The stock markets are once again close to major topping levels - indeed, now more than before. While the rally has been able to carry on longer, that's only in a few bigger-cap, more widely followed indices like the Dow Jones Industrial Average, as it tagged its 50% retracement to its 2007 high. Meanwhile, the market internals and technical backdrop have continued to deteriorate. Elliott Wave analysis is a way to measure the patterns the markets make as they go up and down. We primarily reference the work of Tony Caldaro in his Objective Elliott Wave methods - and here's his weekend update from his Objective Elliott Wave site (links here and below, and always at right). It's very tempting to say that any new high perhaps in the next few days will finish the "B" wave top we've been looking for - admittedly for a while now. We do think that a "B" wave high already has been completed in some indices and sectors, like the Russell 2000, the banks (KBE and KRE) and financials (XLF) - so the Dow and S&P 500 may indeed be on their last legs for their own "B" wave tops. But I don't want to speak for Tony ... And this weekend, Tony has some interesting financial discussion about the inflation-versus-deflation context, too. Let's see what he's saying in his weekend update:
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the ELLIOTT WAVE lives on
Market analysis using proprietary Objective Elliott Wave techniques
by Tony Caldaro
November 14
weekend update
REVIEW
Economic reports for the week were sparse and mostly on the downside: jobless claims dipped but remained over 500K, the trade deficit widened, import prices rose and consumer sentiment dropped. The key factor of the week, however, was the non-event meeting by the G-20 last weekend. When Forex traders did not hear any concern about the decline in the USD, they immediately sold it starting sunday night into monday, and took it to new lows for the downtrend on wednesday. As a result the stock market had a strong rally on monday (+2.2%), extending the uptrend, and made new uptrend highs on wednesday. Then the SPX ended the week exactly where it had closed on monday. For the week the SPX/DOW were +2.4%, and the NDX/NAZ were +3.0%. Asian markets rose 2.2%, Europe gained 2.7%, and the Commodity equity markets rose 3.0%. Bonds gained 0.5%, Crude dipped 0.5%, Gold made new all time highs +2.2%, and the USD dropped 0.7%.
LONG TERM: bear market rally
Lets's review. The bear market started in Oct 07 at SPX 1576. OEW turned bearish in early Jan 08. The stock market then declined for 17 months until Mar 09 and SPX 667. At this point we recognized a completed wave pattern from the bull market high. We then projected, based upon historical references, a 50% bear market retracement rally to SPX 1122. We did not believe the bear market was over, only the first wave. Cyclical bear markets unfold in three Primary waves: ABC. We labeled the SPX 667 low Primary wave A, and expected a counter-trend bear market rally for Primary wave B. When Primary wave B completes, a downward Primary wave C will follow. Historically, bear markets of this degree can last anywhere from 23 months to 60 months. Since Mar 09 we observed three potential areas where the Primary B rally could have failed: Jun SPX 956, Aug SPX 1041 and Oct SPX 1101. Each time the market pulled back, or corrected, and then resumed the counter-trend advance. This week the DOW, which had been lagging, hit the projected 50% retracement level. Throughout this entire Primary wave B, OEW has only been in a confirmed medium term downtrend for about one month. The other seven months it has been in the uptrend mode. We have labeled these trend reversals as Major wave A SPX 956, Major B SPX 869, and Major C SPX 1105 thus far. This Major wave ABC pattern, when completed should end Primary wave B.
We all are well aware that this is not the typical bear market. The bear markets we are accustomed to are inventory demand related, the result of inflationary pressures or currency crises. This bear market was created by a credit contraction of historical proportions. While credit has been contracting in the private sector. The US government (public sector) has committed $23.7 tln in cash infusions, loan guarantees, debt swaps and debt monetization. Considering that the entire US GDP is only about $15 tln, this is a massive monetary intervention. In addition, the US government is running unheard of budget deficits, the FED is debasing the USD through it's monetization program, while Congress is trying to push through huge programs like Health Care Reform and a Climate Change bill. While all this is occurring the unfunded future liabilities of Medicare and Social Security go unaddressed. Naturally, most of you have heard all of this before. Yet, the question remains, what's driving this stock market higher? Simply put, the decline in the USD and record low interest rates.
Every day we report the results in trading for stocks, bonds, crude oil, gold and the USD. We will attempt to make sense of what's transpiring using these five asset classes plus another factor, inflation. A credit contraction leads to deflation. We see this specifically in real estate, resulting in bank failures, rising unemployment and a contraction in demand from highly elevated levels. In response the government, treasury and the central bank have tried to re-inflate the economy with the previously noted actions. The result of committing funds equal to 1.5 times the GDP has had a stabilizing effect in the near term. Long term, however, there is still a problem for this economy, namely the potential for inflation.
Typically when a currency declines, and/or debt is monetized, imports become more expensive and the end result is inflationary. With the overriding trend in the US deflationary, and China's currency the Yuan pegged to the USD, its largest trading trading partner, the potential for inflation has been stable. This allows the US to maintain record low interest rates in an attempt to allow time for the economy to heal itself. The result of low inflation, low interest rates, a declining USD and an expansive monetary policy, is a rising stock market, and rising prices for Crude and Gold. Excess dollars, created by the FED, are flowing into the stock and bond markets. While Gold and Crude are rising inversely to the decline in the value of the USD. If the FED has the luxury of maintaining this posture for a few years, which is probably its intention, while the deflationary cycle runs its course. Then when credit has stabilized and starts to expand again, the deflationary pressures will ease, and the expansive monetary policy can be begin to unwind. This is the best case scenario.
