Monday, June 22, 2009

Alternate Elliott Wave Possibility...

While Elliott Wave is admittedly NOT my strong hand, Yves Lamoureux has written an interesting article that offers a different bear market count from those I’ve seen and been working with.

McHugh is labeling the rally off the 666 low as wave B up (the eye of the storm) with wave A having finished at that low in March. He believes that wave C will follow and that it will be devastating. I agree completely with that sentiment but am not certain of the count, not that it matters much in the short term, but in the longer term it will matter, so let’s take a look...

Speaking of the short term, this trumped up rally has been very difficult to count on the way up – almost unnatural, because that’s exactly what it was. But the recent decline that began on June 11th is very easy to count… you can see in the 10 minute SPX chart below that we had 5 clean waves down in a neat channel (wave 1), we broke that channel up with a smaller corrective channel (wave 2), and we have now begun wave 3:

That’s the short term…

Now going to the long term, I’ll let you read Yves’ thoughts and pay attention to how he has his long term chart labeled…

Yves on the Greenshoot-Fed Sacred Fed Bull Died Fat and Happy

Or, how wave 4 is rolling over…

The obvious sometimes stands clearly. You face it and prepare for the outcome. We stand at a juncture that would have you believe in the coming outcome. But wait - lets take a quick journey into what seems to dominate my observations and you can determine the best course of action for yourself.

We have continually watched monetary aggregates and they are contracting. You will notice from the M2 chart divided by the monetary base a drop. This is significant and comparable to the 1930’s. The complaint would be the same as to banks sitting on a monstruous pile of cash but not lending it. The tradional behavior of the consumer to start saving instead of buying also compounds this problem. M2 decceleration cannot lead to inflation. The Fed cannot force the banks to lend and monetizing bonds will continue to aggravate the only asset that people have en masse their household. An inflationary outcome is tantamount to financial hara kiri. The bonds vigilante will strike hard and mortgages will keep rising, killing any stabilization that is in process. The impact of the recent rates hike will be felt in the stock market in the next few months.

Given the choice to protect housing or stocks, the Fed will surely realise to go the real estate way. A liquidity trap as such is deflationary. The money base also doubled in Japan after the stock bubble collapsed and to no avail the economy kept contracting.

Are bonds finishing the C wave or are they in complete fast and furious 3rd wave? This is the question we did pose in the article May 2nd. If the Fed gets it, they stop buying and monetizing the debt then it is a C wave.

On the next graph, the spread of the discount rate to the rate of the long Treasury has never been so wide. If you had bought on a few occasions where the spread was wide as 4% between both, the resulting trade would be a winning one on most occasions.

Unless you are suggesting the Fed raises rates by about 2% over the next 24 months then buying treasuries would not be a great investment. On the other hand if you believe that there is little room for the Fed to move, then long bonds are an even better bet. There is a fine line that the Fed is walking and a slight tilt of strategy can undo with great damage what they have built so far. Mild deflation is the preferred outcome and necessary one.

We have sold all of our inflation hedges that we owned for the last 2 months. We are turning to deflation trades or unwind. Possibly the greatest misunderstanding in the lift off of all markets singularly correlated is a function of investment demand and not real changes from supply/demand. Realise that all markets cannot possibly beat to the same rhythm for a prolonged time. Those correlations will unwind and support real bull market where there is cause for that.

We have held for a while our position of a rare 4th wave at this juncture. The last move up does look impulsive but is part of an ABC ABC 12345 pattern. The pattern still holds to the rules established. The implication is for a 5th finishing wave that will complete a bigger A wave down. The general area of the March low is the objective. It could be truncated or extended. I will be looking for an equivalent 3 standard deviation in sentiment measures to call the bottom if that was to occur. We are looking to short the market on the wave 2 of 5 and not before since window dressing could still be part of present activity.

The bull market ate too many greenshoots and died of natural causes. Often bull markets roll over from their own weight.

Yves Lamoureux, Investment Advisor, Blackmont Capital Inc.

The opinions contained in this report are those of the author and are not necessarily those of Blackmont Capital Inc.. Every effort has been made to ensure that the contents of this document have been compiled or derived from sources believed to be reliable and contains information and opinions which are accurate and complete. However, neither the author nor BCI makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use of or reliance on this report or its contents. BCI is an independently owned subsidiary of CI Financial. CI Financial is a Canadian owned diversified wealth management firm, publicly traded on the TSX under the symbol CIX. Blackmont Capital Inc. is a member of CIPF and IIROC.

While I completely agree with Yves’ fundamental and psychological analysis (he specializes in market psychology), I explained to Yves that I was not sure of the count he was using as his wave B has a much lower low than his wave A… he explained that a similar event happened in Japan when the Nikkei collapsed and that, “Wave B going lower than wave A is a necessary part of the psychology to get even more shorting from bearish participants to wipe them out on the subsequent C rally. It also confirms to the main crowd to not sell in the drop as we have just evidenced super strong rally (the market always come back strong psychosis). You then get most bullish people to not sell in the next drop (because they have learned the lesson to stay still) and to most bearish players to second guest themselves or lick their wounds.”

In this way both the bears and the bulls are suckered into their own mass psychosis. The awakening will be particularly RUDE in my own opinion.

Yves believes that this recent rally was a part of wave 4, part of a running or expanded flat (a fairly rare formation). Here is a chart of what a running flat looks like in both a bull and bear market:

Here’s a good article by Thomas Bulkowski on Running Flats…

So, this is one possibility to be on the lookout for. Either McHugh’s count or the one presented by Yves will look the same initially. In the short run I believe we are at a minimum in wave b of a larger wave B. We won’t know which is the correct count until we look at it in hindsight, but for now the key level to watch is 880. A break beneath that level will put a larger correction on the table and we’ll look at the situation further if or when that occurs.

Thanks to Yves for sharing his work with us!

And as Yves points out, it is necessary to have enough people believe the worst is behind – Gotta love ‘em, like Alzheimer’s disease, the Economic Mass Psychosis numbs their little brains and leaves the market vulnerable to more declines – Hey, don’t stop believing!

Fleetwood Mac – Don’t Stop: