Sunday, August 09, 2009

Stockmarket and USD update 10 August 2009

A somewhat lengthy update after this past weeks market action (click all charts to enlarge):

SPX 6 month daily:

All technical indicators on the daily trading chart are still bullish. The market is still overbought (as it was last week) and could pull back at any time.

The bearish wedge formation I spoke of in my last blog is still in place. This, combined with the overbought indications, is very indicative of a forthcoming short term pullback.

SPX 4 year weekly:

The second of my "holy grail" mid-to-long term charts turned bullish this week when the 13 week exponential moving average crossed above the 34 week exponential moving average. This is a very bullish development and has now officially changed my view of the markets from bearish to bullish.

It is now reasonable to expect price could rise to the 1200-1230 level on the SPX. This level is where the next strong volumetric resistance is located along with the 61.8% Fibonacci retrace level (as shown on the chart).

Price is still overbought on the weekly chart as indicated by the Full Stochastic >80. On a market correction we would not want to see this indicator drop below 50 to keep the bull market in effect (ie. stay between 50 and 80).

SPX 10 year monthly:

The 10 year chart once again shows the bullish crossover at the close of July. The MACD has yet to confirm; a crossover would be extra "insurance" the crossover was not a head fake.

USD 6 month daily:

The USD had a strong couple of days on Thur and Fri.

Price is still trapped in both the longer term downtrend channel (black) and shorter term downtrend channel (blue). Note both channels meet near the 80.25 level on Aug 18; price could rise to this level and still be in a technical downtrend. A price break above both those channels would be very bullish for the USD.

Given my expectation the SPX will decline soon in a short term pullback, this would support a short term rise in the USD given the inverse relationship that currently exists between the two.

USD 3 year weekly:

An important level was tested but not broken this week (the 61.8% Fibonacci level). A weekly close below this level (77.93) and it would reasonable to expect the USD to challenge the previous low at 70.70.

It needs to hold this level on any further pullback.

Random Thoughts:

While normally I would be very encouraged by the current bullish market signals on my weekly and monthly charts (and I am short term), I am bothered somewhat by the "road we took to get here" and where we are going.

What we are currently witnessing is an event that is not part of a normal "business cycle" but it is part of a normal "economic cycle".

Everyone keeps calling this a recession but it is not a recession. This is an economic credit collapse due to over-leverage in a capitalist based financial system that cyclically occurs once every 80 years or so in modern times (as opposed to business cycle recessions that occur cyclically once every 4 years or so). The name for this is an economic depression.

The last 2 economic collapses of this magnitude were in the in the 1850's and 1930's. In both cases it took many years before a final bottom was found and during those times prices fell 80-90% from peak to trough. Specifically in the 1930 collapse (the "Great Depression") the stock market bottom was found in 1933 (a 4 year decline) yet the economic depression (based upon measures of GDP and domestic economic expansion) did not end until 1942 (12 years from the beginning to the end). I think this is the situation we find ourselves in today.

It is true the U.S. has done everything in its power to prevent this event from coming to its natural conclusion. The problem I have with that is "the law of unintended consequences" applies in all things humans attempt to manipulate; and that includes economics. As we all know, when you attempt to manipulate Mother Nature you are always ultimately on the losing side of the battle. You may be able to manipulate weather, floods, genetics, etc in the short term, but ultimately Mother Nature wins out and "does what it does". I think the same applies with our current economic situation.

Literally trillions of dollars have been thrown at this economic problem and it has only put a dent in it. How many trillions more must they print in order to manipulate a natural economic cycle to get things turned around the way we would like to see them? And if so, what is the final outcome of the injection of those trillions upon trillions of dollars? What will be the "unintended consequences" of what Bernanke is currently trying to achieve?

I've always been a big believer in taking the pain when necessary. In today's world everyone loves "the punch bowl at the party" but nobody wants to have to deal with "the hangover". I don't believe the U.S. is doing the right thing in trying to manipulate an 80 year economic cycle through the experimental printing of unlimited quantities of U.S. dollars.

We know how to live through great depressions; we've done it in the past. We know that once the capitalist economic system purges itself of all the excesses it returns in the next cycle invigorated and alive. What we are going to be left with at the end of this mad experiment currently underway in the U.S. is a very bothering question to me, both economically and socially.

From the outside looking in, it feels like the U.S. is being socially "torn apart" given the current socio-economic imbalances in the system. The gap between the "Haves" and the "Have Not's" has never been more pronounced. In the 1950's, 1960's, and 1970's the CEO of a company traditionally made a maximum salary 100x that of his or her employees average wage. Over time the gap has increased and the multi-million dollar salary and bonus became the norm.

Note this is a recent event and is all part of the excesses that have built up over the past 80 years with the "Haves" owning more and more, the "Have Not's" owning less and less, and the "Middle Class" being economically stretched to the limit in a futile attempt to pretend to be like the "Haves" (only achievable through both spouses working full time and the taking on of excess mortgage debt, car loans, and credit card debt). There comes a breaking point and it will be interesting to see how it develops over the next 2-3 years.

