Wednesday, June 26, 2013

Taking Market Decline into Perspective

Two months ago no one was talking about emerging markets and what their implication was about a potential global credit crunch. In fact, “Dr. Doom” Nouriel Roubini came on TV in early June and suggested that stock market will continue its ascent for next 2 years. This happened within the IPM Model Turn Window on a weekly time-frame. Witnessing a perma-Bear turning bullish within the IPM Model turn window was not only a unique experience and a great contrarian indicator; it proved that, by the grace of God, IPM Model commands merit. (P.S. Market again bottomed within the IPM Model Turn widnow, sent to subscribers over the weekend)

Although Nouriel Roubini’s bullish embracement was a good support for IPM Model’s Top prediction, it was not the only reason for concern. From mid-May to early June, several reasons were highlighted on this blog, which hinted towards upcoming issues with the global equity markets. UST’s Market Matrix analysis suggested that markets were heading towards a big decline.

After 3-4 weeks of sharp decline in the global stocks, financial media has now turned bearish. Media is now highlighting the same reasons for the decline, which Understand, Survive and Thrive presented when U.S. indices were hitting all-time highs. For example, China potential credit crisis is destabilizing world markets. But I always ask: “What’s the value of giving reasons after the fact?”

At this point, I would like to highlight that the upcoming crisis (if materializes) will be different than 2008’s mini-depression. Unlike 2008 when U.S. Bond prices rose in the midst of the credit crisis as a form of safety trade, this time U.S. Bonds have started collapsing. Decline in bond prices are a clear indication that investors have started to doubt the viability and eligibility of global debt servicing commitments by U.S. and developed countries. Although there are other reasons behind Bond price decline, it appears as if Bonds will not be a safe-haven to weather the upcoming storm.

According to classical economics, in a deflationary crisis everything goes down. Nothing is secure. No one believes the stock market and the bond market, because people are scared about the prospect losing money. Since investors are not sure if their investments will be repaid, they stop investing in bonds and stocks. At the same time, commodities decline due to large-scale liquidation.

As for today’s market, real drivers behind recent decline are the credit issues being faced by the emerging markets and the bonds market decline. This decline could last longer than what people are expecting. Therefore, one should be careful about long-term investment decisions.

In the event, one should realize that no market (bonds, stocks or commodities) goes straight down. There are rallies on the way down. Bear market rallies are sharp and could even result in 5-25% gains over a short period of time. We might be at such a juncture right now. In the next update, technical reasoning will be provided for the upcoming market rally.

Please note that this reasoning goes hand in hand with the IPM Model. Subscribers already know the IPM Model Turn window (next 2), and the possible trajectory market should take over the next few weeks based on the market timing model.

Monday, June 24, 2013

IPM Model Update E-mailed to Subscribers

Wednesday, June 19, 2013

Market Actions & Federal Reserves

Market declined more than 200 points after Fed’s announcement regarding potential QE tapering. This announcement accompanies the fact that Chairman Bernanke will be stepping down soon. Both of these developments created uncertainty among investors, and gave them a reason to sell out of their positions. An interesting observation regarding today’s action is that today all asset classes ranging from stock to commodities went down. In the last few years, days like today where all assets went down together have been considered deflationary.

One can say similar things about today's market action i.e. Fed’s tapering could bring back deflationary pressure and will force a market sell-off. However, previously when we had such deflation related sell-offs, bond prices went up as part of a risk-off trade. But today, bond prices also declined along with the rest of the market.

On one hand, this behavior makes sense because Fed’s departure as a ginormous bond purchaser would reduce bond demand. But on the other hand, this also means that U.S. bonds are no longer attractive in the global market. It was just the Fed that was fueling the bond rally over the past few years. This would also hint towards a weakening U.S. economy and potential Europe like scenario in the United States.

In Europe last year, both stock and Bonds went down as the credit crises spread from one nation to the other. We have already discussed this scenario in our analysis over the past few weeks. Keeping this in mind, let’s do a scientific analysis to understand the future of U.S. economy: 

If the U.S. market keeps acting weak over the next few weeks and the bond/commodity prices keep on declining then it would suggest that
  1.  We are heading towards deflation è Weak stocks and commodities
  2.  Bonds are declining because Bond Bull market has ended and confidence in the U.S. economy has begun to erode.
On this blog we have already discussed (here) a possibility of a sharp decline in the U.S. markets based on performance of emerging markets. Emerging markets have been declining for the past several weeks. In fact they are in 3 of 3 wave decline, which could result in significantly lower levels. Furthermore, we have already discussed Head & Shoulders patterns being completed in the Bond and Emerging Markets.

