.  Yelnick thought it least likely: "The STU crew was soooo convinced of Big Debacle last October, which ended short, that they have been overly anxious to see the drop recommence ever since." 

2) Cycles rule.  Did happen.  Yelnick thought this most likely: "Historical analysis would predict the next up cycle as 9 months and the down as one year to 15 months, meaning generally up or flat through the first half of 2003, with a drop in the 2d half that extends into the last half of 2004 to end this cycle down."

3) The Bull is Back.  Could happen.  Yelnick still thinks unlikely: "Current worries are over the uncertainties of war, but a war in Iraq would be much less costly to us than real dip in the economy or another 9/11 event.  These uncertainties should be behind us by 2Q03, as a war in Iraq if it occurs seems timed to commence in Feb/Mar.  The market tends to anticipate the end of a recession by 6 months - which means the Oct bottom predicts we begin to grow again in 2Q03."

So, not bad in predictions.  The cycle prediction expected a downturn in late 2003 which has not yet happened; mid-year Yelnick modified that prediction to target Mar/Apr 2004 as the turning point.  This is still the preferred view.  If we pass by that turn period, however, the third prediction becomes interesting.  What about the return of the Bull? 

Demographic Destiny and the Global Scramble for Yield

We are entering a one time event in human history - population will peak and then drop in our lifetimes. The demographics are clear - in developed nations, birthrates are below replacement, and in developing nations, they are plummeting towards below replacement. The primary cause seems to be the education of woman, who then see much more to life then being barefoot & pregnant. (Just in case anyone has any doubts, I find the liberation of women to be the a GOOD thing, the seminal achievement of this era.)

One consequence is a radical change in investment. We all tend to believe in regression-to-the-mean, so if rates are low, they will rise; or if bonds are high, they will fall. The demographic trend may lead to a one-time direction that should last 40 - 50 years, and the fact it doesn't change will catch everyone by surprise.

Another consequence is grave risk of the Japanization of developed countries - decades of slow growth or modest decline. One massive driver of growth are the Tweeners - twenty-somethings who enter the workforce and buy their first car, house, appliances, etc. Subsequent purchases tend to be trading up or trading in. Without the Tweeners, economies grow much slower. (Hence the wisdom of consumer credit - fuels the Tweeners, is paid back when they begin saving in their 40s and 50s.) The Birth Dearth means the Tweener growth engine sputters.

(As a policy implication, it may be time for the US to open the immigration spigot, particularly for the best & brightest Tweeners from around the world.)

Economists at CSFB have assessed the inevitable demographic trends and made five predictions.

Prechter's New Count, Same Message

Yelnick has noted that Prechter has hinted at changing his count in recent newsletters.  Today he unveiled his new count.  The count may be different, but the message is the same, and the prediction is much closer to Yelnick's view: a top of around Dow10K at around Nov 11.

 

Prechter had counted the Dow since Jan00 as a nested series of waves 1 - 2, so that we were nearing the 3 of (3) of [3] wave.  This is what normally happens.  However, the recent wave 2 of (3) of [3] has proceeded longer and higher than should have been expected of a wave 2 of third degree down.  In particular, it had passed the normal 61.8% retracement and was heading for a 78% retracement, as had the prior wave (2) and wave [2].  While explainable by the unusual circumstances of the mania, it nevertheless is rare for wave 2's to retrace that far, let alone three times in a row. 

 

A simpler way to count the bear market would be to see the whole drop to Oct02 as wave [1] down.  Zoran had moved to that view a while ago.  Yelnick had suggested that view in informal communications.  Now Prechter has found the systematic justification for that view. 

 

The best reason for this change is the psychology of the current wave we are in, which is now relabeled as wave [2].  The investment climate has been uber-bullish, as expected in a wave 2.  Wave 2's are often more bullish than the peak of the bull since investors are convinced that they have caught the bottom, so feel they have deeper justification for their bullishness.  The level of bullishness now is higher than in the prior waves [2] and (2), which suggests that THIS is the highest degree wave [2], not the previous ones. 