The U.S. government and Bernanke are trying their best to keep the status quo for the benefit of Wall Street and the "Haves"; I get the impression the "Middle Class" and the "Have-Not's" have had enough. I would expect more and more public protests (both peaceful and violent) and a marked increase in theft, murders and violent crimes in the U.S. associated with this economic event.

Economically I am afraid many are too complacent when assessing the dangers associated with the current situation we face and how we are going to get ourselves out of it. We are in uncharted waters with Captain Bernanke at the helm and I question to what extent the markets (including the use of technical analysis) are able to digest current economic conditions and rationally input future risk in the current pricing of equities.

The markets were severely oversold going into March, 2009 and the entire rise from that point has been due to the financial stimulus the U.S. government has injected into the system. There is very little fundamentally to like about the economy, employment or corporate profits at this point.

I think the markets may have gotten ahead of themselves given the dangers that currently remain in the system and I am of the opinion we have yet to reach the bottom in either the stock market or the economy.

My stock market view is based partly upon economic history and the study of cycles, and partly upon Elliott Wave.

Elliott Wave Theory:

I am not going to go into the specifics of Elliott Wave because for most subscribers it would make your eyes glassy. Instead I have included a Wikipedia link for those who might want to learn more on the subect:

Ralph Nelson Elliott was an accountant who developed the Elliott Wave Theory in the late 1920s. He discovering that stock markets, thought to behave in a somewhat chaotic manner, in fact traded in repetitive cycles.

Elliott discovered that these market cycles resulted from investors' reactions to outside influences, or predominant psychology of the masses at the time. He was one of he first to develop the idea that "crowd psychology" had a great influence on the direction of the markets.

He found that the upward and downward swings of the mass psychology always showed up in the same repetitive patterns, which were then divided further into patterns he termed "waves".

Elliott wave theory has it's benefits but is more useful as a "road map" rather than as a specific trading tool.

Have a look at the monthly chart of S & P 500 Index over the past 10 years:

SPX 10 year monthly with Elliott Wave:

It is possible what we are currently experiencing is an A-B-C decline from a primary bull market rally that ended in Oct, 2007. If this is the case, wave A completed in March, 2009 at the 666 low and consisted of 910 points.

Using Elliott wave theory, wave B should retrace 50% to 61.8% of wave A (Fibonacci retracements are shown on the chart). This would equate to a rally of 455 to 562 points to complete wave B (wave B target would then equal 1121-1228). At this point, the wave C decline should begin.

If this count is correct, wave C is ususally the same length as wave A. Given that, the target for wave C (once wave B is confirmed completed and we have begun the next decline) can be calculated as follows:

-wave A = 910 points therefore wave C should = 910 points
-if wave B tops at the 50% retrace level (1121), wave C target would = 211
-if wave B tops at the 61.8% retrace level (1228), wave C target would = 318

This is the pattern that was followed during the stock market crash of 1929-1933.

During the 1929 crash the Dow Jones Industrial Average fell from 386 to 195 (191 points and 50%) before rallying in early 1930 to 297 (95 points and 52%).

Then it rolled over and declined for a further 3 years (to July 1932) for a bottom at 40.56; 89.5% from the top and 86% from the perceived top in April, 1930 when most market participants were calling the "recession" over and the start of the new bull market.

Green shoots anyone??????

Take a very close look at this chart (click to enlarge):

Dow Jones Industrial Average 1929-1933:

Are "We" currently at the equivilant of 297.25? Are we at the top of wave B and is wave C on its way soon? History does not repeat but many times it does rhyme.

I think it would be unwise to discredit the notion we could decline a further 80+% from our current levels given the historical declines we experienced the last time we were in an economic depression.

Bottom Line:

The weekly chart issued a bullish signal based upon the 13/34 exponential moving average cross. Now both the monthly and weekly charts are on a long term bullish signal.

The shorter term daily chart is still bullish but overbought. I am now "officially" bullish but am waiting for a pullback in the daily chart to initiate long positions in the provident fund.

My initial position will be a 50% equity/50% cash position strictly due to the fact we are on the verge of entering the Sept/Oct period (which is traditionally the 2 weakest months of the year as I've shown previous).

It is sensible to believe price will retrace somewhat during this Sept-Oct period. The nature of any such decline will tell me whether my worries about the economy (as discussed above) are overblown and we are at the beginning of a new bull market or whether we are on the verge of the next collapse. In other words, I will be hedging my bets by only being 50% in equities until the economic road ahead is clearer.

I expect the view ahead will be clearer by November and will allow for a better entry of the remaining 50% of my provident fund portfolio at a lower level if all looks well. Alternately, if we do top out here and head down my exposure is limited and I will look to exit back to cash should my mid to long term charts return to bearish.

We are at a very dangerous point in the markets. This could go either way from here into the late fall.

Risk adverse subscribers who have shadowed my moves would be wise to wait in cash until past the Sept-Oct period to commit funds into equities.

Those who are more risk tolerant may want to move in line with my upcoming positions (50% on a short term pullback and 50% later into the fall when I see how the market behaves in Sept/Oct).

I am still holding current positions as of today (approx 16% equities and 84% USD cash). I will immediately blog any changes I make.

**Strategic allocated 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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