December 8, 2011
The imminent cataclysmto make or break investors
A Bear Market impliesat least a“double-dip”
Since the market is a fractal, the pattern of the whole is echoed in its parts.The same patterns recur at every degree of trend with only slight variations, from the 1-min chart to the multi-yearly chart. Below is the 10-min chart for DRV, which traced out an “expanded” simple a-b-c correction between January 5th and 7th, framed by the yellow box. As you see the bwavewhich only lasted 2 ½ hours, made a new high, despite being part of a correction.On a weekly or a monthly chart this is what’s known as a Bear Market Rally. What’s more, each sub-wave a-b-a, a-b-b& a-b-cechoes the larger a-b-cBear Market Rallystructure. In the market, we are analogously at the bto the right in the orange boxat Supercycle degree,as you see this is a “sucker’s rally” all over again.While the cwave troughin this wave iiwas rather shallow, the wave iv trough, which closely parallels the greater Market,is most similar to the bin the aqua box at the far right below. It will drop off this chart entirely, to a minimum low of 17.3. In the same manner, the S&P will drop ~80%from its current level. (Supercycle degreeBear Marketsplunge~90% from the high).The crux of the matter is that bwaves are “sucker’s rallies” because small investors always fall for b waves and usually get fully invested right at the top.In fact no Bear Market would be complete without this phenomenon. Below you will see to the extent to which “individual investors” are dependablyfully-invested.At Supercycle degreeeven supposedly “sophisticated” investors fall victims of their own tunnel vision to remain fully invested.
Therefore, a Bear Market is no more than a “correction” on a weekly or higher degree chart, where each candle represents a week, a month or a year. (so that you can see the entire pattern).That same chart would only include three days on a chart of 10-min intervals, as you saw above. A daily chart will show a PrimaryBear Market usually lasting less than a year, while a weekly chart will show a CycleBear Market lasting between 7-15 years and a monthly chart is required to show a SupercycleBear Market, lasting at least 20 years.The simplest correction is an a-b-c, where waves ac are collapses and waveb is a Bear Market Rally, therefore a simple Bear Marketimplies at least a double-dip, while a complex Bear Market can contain three or four dips, depending on how they are classified in terms of severity as did the Cycle wave IV Bear Market from 1964-1977.(see chart below)
The problem is in that those responsible for identifying and classifying Bear Markets have a“one-size fits all” approach, and dice Bear Markets up into bite-size “recessions” and so miss the forest for the trees.We must learn instead to think of Bear Markets according to their degree of severity as we do with Earthquakes, and complexity, knowing that they alternate between simple and complex at the same degree of trend. Simplistically there are three degrees of Bear Market that concern us: Supercycle,CyclePrimary degrees, which correspond to Papa Bear, Mama Bear and Baby Bear, if you will.We are in a “Papa Bear”,Supercyclewave (IV) Bear Market, a simple structure, which alternates with a complex Supercycle wave (II), the period between 1909-1932, where only 1930-1932 the “ouch years” are recognized as the entire Bear Market.It cannot last less than 20 years, andcould last quite a bit more than an additional ten years.In effect the possibility of a recovery now is figment of our Megalomaniac Fed Chairman’s imagination and absolutely ludicrous. To sum up degrees: within a Supercycle Wave (III), which began at the completion of Supercycle Wave (II) in 1932, there were two CycleBear Markets, at waves IIIV, and within CycleWave IIIthere are two PrimaryBear Markets again at waves 24. While we would expect CycleWaves IVto also contain two PrimaryBear Markets, they do not. They are transitions instead from higher to lower degree and vice-versa.Contrary to current practice of labeling every fifth waveas being synonymous with the next higher degree is in error. For example, rather thanCycleWave V,it is a transition to Supercycle Wave (III). Likewise, CycleWave Iis a transition from SupercycletoCycle degreeand so even when it’s the longest of waves 1,3 and 5 it will not contain Primary degreewaves.
