Welcome to the latest issue of ECAM.

Since my last update nothing has changed with respect to equity investment. We are still in the grip of what will be a severe bear market in equities that may last an additional 2+ years.

Just to refresh everyone's memory, my longer term charts turned bearish at the end of Dec/2007 and at that point I switched to 100% non-equity holdings. At the time that was the Euro (25%), Australian dollar (25%) and Fidelity International Bond fund (50%).

My last switch was out of the Euro and Aussie dollar into USD cash based upon the sudden strength in the USD. I held my International bond exposure until I saw further evidence of technical strength in the USD.

We have now seen this strength and it has forced me to switch my 50% position in the bond fund into USD cash. As of today I am in a 100% USD cash position.

First the equity charts (click all charts to enlarge)


Dow Jones World 1 year daily chart:



This short term chart last turned bearish in early June as indicated. This chart will be one of the first to indicate when it is time to re-enter the stock market.

There is no technical indication we have turned the corner yet and I suggest it is extremely dangerous to attempt to front run any advance before the technicals indicate it is time to do so.

It is possible we have put in a double bottom. If so, price would have to get at least above 191.27 (and to be ultra-safe, above 198.15) to give us a reasonable picture that a short term bottom is in place. Until then, it must be assumed the market is still in a downward trend.


Dow Jones World PNF 1-box chart:



This short term Point and Figure chart remains bearish. It is interesting to note the newest row of "0"s has just formed. If price were to turn around from here and begin to climb, this chart would give a buy signal if price were able to pass 185. This would be the 1st technical sign we are turning the corner but it would be dangerous to go long based upon just this one indication.

I would not go short term long until both short term charts indicate it is safe to do so.


Dow Jones World 10 year weekly chart:



A reminder that irrespective of any change in the short term direction of the markets, the longer term trend is still down.

Until the 13 week EMA crosses above the 34 week EMA we are in a bear market. It really is that simple.


S&P 500 30 minute candlestick chart:



I have included this chart for a specific reason. This is a 30 minute chart of the S&P 500 index. I have shown what looks to be a symmetrical triangle that is forming. This is referred to as a pennant as it forms to resemble a pennant type of flag.

Should this be a pennant, the rule of thumb is that "pennants always fly at 1/2 staff". What this is saying is the pennant is a pause point approx 1/2 way through either a rally or a decline.

This pattern usually takes the form of 5 waves and tends to exit the pattern the same way it entered. In other words, it entered from above (ie. the market declined into the pattern) therefore it is expected it will exit downwards when it completes.

It appears 3 waves have completed. If so, wave 4 should go down to test the lower trend line followed by a wave 5 bounce upwards. This wave 5 usually does not get up to the upper line before turning down. A break of the lower trend line will complete the pattern.

Should this pattern play out as "textbook", it would suggest a further 426 points to the downside from the point at which the pennant exits the pattern (1265 - 839 = 426). That exit point would be approx. 920'ish so the target would be 500'ish on the S&P 500 (920 - 426 = 494).

Even using the more optimistic start point of 1168 would give us a target of 600'ish (1168 - 839 = 329) (920 - 329 = 591).

In either case, it can be seen there is still very real danger in these markets and we better hope to hell that bottom trend line holds or we are in real trouble.

While I am still looking for a short term bottom and then a rise into the spring, should this pattern play out I would highly suggest anyone who is still holding equities in the hope of participating in a bounce consider selling out their positions on the breakdown (should it occur).


US Dollar 10 year daily chart:



Unbelievable strength shown in the USD. While there are a ton of reasons why the USD shouldn't be so strong, it is what it is. I suspect the reason is the 1000's of US based hedge funds having to liquidate foreign holdings to meet margin calls on leveraged positions. This forced liquidation is forcing them to sell all assets and convert their holdings into USD cash. This is leading to a short term demand for US dollars, driving up price.

Long term I think the USD is doomed but you cannot fight the trend. The downtrend has clearly been broken, the back test completed, and the resistance @ 80.39 was decisively broken to the upside.

