F.E.A.R — False Evidence Appearing Real by Larry Pesavento

Last week our letter focused on the divergence between the NASDAQ and the New York Stock Exchange indices. It is apparent by looking at the patterns this week, that we are coming into something that could be an important bottom. The following reasons are why I think this could happen:
1. September 26th is a P index date which has a high correlation to see markets have turning points. The new moon comes on September 27th. All markets around the world are very oversold and due for rallies. How long this rally will last is anybody’s guess but several weeks could actually not be very surprising. The other alternative is that we continue down this week and we would be looking at a potential bottomless pit in prices.
2. There are so many AB=CD patterns in so many markets that it seems likely that a short-term bottom is at hand. Take a look at the S&P 500, New York Stock Exchange, NASDAQ, Russell 2000, and also the Dow Jones Transportation Index. All of these are at pattern completions as can be seen on the enclosed charts.
3. Volatility Index, VIX, has made three lower tops which is also an indication that fear may be abating.
4. Treasury bond market also has reached some key objectives on long-term weekly charts which means the flight to quality might take a back seat shortly.
This should be a short-term rally as we have stated, but how long it will last will remain to be seen. Usually in bear markets you only get 3 to 5 days but this market has been down for weeks and could surprise some people on the upside.
Stock markets around the world are still acting very poorly but are extremely oversold. On a worldwide basis this rally could be expected. But a rally is all it will be as these markets look as sick as any we have seen in a long time i.e. 2008.

Treasury Bonds

This market has been up for 10 weeks in a row seeing yields reach levels not seen in 60 years. Everyone believes that this is a flight to safety play. Nothing could be further from the truth if you look at it the enclosed chart on treasury bonds. Wild swings of $6-$10,000 or more can happen in a heartbeat. Gold and the Swiss franc both former safe havens have experienced the same thing. Bullish consensus is at highs as it was in gold at 1925 per ounce.

There are two major targets based on the AB=CD patterns on the longer-term charts that end up at 147 to 151. We did make the 147 this past week and sold off three points very quickly which could be the first sign of weakness. The last major rally occurred over 20 week cycle and stopped at the 1.618 expansion. The current rally was 10 weeks and stopped at the 1.27 cycle!

Foreign Exchange

There are patterns appearing in the foreign exchange market similar to what we are having in the stock and bond markets. US dollar index has completed a perfect AB=CD pattern at the 79 level. This past rally is exactly the same amount that occurred several months ago as can be seen by the yellow boxes on the dollar index chart. It is worth taking a look at this chart. The Swiss franc has dropped more than 25% against the dollar in the past few weeks surprising nearly everyone in the foreign exchange market. We believe the same situation could happen with the Japanese yen as long as it stays above 76 to the US dollar. The euro could be completing a bullish Gartley pattern and the British pound also has been down 10 days in a row which makes it do for a strong rally. Longer-term we think the dollar will remain strong versus the other currencies but for the next few days it could be under some pressure

Precious Metals

Gold, silver, and copper dropped to new weekly lows this past week. Silver in particular looks increasingly bearish in my opinion. The target for this move could take it to $26 per ounce or potentially lower. Gold on the other hand seems to have support coming in at $1550 per ounce but failing there would tell us that we are looking at probably the highs for this decade in gold. Copper has some support at the $3.15 per pound level but failing there would show prices going considerably lower. Keep in mind that this is the exact opposite of what they had been telling us about the emerging markets and how they need copper particularly the Asian markets.

Crude Oil

Crude oil has held the 786 level at $79 a barrel thus far. Going below that would set up prices to retest the $75 level and going below that you would be looking at the mid-60s for crude oil. Gasoline futures are also forming a pattern that could take them a little lower before rallying. Longer-term basis for oil continues to look bearish and we expect prices to go to the lower 60s sometime in the near future probably during the winter.

Trade of the Week

Once again I’m going to jump into the lion’s den and buy the ETF for treasury bonds, TBT, at the market on Monday risking two points. Keep in mind this is the third time that we’ve tried this trade but eventually we will get it right. Most of these targets of the ten-year bonds have been reached and with 60 year yields at all time lows it is only a matter of time until we see a rise in rates.

Technical Corner

There is a big difference between analysis and trading. Analysis involves no emotion and is not kept score with money. Trading on the other hand is exactly the opposite. Trading actually occurs after the market order has been placed because this is when the trader must assume the risk is taken on the trade and how he must manage that risk. It is very important for traders to understand that the risk is the most important thing we can do to be successful. It is the only thing we can control. We never know if we’re going to be right or wrong nor do we know how much were going to make on a trade. Keep in mind the saying “he who knows not what he risks- risks all!”

Final Thoughts

One of the greatest misconceptions in the market is a flight to quality or the safe haven argument. All one has to do is to look at what happened in the Swiss franc and gold to understand that there is no safe haven especially during these times when we are facing economic chaos on a worldwide basis. The safe haven is in the risk control that you make when you place a trade. Markets don’t go vertical up nor do they go vertical down without some rallies and corrections in between. Pattern recognition tries to identify some spots without listening to all of cannon fodder that goes on in the financial press. The difficulty arises because you must act on what you see and not what you think. Opinions are most difficult to release. It is better to lose your opinion instead of your money. Focus on the risk not the profit!