Rallies in Bear Markets from Larry Pesavento’s Patterns – Profits & Peace of Mind

Stock markets around the world have been falling since early spring and even earlier in other parts of the world such as Asia and Europe. Markets are extremely oversold and we are looking at many bullish Gartley patterns, particularly in China and Japan, which we focused on in last week’s letter. Thus far these lows have held. The thing that we must watch and pay very close attention to is the low made on August 9, 2011. This important date was marked by, none other than, 618 or 786 Fibonacci retracement’s on nearly every major index that we follow. Make no mistake about it if we go below that low we could drop dramatically. Look at the chart that compares 2008 to 2011 and see the similarity. In 2011 we’ve actually dropped farther but it’s taken one month longer to accomplish this. The question of whether we rally much from the key date of August 29th, the new moon, will be answered by early this week. If we have a sharp increase in prices this coming week, the market could rally all the way to the September 12-16 dates, and take the S&P to a price of 1245 basis cash and 1242 basis futures. This would complete the classic thunderbolt or AB=CD
pattern. Emotion is in play regarding the Jackson Hole, Wyoming meeting, reduced tensions in Europe, along with the moderating effects of Hurricane Irene. These together could be enough to make the market rally farther than we expect. This market will go lower, the question is how much of a rally we will have until it gets to that point. Ideally, the new Moon on Monday, August 29th will mark the high end of the head down and quickly take out the lows of August 9th. One amazing statistic that came across the tape late in the day on Friday is that the German DAX, the fourth largest economy in the world, has seen a 28% drop in the stock market in a one-month period. Even though a well battered banking index is showing a bullish Gartley pattern and they must be respected, these patterns fail and when they do look out below.

Treasury Bonds

This market continues to hover near all-time highs and completed long-term AB=CD patterns on the weekly and monthly charts. Interest rates have been dropping for 30 years since 1981 and we will be long until this is reversed and rates are placed at a more normal level. The Federal Reserve may use some more bullets but frankly they have fired as many votes as they can and yet nothing is happening to the economy. The United States needs major legislation to reform the tax code and make more equitable taxes among corporations and rich individuals.

This is been the most frustrating market for me over the past several months because I do not believe, much to my dismay, that interest rates would go even lower. Still I haven’t given up the strategy of going short but it’s best to wait. I will cover that in the trade of the week section.

Precious Metals

Gold is having wild swings of $100 per ounce in a matter of hours. This is indicative of a market that is getting ready to have a major correction in my opinion. It dropped over $200 per ounce in a matter of two days and quickly reversed to the 618 retracement of $1835 per ounce. If this level is not exceeded this week, and we continue to head lower, the first price level we will be watching is around $1555 per ounce. Silver continues to lag behind gold badly and just went to the 618 retracement off of the April 25th high which is bearish indication once again. Copper has held up reasonably well but is still in a downtrend.

Foreign Currencies

Much has been said about the US dollar and how it has very little standing in the world. Enclosed in this letter is a chart that goes back nearly 25 years showing although it is in danger of violating this level, one should not be too bearish on the US Dollar. At this point, based on looking at the long-term dollar index and the other major cross rates, such as the Euro, Yen and British Pound versus the Dollar you should not be too bearish. Foreign-exchange has been rather quiet compared with the rest of the markets but this could change in an instant. Should the US dollar close below the 73 level it would be an indication that the Washington bureaucrats are giving up on the dollar and allowing our huge debt to be repaid with cheaper dollars by inflation. This would not make some of our major creditors i.e. China very happy one would think. The euro looks to be a sale in the 1.45 level and the British pound looks to be a sale in 1.65 level as these levels have formed formidable resistance over the past weeks. The US dollar is at
major swings of incredible proportions and yet has still held the 73 level quite well.

Crude Oil

Crude oil appears to be forming a perfect Gartley sell signal at the level of $92 a barrel. This would complete a perfect AB=CD pattern, all for a very low risk selling opportunity. The market has bounced over $10 a barrel from the $75 per barrel level and completed the major patterns that we had been looking at for the past several months. Going above $92 a barrel would signal the market should be going higher and not lower as was expected.