The problem with this scenario is that it requires a fine balancing act between deflationary pressures and re-inflationary intervention. Many things can go wrong. For example on the currency front. If the USD drops too fast, or breaks to all time new lows, the FED will have to act. The last time they did act was in mid 2008. The FED created a $600 bln currency swap to strengthen the USD. The end result was a crash in the stock market and commodity markets. CPI inflation, at the time, was running over 5%, and PPI inflation had hit 9%. If China decides to allow its currency to float more freely, which was announced this week, inflationary pressures will again start to rise in the US: http://www.reuters.com/article/usDollarRpt/idUSSHA20591820091112.
With $437 trillion in interest rate derivatives worldwide, anticipating years of low interest rates, the FED will not be able to raise interest rates, and again have to respond by supporting the USD. This would not be good for stocks or commodities. If the economy rebounds too strongly and pent up demand, with plenty of excess dollars, this starts to drive up prices due to limited product supply. Inflation will become a factor again. Inflation, as they say, is the canary in the coal mine. For now, with the USD declining expect the Stock market, Crude oil and Gold to be generally rising, and Bonds to be generally steady. When inflation kicks in again, and it will, the FED will need to respond, and its options are limited.
MEDIUM TERM: uptrend makes new highs
The OEW uptrend that started in July at SPX 869 extended again this week as the SPX hit 1105. The short term wave pattern within the uptrend is becoming quite complex, as compared to the previous uptrend from Mar-June. Twice during this uptrend a potential completed pattern appeared, and twice the market pulled back for a few days and then turned higher. The USD, btw, has been in a steady downtrend since April. We continue to count this uptrend as a series of overlapping smaller waves which is corrective in nature. After the initial 149 point surge from the downtrend low at SPX 869 in July. The SPX has displayed a series of smaller rising waves: 60 points, 88 points, 81 points and recently 76 points. Our wave labeling for Major wave C remains the same: Int. wave A SPX 1039, Int. wave B SPX 992 and Int. wave C underway. The fibonacci relationships noted over the past several weeks are still relevant. During Major wave A SPX 667-956, Int. wave C = 0.618 Int. A. During our current uptrend, Major wave C SPX 869-1105, Int. C equalled 0.618 Int. A at SPX 1097.
Also the long term OEW pivots are still in play. During this entire bear market every uptrend has stopped at a long term OEW pivot. The current OEW pivot at 1107 has provided significant resistance during the October rally and now the November rally. Should this pivot be broken to the upside, the next long term pivot is at SPX 1179. We continue to observe negative divergences on the daily and weekly charts, plus a negative divergence in market breadth. Despite the recent rally in the US to new uptrend highs, only the uptrending sectors made new highs, and the downtrending sectors (HGX, KBE, KRE, R2K, SOX, TRAN, XLF and XLU) remained in downtrends. Also of note, the seven foreign indices we follow also remained in downtrends: ASX, BSE, DAX, EUR50, IBEX, NIKK and TSX. There certainly appears to be less participation during this recent rally.
SHORT TERM: Support for the SPX is at 1090 and then 1061, with resistance at 1107 and then 1133. Short term momentum was oversold on friday's lows, then turned higher to end the day around neutral. This rally from the Nov 2nd SPX 1029 low appears to be another impulsive five wave structure. These types of short term structures have occurred since Primary wave B began. The problem is that these short term five wave structures have often overlapped into ABC's during both of the uptrends. Or else we'd be in an OEW bull market. We are, however, in a relative bull market as a 50% retracement has occurred in the DOW, and nearly the SPX. The current rally is being counted as: wave 1 SPX 1061, wave 2 SPX 1045, wave 3 SPX 1105, and wave 4 currently 1085.
Wave 4 may become a bit more complex as we noticed some weakness on friday afternoon. Wave 5 during these five wave rallies have been quite weak. Expecting the pivot at SPX 1107 to hold. The USD may be forming a diagonal triangle fifth wave. It's action of late has been quite choppy. Also, continue to observe the Canadian dollar. It moves with the SPX. Best to your trading!
FOREIGN MARKETS: The European markets were +2.7% for the week but continue to display a mixed picture. The DAX, EURO50 and IBEX remain in downtrends.
The Asian markets were +2.2%, and again a mixed picture with the ASX, BSE and NIKK in downtrends.
The Commodity equity markets were +3.0%, only the TSX is downtrending, with the BVSP and RTSI still in uptrends.
COMMODITIES:Bonds gained 0.5% on the week despite another huge bond auction. 10YR rates remain in an uptrend unconfirmed by bond prices.
Crude lost 0.5% for the week in a volatile session. Up strongly on monday, then down even more so on thursday. Crude is still in an uptrend.
Gold made new highs +2.2% for the week. Gold has been extending its uptrend while Silver has been going sideways. Worth watching this relationship.
The USD (-0.7%) made new downtrend lows this week. The EUR (+0.4%) and the JPY (+0.3%) gained against the USD. A potential fifth wave diagonal triangle may be forming in the USD, while the EURUSD failed to confirm the USD low.
NEXT WEEK
Busy week ahead. Monday kicks it off with Retail sales and the Empire index at 8:30, then Inventories at 10:00. On tuesday we have the PPI (worth noting), Industrial production and the Home builders index. Wednesday follows with the CPI and Housing starts. Then on thursday we end with the Jobless claims, Leading indicators and Philly FED. The FED has two scheduled speeches both on monday. First FED chairman Bernanke in NYC at 12:15, then FED vice chairman Kohn in ILL. at 6:15. Technicals and economics come into play this week. Best to you and yours!
CHARTS: http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID1606987
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