The markets around the world go round and round by Larry Pesavento

Stock markets

As we described last week, we expected stock markets around the world to react bullishly over these past few days due to the patterns that they had completed on the downside. Another reason for the bullishness was that some of the more famous names in economics such as Volker, Bernanke, Stieglitz and Bill Gross have all called for the beginning of a full blown depression. Public figures often become maligned when they make a bad call (or two). Over the past few months, Bill Gross has been given a “literal” beating in the press due to the poor performance of his Pimco bond fund, which ranks near the bottom of this category of funds. This is also true of John Paulson whose hedge fund has taken some very bad hits recently. Of course, all of this does not detract from the successful track record of these gentlemen, but rather reflect how the financial press operates.

The low we made on October 4th, which coincided with the completion of many patterns in both domestic and international indices, is an important point in the current market. While we remain very bearish over the longer term, I believe that we may still see a rally in the S&P 500 back towards the 0.618 or 0.786 levels. The performance of the S&P this week was the strongest in several years as it rallied nearly 6% during this period. Although the banking index and foreign

Markets continue to look weak, they too have rallied to a considerable extent. In contrast, the Nasdaq has already reached this level and several of the stocks in the technology sector are making dramatic vertical moves (i.e. AMZN and AAPL). Note however, that the Nasdaq is a very biased indicator as it tracks only 100 stocks in a cap-weighted manner, so that expensive stocks are equally weighted as cheaper stocks.

This week I have also featured the Bradley model that is useful in giving us a rough idea of how stocks should perform over a shorter term interval (i.e. 6-10 weeks). The charts I have included show both the shorter cycle (going back several months), as well as for the whole year, showing a broader approach to cycle theory over the long term. While the Bradley model is accurate nearly 70% of the time, it should also be used in conjunction with Fibonacci patterns and over bought/sold indicators to provide the most reliable results.

Treasury Bonds

Treasury bonds have completed their first bullish AB=CD pattern at the 138 level. As H.G. Gartley once said, one should buy all AB=CD patterns whenever they appear in a bull market. Even as we keep in mind that over the long term, this market is making a top of biblical proportions and could easily come down very hard, there is still the opportunity to go long bonds at this point with limited risk. As illustrated in the chart, the risk for the proposed trade would be approximately 1 point with a potential profit of at least 2 points.

Precious Metals

Copper was the feature member of the group this past week as it held the 3 dollar per pound level and rallied 40 cents in step with the overall stock market. As long as copper manages to hold this level, it has a fair chance of making a Fibonacci retracement towards the 3.75 per pound area. However, we still believe that the $3 per pound level will be broken to the downside over the long term.

Gold continues to move in a sideway motion between $1,590 and $1,690 per ounce. There should be strong resistance at the 1,770 level on the upside and reasonable support around 1,590. As with copper, we also believe that long term gold prices are likely to head lower. This downward trend is particularly true for silver as it underperforms gold, copper, and even platinum and has essentially become the ugly sister among the metals.

Foreign Currencies

The big winners in foreign exchange this week were Euro and British pound, both of which completed perfect Gartley patterns as illustrated in last week’s letter. We should now expect some resistance for the Euro at the 140-141 level. Over the long term, it looks as though the Euro could be headed much lower. As for the pound, it has now completed at 75-week cycle at the exact Fibonacci Gartley buy pattern and could rally to the 161-162 level before moving lower.

The US dollar index has now completed another rally that was equal to the major move several months ago and now appears to be retesting the 0.618 or 0.786 levels to see if it will hold. Should the dollar index break below 73, it would be an extremely bearish sign for the dollar over the long term.

Crude Oil

Gasoline futures have now rallied over 40 cents per gallon off of the Gartley pattern that it completed several weeks ago at $2.46 per gallon. It now looks ready for some type of correction particularly since the pattern it completed was a perfect Gartley which also incorporated a “3-drive to the bottom” pattern.