Price has now risen to its next area of resistance at 84.29 (61.8% retracement level)-84.56 (current price resistance level from 2004). A break above here and we will look to retrace all the way back to the previous start of the bear market @ 92.63. There is no reason technically why this is not possible so we have to assume the USD is able to climb a further 10% from current levels.

As a result, my decision to move out of Euro and Australian dollars was a good one. However, my holdings in the International Bond fund have taken a beating due to its holdings (foreign currencies) not being hedged within the fund and dragging down price.


Fidelity International Bond Fund chart:



Price has broken long term support. If the USD climbs a further 10%, this fund will suffer at least that amount in losses.

As such, I have switched my Fidelity International Bond Fund position into Blackrock/MLIM USD cash fund. Should the USD reverse I can always re-enter the bond fund but to this point it appears the potential short term upside to the USD is a danger I cannot take.


Bottom Line:

-It is still too early to enter equity positions. The only thing currently making money is the USD and short term US treasuries.

-I am looking for an equity price bottom to occur soon. When my short term indicators indicate it is safe to do so I will switch a small portion of my holdings to equities.

Once again I stress this will be a short-medium term trade only with a small position of my total capital as I believe we are within a 3 wave multi-year bear market. Wave 1 is almost complete and when the turn occurs it will result in a multi-month wave 2 up. This will be followed by a multi-month wave 3 down that will result in a price low well below the levels set at the 2003 market lows and may be comparable with the 1929-1932 stock market crash (the DOW lost 90% of its value during that period).

-The USD has shown unbelievable strength and appears to have started a long term uptrend. It is easily possible for it to now regain 100% of the current downtrend to 92. There is strong resistance at that level; from there it is possible the USD collapses into a new low (this could come with the US government defaulting on their debts).


Based upon the above, as of today I have switched my Fidelity International Bond Fund into BlackRock/MLIM USD cash fund.


As of today, my "strategic" positions are as follows:

-100% BlackRock/MLIM US Dollar Cash Fund*

*(actual positions: USD cash 92%, equities 8%)


*percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).


Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANICAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Urgent update

If you have not done so, read the article I posted previous about the approaching economic "winter". Then read the following and prepare accordingly.

This time it really is different.

Nouriel Roubini's Global EconoMonitor

The world is at severe risk of a global systemic financial meltdown and a severe global depression

Delicious Digg Facebook reddit Technorati Nouriel Roubini Oct 9, 2008

The US and advanced economies’ financial system is now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms.

On the real economic side all the advanced economies representing 55% of global GDP (US, Eurozone, UK, other smaller European countries, Canada, Japan, Australia, New Zealand, Japan) entered a recession even before the massive financial shocks that started in the late summer made the liquidity and credit crunch even more virulent and will thus cause an even more severe recession than the one that started in the spring. So we have a severe recession, a severe financial crisis and a severe banking crisis in advanced economies.

There was no decoupling among advanced economies and there is no decoupling but rather recoupling of the emerging market economies with the severe crisis of the advanced economies. By the third quarter of this year global economic growth will be in negative territory signaling a global recession. The recoupling of emerging markets was initially limited to stock markets that fell even more than those of advanced economies as foreign investors pulled out of these markets; but then it spread to credit markets and money markets and currency markets bringing to the surface the vulnerabilities of many financial systems and corporate sectors that had experienced credit booms and that had borrowed short and in foreign currencies. Countries with large current account deficit and/or large fiscal deficits and with large short term foreign currency liabilities and borrowings have been the most fragile. But even the better performing ones – like the BRICs club of Brazil, Russia, India and China – are now at risk of a hard landing. Trade and financial and currency and confidence channels are now leading to a massive slowdown of growth in emerging markets with many of them now at risk not only of a recession but also of a severe financial crisis.

The crisis was caused by the largest leveraged asset bubble and credit bubble in the history of humanity were excessive leveraging and bubbles were not limited to housing in the US but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies: an housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.