Technical Corner

Technical corner this week will focus on two things. First, the perfect Gartley buy pattern in Bank of America. This current stock is the favorite of none other than Warren Buffett. It is perfect as the legs from the AB are equal to the CD leg. They are also perfect in price. I find it ironic that Mr. Buffett decides to buy at the completion of this pattern which I’m sure he has no clue exists. One word of caution and that is if Bank of America goes below six dollars a share Mr. Buffett will most probably holler uncle and get out somehow. He is a very astute investor
to say the least. Remember just because he says something in the news isn’t exactly the way it might be in real life.
The second part of the technical corner will focus on strong trending days that we have in the markets. The particular example that I’m using today is the E-Mini S&P 500. As you can see from the chart, on this very strong trending day when the S&P was up almost 50 points there were still six opportunities when the market made nearly perfect equal retracements. The lesson here is that when you do have these strong trending days i.e. far above or below the open in the first hour, watch for the first correction. This will most probably be repeated more than once as is shown on this chart.

Trade of the Week

The trade of the week this week may be buying the TBT which is the ETF for the short treasury bonds one more time. However, my entry technique is going to be based on the possibility that the bottom is in and I want to see the first rally that might take three or four days, possibly more. After the rally, we want to look for a 61% pullback to buy the TBT with a stop below the current low. As we get closer to this pattern completing I will send out a special notice that this should be a tradable opportunity with relatively low risk.

Final Thoughts

There is no other way to put this than to say that the world’s markets are in incredible bear markets in my opinion. The precipitous drop that we have seen since late May has affected every market in the world. This is indicative of a
major cycle top particularly because the rally back after the 2009 low, which took 26 months, has given back substantial amounts very quickly. Whether the government is capable of pulling out of this is a question that will be answered by history. Our current Fed Chairman has said many times that he did not want to be the Fed chairman during the second Great Depression. Sometimes our greatest fears are realized whether we like it or not. I do not know whether we will go into another depression or not, but I feel strongly that the stock markets are going to go much lower than where they currently are and not bottom for any substantial rally until October. Should we close higher than 1250 in the cash S&P I would probably think I’ll have to reconsider my position on being bearish.

Larry Pesavento - Combust is due on August 17

One of the most accurate of the astroharmonic cycles, mercury conjunct sun, occurs approximately four times a year and typically carries with it a great deal of volatility. The upcoming one is due on August 17 (this coming Wednesday) and also coincides with three other major planetary pairs on Tuesday and Wednesday that offer almost as much action.

To say that financial markets around the world are currently oversold would be a gross understatement. The question now is if and when the markets will rally. The profit objectives from the head-and-shoulder patterns in the major indices that we mentioned previously have been met. The NASDAQ managed to hold the 0.618 level although it is the only index to do so. In my opinion, the medium to long-term picture is now very bearish (at least into October) and a drop similar to the one we saw back in 2009 is easily within the cards. Adding to the potential for more bearishness is the fact that it is not just the U.S. markets that collapsed over the span of little more than a week, but markets worldwide seem to be teetering, including emerging powers such as China that were supposed to carry us out of the recession that QE2 clearly failed to reverse. If we do in fact drop into new lows into the August 17 date above, it should bring a very strong rally. On the other hand if we have a strong rally into the August 17 date, it could mark the C-leg of a further slide.

Larry Pesavento - Combust is due on August 17

Treasury Bonds

A close look at the weekly chart for Treasury bonds shows an AB=CD pattern completing at 139. This pattern is correct in both price and time, thereby suggesting that a major top in bonds may finally be here. The short ETF for bonds (TBT) collapsed in parallel with bond yields (a possibility we warned of previously) but TLT, the bond ETF representing shorter term Treasuries did not even get above the 0.618 level. Unless I am reading this entirely wrong, it points out a glaring problem in trading ETF’s. The fact that the S&P downgrade did nothing but make Treasury bonds go higher (translating into lower interest rates) on an instrument that is now technically deemed as lower-quality debt is rather intriguing. A key thing to watch out for now is whether the market really will continue to perceive U.S. Treasuries as a safe haven (note that the Dollar’s gains have primarily come at the cost of the Euro) and if the downgrade effect will trickle down to corporate debt.