Irrational Exuberance heralds a Market Plunge
Although heightened “tail risks”, has entered into investors’ lexicon to mean the outliers on a bell-shaped distribution, for which no measures of risk are currently available, it has failed to change investor behavior. What Mandelbrot termed “Noah effects”, to indicate a catastrophic event akin to the great flood,which either makes or breaks investors, as opposed to the typical “Joseph effects” of seven bountiful years, followed by seven lean years to which investor are accustomed. Theycontinue line up like sheep for the slaughter.
Anytime everyone is thinking and doing the same in the Market, it is precisely the wrong thing to do - a “crowded trade”.Conventional Wall Street Wisdomwould counsel “there arealwaysbetter fish to fry”. Yetnearly everyone agrees that stocks will be going up in 2011. While investment newsletters were at their most bullish since the October 2007 market top at Christmastime, bullishness has dropped off only slightly since, according to Investor’s Intelligencesurvey of 100 Newsletters. What’s more, the overwhelming bullish sentiment is back to levels that herald a major “correction”. When investor sentiment is this extreme in either direction, it often marks the Market’s turn within days. Institutional Investors are not any smarter than the “dumb money”,asmeasured by the American Association of Individual Investors. The four-week rolling average of put-to-call options is at their lowest ratio since April, just before equities plunged.This would indicate few “sophisticated investors”fear a plunge and are willing to buy protection through puts. Equities are overbought and US Treasury bonds oversold. Meanwhile, the VIX has dropped to levels last seen before the “credit crunch” hit, once again presaging a brutal storm with excessive calm. Finally, the premium demanded by investors to buy junk bonds over Treasuries is the lowest since November 2007. All this suggests an imminent dramatic and violent reversal threatens.
Risk on/Risk off reflects Supercycle Bear Market
Risk on/ Risk off has been dominating the way the Market behaves since the Lehman’s collapse in 2008. One week the “global recovery trade”looks rosy and risk is on in all risk assets and all markets, the next it reverses into “fear of a double dip”and risk is off as the crowd piles into safe havens. These movements are characteristic a time of crisis and no time of crisis is greater than a Supercycle degree “PapaBear” Market. Since assets are all highly correlated,with the exception of dollars, inverse equity funds, and temporarily gold, there are no longer diversification benefits, all assets, move in lock-step. That’s why we evolved to a simpler, more judicious,“crash” allocation to trade against the “global recovery trade”,as all risk assets will crash in tandem, while our portfolios will Spike up in the “Noah effect”of a Millennium.
Manufacturers Recovery “Hopes” are just that
Although manufacturing sector grew in December, the news cited it was up for “the 17th straight month in a row”, raising hopes of that recovery is gathering pace. However, that is neither accurate, nor does not tell whole story. When you look at the chart below,you can see that the US Institute for Supply Management’s index peakedslightly above 60 earlier in March 2010, and has since reversed and started down in wave c. Wave cis a 5-wave decline, of which wavesii & ivare “upside corrections”. Once wave ii completes, the “point of recognition”likely below 50 in wave iii follows. “Fifty”(50) on the y axis demarcates between economic growth and contraction.What’s more, the index,which edged up just 0.4 points to 57in December,overstated growth over the past year since it is a“big company” survey, and its small companies that are squeezed for credit.Despite the uptick these big companies are not fooled by a “recovery trade”, they are not hiring. By now you know that a Bear Market is no more than a “correction” on a weekly chart or larger, and every Bear Market contains at least one “sucker’s rally” sandwiched between two collapses.Therefore, every Bear Market is at least a double-dipand a Supercycle“recession” equates to a full-blown Depression! Below you see how this sucker’s rally is global, although not shown, the Chinese PMI looks very similar.
Meanwhile, the lack of action to tackle deficits US deficits raises fears of a dollar collapse, at the same time as the PIIGS pose a threat to the €uro and the European Union. The €uro 12**,ex-PIIGS,have made the most progress in reducing deficits through austerity programs, while the UK is on a solid deficit reduction course, although on a par with the PIIGS in terms of record-high deficits. Notice that all are above 160% of GNP! The result of these mindless Keynesian remedies put into action in attempts to reverse the natural flow of economic cycles into a contracting phase. The result has been to make matters far worse! Now there will be far less money to feed and house the millions who will be unemployed and homeless, world-wide. From the wave count this would seem to be a wave 4 correction in process, before deficits soar in wave 5.(the wave count is estimated for the US deficit/GNP with white dots at waves 1, 2 3, blue rings for projected waves 45.)