Crude oil itself formed a bottom at the 0.786 level at 75 dollars per barrel, which was also a double test of the 0.786 retracement off of the lows from last May. As long crude remains above 75, there is a good chance it could work higher.

Trade of the Week

This week, we see an opportunity for profit in buying January 180 puts on IBM. Earnings for IBM are due to come out on Monday just as the stock is completing both a “3-drive to the top” pattern as well as a bearish butterfly pattern. In our opinion, these combinations of patterns make this a very low risk trade. Using a put option here provides us with the flexibility of maintaining unlimited profit potential with limited and well defined risk, which at this time is the price of the put (around $5).

Technical Corner

One of the most common errors people commit in trading is to over-trade. Any time you find yourself trading in the realm of more than 10 times per day, you are likely to be over-trading. The danger with this type of situation is that it is very difficult to focus on so many things at one time. Although some of the younger folks can focus simultaneously on multiple online games, this is very different when substantial amounts of real money are involved. A second common mistake is placing stops that are too close and failing to prepare where entry levels should be. As a result, mistakes start piling up, which then lead to one after another. By preventing these avoidable initial mistakes, one can follow the adage: take care of the first mistake and the second will take care of itself.

Final Thoughts

After looking at all the charts this weekend, the big question I now have on my mind is how much the markets can/will rally before we start towards the downside again in earnest. Although the next big cycle does not come until October 26, keep in mind that once markets start gaining momentum they can move very quickly. This was very evident in the S&P 500’s 6% move this past week.

I am also watching to see how the bond market responds to the bullishness in the stock market. From a long term perspective, bonds are looking like the best short since tulip bulbs in 1670, but that is my opinion and has been yet to be verified by actual profits. Nevertheless, I continue to wait for an entry in the bond market either via an ultrashort ETF (e.g. TBT) or Treasuries themselves. The outstanding target of 150 is still possible for Treasury bonds, but this is likely to occur only if there is some very bad news coming out from Europe.

Roger Ward Babson – (July 6, 1875 – March 5, 1967), founder of Babson College in Massachusetts. Entrepreneur and business theorist in the first half of the 20th century.

Excerpt taken from Wikipedia: “On September 5, 1929, he gave a speech saying, “Sooner or later a crash is coming, and it may be terrific.” Later that day the stock market declined by about 3%. This became known as the “Babson Break”. The Wall Street Crash of 1929 and the Great Depression soon followed.”

He was the only person warning of a financial panic at that time.

We now have 15 famous figures that are warning us of great dangers to the World economies, most of them are house hold names:

• Fed Chairman: Ben Bernanke
• Former Fed Chairman: Alan Greenspan
• Former Fed Chairman: Paul Volcker
• Former Federal Reserve Governor: Frederic Mishkin
• Head of the Bank of England: Mervyn King
• Nobel Prize winning Economist: Joseph Stiglitz
• Nobel Prize winning Economist: Paul Krugman
• Economics professors: Barry Eichengreen and Kevin H. O’Rourke
• Investment advisor: Nassim Nicholas Taleb
• Well-known PhD economist: Marc Faber
• Morgan Stanley’s UK equity strategist: Graham Secker
• Former chief credit officer at Fannie Mae: Edward J. Pinto
• Billionaire investor: George Soros
• Senior British minister: Ed Balls

The patterns we completed have held over the past 2 weeks and the markets are very oversold. As bearish as I am long-term it makes sense to be cautious at this time.

I went over every chart on a global basis and found the same oversold conditions along with patterns associated with bottoms. These bottoms may be short lived but we must respect them. Make no mistake about it, the long term picture looks bleak in almost every country. It is a debt cycle of monumental proportions and it is getting worse not better.

I originally thought that we could melt down in a crash like scenario in the cycle date of October 26th. This is still a possibility but the odds are lower than I had originally thought.

We have a cycle date due Monday October 10th and a full moon due Wednesday October 12th.

