Friday, October 28, 2011

MTU Weekend Ed. - Points of Recognition (10/28/11)

Stocks, Points of Recognition
The conclusion reached in Chicka Chicka Boom Boom (10/21/11) that “odds favor a zigzag rebound or the bottom being in place” is consistent with the subsequent price action. Stocks surged globally on news of the latest deal on European debt crisis, with SP500 up 3.78% over the past week and for a fourth straight week.

Whether the October rally is a rebound against the decline since May or the beginning of a fresh leg of the Hope Rally remains to be seen (Chart 1). Nevertheless, here are some relevant observations under the bearish and bullish interpretations.

Under the bearish interpretation …
The rebound in SPX to date is well described by a simple but powerful zigzag, a structure and accompanying personality that suites a 2nd wave rebound. There are potential challenges:

(a) The surge over the past week may be too strong to suit a terminal wave (i.e. C-up of (2)-up).
(b) The proposed wave (2) rebound may be too short relative to the sell-off from the top (i.e. 1 month vs 5 months).
(c) NDX has almost retraced to the maximum and is about to breakout to a new recovery high. It’s possible that NDX is on a different wave count, but a difference of 6 months (and potentially longer) in topping dates is probably too generous. Note that NDX and SPX topped in 2000 within three months.
(d) DAX, a key European benchmark, may be wrapping up only the first wave of its rebound (Chart 2).

So if the bearish count is playing out, it's prudent to leave room for a double zigzag or a complex three wave (2)/(B) rebound. In other words, for strategic bearish positions, it’s prudent to maintain wide stops and size accordingly following the next reversal.

Under the bullish interpretation …
All is well as a potential (small-degree) point of recognition (say, [iii] of 1 of (A)) is being made, except for the visual five-wave decline since the May top. If a new recovery high does materialize, a way out of the dilemma without damaging the existing EWP is a complex three since the Feb high or a simple ABC since the early July high as outlined many times in recent weekly commentaries.

Bond, Rhythmic Bond

Following a decent-size sell-off in Treasuries accompanying the early hope rally in stocks, Treasury yields eventually managed to reverse course and dip below their 2007-2009 financial crisis lows, across the curve. Bonds have benefited directly through outright purchases from the Fed and indirectly through yield-chasing bids as a result of persistent quantitative easing policies. From time to time, Treasuries also got a favorable push from flight-to-quality (printing press) bids away from European sovereign debts, the drama over the U.S. debt-ceiling debate and the downgrade of U.S. by S&P notwithstanding.
The continuation of the bull market in bonds and particularly the recent new lows in yields have revealed a rhythmic / fractal-like wave structure that nicely captures the bullish move since the early 1980’s (Chart 3).
The proposed wave structure describes the bull market in bond prices since the early 1980’s as a complex three: double zigzag – triangle – double zigzag – triangle – double zigzag. A secular bear market in bonds is within sight based on this structure. If this is the case, the Fed’s stated intention to maintain its ZIRP policy till at least mid-2013 may turn out to be complacent with respect to its ability to either maintain price stability or manage the bond bubble. Also, it is not clear that falling bond prices will be reflationary and stock friendly per se in an environment where investors focus on sovereign debt bubbles and fiscal sustainability.