As Elliott reasoned, the wave principle is Nature’s Law. Most life cycles faithfully adhere to it, even our own; the only difference is there are far fewer “data points” gathered than in the market. The ISM survey above takes only a monthly reading of thisa-b-ccorrection, which started down in 2000. In wavea for example, there was no measurement taken between waves ii the end of a, since the entire plunge occurred in a single month. Once again, we are likely to bypass wavesiii iv altogether and plunge right to the depths to complete wavec.
Facebook valuation indicative of a major Market Top
There’s no way that Facebook is the next Google. Unlike Google, where a high portion of searches originate from the need for a commercial “product”, social networking is about “minding other people’s business”, with far less commercial appeal. It is highly unlikely therefore that Facebook can transmogrify a colossal “time waster” and cheap pastime for the unemployed into anything like Google’s high profit margins. Far fewer Facebook users are likely to be intent on “spending”, nor have the buying power that is currently ascribed to them. It is unlikely that those who waste hours on social networking have much less disposable income; otherwise they would have better uses of their time. It would seem that Facebook is a cheap entertainment, and the primary “pastime” and for the 10% of the population that’s unemployed.
Although Goldman Sachs’ analysts have valued the social networking site at $50bn, expected 2010 revenues of $2bn are all coming from the same sort of generic advertising that has not provided much profitability for more conventional media sites. That implies Facebook is worth more than Time Warner or Yahoo, and values each of its 500m users at $100 each. Mark Zuckerberg, the company’s 26-year old founder with a 24% stake, worth $12bn on paper would be wise to cash in some more shares at these prices. At 25 times revenues, Facebook’s current valuation is far ahead of other internet companies at this stage of development. Although Facebook attracts more “page views” than Google, they are not monetized at anywhere near the same rate. In effect, like the dotcom bubble of 2000, Facebook provides further evidence of a market top, with its “sky high” valuation and little chance of becoming a cash cow. Unless there’s a magic, it will be hard to justify its current valuation.
Fool of the Week
This week’s fool is Jan Hatzius, Chief US economist at Goldman Sachs who forecasts a rise of US GDP 5% for the 4thQ and 2.75% for all of 2011, well above published consensus. Mr. Hatzius,who cites the main reason for improvement in 2011 will be the slowdown in the pace of private sector deleveraging, is mistaking a small degree “upside”correction,as shown above,for the start of a new bull market. No one escapes the Market’s occasional “humbling”.
The Charts
The S&P is into upside overtime. A Diag II in the S&P 10-min below indicates the upside is limited by the start of the downside. A min retracement to at least 1271 is expected after this first drop completes, then the downside continues. Note the very clear 5 waves of both waves 3 & 5.
After threeDiag > in sequence the downside in bonds is over….an upside containing Diag > means its terminal, but can still go substantially higher, our first scale out is 52.
The Dollar is tracing out a second Diag > on the way up to at least 88. A small move down should reverse to reach 82.5 before reversing to complete wave iv of the Diag >.As you see fears of a dollar collapse in 2011 are borne out by this chart, once 88 hits, a drop to below 73 follows, although two Diag II’s indicate a lot lower trough for the dollar.
The VIX appears to be on a launching pad with excessive calm before a brutal storm.
DRV should have a small bounce on Monday allowing us to sell slightly higher at 18.54 before the drop to 17.3 to complete the Diag II.
Like DRV, EDZ should have a small bounce on Monday allowing us to sell slightly higher at 21 before the drop to complete the Diag II below 19.6.
In FAZ the trading is not likely worthwhile.We will just wait unless there is a spike to 9.4, in that case we sell the first scale on Monday, otherwise we hold for wave i above 9.45.
Best regards,
Eduardo Mirahyes