Saturday, February 25, 2012

MTU Weekend Ed. - Rolling Over (2/24/12 Close)

As the market got sandwiched between a newly minted bailout package for Greece and ECB’s LTRO next week, SP500 managed to climb “only” 0.33% this past week. Risks continue to be priced out by stocks as option premia dwindled. Odds favor the stock market to roll over, sooner than later.   Sections - (a) near term outlook, (b) long term options for the hope rally, (c) funda"mental"s.

near term outlook
An impulse wave advance since the December 2011 low (and probably since the November 2011 low) is ending based on wave structure and time considerations.

wave structure
Chart 1 shows the most probable counts on INDU. The blue count shows the market at the very late stages of wave [iii]-up since the November low where (v)-up of [iii]-up is an extended EDT. The red count shows the market wrapping up a five-wave advance since the November low, where wave [iv]-down ended on Jan 30th and wave [v]-up is a regular five.  In either case, the minimum requirement has been met based on the higher highs this past week. 

Chart 2 tackles the recent wave structure from a different angle. It counts the number of five-wave advances since the December 2011 low and highlights their channeling characteristics. The options are clear.

(a) The market is at the green wave number 9, which is logically wave [iii]-up from the November 2011 low.
(b) The market is at the purple wave number 11, which is logically wave [v]-up from the November 2011 low.
Note that options (a) and (b) coincide with the traditional wave counts on INDU as outlined in Chart 1

(c) The red wave number 10 could be in progress, which is logically wave [iv]-down from the November 2011 low.  Wave [iv]-down is tracing out a triangle or an expanded flat.

With respect to the near term, one notes from Chart 1 (INDU) that each leg of the proposed blue EDT wave (v) of [iii]-up is roughly of equal duration. This puts a turn date sometime this coming week - see the red vertical turn lines in Chart 1.

With respect to longer term prospects, we have mentioned in recent weeks that the first three phases of this Hope Rally appear to follow an interesting fib time relationship (see Turn Window (2/17/12)) .  The next turn window straddles an early March turn date which is about one week away.  Chart 3 refreshes.

longer term options for the hope rally
In addition to a potential triple-three structure for the Hope Rally highlighted in Chart 3, it's prudent to track a few more (Chart 4).  As many seasoned wavers know, it's the probabilistic rather than the predictive characteristics that count - a map of potential paths beyond the horizon.

(purple) - A large sideways triangle dating back to early 2011.  The market is wrapping up wave (B)-up. Wave (C)-down, (D)-up and (E)-down should follow to complete the stagnation around an election-year.  But the 2011 low holds.

(blue) - An expanded flat dating back to early 2011.  The market is wrapping up wave (B)-up. Wave (C)-down will breach the 2011 low.

(green) - The 2011 low completed a long and odd running flat correction.  The market is in the early to middle stages of wave [C]-up.  Expect pullbacks, but shallow to moderate ones only.

Perhaps the most uncertain and certainly the most debated aspect of this Hope Rally is whether it is the beginning of a new bull market or just a large upward correction.  The practical implication on the stock market is the uncertainty surrounding (1) whether the rally has legs or (2) whether we have a sideways range at best or (3) a eventual collapse beyond the 2008/2009 low.

As discussed above, there are likely no definitive answers, only probable "maps".

Let's take a look at one of the "maps" - how the economic recovery accompanying the Hope Rally fares with the historical norm (Chart 5).  We use BEA's reported GDP numbers as a reasonable proxy for the recovery.  Despite measurement errors and other imperfections, GDP numbers likely put corporate-earnings prospects into perspective, especially in aggregate terms and in terms of longer term trends.  

As Chart 5 shows, the Hope Rally recovery severely lags past cycle average and the gap is only widening.  Furthermore,  economic output has just barely reclaimed its pre-crisis peak and it took much longer this time than before.

While the market tends to be forward-looking and monetary policies around the world have been desperately accommodating, there's a limit to visibility and to hope. The clock is ticking before the next cyclical downturn knocks on the door.