If something changes at that time I will send a special report. Be sure to read the Technical Corner in this week’s letter as it relates to market volatility.

market volatility

Treasury Bonds

They continue to stay above the 141 level and have the capability to make the 150 level on one more flight to safety or safe haven play. I still believe that this will be the surprise in the market. In the coming years as bond prices drop, they will bring in higher yields. This has continued to be my most frustrating market. Some of you suggest I just get short and hold on for dear life!

BEEN THERE – DONE THAT! It is better to pick your spots and control your risk. There will be many chances to get aboard the short side of this one.

Foreign Exchange

The Forex Markets stopped at the pattern completions we featured in last week’s letter and also in this week’s letter. The dollar index has rallied for weeks now and has equaled the rally it had last year. The news from Europe keeps getting worse but the markets seem to be ignoring the supposedly concrete facts that Europe is broke. Currency markets can move very quickly so it is best to let the markets decide their course. Remember that prices go up because of more buying and go down because of more selling!

Precious Metals

These markets held critical levels and this was especially true of copper. Last week we suggested that copper must hold the $3.00/lb level ala 2008. It has so far done just that.

Gold has also tested the 618 support at 1590/oz and seems ready to test the 1720/oz level. Silver continues to lag behind gold badly. It is worth mentioning that gold could go to new highs on a move above 1850/oz as it did not collapse like silver did in April after it made its parabolic top.

Crude Oil

Both crude oil and gasoline futures completed bullish patterns are testing critical support i.e. $75/bbl in crude. This level is extremely important support and MUST be respected.

Trade of the Week

We should cover the gold bug HUI we shorted near the 3 drive to a top as it has had a good move down! I am still waiting (again) for a short position in treasury bonds. We would also cover the Ryder Systems short as it has also dropped a great deal.

Technical Corner

Market crashes are a rare event, the last great crash was in October 1987.

It was brought on by a decision made in Japan that weekend, it caused the currency markets and all financial markets to be in turmoil on Monday the 19th of October with the DOW down 17% in 1 day. There were no overnight markets and few traders even did Forex trading. Now we all have access to Forex as it is free on many internet sites. When money gets scared, the spreads in the Forex cross rates, PIP (Percentage in Price), begin to widen dramatically because everyone wants some protection. All cross rates will have wide spreads but the Euro, GBP, Swiss Franc, AUD, and Yen will see the biggest moves in PIP spreads. It is nothing to lose sleep over and if I see it happening I will let you know as soon as possible.

Final Thoughts

This week i was expecting a potential big downdraft into October 26th, the big cycle date with the currency markets completing patterns and copper holding. So well I am not as confident as before, longer term we are going lower, but shorter term is more difficult to predict. Should we get a good rally into the 26th it could be a great selling opportunity. Even the European markets held major support and Asia finally rallied especially the Heng Seng.

I am traveling for the next 2 weeks so there may be a few short term updates.

The following memorandum was sent out by Sir John Templeton in 2005, warning of increased volatility and potential hard times in the future. He was the founder of the Templeton funds and one of the most respected minds on Wall Street.

John M. Templeton Lyford Cay, Nassau, Bahamas

MEMORANDUM (June 15, 2005)

Financial Chaos — probably in many nations in the next five years. The word chaos is chosen to express likelihood of reduced profit margin at the same time as acceleration in cost of living.

Increasingly often, people ask my opinion on what is likely to happen financially. I am now thinking that the dangers are more numerous and larger than ever before in my lifetime. Quite likely, in the early months of 2005, the peak of prosperity is behind us.

In the past century, protection could be obtained by keeping your net worth in cash or government bonds. Now, the surplus capacities are so great that most currencies and bonds are likely to continue losing their purchasing power.

Mortgages and other forms of debts are over tenfold greater now than ever before 1970, which can cause manifold increases in bankruptcy auctions.