 

Under this new count, we look for a 61.8% retracement of the full wave [1] down from the peak.  The former Yelnick target was 78% of the wave 1 of (3) of [3] down, or Dow9930.  The new ideal target is essentially the same, since whole drop of the new wave [1] is full of fibonacci relationships.  (78% is the square root of 61.8%, so since the prior wave 2's each retraced 78%, it should be no surprise that 61.8% of the whole drop calculates out as 78% of the most recent drop.)  Suffice to say the target is Dow10K +/- 200 points. 

 

Dow 10K is also a major psychological barrier.  When the Dow first broke 100, it took another 18 years (and the Roaring '20s) to go above it again.  When the Dow first broke 1000, it bounced off it a few times but didn't break through for another 16 years.  It should be no surprise if we slightly break through the 10K level and then turn south again.   

 

Timing for the top is anywhere from Oct15, the day Zoran has already called as the top, to Nov 14, with a most likely time around the first full weekend in Nov, or Fri Nov 7 through Tues Nov 11. 

 

Yelnick sees Nov11 as one of two likely times for the top.  Besides the above analysis of Prechter, Nov11 also fits the pattern the market saw in 1987.  If the 1987 model continues, it would point to a crash the first week of Jan04.  The other likely time for the top would be in late-Mar/early-Apr04, reflecting the impact of the Presidential four-year cycle on the timing of this wave [2].  To put it in simpler terms, Bush and Greenspan are doing everything possible to pump the economy and get re-elected.  Their manipulations will either have worked or not worked by the end of the first quarter, right smack dab in the middle of the primary season.  These manipulations have the effect of extending the timing of the wave, but not affecting its height or overall pattern. 

Can the Fed Stop Deflation?

Prechter's EWI site has posted their primary
deflation analysis. Worth studying.

Prechter defines deflation as follows: "Just as inflation is an expansion in
the supply of money and credit, deflation is a contraction in the supply of
money and credit. Deflation is not falling prices. Falling prices are a
consequence of deflation. It is dangerous to confuse the two ideas because
prices can fall without deflation." PC prices are an obvious example of
this.

Is deflation impossible because the Federal Reserve Bank can just print
money? Prechter says no, since the Fed primarily 'prints' money by
fostering the expansion of credit. Banks create money by lending. The
volume of bank money dwarfs the volume that the Fed could sensibly create on
its own. Hence the Fed has to weave its magic by trying to manage credit
markets.

Currently credit markets for business ("Main Street") are not working well -
another way of saying that it is hard to get venture capital, or go public,
or get commercial loans at reasonable rates and terms. It is virtually
impossible in certain segments, such as dot-coms, or new telecom companies.
During the Great Depression, banks simply stopped lending, and the levers
the Fed used to change behavior did not work. This was called the
'liquidity trap' since the Fed made credit available to banks but the banks
did not make it available to borrowers. The psychology had to be broken
before banks lent. Speeches about fear, big government deficits, government
job programs, Fed pump priming, cheapening the currency, failed to do so
then, just as they have failed for Japan more recently. It took WWII to
break the psychology.

(A fascinating validation of Prechter's point of view can be seen in WWII
movies. Some of the most commended early movies about WWII are actually
about the Depression; watch From Here to Eternity or In Harm's Way. These
movies start with people being bored, and when the war comes, it is
welcomed, as a way to escape the psychology of the Depression. More recent
WWII movies, such as Saving Private Ryan or Pearl Harbor, completely miss
this context, as they were made during the social mood of the '90s.)

Three credit markets have been working in lieu of Main Street: Muni's,
Mortgages and Margin, although the window on two of them appears to be
closing. Given the sorry state of California, muni borrowing is approaching
its limit. Given the recent jump in mortgage rates, after a final rush to
borrow, the real estate boom is likely to end. That leaves the stock
market. As Yelnick has reported, it appears the Fed has used any
significant event (9/11, Iraq War, blackout) to pump credit into equity
markets and keep the stock markets afloat without creating a dysfunctional
reaction from naked credit pumping.

Greenspan's strategy is use credit in these ancillary markets to keep the
economy afloat long enough for Main Street to return to normal. This means
the Fed is primarily trying to manage social mood and psychology, not more
mechanistic targets such as money supply growth.