At this point the recession train has left the station; the financial and banking crisis train has left the station. The delusion that the US and advanced economies contraction would be short and shallow – a V-shaped six month recession – has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the US and close to two years in most of the rest of the world. And given the rising risk of a global systemic financial meltdown the probability that the outcome could become a decade long L-shaped recession – like the one experienced by Japan after the bursting of its real estate and equity bubble – cannot be ruled out.

And in a world where there is a glut and excess capacity of goods while aggregate demand is falling soon enough we will start to worry about deflation, debt deflation, liquidity traps and what monetary policy makers should do to fight deflation when policy rates get dangerously close to zero.

At this point the risk of an imminent stock market crash – like the one-day collapse of 20% plus in US stock prices in 1987 – cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown.

This disconnect between more and more aggressive policy actions and easings and greater and greater strains in financial market is scary. When Bear Stearns’ creditors were bailed out to the tune of $30 bn in March the rally in equity, money and credit markets lasted eight weeks; when in July the US Treasury announced legislation to bail out the mortgage giants Fannie and Freddie the rally lasted four weeks; when the actual $200 billion rescue of these firms was undertaken and their $6 trillion liabilities taken over by the US government the rally lasted one day and by the next day the panic has moved to Lehman’s collapse; when AIG was bailed out to the tune of $85 billion the market did not even rally for a day and instead fell 5%. Next when the $700 billion US rescue package was passed by the US Senate and House markets fell another 7% in two days as there was no confidence in this flawed plan and the authorities. Next as authorities in the US and abroad took even more radical policy actions between October 6th and October 9th (payment of interest on reserves, doubling of the liquidity support of banks, extension of credit to the seized corporate sector, guarantees of bank deposits, plans to recapitalize banks, coordinated monetary policy easing, etc.) the stock markets and the credit markets and the money markets fell further and further and at an accelerated rates day after day all week including another 7% fall in U.S. equities today.

When in markets that are clearly way oversold even the most radical policy actions don’t provide rallies or relief to market participants you know that you are one step away from a market crack and a systemic financial sector and corporate sector collapse. A vicious circle of deleveraging, asset collapses, margin calls, cascading falls in asset prices well below falling fundamentals and panic is now underway.

At this point severe damage is done and one cannot rule out a systemic collapse and a global depression. It will take a significant change in leadership of economic policy and very radical, coordinated policy actions among all advanced and emerging market economies to avoid this economic and financial disaster. Urgent and immediate necessary actions that need to be done globally (with some variants across countries depending on the severity of the problem and the overall resources available to the sovereigns) include:

- another rapid round of policy rate cuts of the order of at least 150 basis points on average globally;

- a temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made;

- a rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures;

- massive and unlimited provision of liquidity to solvent financial institutions;

- public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses;

- a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;

- a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers;

- an agreement between lender and creditor countries running current account surpluses and borrowing and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.

At this point anything short of these radical and coordinated actions may lead to a market crash, a global systemic financial meltdown and to a global depression. At this stage central banks that are usually supposed to be the "lenders of last resort" need to become the "lenders of first and only resort" as, under conditions of panic and total loss of confidence, no one in the private sector is lending to anyone else since counterparty risk is extreme. And fiscal authorities that usually are spenders and insurers of last resort need to temporarily become the spenders and insurers of first resort. The fiscal costs of these actions will be large but the economic and fiscal costs of inaction would be of a much larger and severe magnitude. Thus, the time to act is now as all the policy officials of the world are meeting this weekend in Washington at the IMF and World Bank annual meetings.

Thursday midnite update: A few hours after I had written this note the market crash that I warned about is underway in Asia: the Nikkei index in Japan is down 11% and all other Asian markets are sharply down. This reinforces the urgency of credible and rapid policy actions by the G7 financial officials who are meeting in a few hours in Washington and the need to also involve in such global policy coordination the systemically important emergent market economies.

Kondratieff Winter has arrived?

I have been watching with interest the developments in the markets the past few weeks.

It is clear by the tone and concern of some very experienced traders that they have never experienced what is currently happening in the credit and stock markets. When traders who have been on the floor of the NYSE for 40 years tell you this is something they have never seen, you better take notice.