Head and Shoulders mean that these markets have topped and we could see further decline. Therefore, at this point in time, one should be careful about the market (stocks and bonds) and its downside potential. Downside surprises can be expected. Emerging Market and U.S. markets topped out at the weekly IPM Model turn date (sent to subscribers). IPM Model will be used to identify upcoming market turns and will be emailed to subscribers on a regular basis.

In the next update, we will be discussing Elliott Wave analysis of the U.S. markets. 

Saturday, June 15, 2013

Emerging Markets's Elliott Waves

Emerging Markets have been discussed on this website for few weeks now (here and here). It seems like they have stayed down after breaking down, which could lead to further decline. Yesterday's sharp decline negated Thursday's sharp rally in the emerging markets. This suggests that downside pressure has not yet exhausted itself and that there is something fundamentally wrong with emerging economies. We have discussed several reasons and can discuss many more, but today I would like to analyze emerging markets from an Elliott Wave perspective.

Elliott Wave analysis will give us an interesting perspective about market's decline phase, and what should we expect in the upcoming weeks. Please note that Elliott Waves evolve over time, and one should be aware of potential risk scenarios to justify or negate a count. For example, market will typically decline fastest and with most ferocity during 3rd Waves and 4th wave should not enter Wave 2 area.

Looking at the current Emerging Markets (EEM) Elliott Wave count shows that markets are declining in Wave 3. Decline since mid May 2013 (IPM Model's turn date) has been relentless, persistent and powerful. All rallies have  been followed by lower lows. At the same time, market completed the 8/4 test to the downside, broke below long-term MA and completed an upright Head & Shoulders pattern. All of this happened as market was breaking down in wave 3 (shown below).

On a longer term time-scale, it appears that Emerging Markets are once again in a 3rd Wave decline (shown below) of a higher dedgree. Initial top was put in place in April 2011, which was followed by a sharp 5-6 month decline. Market then managed to rally for more than 1 year but remained below 2011 highs. Finally, in December 2012 EEM put in a wave 2 high. Since January, EEM only managed to make a lower high.

This lack of leadership from the emerging markets is worrisome, and has given way to recent sharp decline in global markets. Furthermore, above analysis suggests that emerging markets are undergoing Wave 3 of 3 decline. This phase of decline is the most powerful phase and can result in surprizes to the downside. Therefore, one should be ready for significant surprises, especially in the emerging markets.

While all of this is happening in the EEM, U.S. markets have managed to make new all-time highs. I don't know whether these new highs were a distraction tactic by the Fed/Central Banks or the U.S. economy is that much stronger than the global economy. But, one thing is clear that there is something significant brewing under the economic ocean. It might be very significant. And by the time, U.S. realizes this sea change it might be too late.

So one should be very careful in making big investment decisions in the current environment. As always, IPM Model will be used to identify long-term and short-term turn points in the global stock markets (subscription to IPM Model), along with proprietary 8/4 tests and Market Matrix model.

Tuesday, June 11, 2013

Reasons Behind Bond Price Movement

Reasons for Bond Price rise (Both of these reasons are valid for the US Bond Bull market): 
  • Prices will rise if interest rates go down e.g. Federal Reserves lowers the interest rate or we have deflationary pressures.
  • Prices will rise if there is extra demand (supply/demand curve -  Higher Demand = Higher Price). This typically happens under two scenarios: 1- Economy is doing well, and people feel that they will get the returns promised by the country. As a result, they buy bonds as investment (Economic Confidence Trade). 2- Everything else is doing so bad that investors don't have any choice but to buy bonds (Fear/Safety/Risk off Trade).
Reasons for Bond Price Decline (Yield Rise):
  • Prices will decline if interest rates go up e.g. Federal Reserves increases the interest rate or there are inflationary pressures in the market. Inflation typically happens in a good/robust economy (not always).
  • Prices will decline if there is lesser demand (Supply/Demand curve -  Lower Demand = Lower Price). This typically happens under two scenarios: 1- Economy is doing very poorly, and people feel that they will not get their money back from the country. As a result, they will dump their bonds (This was seen in Europe in 2012, where the Bond prices fell along with the Stock Market, and the yields reached 6% for some countries, which had to seek bailout funds). 2- Everything else (commodities and stocks) are doing so good that investors don't have any choice but to sell bonds (Rotation/Risk on trade).
Based on the above mentioned explanation, lets analyze the U.S. Bond market. 

US Bond market has been going up because U.S. Bonds were considered safe haven during the financial crisis of 2008 and during the 2012 European crisis. This situation was further amplified by Federal Reserves extra low interest rate policy, and the subsequent QEs. Finally, there is a 30 year cycle in the Bond Markets. This cycle bottomed in 1980 and will be topping out soon. All of the above reasons have contributed towards a Bond Market's Bull run. 