Prechter's point is that the Fed is running out of arrows in its quiver to
affect credit market psychology, and when there is no more it can do, the
negative social mood may overwhelm all that it has tried to do, and send us
into a deflationary spiral and subsequent depression. The marker for when
the 'herd' recognizes this point of no return is a severe stock drop, or
even crash. If it happens, it will be said after that the crash caused the
subsequent depression, or 'discounted' it, when in fact, the crash only
reflects a collective "Oh, $#!@" reaction as investors head for the exit,
not knowing what may follow.

K-Wave V: The Rise of Machines

Thinking about the K Wave question: will the coming always-on world being brought to us by widespread broadband and wireless connectivity be the new factor of production that takes us out of the K-Wave Winter and starts the cycle anew? 

A broader new factor is digitization, of which the always-on world is a subset.  It may finally take us out of the 'paperless' office into a new paradigm where documents are not created with the intention to print but created for a pure digital existence.  More generally it will spawn a vast collection of web services, which are machine to machine communications.   

We have only so much attention time to give to always on communication, but our machines can talk to each other orders of magnitude more.   They will allow the scaling of an information economy beyond the bounds of the prior analog world.

Kondretioff Rules

Yelnick has received some questions regarding whether the Kondretioff Wave conditions have been satisfied, which would be another supporting condition for a new bull market, or whether a major deflationary debacle awaits.  Like all cycles,  the K Wave is more descriptive than prescriptive (Elliott Waves are more prescriptive than cycles), but provides enormous insight into our current  economic condition.

The K wave was identified in the '20s by Kondretioff,  a Russian economist who studied capitalist systems.  When asked by Stalin in the '30s if the Great Depression was the collapse of capitalism predicted by Marx, he said no; based on his work, the West would rise again.   For his insight, he was sent to the Gulag.  Unfortunately for him, he never returned.  Fortunately for us, his work filtered  out.

The K wave is a 54 year cycle (+/- a year or so) with internal phases that are sometimes characterized as seasons: spring, summer, etc.  Spring   phase: a new factor of production, good economic times, rising inflation.  Summer: hubristic 'peak' war followed by societal doubts and double digit inflation.  Fall:  the financial fix of inflation leads to a credit boom which creates a false plateau of prosperity that ends in a speculative bubble.  Winter: excess capacity worked off by massive debt repudiation, commodity deflation & economic depression.  A 'trough' war breaks psychology of doom.  New factor of production emerges, happy days are here again, cycle begins  anew.

K-wave I: 1789 - 1842.  New   factor:  canals.  20 good years. 1812, peak war. US invades Canada, gets slapped back.  White House burns. 1815-1824, inflation, turmoil, weak Prez (John Quincy Adams), end of Federalist rule.  1828, Andy Jackson elected, false plateau of prosperity. 1837, Bank of US cancelled, severe depression, deflation.  Ends with trough war, Remember the Alamo! we win Texas from Mexico.

K-wave II: 1843-1896.  New factor: RRs.  1861, peak war. 1865-1873, reconstruction, inflation, Prez   impeached.  Turmoil. 1873, RR fiasco, financial panic.  First bought of deflation as Civil War inflation ended.  False plateau of growth.  1879, return to gold standard.  Second RR bubble bursts.  Deflation continues. Ends with trough war, Remember the  Maine! we conquer Spain's remaining colonies. 

K-wave III: 1897-1949.  New factor: oil/autos.  20 good years.  US becomes world economic leader.  1914, peak war to end all peak wars.  1919-1925, inflation, turmoil, scandal (teapot dome).  Coolidge becomes Prez.  False plateau. Roaring  20s.  1929, Crash.  Depression.  Severe deflation.  Ends with trough war, Remember Pearl Harbor!, Pax Americana.