While many have said it before in previous economic crisis (and have been proven wrong), THIS TIME IT MAY REALLY BE DIFFERENT.

This got me thinking about an economic theory I have been aware of for some time and have been on the lookout for. It falls into the area of heterodox economics (a term used to cover various "outside the mainstream" economic theories) and involves the concept of market cycles. The theory is what is known as the Kondratieff Cycle.

The cycle is a period of approx 60 years covering 4 distinct phases in a capitalist system. The 4 phases are termed Spring, Summer, Fall and Winter. The event that we may now be entering is known as a Kondratieff Winter.

Each cycle is approx 15 years in length but can be manipulated by government intervention. The key to this theory is it is not necessarily a "time" based theory but an "event" based theory. While the cycles run around 15 years each, much more important than the length of time is identifying the EVENTS that signal a transition from one cycle to the next.

I have not mentioned it previous because it is a very rare occurrence (as I said, it occurs once every 60 odd years) and, until recently, I had not seen enough evidence to indicate we had made the transition. However, it appears we may have now made the transition and, if so, this document could be the single most important piece of information you need to survive the coming winter storm.

To introduce the concept, first the history of Nikolai Dimitrievich Kondratiev:

Nikolai Dmitriyevich Kondratiev, Russian: Николай Дмитриевич Кондратьев (4 March 1892 - 17 September 1938) was a Russian economist, who was a proponent of the New Economic Policy (NEP) in the Soviet Union. He was executed at the height of Stalin's Great Purge and "rehabilitated" fifty years later.

He proposed a theory that Western capitalist economies have long term (50 to 60 years) cycles of boom followed by depression. These business cycles are now called "Kondratiev waves", or grand super cycles. Two Dutch economists, J. van Gelderen (1891-1940) and Samuel de Wolff, previously argued for the existence of 50- to 60-year cycles in 1913. However, only recently has the work of Wolff and Gelderen been translated from Dutch to reach a wider audience.

Nikolai Dimitrievich Kondratiev was born on 4 March 1892 in the province of Kostroma, north of Moscow, into a peasant family. He was tutored at the University of St. Petersburg before the revolution by Mikhail Tugan Baranovsky. A member of the Socialist-Revolutionary Party, his initial professional work was in the area of agricultural economics and statistics and the problem of food supplies. On 5 October 1917, at the age of 25, he was appointed Minister of Supply of the last Alexander Kerensky government, which lasted for only a few days.

After the revolution, he dedicated his attention to academic research. In 1919, he was appointed to a teaching post at the Agricultural Academy of Peter the Great, and in October 1920 he founded the Institute of Conjuncture, in Moscow. As its first director, he developed the institute, from just a couple of scientists, into a large and respected institution with 51 researchers by 1923.

In 1923, Kondratiev intervened in the debate about the "Scissors Crisis", following the general opinion of his colleagues. In 1923-5, he worked on a five-year plan for the development of Soviet agriculture. In 1924, after publishing his first book, presenting the first tentative version of his theory of major cycles, Kondratiev travelled to England, Germany, Canada and the United States, and visited several universities before returning to Russia.

A proponent of the Soviet New Economic Policy (NEP), Kondratiev favored the strategic option for the primacy of agriculture and the industrial production of consumer goods, over the development of heavy industry. Kondratiev’s influence on economic policy lasted until 1925, declined in 1926 and ended by 1927. Around this time, the NEP was dissolved by a political shift in the leadership of the Communist Party.

Kondratiev was removed from the directorship of the Institute of Conjuncture in 1928 and arrested in July 1930, accused of being a member of an illegal and probably non-existent "Peasants Labour Party". As early as August 1930, Soviet Premier Joseph Stalin wrote a letter to Prime Minister Vyacheslav Molotov asking for the execution of Kondratiev.

Convicted as a "kulak-professor" and sentenced to 8 years in prison, Kondratiev served his sentence, from February 1932 onwards, at Suzdal, near Moscow. Although his health deteriorated under poor conditions, Kondratiev continued his research and decided to prepare five new books, as he mentioned in a letter to his wife. Some of these texts were indeed completed and were published in Russian.