Pesavento -Treasury Bonds

Foreign Currencies

Speaking of safe havens, the Swiss franc was the currency of choice in the “flight to quality” this past week following the U.S. downgrade and then the market disintegration, as illustrated by the price weekly chart. I will be looking to short this currency (which is not part of the Euro) as soon as we test the bottom once more.

The Japanese yen is also trying to find a bottom at the 76.00 level but at this point it is in danger of going into a free fall. Meanwhile, the Euro/U.S. dollar is still in the triangle between 1.45 and 1.41 but looks bearish due to the progressively lower highs that are forming.

Precious Metals

Gold may have finally made a top (at least in the short term) as the candle formation left a huge tail at the most recent top and the market dropped by nearly $80 per ounce in a matter of a few hours. If prices move above $1,822 per ounce, it would suggest that this analysis is wrong. From here, gold needs to stay above 1,580 to remain bullish. Being long at this point (or being short for that matter) is very dangerous because parabolic moves always end badly (what goes up must come down) but are very unpredictable towards the end. Although gold prices have skyrocketed, silver is looking really bearish by not being able to rally the slightest bit.

Crude Oil

Oil completed the larger AB=CD pattern to the downside and should now have strong resistance at the $91 per barrel level representing the 0.618 retracement from its last high.

Trade of the Week

With record volume in TBT and an AB=CD pattern in U.S. 30-year Treasury bonds, I will try to go long on this ETF once again with a stop at 23.99. I cannot stress enough the importance of a stop – our last stop for TBT was at 31.00 and saved a great deal of capital and pain when the stock moved downwards. We suggest holding on to our previous positions in SDS, MUB, and IBM.

Final Thoughts

These following two weeks will see shorter versions of the letter as I am traveling to multiple speaking engagements in Asia including the Asia Invest Fair in Singapore. This venue has conventionally been for stocks, bonds, and Forex, with all of the speakers covering one of these three topics. This year there will be almost as many real estate companies from the region (including China). Some of the claims touted by the sales people here would startle Bernie Madoff. While this may not be a sure sign of a top in real estate over here, it certainly hints at an impending collapse.

Japanese and U.S. stock markets: A Parallel? – by Larry Pesavento

Our good friend Dr. Al Larson has constructed a very informative chart showing the similarities between manias that have occurred in past markets. In particular, he compares the Japanese stock market versus the current U.S. stock market over the span of many decades. If you recall, the Japanese stock market topped in December 1989 at a price level just shy of 40,000 points in the Nikkei index. Although hard to imagine, this subsequently dropped to under 7000! During the hectic times of the late 1980s, I acutely remember one particular news broadcast in which a reporter laid a $1,000 bill on the pavement in front of the Imperial Palace in Tokyo. He made the staggering point that the $1,000 bill would barely buy the land it occupied. At the time, there were also estimates that the five square mile area within the Imperial Palace was worth more than all the real estate in California. This absurdity typifies the period. What is interesting about the markets in Larson’s charts are their undisputable similarities. And the way things in our country are going, it certainly looks like it could happen again in the U.S. I certainly hope I am wrong but it’s looking more and more like the Japanese drama of the 80s will unfold here and watching the politics is comparable to cleaning a septic tank by hand it seems. In my opinion, the stock market appears to have bottomed on Friday July 30th, where there was a full moon. The overnight markets on Sunday, leading into August 1st, have been considerably stronger. However, if we remember that the high was made on May 2nd with a bullish enthusiasm brought on by the death of Osama bin Laden, that new moon marked the high of the current spring rally. These next few days look to be highly volatile to say the least and the reports coming out of Washington regarding a debt ceiling deal should not be believed until they are signed by the president and brought into law.

Treasury Bonds

The flight to quality towards Treasury bonds continued his past week with the short-term 10 year notes reaching the 0.786 retracement of the entire bear market. Note that the 129 price level represents the 0.618 retracement for the 30 year bond. How experts can still call this a flight to quality is to me the ultimate oxymoron – if you had told me three weeks ago that we are near default and interest rates were going to drop and bonds rally, I would have thought it to be a hundred percent wrong! With stocks rallying Sunday night on news out of Washington, this may or may not cause a correction in the treasury bonds. We are still currently long the short ETF for long term Treasuries (TBT) but it missed our stop by four cents having made a low at 31.04. We will continue to use a stop below 31.00 because this still has the potential to go anywhere.