K-wave IV: 1950 - 2004 (?).  New factor: aerospace.  20 great years.  American Century. 1966, peak war: Vietnam!  Rising inflation.  Wage and price controls.  Oil crisis.  Nixon resigns.  Vietnam war is lost, American innocence gone, stagflation, Prez Carter blaming malaise not on government but on the people. 1980, Reagan elected.  Morning in America.  Volcker kills inflation.  False plateau!  Greed is good.  1990s, deflation in Japan, dot-coms in US, Greatest Asset Mania of All Time, bubble bursts, now in longest bear market since 1930s.  On schedule, trough war, Remember 9/11! we go into nation building. 

Most of the primary K-Wave predictions have been satified.  We have had the K-Wave false plateau followed by a speculative bubble. We have had deflation in commodities for a while, and some currency deflation (eg. Japan).  We have had enormous rolling debt repudiations: Mexico, Asian Flu, Long Term Capital  Management, Telecom bubble companies. We have started our trough war (War on Terror). NYFD is heroic again!

Is the cycle turning? In timing the K-Wave would nominally end now, in the period of 2003-2005.  But two caveats. First, in previous cycles we had much more severe economic disruption - the downturns in 1840s, 1880s and of course 1930s were considered depressions.  Second, the new factor that leads us out of economic hardship should be emerging.  It might be broadband/wireless - the always-connected world - but that was the subject of much of the bubble!  So while the new factor is apparent, the K-Wave Spring recovery is not yet emergent.  Both caveats suggest more trouble ahead, and more likely bottoming in 2004 or later than now.

Elliott Wave Basics

The Yelnick thread has new members, so I thought it worthwhile to give a brief intro to ewaves. A better tutorial is available for free at Club EWI.

Ellliott developed his theory in the 30s. Prechter picked it up in the 70s and made a killing calling the 1982-87 period correctly. (Typical wave 1, many people were skeptical of the bull.) Then, Prechter called the top multiple times in the 90s and his cachet faded - until the real top in 2000. Now Prechter is back!

The Elliott religion has split into several sects, the most popular being Neely, whose work is being improved on by Zoran Gayer, often mentioned here. The Yelnick thread looks at multiple Elliott sites and derives a consensus opinion. The STU from the Prechter camp is usually the best source; also very good in the orthodox Elliott camp is Ryan Henry, whose work is available under the name Wavespeak online here. Some of the more active Yelnick readers share their views either with me or the group, and that is encouraged.

The basic ewave is either a 5-wave impulse or a 3-wave correction. Impulses travel in the direction of the trend, corrections counter. The impulse is counted as waves 1 - 2 - 3 - 4 - 5, where the odd waves go in the direction of the trend and the even waves go opposite. The correction is counted as A - B - C, where A and C go in the corrective direction and B goes the other way. You can count the bull market this way:
> wave 1 from 82-87
> wave 2 correction from 87-91 (the Crash of 87 plus the Gulf War)
> wave 3 from 91-97 (includes the first Internet mania in 95-96)
> wave 4 correction from 97-98 (the Asian Flu)
> wave 5 to the manic peak in 2000 (dot-com fever!)

Impulses only have two basic forms: the standard five wave and an overly enthusiastic variant of 9 waves where one of the segments 'extends' or breaks into a mini-5 wave of its own. Corrections come in 11 variants, including:
> Flat, an ABC in a trading range, which subdivides as 3 - 3 - 5 waves
> ZigZag, an ABC which goes deeply down, which subdivides as 5 - 3 - 5 waves
> Extended flats and zigzags, where you get double or triple ABC moves
> Triangle, a very extended series of five ABCs that have lower highs and higher lows

The ewave is a fractal, meaning it has the same form at all degrees (minutes, days, decades, etc.). Within a impulse pattern, each wave itself breaks into subwaves. The odd waves in the direction of trend, waves 1 - 3 - 5, subdivide into impulse patterns. The even waves, 2 - 4, subdivide into corrective patterns. So after a 5-wave wave 1 up, we see an ABC wave down, then the wave 3 starts, etc.