His last letter was sent to his daughter, Elena Kondratieva, on 31 August 1938. Shortly afterwards, on 17 September during Stalin's Great Purge, he was subjected to a second trial, condemned to ten years without the right to correspond with the outside world. However, Kondratiev was executed by firing squad on the same day the sentence was issued. Kondratiev was 46 at the time of his execution. He was rehabilitated almost fifty years later, on 16 July 1987.

In my study of the Kondratieff cycle, I have found one document to be the most well written description I have ever seen. Here is a link to the site. The document is a PDF file that is 31 pages long but I highly suggest you read the whole thing.


http://www.thelongwaveanalyst.ca/pdf/08_01_07_News.pdf


The key to identifying the transition from the various seasons of the Kondratieff cycle is not the length of time but the events that signal the transition. Broadly speaking, during a K-wave winter the thing to look for:

-a rapid contraction in credit availability (bank failures, interest rate spikes)
-a sell off in commodities (including oil, copper, silver)
-a rapid fall in GDP
-a flight to currency, gold and government bonds


The charts to tell the story (click on charts to enlarge):


1 month LIBOR vs. 1 Month U.S. Treasury



This is a ratio chart of 1 month LIBOR rate (London Interbank Offer Rate) to 1 month U.S. treasury rates. LIBOR is the rate you want to watch as it is the interest rate the banks offer to each other to lend each other money.

The rate is usually fairly constant (at around 30-40 BIPS above UST) but note the spike the past 3 weeks.

This spike is the seizing up of the credit markets and indicates the degree to which banks have become risk averse and not willing to lend to one another.

This is the start of a credit contraction that will last up to a decade. With it will come a severe recession/depression.


CRB (Commodity) Index



Copper



Crude Oil



Silver



As can be seen, all commodities have begun to collapse in the past 3-4 weeks. This is a key component in a K-wave winter and signals deflation in the world’s economy.


US Dollar



The first signs of a “flight to safety” have begun. Many were wondering why the strength in the USD given all the problems. Could this be a sign that winter has arrived?


If the Kondratieff Winter has begun, where is the safe place to be:

1) Gold and gold stocks (yet to rise after their recent down turn; watch close)
2) Government notes (i.e. cash)
3) Government bonds

I still do not believe long term the USD will be the place to be. I am thinking the "safe" currency will be the Japanese Yen (they have been in deflation for over 10 years now and do not have the debt problems the U.S. and Europe have) but have yet to switch into the Yen in my trading account.

Gold stocks have yet to begin a significant move up. When they do, I will be moving a large portion of my trading account into them.

I have begun re-accumulation of physical gold bullion on a monthly basis with excess personal savings.

If Ian Gordon is correct, this Kondratieff Winter could last into 2020 and will be worse than the 1930's Great Depression.

I think it would be wise to consider how you/your family will do if we really have entered a Kondratieff Winter. I think there is a very good chance we may be there and, if so, god help us all. Safety and preservation of capital will be paramount over the next decade.


Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANICAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Stock Market Update 04 October 2008

Another unprecedented week in the markets. Wachovia goes down (taken over by Wells Fargo) and a $700 billion bailout package gets approved on Friday.......and the market falls on the news.

There is an old saying that there is always a bull market somewhere but over the past few weeks the ONLY bull market has been in the U.S. dollar. Unbelievable but it is what it is.

I made a switch to my provident fund as of Friday’s closing price. I have moved out of the Euro and the Australian dollar funds and into the USD. See charts for details.

I have held my Fidelity International Bond fund (as of today) until I see what the USD does next week. As the bond fund is unhedged, it has taken a beating due to most of its holdings being non-USD denominated (and the USD having been so strong as of late).

Should the USD show continued strength I will be moving out of the bond fund. For now I will continue to hold both the USD cash fund and the international bond fund as it gives me a neutral delta hedge. See chart for details.