Surplus capacity, which leads to intense competition, has already shown devastating effects on companies who operate airlines and is now beginning to show in companies in ocean shipping and other activities. Also, the present surpluses of cash and liquid assets have pushed yields on bonds and mortgages almost to zero when adjusted for higher cost of living. Clearly, major corrections are likely in the next few years.

Most of the methods of universities and other schools which require residence have become hopelessly obsolete. Probably over half of the universities in the world will disappear quickly over the next thirty years.

Obsolescence is likely to have a devastating effect in a wide variety of human activities, especially in those where advancement is hindered by labor unions or other bureaucracies or by government regulations.

Increasing freedom of competition is likely to cause most established institutions to disappear with the next fifty years, especially in nations where there are limits on free competition.

Accelerating competition is likely to cause profit margins to continue to decrease and even become negative in various industries. Over tenfold more persons hopelessly indebted leads to multiplying bankruptcies not only for them but for many businesses that extend credit without collateral. Voters are likely to enact rescue subsidies, which transfer the debts to governments, such as Fannie May and Freddie Mac.

Research and discoveries and efficiency are likely to continue to accelerate. Probably, as quickly as fifty years, as much as ninety percent of education will be done by electronics.

Now, with almost one hundred independent nations on earth and rapid advancements in communication, the top one percent of people are likely to progress more rapidly than the others. Such top one percent may consist of those who are multi-millionaires and also, those who are innovators and also, those with top intellectual abilities. Comparisons show that prosperity flows toward those nations having most freedom of competition.

Especially, electronic computers are likely to become helpful in all human activities including even persons who have not yet learned to read.
Hopefully, many of you can help us to find published journals and websites and electronic search engines to help us benefit from accelerating research and discoveries.

Not yet have I found any better method to prosper during the future financial chaos, which is likely to last many years, than to keep your net worth in shares of those corporations that have proven to have the widest profit margins and the most rapidly increasing profits. Earning power is likely to continue to be valuable, especially if diversified among many nations.

It is becoming more and more apparent to people around the world that something is happening that is affecting the economies of the world. What started in Europe and spread to Asia is now prevalent across the globe. Commodity prices are beginning to look very weak and have the potential to drop a great deal more in the coming weeks. The S&P cash index on a weekly basis looks very reminiscent to 2008. Please take a minute and look at the weekly chart enclosed with this letter and particularly the 2008 area comparing it with what is happening now.

The market has made some type of the bottom on August 9th but has gone absolutely nowhere. It is at such a critical level now that it would take very little to turn it to the downside i.e. 2008! The banking index is looking particularly vulnerable. Bank of America looks so bad that if it goes below $5.90 a share it could be the next Lehman Brothers.

The next significant cycle is due on October 10. Alas, five that we had this week occurred on the new moon but we had expected the market to rally much stronger than for just two days. Should the market gap down on Monday, October 3rd it would be the potential for something quite sinister. Historically it was October 2, 1987 that started the market down into the crash of October 19, 1987. Just looking at a Chinese stock market which was supposed to pull us out of the doldrums along with the rest of the world and one can see that this market has been bearish for considerable months and is increasingly looking more bearish. Copper which has been a good predictor of economic trends looks very suspicious like 2008. Here again we would suggest you look at the Copper chart and watch what will happen if Copper goes below three dollars a pound.

Treasury Bonds

Treasury bonds are having a snap back rally as can be shown by the hourly chart on the 30 year Treasury bond futures. Although they made a high at 147 it is still a possibility that they could make that secondary high at the 151 level. Treasury notes also look like they’ve topped but if the market reacts poorly next week this flight to quality or safe haven story might come to bear again. Keep in mind that treasury bonds and notes are an asset class. They are not a safe haven. They never have been and they never will be. They are made of paper. It is the perception of the market participants that they are safe. Looking in any chart either short-term or long-term you can see that treasury bonds and notes fluctuate in wide ranges most of the time.