The waves follow certain rules, the most important of which are:
> fives waves in the direction of trend, three waves counter
> wave 4 cannot go lower than the start of wave 2 (the top of wave 1)
> wave 2 cannot go below the start of wave 1 - if it did, the pattern would be counted as 3 and not 5 waves
> wave 3 is never the shortest wave - indeed, it usually is the most intense
> waves 2 and 4 alternate in form - so if 2 is a Flat, 4 is a ZigZag or Triangle

The rules as stated are for a bull trend; the rules reverse if the trend is down (eg. wave 4 cannot go above wave 2)

These rules are in play right now. At the top on Monday, we reversed and came down in a 5-wave pattern. This suggests the trend has changed. Today we corrected that 5 wave move in 3-wave pattern. The first 5 waves make a wave 1, the second 3 waves make a wave 2. Tomorrow will be very interesting. The wave 2 correction may not be over yet; futures are up overnight. If the market breaks its Monday highs, then the rule about wave 2's not breaching the start of wave 1 fails, and we know we have not yet changed trend. if the market turns down again, it would have entered wave 3, which is usually the most intense.

It is easy to get lost in numbers. Also, watching the ewave theory over the past two decades, it doesn't seem to work as well during corrections. This is where Zoran may be about to improve on the theory, since he has been developing a way of fixing the Bifurcation Point when the correction ends.

One way to understand the waves is that the market does not recognize a change in trend until wave 3. That is why wave 3 is the most intense. Everyone piles on! This lack of recognition of trend is what is happening right now. Everyone is eager to call a bottom and get back on the Bull. We have come down in a wave 1 to the low in October. Was that the end of the Bear? We have now come back in a wave 2. Bullishness is at levels not seen since 1987! This is extreme, but typical of wave 2s. When wave 2s fail to exceed the prior level, then the herd begins to recognize the trend and a wave 3 starts.

Another way to understand this is the difference between stock distribution and stock accumulation. After a peak, the waves A and B down (if corrective) or 1 and 2 down (if trend change) can look the same. Often they will mirror the waves 4 down and 5 up from the prior trend. This pattern forms a classic Head and Shoulders pattern. The traders who bought during the wave 5 up but didn't sell at the peak will try to get out during wave B or 2. If the stock is being distributed not accumulated, wave 2 will fail, and we turn down into wave C or 3. At some point wave 3 reverses in wave 4. If at that time stock is accumulated, wave 4 could exceed the start of wave 3. This changes the count from 1 - 2 - 3 - 4 down to A - B - C down followed by wave 1 up. If wave 4 fails to exceed wave 3, then the final wave 5 down will follow.

Final part of the basics is fibonacci numbers. Prechter believes what separates Elliott Wave Theory from Ptolemaic epicycles is that it reflects underlying social mood, which follows certain biological patterns based on mass psychology. Many aspects of biology show fibonacci relationships. The ratio of fib numbers is the very interesting number Phi, which is more irrational than Pi or e. Often Elliott Waves show numeric relationships based on Phi ratios. Phi is approxiamtely 1.618, and the inverse of Phi is 0.618. The square of 0.618 is 0.382. Often waves 2 reverse 61.8% of wave 1, often wave 3s are 1.618 the length of wave 1, and often waves 4 reverse 38.2% of wave 3, which happens to also be 61.8% of wave 1 if wave 3 goes 1.618 times wave 1.

This relationships can be used to predict both reversal levels and durations of waves. A full 5 wave pattern often runs 2.4x its first leg, for example, which can be calculated from those fib relationships. Usually wave 2s do not exceed 61.8% reversal of wave 1. And usually in ABC corrections wave C equals wave A. The current wave 2 is running into a number of these relationships. It topped on Monday at close to 61.8% of wave 1 and also where its A wave = its C wave.

Thus the next few days are extremely interesting. The wave pattern strongly suggests we have or are about to end wave 2 and start wave 3. Yet bullishness is rampant. One of these two perspectives will have to break, shortly.

Has the Nasdaq Bottomed?

As we near the end of a wave 2, the extreme bullishness reflects a higher level of the same bullishness that got us into the mania in the first place. Mutual funds and day traders are buying because everyone else is & they don't want to be left behind - significantly, not because their analysis of individual stocks or of the market says to do so. It is goin' up 'cuz it's goin' up.