To start with, here are the year-to-date returns (01 Jan 2008 to present) for the funds I currently hold within the Provident Fund A and B accounts:


Core Holdings (currently approx 91% of portfolio):

BlackRock/MLIM USD Cash Fund: -0.35% (new entry)

Fidelity International Bond Fund: -7.22%


Exited Funds:

Fidelity Australian dollar Fund: +4.83%

Fidelity Euro Fund: +2.62%


Ongoing Equity Purchases (currently approx 9% of portfolio):

BlackRock/MLIM Equity: -26.87%

Fidelity International Fund: -30.35%

Russell Global 90 Fund: -27.37%


Representative Charting Index:

Dow Jones World Index: -29.22%


Here are the charts (click on all charts to enlarge):


Dow Jones World 6 year monthly chart:



-chart went bearish in Jan/2008 when the monthly closing price for January closed below the 12 month moving average.

Chart continues to be BEARISH.


Dow Jones World 10 year weekly chart:



-chart went bearish in late December/2007 when the 13 week moving average broke below the 34 week moving average with the MACD confirming by crossing below zero.

Chart continues to be BEARISH.


Dow Jones World PNF Traditional chart:



-chart went bearish on a price break below 264 in August/2008. Project price target based upon the structure of the chart is 156.

Chart continues to be BEARISH.


Dow Jones World PNF 1-box chart:



-chart made a great call turning bearish in June when price broke below 288

Chart continues to be BEARISH.


Dow Jones World 1 year daily line chart:



-chart turned bearish in early June when price broke below the 50 day moving average in combination with the red -DI line crossing 60 and the MACD crossing below zero.

Chart remains BEARISH.


As you know, I have been waiting for an opportunity to move back into equities at the right time to catch what I expect will be a strong bear market rally.

I have mentioned in the past that there has not been enough fear in the market to all that to happen. Now there is:

VIX Historical chart:



This chart is a historical view of the VIX; the Volatility Index published by the Chicago Board Options Exchange (CBOE). Here is the definition:

The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the 'investor fear gauge'.

There are three variations of volatility indexes: the VIX tracks the S&P 500, the VXN tracks the Nasdaq 100 and the VXD tracks the Dow Jones Industrial Average.

The first VIX, introduced by the CBOE in 1993, was a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors' expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

One of the better ways to make money on the long side of the market is when everyone is fearful. This contrarian way of investing is based upon the simple premise that when everyone is bullish they are already in the market (pushing price up) and therefore there is no "new money" sitting on the sidelines to propel price higher. When everyone is scared and bearish, that means they out of the markets (pushing price down) and a lot of money is sitting on the sidelines waiting to re-enter.

I monitor the VIX to determine the degree of fear in the markets. A reading >30 usually indicates sufficient fear in the markets to enter a long trade. However, if you really want to catch a bottom you need the VIX to get up into the red box I have outlined on the chart.

Note that on Friday the VIX hit an intraday high of 48.40 and closed at 45.14. The only 2 times it has hit these levels was in late 1998 (associated with the collapse of Long Term Capital Management (a U.S. based hedge fund that collapsed and just about took down the world’s economy with it) and July, 2002 (which marked the end of the bear market from 2000). Both were excellent buying opportunities.

Normally I would be going 100% long based on this but I know there is bound to be some distortion of the VIX due to the ban on short selling that is currently in place.

Having said that, my finger is on the "buy" button and I will be buying as soon as my short term charts indicate it is safe to enter the markets.

Based on the readings on the VIX, we are very, very close.


Currencies:

As I said in the opening, the only bull market of late has been the USD.

It has been on a rocket ride north that has taken everyone (including me) by surprise.

USD daily 6 month chart:



The USD shot out of its previous trading range like a cannon. From its breakout level of 74 it move to 80 (8.1%) at a unbelievable rate of change.

I said at the time it was overbought and due for a correction; that occurred at another stunning rate with a drop from 80 to 75 in 6 trading days (a 6% decline) ending with a bounce off the 50 day moving average. Since then it has gone from 75 to 81 in 9 trading days (8% move).

Unbelievable volatility.