Foreign Currencies

If there was ever a reason for the US dollar to collapse and go into meltdown mode, the news coming out of our nation’s capital would be more than sufficient! It is an embarrassment to see elected officials act in such a childish manner and make such unbelievable statements that even children would laugh at. This is why I typically avoid national politics but there is no question that the future of the dollar is hinging on it. The U.S. dollar must hold a 73 level and below that we would be looking at prices around the 68 (or even 65) price level in the dollar index. Europeans have watched the Euro hold up this past week and it is still in a tight triangle between 145.50 and 142.50. Going through either of these price points would most probably determine the trend over the next several weeks. The British pound is also showing strong resistance at the 1.65 level but this could dissipate in a matter of minutes given the current political environment. The key currency to watch this week in my opinion is the Japanese yen which is now making a double bottom (i.e. potentially at the 76 level) which is the same level that occurred when the earthquake and tsunami hit a few months ago.

Precious Metals

Gold continued to make new highs this week reaching above the $1,635 per ounce level but silver again lagged badly, closing nearly 2 dollars per ounce for the week. Copper has continued to hold up even in the face of a very weak stock market. This is unusual because the correlation between copper and stocks is typically close to 90%. It will be interesting to see the reaction to copper as stocks moved up so strongly on Sunday night. Given this, it is looking to me more and more that gold may be making its last gasp run. I originally thought it had the probability of making a parabolic run but this is less and less likely as there has been no increase in volume or decrease in open interest (i.e. short-sellers exiting). The Gold/Silver Index (XAU) has also stopped at the 0.786 retracement and looks poised to go lower.

Crude Oil

The economic news this week, especially on Friday was incredibly bearish, causing the big sell off in the crude market. The $94 per barrel price level in crude oil is extremely important as it marks the 0.786 retracement of the last swing. If this level is broken it would mean that the price objective of 104 per barrel is highly suspect. But if this level holds, it would add credence to the trend that crude oil could go to the 104 level that would complete the current AB=CD pattern.

Trade of the week

The Trade selected for this week is to watch the price of IBM as it is completing a major butterfly pattern on the weekly charts. Should IBM reach near the 185 level one more time, I would suggest looking at October 175 puts as these would not be too expensive but could offer great potential if the pattern does complete. It certainly has all the symmetry necessary to make this a viable pattern.

Technical Corner

This week we expand on the relationship between stock market and the copper market. The reasons given for copper being so important in building in electrical infrastructure also extends to the Chinese and other Asian markets. The charts of these foreign markets do not look bullish by any stretch of the imagination as they have lower tops and lower bottoms and have been in downtrends for many months. In the case of China this would be several years. But over the short-term, the price of copper has held up incredibly well given the last two weeks in the stock market in both the US and China. While it is suggested that the copper market is controlled by a cartel out of South America namely Brazil, this has never been proven in my opinion. It will be interesting to watch the action this coming week as the $4.50 per pound level represents pretty strong resistance in copper.

Final Thoughts

Since August 15th 2007, I have felt that this debt-laden economy and stock market closely parallel the relationships of the 1836 market because of the same cyclical format that occurred at that time. We and the rest of the world have been borrowing for years through margin, credit cards, personal loans, and mortgages without end. By comparison, when I was a boy growing up in the early 40s and 50s one could only buy with cash: credit was an alien concept and inaccessible to the masses. I can remember getting my first credit card (an American Express card) when I was at Drexel Burnham in 1976. Up until that time had always paid by cash or check. Now it’s almost impossible to live without a credit card especially if you travel. Regardless of the type of expense, all these bills (including sovereign debt and public spending) must be paid eventually. I do not think there’s any chance in this world that the United States will default on its debt. It is likely that the government will let the US dollar go to zero before they allow a default to take place, even though it is just another way of defaulting anyway.