The ewavers are saying the end of the uptick may be with us, and the big wave 3 of 3 is coming. So continue to watch the recent highs like a hawk, since if wave 2 has topped yesterday's highs wil hold. But the market is behaving corrective and may still be in the wave (2) from October. Rather than having topped in Dec, we might be in a long ABC wave 2 since Oct. Possible turn date is the next fib date of around May 31. STU thought it would be a bottom; may instead be a top, of wave (2). THEN the big 3 of 3 starts.

The strongest bullish case can be made in the Nasdaq. Its drop from Mar00 to Oct03 parallels the drop of the Dow in 1929 - 1932 eerily. There are indications of a bottoming of tech. VC investments in new deals are up since 4Q02 - up quite a bit. Enterprise software budgets are being set right now for 2004, and early reports are for a return to buying. Anecdotally, at Valley events six months ago, half the people were unemployed and looking. Today, they are still unemployed, but they hand over business plans, not resumes. Best way to find a job is create one!

It feels a lot like 1994, when the Web was young and VCs were stingy. No one can make money in the Internet! they said, to the extent they knew what it was. Today, the contours of Web 2.0 are emerging, and the VCs again are stingy and say No one can make money in WiFi, or Blogging, or Web Services!

And yet, it was reported that around 200 dot-coms have emerged from the wreckage, 1/3 of which are profitable now and 1/2 are expected to be profitable by year end. Remarkable! After the PC mania ended in 1983, around 40 companies emerged and around 20 became enormously successful - Sun, Dell, Compaq, Microsoft, Oracle, Adobe to name a few. This time it looks like a 5x bigger success pool.

Why is the Smart Money smart? Because it is contrarian. It buys in when the herd is out, and it stays out when the herd rushes in. The general malaise over tech belies the unnoticed success of the 200 dot-coms. It overlooks the continued march forward of Moore's Law. And it ignores the entrepreneurial spirit, which is alive and well despite the dearth of IPOs, the depression of valuations, and the deer-in-the-headlights look on the marginal VCs. Watch this space for developments. Yelnick will continue to report from the tech Ground Zero, Silicon Valley.

Battle of the Bulletins

Prechter, Wavespeak & Zoran all launched mid-day bulletins today.

You gotta love Prechter. On Friday he says no way will it poke above Dow8612. Today it did, and Prechter stuck to his guns. Ok, so what he read as a wave 5 on Friday was only a 3, and needed a final wave 5, so that is what happened. But this is it. He compares this to his most epic call, a call for the ages: in Sep 1985, in a downturn of a then weak market, he saw that a perfectly interlaced series of waves 1 - 2 had coiled up ready for a massive wave 3. He not only called it when other pundits were bearish, he bet heavily - and made a fortune. He sees this as almost the perfect inverted setup, where the massive wave 3 heads down and not up. As he says:

We think we may see a new extreme in bullish advisory service sentiment on the next report. New extremes in sentiment opposing an established trend are so rare that this is only the second one I have seen in the stock market in my career. ... Whether there is any further rally or not, in the long run, markets never look back from such junctures.

Ryan Henry of Wavespeak (which is about to graduate from StockCharts to Free Newsletter to Paid Service - good on him!) continues to do clear wave counts & predictions. He noted that the Nasdaq has broken the Dec high (1521), which changes the wave count. The old count had the Nasdaq ending its wave 2 off the Oct low in Dec; the new count has the whole action since Oct as an unfolding ABC wave 2. Only wave A ended in Dec, not wave 2; we are now in wave C.

He predicts an intense down move over the next few days, but staying above 1425, and then continuing back up towards 1600 in a fairly strong rally. In contrast, the Dow is a different story - although it went through Prechter's 8612 level, it has not broken 8664, where it would violate a fundamental Elliott rule, that wave 3 cannot be the shortest wave.

We have noted how the Nasdaq has presaged moves in the NYSE indices. The Nasdaq has now diverged from the Dow and S&P. Is it presaging that those indices will also break their Dec highs? Wavespeak thinks not.