USD daily 10 year chart:



The key to note is on this longer term daily chart the previous resistance at 80.39 has now been broken (the USD closed Friday @ 80.47). The re-test of the broken trend line that I said I expected has occurred. The RSI is no longer in overbought territory.

That is BULLISH for the USD short term.

USD weekly 3 year chart:



The 13 week moving average has crossed above the 34 week moving average in combination with the MACD above zero.

This longer term view of the USD is BULLISH.

USD Monthly 10 year chart:



At the end of August price closed above the 12 month moving average. The previous resistance level at 80.39 is clear on the chart and has been broken to the upside.

The long term view of the USD looks BULLISH.


Euro weekly 3 year chart:



The 13 week moving average crossed below the 34 week moving average 4 weeks ago confirming the MACD cross which occurred earlier.

The Euro is BEARISH.

Euro monthly 10 year chart:



At the end of August price closed below the 12 month moving average, signally a new bear market in the Euro.

This chart remains BEARISH.


Australian dollar weekly 3 year chart:



The 13 week moving average has crossed below the 34 week moving average confirming the MACD cross.

The Australian dollar is BEARISH.

Australian dollar monthly 10 year chart:



In August the Australian dollar closed below its 12 month moving average signaling a new bear market.

This chart remains BEARISH.


Based upon the previous longer term signals in the Aussie and Euro, I have been watching for a USD correction to moving out of the Aussie and Euro and into the USD.

While I expected a short term decline in the USD, I did not expect the retrace and subsequent renewal of the USD uptrend to be so violent. As such, it has caught me (and everyone else) somewhat off guard.

A price break above 80.39 was my "line in the sand" and it has been broken to the upside. It appears technically that the USD has started a medium to long term uptrend that should last some time.

Based upon the above, I switched my Euro and Australian dollar funds into the BlackRock/MLIM USD cash account as of Friday. I do have some hesitation in doing so (due to the money market fund having credit default swap exposure) but I am counting on the $700 billion bailout to reduce the risks associated with money market funds holding mortgage backed securities in their accounts.


Bond Fund:

Fidelity International Bond Fund 5 year chart:



This has been a real disappointment. Fundamentally the premise behind investing in an international bond funds is sound (based upon the assumption that as countries around the world go into recession you will see coordinated interest rate cuts worldwide along with bond price increases).

The problem (as I mentioned in a previous blog) is because the Fidelity Bond Fund is unhedged it is exposed to "other currencies" that depreciate within the portfolio (so any gains in foreign bond prices is offset by foreign currency depreciation). There are bond funds that hedge the currency exposure but we do not have access to them in our provident fund.

To illustrate my point, ponder the following:

-the Fidelity International Bond fund peaked 17 Mar 2008 @ 1.266
-the USD bottomed the same day (17 Mar) @ 70.70
-the 10 year US treasury bond peaked the same day (17 Mar) @ 121.81

Since that date (17 Mar 2008):

-the U.S. treasury bond has fallen by 4.77% (as have other countries bond prices), yet
-the Fidelity International Bond fund has fallen 13.9%, and
-the USD has risen by 13.82%

As can be seen, while I have only shown the U.S. 10 year bond, the bond fund has fallen dramatically not due to the bonds it holds but due to the strength of the USD.

This fund does best when stock markets are weak and the USD is weak. It does poorly when stock markets are weak and the USD is strong (as is the case currently).

I will hold this fund for another week to assess what happens. My moving into the USD has hedged my position to essentially neutral. The last line of support I have clearly drawn on the chart. If this is broken to the downside I will exit my bond position.


Bottom Line:

-I am looking for an equity price bottom to occur very soon (in fact, it could have been Friday) based upon the VIX.

-The USD has shown unbelievable strength and appears to have started a long term uptrend.

Based upon the above, as of Friday I have switched my cash position into USD and out of the Euro and the Australian dollar.


As of today, my "strategic" positions are as follows:

-50% BlackRock/MLIM US Dollar Cash Fund*
-50% Fidelity International Bond Fund*

*(actual positions: cash 45.10%, bonds 45.55%, equities 9.35%)

*percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).


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