Weekly Wrap

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Last week, I listed signs that the manic bullishness which has driven stock (and junk bond) markets to all-time highs was running out of steam.

Yesterday’s market action has provided me with even more evidence that this is indeed the case – and that stocks are on their way to the cascade declines I have been anticipating for too many months (!).

There are several signs that social mood is changing – and it is social mood that drives the markets.  One such sign is the extreme punishment Israel is inflicting on the Gaza strip, which they continue to blockade.  This is an object lesson in what happens when a militarily superior nation bottles up a neighbouring people for long enough – they lash out wit the only weapon they have – rockets.  This ‘conflict’ is about as uneven as can be imagined.  It’s a nuclear power against a stone age tribe.

But for students of the markets,  the timing is noteworthy.  While social mood was on the up (along with markets), the Palestinians’ anger was contained.  But now with social mood on the decline, that anger has boiled over.

However, politics is not my beat, but there is another straw in the wind: Ukraine.  Just yesterday, it appears the EU is ready to impose draconian sanctions on Russia – no doubt fueled by the civil airliner disaster where many EU citizens were killed.  The talk earlier in the week was that Germany refused to consider sanctions because it would jeopardise its natural gas trade.  But that appears not to be the case.  A consensus for using a big stock is being reached.

AEP in the Telegraph has an analysis here and concludes that the balloon can go up at any time on the markets.  Next week’s action in the markets should be lively.

One more rather unusual omen is this year marks the 100th anniversary of the start of World War 1, and I have noted that the BBC  (radio and TV) has been falling over backwards to commemorate the event with week upon week of blanket coverage of music, drama and poetry from that period.  To my mind, this is really going over the top.  That war marked a new low in social mood.

With leverage in the markets sky-high, even a small degree of nervous selling will use that leverage and cause mighty big losses as margin calls explode.  We are seeing credit markets lead the way (see last week’s junk bond chart).

We are getting closer to the Deflationary Depression that is baked into the markets.

RUSSELL 2000

This is a highly-traded US stock market index and shows the EWs beautifully.  Here is the long-term chart:

The large pattern is an A-B-C with the C wave sporting a clean five wave impulsive pattern.  We have a potential double top at the early July high. But the key is to wait for a five waver down followed by an A-B-C correction.  And right on cue, here it is:

The five down is as textbook as you will find – likewise the three waver up (to the Fibonacci 38% level).  Also, my wave 5 also contains its own five sub-waves.  Not shown is the large pos mom div at the w5 low.  This is a very bearish setup.

Also note the neg mom div at the c wave high.  The whole pattern is absolutely perfect! But now, the moment of truth has arrived.  We could see a rally extension to the 50% or 62% levels before peeling away – that would not negate my bearish forecast.

But EU/Russia politics may take over on Monday and if the market can swiftly move below the w5 low, we would be in a large third wave down – and much lower prices beckon.

Either way, the setup is bearish.  I remain short the Dow and Russell 2000.

GOLD

Last week, I have two options for gold.  Either it would rally to complete the E wave, or the w4 was in place and the market would decline beneath support in a new w5.  But with yesterday’s flight into gold and away from risk, the first option appears to be on:

A solid break of my upper tramline yesterday has confirmed the A-B-C pattern and the market is off towards the pink targets.

I remain on the sidelines, looking for a low-risk entry (a tramline kiss, perhaps?).

GBP/EUR

The received wisdom is the the GBP is stronger than the EUR because of superior growth data and a likely early increase in interest rates.  But like all good stories, they turn out to be fairy tales.  Here is the long-term picture:

For over a year, the cross has been gaining by leaps and bounds in an A-B-C pattern.  But is the end of the road near?  The move during the past three months has been almost vertical with few set-backs.  This is a perfcet set-up for a reversal and I shall be looking for a sell signal next week.

USD/JPY

Last week saw a heavy flight to the US dollar, confirming we are in a massive third wave up in the dollar index (EUR/USD still continues to decline).  This has made the 101 support (see last week) even stronger:

This is a horizontal triangle – a classic chart pattern.  If the upper line can be breached, that would set the seal on a resumption of the bull market that paused at the January high. A continued flight into the dollar (which I fully expect) will fire up this cross and the upside targets are huge – surpassing the January highs.

I have covered my short and looking to go long in a change of heart.

Have a great weekend!