For clarity on these conflicting bulletins, we turn to Zoran. His count has been the alt count all along - that we remain in a wave 2 correction from the July lows (Oct lows being merely the second leg of the five-leg Iraqi War Triangle). He notes that the S&P did go the wee bit higher he thought it might, but it rests right at the tipping point. If it drops, then the Prechter view is right. If it continues up, then the whole wave count needs to be rethought. We would be in a wave 3 up of wave C of 2, and should have a fairly broad-based rally!

For those of you who trade, a nerve-wracking time. For those who blog, a truly wonderful Elliott moment!

The Big Picture

The big picture scenario: markets dropping in 2004 to levels of below Dow4000 and SP400, and then continuing in a triangle formation (lower highers and higher lows) into 2011-2016. If so, the period from 2004 - 2008 should be a barn-burner bull market similar to 1933-37, where the Dow went up roughly 5x in 4 years.

Many technical indicators give the forecast of below Dow4000 / SP400:
> manias retrace all the way, and this one started in Nov94 (after the Republicans won control of Congress for the first time in 40 years) around Dow3600 / SP400
> in a head-and-shoulders pattern, the amount of the rise above the neckline is the amount of the drop below, and the 1998-2000-2002 H&S pattern in the S&P has a neckline of ~SP950 and a head at SP1550 - hence the drop should be 600 pts or ~SP350
> P/E ratios get down to ~10 at a bear market bottom, whereas currently the ratio is 24 based on reported earnings (and much higher based on more traditional earnings metrics), meaning the S&P would be 2.5x lower on current earnings at a typical bottom, or around SP350

A drop of this magnitude is nevertheless extraordinary and would reflect fundamental problems in the real economy. Currrently debt is at record levels and economic conditions are deteriorating. While unemployment has been flat for two years and consumer spending relatively bouyant, this may be due to the massive refinancing of homes with the drop in interest rates. If this market scenario plays out, we should see in parallel an accelerating deterioration of the real economy.

There is a divide in the Elliott Wave community on the magnitude of the current drop. The extreme view, trumpeted by Prechter, is that the Great Bull Market of the Industrial Revolution since 1789 has run its course. This is based on wave count, which has us just ending the fifth wave of the bull market that began in 1932, a bull market that reflects the fifth wave at a higher degree since 1789 (grandiosely numbered as V). The problem with this count, besides the obvious that industrialization does not seem to have run its course, is that on an inflation-adjusted basis it appears that the bear market that started in 1929 did not end so quickly, and indeed ran until 1949. This is also consistent with more general economic and political views on the Great Depression, that are that it did not end until after WWII.

The alternative view, supported by Zoran among others, is that we have completed wave 3 of V and are in wave 4 down, with a final wave 5 to go. Under this count, wave V began in 1949, and we have had only 3 waves so far - wave 1 from 49-66, wave 2 from 66 - 82, and wave 3 from 82-00. Prechter counters this by saying that the wave from 49-66 had better technicals than the recent wave from 82-00, and typically wave 3's have the strongest underlying characteristics. The relative weakness of the 82-00 bull market vs. the earlier one may be explained by the Kondretioff Wave, which began in 49 and is ending in 04; a bull market wave which runs through the end of a K-wave will show weaker characteristics. K-waves begin with a bang, peak with inflation, and end with deflation.

The implications of these differing views is profound. If we are correcting the 200 year run-up of the Industrial Revolution, the potential depth will be quite low, the duration quite long, and the fundamental economy quite weak. If we are in a wave 4 of V, the depth should be lower, the duration shorter, and a long bull market wave 5 will follow, carrying beyond our investment horizon.

Most likely we are in that wave 4, as key elements of the core economy look sound: Moore's Law is still working, oil is not running out, and globalization continues.

The Foundation for this blog

The Foundation for this blog: Hari Seldon Psycho-History

Commentary on the stock market guided by Elliott Wave principles, as developed by Bob Prechter. Is he Hari Seldon, and has he invented Psycho-History? Or is Elliot Wave no more than Ptolemaic epicycles? Fourier informs that any complex pattern can be modeled by proper weighting of cycles. On Cheer's, Cliff Claven said he had an infallible system for predicting the next President, and it could predict all prior elections. His prediction: "Yelnick McWahwah." And yet, Elliott often provides remarkable predictions. Stay tuned.