At this point in time we are at a critical juncture in the Bond Market. On one hand Bond Prices have put in a Head and Shoulders pattern, which suggests that Bond prices are about to head much lower. And on the other hand, Bond prices are sitting at a long-term Moving Average support. If this support gives way to further decline, we can be assured that Bond Bull has come to an end. If this support holds, that would suggest another rally phase is approaching.

In both cases, U.S. economy might be headed for an interesting period. On one side, sharply higher interest rates will not only choke off economic activity in the long-run and put us back into recession territory, it might also suggest that global demand for U.S. bonds had declined, which could be very bad for our economy. And on the other side, sharply declining interest rates (increasing bond prices) could bring back deflationary fears. 

In short, we are approaching a very interesting period in the financial markets. Can you think of other ways to interpret Bond Market's price action? If so, please share in the comments section.

Monday, June 10, 2013

Head & Sholders suggest Credit Tightening!!

Emerging markets ETF declined another 1%+ today. This decline came on the heels of warning put out by Understand, Survive and Thrive few days ago about possible breakdown in the emerging markets. Persistent decline in the emerging markets has validated the Head and Shoulders pattern, which will in turn validate the argument that emerging markets are now in a pronounced downtrend.

Downtrend in the emerging markets is a dangerous omen for the global economy. Emerging markets are most sensitive to credit markets, and react first when there are possible problems on the horizon. At this point in time, it seems like these markets are foreseeing a tightening of global credit along with reduction in money printing spree of global central banks.

Tightening of money printing might result in lower demand for the bond market because Bonds were the primary purchase targets of U.S. and World central banks. This suggests that if Federal Reserve’s ginormous bond buying invisible hand vanishes from the scene, there will be very little demand left for the U.S. Bonds. Consequently, bond prices will start declining and yields will start creeping up.

Well, this has already started to take place. Looking at the following bond chart suggests that bonds are now in a free fall territory, at least in the near term. Like Emerging Markets Bond prices have also carved out a long-term Head & Shoulders pattern. This pattern seems complete and the market is now breaking down.

Long term Head and Shoulder pattern along with lack of appreciation of this pattern in the media is a very good indicator that a Head and Shoulders pattern has been completed. This pattern could result in sharp losses in the Bond Market.
As far as U.S. stock market is concerned, there can be far reaching consequences.
  1. U.S. Market is in a long-term Bull Run è Rising Yield = Improving Economy and Strong Market
  2. U.S. Market is about to Follow Bonds & Emerging Markets è Rising Yield = Poor Economy like Greece
Only time will tell the real story, but we will analyze these two scenarios further in the upcoming posts.

Please note that the IPM Model's Weekly Turn Date predicted this decline in the Emergig Markets.

Friday, June 7, 2013

Emerging Markets Hinting a Decline?

Global markets have witnessed a sharp rise over the past few months. The best example in this regard is the Japanese market, which almost doubled since November 2012. However, after topping on May 23, it has declined almost 20% in less than 2 weeks. This sharp decline has captivated many in the finance industry. Decline of the Japanese market has been accompanied by a sharp decline in the Emerging Markets and the US market. Today, we will be analyzing the emerging markets to understand their implication on the global financial markets. 

Emerging Markets were one of the primary reasons why Understand, Survive and Thrive proclaimed the start of a new bull run in early December 2012. Since that time, US markets have rallied very sharply and were at over-bought levels not seen since 2007 and 2000. However, over the last 2 months, Emerging Markets did put in a lower high. This lower high was followed by a sharp decline and break of the March lows - a combination which has triggered several technical warning signals.

Head & Shoulders:
First of all, Emerging Market's ETF EEM has completed an upright Head and Shoulders patterns (shown below). This pattern suggests that there is further decline at hand. Decline in the Emerging Markets would suggest US markets are also about to undergo a sharp correction.

Key MA:
Emerging Markets ETF has broken below the key MA, used to demarcate between Bull/Bear market. This MA has been very accurate in predicting periods of sideways/down market action over the last 20 years. Break below this line is a sign of concern for the overall global financial system.

8/4 Test:
EEM has also completed an 8/4 Test to the downside on a weekly time frame. Weekly tests are very meaningful and have resulted in sharp declines in the past. Therefore, one should be vigilant of the domino effects that we might see in the global markets.

Emerging Markets are showing signs of weakness and this weakness can translate into other global indices. Please note that UST IPM Model predicted a weekly Top in the current time frame. All of these things combined suggest that markets are at a critical juncture. If Emerging Markets cannot pull off an impressive rally in the next few days, we might be in for a global sell-off in June.