Foreign Exchange

This should be a very interesting week in foreign exchange. The euro versus the dollar is reaching a 34 week cycle low in completing a bullish Gartley pattern at the 133 level. It has been down five weeks in a row. The British pound versus US

Dollar has been down six weeks in a row and is also forming a bullish Gartley pattern. The Japanese yen has been on a 48 week cycle low that appears to be turning. The support at 73 versus the US dollar appears to have held short-term and it could be a big surprise to market participants.

The dollar index which is the reverse of these Forex pairs has also completed an AB = CD pattern and should have strong resistance at the 80 level. These markets are much oversold and due for a correction but oversold markets sometimes get out of control so beware of the euro below 1.32 and the dollar index above 81.00

Precious Metals

Gold and silver completed major AB=CD patterns last week and gold stopped at the exact 786 of the yearly low from January. Silver completed the same pattern at the $27 per ounce level. Going below these levels would be a sign that markets are going much lower. Notice the wide ranging bar’s in this decline which is also a sign that prices can go a lot lower. Platinum is now trading at $100 discount to gold. In my opinion, this is further evidence that the industrial demand for platinum is dissipating. It is only the speculative market makers in gold and silver that are keeping these markets higher. They are an asset class just like anything else and if push comes to shove they will be liquidated during times of fear i.e. margin calls, etc. Pay particularly close attention to the Copper chart this week and notice a similarity to 2008. Below three dollars a pound suggest much lower prices in Copper and most probably another recession or possibly worse. Not trying to be a doom and gloom advocate I’m just saying that the charts on Copper in the emerging markets, Europe, and Asia are all looking very vulnerable.

Crude Oil

Crude oil is attempting to hold the $75 per barrel level but is beginning to look very weak. We started the week with a strong rally but we ended badly, closing below the 786 of the last major low. Prices in crude oil could measure below $65 a barrel should the $75 per barrel level fail. Gasoline futures are also trending lower and can very easily drop another $.20 per gallon.

Trade of the Week

The trade of the week this week will be to watch our position in TBT which is the ETF for treasury bonds. We suggested buying it last Monday and watched it rally 8% before falling back on Friday which now shows a $.25 loss. Keep the stop working below recent lows because there is still a potential for treasury bonds to make the 151 level. This will be a critical week because the market has made a slightly bearish Gartley on the hourly chart. However, going above 145 level would suggest that the 151 level is still a viable target.

Technical Corner

This week’s technical corner will focus on how to handle economic reports. It is best to wait until after the reports are made public to enter a position. A perfect example of that would be this week’s grain report that surprised most analysts stating that the bearish position in corn, wheat, and beans was the proper trend. The same thing occurred in July and yet these commodities rallied strong. We’re coming into a strong cycle low in the second week of October which corresponds to the harvesting of corn. Soybeans have been down every day but one during September. This is so unusual that it is difficult to find an example of such bearish behavior. To say these markets are over sold is an understatement. Wait until the reports are published before looking to make a position. Fear and greed are why the markets react the way they do so there’s no need to stand in front of a moving freight train i.e. economic reports.

Final Thoughts

Last week on Friday we saw the demise of one of our former great companies. Eastman Kodak has been decimated over the past years. Eastman Kodak was one of the great stocks of the 50s 60s and 70s but in recent times through mismanagement and poor planning has gone kaput. It is now trading for pennies on the dollar, down 60% on Friday alone, and facing bankruptcy. It was interesting to listen to reports on CNBC about how some major funds have made this their largest holdings since June. Just looking at a price chart would make one wonder how this could come about. During the 2000 bull market all stocks were going to triple digits and had no earnings and no sales only to be taken to the woodshed on the way to bankruptcy in 2003. Let the charts tell you where things are going. Don’t believe anyone. That includes me. Defy human nature and do the work yourself and learn how to read a chart because that will guide you through the maze of misinformation that we listen to each day. Keep in mind that during the great depression of the 30s, 17 of the 30 Dow stocks went bankrupt!