I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Thursday, December 31, 2009

A Further Step Back

I was taking a look at the Intermediate and Primary Degree Waves a few days ago (Just a Step Back) as a yearly wrap up. I want to take a moment and look the the Primary and Cycle Degree Waves in this post.

I performed detailed FA and TA of the macro picture and drivers for US equities in this recent post: The Long View. And like I said in it, it is only one possibility. From that post:

Even I don't put a 100% chance on the scenario I describe in this post. I am an engineer. I deal with probabilities, and conservative analysis. From a structural standpoint, you have to design for load cases. Load cases are determined from the design environment, but are also determined probabilistically based on past data. You might have an extremely high transient load case, but its chance of occurrence is 1 in 1000000000. But its impact if it does occur: catastrophic. So you must design for these cases. Then there are other load cases where the damage might be high but not catastrophic. You might used a 3-sigma environment for these.

My point is, as thermal analyst and structural analyst, I must be a good engineering risk manager. As a stock market analyst and investor, I view my role in *exactly* the same way. What are the possible outcomes? What are their likelihood and impacts? What are their overall risk profiles?

This is why I go to the trouble of all of this fundamental analysis from the macroeconomic perspective. I am trying to assess the likelihood for economic recovery vs. economic catastrophe. This is why determining what is real GDP growth vs. what is due to government intervention is critical. This is why money supply policy and growth is critical. This is why understanding sentiment and social mood is critical. etc.

My assessment would go something like this (keep in mind, this is just one analysts take):

1) The bottom was in on March 9, 2009 and this is the start of a multi-year bull market.
Odds of occurrence: very low.
Impact: high (being severely short a strong bull market would be detrimental to your portfolio)
Overall Risk Assessment: medium-low

2) Drift higher into the middle of next year and then start heading down
Odds of occurrence: medium-low
Impact: medium-low (I build enough cushion into my positions that I can afford to have them go against me up to a point)
Overall Risk Assessment: medium-low

3) Trade sideways / rangebound for the next several years into what amounts to be a Cycle-Degree X-Wave
Odds of occurrence: medium
Impact: low (If we are range bound for years, there will be opportunities to exit shorts and to go long to play the range)
Overall Risk Assessment: medium-low

4) The count I show in this post plays out (Primary 3-4-5 down)
Odds of occurrence: medium-high
Impact: very high
Overall Risk Assessment: high

So, for myself, when I look at all of the scenarios, it is clear to me that scenario 4 is the clear one to hedge against.

So I wanted to explore scenario 4 just a little bit more, since if it does come to pass will be a serious event.

I have shown this chart of the long term Dow in a few different posts:

But let me take a moment and show the three major US indices side by side, so we can examine the overall behavior the last 30 years in context.

First I have said that the end of the 67-year bull market / start of the secular bear was in 2000, not 2007. I say this for a few reasons:

1) When adjusted for inflation, the 2007 peak on the Dow is lower than the 2000 peak
2) When looked at in terms of Gold, the Dow / Gold ratio has a higher peak in 2000 vs. 2007
3) The kickoff of the "Bubble Era" originated by the Tech Bubble bursting gives the Nasdaq a huge blow-off peak.

The NIKKEI in 1990 shows similar behavior to the Nasdaq in 2000 (from If I had a NIKKel for ....)

The SPX had a deeper pullback in 2008-2009, but the 666 bottom is nowhere near any meaningful long term support.

The Dow has been holding out, it has been showing the strongest long term technicals. How long does it hold out?

So, what is the ultimate message of this post?

The point of this post is NOT to say the crash is happening tomorrow. These are very long term charts and long term trends take a ... well, long time .... to develop.

The point is to show the size of correction so far with respect to the previous large bull move and how these stack up against each other on the three main US equity indices.

You should ask yourself: Does the behavior look strong or weak among the 3? Does this look like topping action with respect to the long term Moving Averages or does it look like the start of a new bull market?

I am not trying to convince you of anything. I am just showing a not-often-looked-at view of long term equity movement. I am asking you, "What do you personally make out of this?". You might look at these charts and say "that's bullish!". Or you may look at them and say "that's bearish". Or you may say "This? Why, I can make a hat or a brooch or a pterodactyl". And in keeping with the risk assessment above, scenario 4 is the one that I choose to hedge against, so I am highlighting the bearish possible outcome. But really I am just offering these up for your consideration.

Addition - Dec 31 9:45

Long term Dollar / Yen Comparisons

blog comments powered by Disqus