Tuesday, August 2, 2011

MTU Special Ed. - Revelations (8/2/11 Close)

Stocks - reassessing probabilities
Today's sell-off pushed several key benchmark indexes below their June lows AND March lows in several cases. The market also closed below its MA200.

This development makes it necessary to award the top count to a W-X-Y structure discussed in Reading the Impasse (7/29/11). As discussed there, this development ought to raise the probability of a fresh round of monetary policy stimulus (e.g. QE 3, see below). Note that fiscal policy stimulus is probably out of the question in the near term after the heated debt-ceiling struggle.

Chart 1 shows the updated W-X-Y structure, with three tracking counts under this interpretation, in light of a bunch of visual "threes" over the past few months.
(blue) wave (Y)-down is a regular five, completing a flat-like large structure since the Feb top
(green) wave (Y) down is a thrust out of a multi-month triangle (X) wave dating back to the March low.
(purple) wave (Y) is an EDT originating from the May high.

Stocks - interesting divergence
Despite the bearish sentiment and price action, the supposedly higher-beta Nasdaq indexes are not close to their March lows, yet.

In addition, VIX is barely budging in the face of a 2+% down day. Of course, there are theoretical considerations to justify low levels in VIX at the moment, but one finds psychological justifications lacking. Is it complacency? Or is QE3 front-running about to commence? Chart 2 presents a bearish count for VIX if this is the case.

Monetary policy stimulus - QE3
History suggests that QE is not motivated to keep bond yields at low levels or push them even lower. Note that bond yields in fact had risen meaningfully following in QE1 and QE2. Put it in another way, the Fed will not necessarily be shy of initiating QE3 when bond yields are low - the opposite is the case, theoretically and psychologically. The FOMC meets next week.

More interestingly, as Chart 3 indicates, 10-year Treasury yields are approaching the QE zone at the moment.

In addition, the QE fractal in the Russell 2000 index has been tracking nearly perfectly (Chart 4), with the exception of breaking it June low today.

Chart 5 (to the right) updates the Triple Zigzag Version of the hope rally, a count highlighted in QE Fractal and Projection (5/27/11) . This is a trajectory that is likely accompanied by form of additional stimulus.

No guarantees, but something to monitor.