Market Update 04.10

Continuation to the downside in equity, commodity and foreign currency markets as the total decline now exceeds the late October selloff in both duration and degree. Market character was very bearish all week, as large cap indices trended down, making a series of lower highs and lower lows. The Nasdaq, Semiconductors, Transports and Small Caps all underperformed the broader market.

The fall has occurred in conjunction with the start of earnings season. So one would be led to believe that earnings have been very poor. They would be wrong. From CNBC:

Of the 220 (~44%) S&P 500 companies who have reported Q4 results, 78% beat estimates, 8% were in-line, and 14% were below estimates.

Even optimistic earnings expectations have been surpassed, yet the market has "sold the news" apparently. Or perhaps it was just going to fall anyway and people have thus ignored earnings and focused on other perceived "catalysts." This has most noticeably been the case in the large-cap tech sector with GOOG, AAPL, QCOM among others beating expectations, but being sold in the aftermarket and experiencing a continuation of that selling in subsequent days. This is the "change in market character" that I have been awaiting for numerous months now.

Two quarters ago, I mentioned that the boost in earnings was, in many cases, merely a reflection of cost cutting, inventory restocking and increased productivity from employers terrified of losing their jobs. I argued that without a recovery in consumer balance sheets, employment, capacity utilization and private fixed investment, the recovery in corporate profits would prove temporary.



The above chart includes preliminary estimates for private fixed investment in Q4. Nothing too spectacular. So I am wondering if analysts are starting to look out a few quarters, knowing that the temporary boosts will have worn off, and seeing that recovering to trend growth is going to be a very difficult task...?

The moment said analysts look away from their mathematical models, which naturally forecast a recovery to trend growth as a given, is the moment they start to rethink the assumptions they have made. And when they do that, present equity valuations simply do not make sense - especially at the point of the business cycle they believe we are in (trough).

Looking at this socionomically (ie. a Prechterian PoV), it all makes a lot of sense. We have people switching from interpreting every piece of information as a positive to now questioning those interpretations, while increasing public anger toward public officials and bankers is growing rapidly. (See the continuous revelations of the AIG-NY Fed-Goldman dealings). At the same time, we are seeing strongly impulsive moves down in the stock market, while corrections are occurring in sharp, overlapping waves, and often peaking in the futures market overnight before selling-off toward the open. If a "P3" move down is going to happen as Elliott Wave Theory seems to strongly suggest, then this is precisely the type of environment one would expect.

Staying on the Elliott Wave theme, I should note that it is not always the best tool to use. I find that if the pattern cannot be immediately identified as obvious, then other TA methods should be used instead. But if I look at a pattern and see the waves immediately, I lend a much larger weight to their validity. Take for example a multi-year chart of the USD Index. The dollar completed a very evident 5 waves up during in '08, followed by a 3 wave decline in '09, and has now turned up quite violently. If a 3rd wave up is what's coming, it should be sharper and longer than the previous up wave. And this is precisely how one would expect it to begin. I've been calling for par with the Euro for a couple of years now. The chart below suggests that is what we'll see.



Let us not forget the carry trade that was a popular idea a few months ago, but seems to be forgotten right now. Those that are losing money on the stock market selloff are in many cases also losing on the currency side. With emerging markets selling off over 10% and the US Dollar higher by 7%, the pain is being felt more than a 6.7% S&P correction would otherwise indicate.

The Volatility index moved sharply higher last week, but sold off without a corresponding recovery in stock prices. This demonstrates complacency among options traders and could require them to panic and cover their bets should the divergence persist much longer.



Lastly, this is a chart of the percentage of stocks above their 200 day moving average. Notice that this is the type of indicator that moves in long waves, oscillating between many above and then many below. Further correction should be forthcoming.



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