Global Markets, Economies Mired in Early Stages of Biggest Disaster Ever

Global Markets, Economies Mired in Early Stages of Biggest Disaster Ever

By Elliott Wave International

The following is a sample from Elliott Wave International's new 40-page report, The State of the Global Markets -- 2013 Edition: The Most Important Investment Report You'll Read This Year. This article was originally published in Robert Prechter's September 2012 Elliott Wave Theorist.

Global markets and economies are mired in the early stages of the biggest disaster ever. Most people think both areas are in the early stages of a prolonged recovery, but in fact they are on the cusp of the second downturn, which will be of epic proportion.

The world is in the grip of a bear market. You wouldn’t know it from watching the S&P and the NASDAQ, but just about every other major market average in the world has been falling, including those of China, Japan, Europe, the BRICs, emerging markets, and even the broad U.S. market, shown in the chart below. And these indexes have fallen far further in inflation-adjusted terms.

Global-equity hedge funds, run by the smartest people in the business, have lost money for clients over the past 10 years. According to Income Research & Management and Bloomberg, over that time annual five-year returns have been up for two years, flat (0.0-0.8% gain) for three years, and negative for five years.

Our recommended short position in 2007-2009 gives us a positive five-year stock market experience. But we returned to a bearish stance too early. If we lived in China, our timing would have caught the exact top of the rally; if we lived in Europe, our current trade would be at a profit, too; but we don’t live in China or Europe. Only in the U.S. does the levitation continue, and even then it’s only in the blue-chip averages. The broad U.S. market, comprising all NYSE stocks, topped out nearly a year and a half ago, per the New York Composite Index shown at the bottom of the chart.

Market perversity is on display here, as both bulls and bears are suffering their own special water torture.

Many bullish fund managers have lost money since April 2011, because their portfolios tend to mirror the broad market. Garrett Jones reminded us that the most-owned stocks among institutions are down by a full one-third since 2000, as shown by the Institutional Index, a capitalization-weighted index of the 75 most-owned stocks by institutions (see the figure inside the State of the Global Markets report). Yet aggressive bears who shorted the S&P or NASDAQ have lost money, too, since the futures-related markets have risen.

It seems pertinent that only the indexes that one can leverage in quantity with futures -- the S&P and NASDAQ -- have risen over the past several months. Maybe this selectivity is for technical reasons, but there might be another explanation. Institutions, not the public, have driven the rally, and they can borrow billions of dollars from banks to leverage their bets. The divergent action among the indexes suspiciously fits the circumstance that major investment banks can make a lot of money by buying futures and then committing their own and clients’ funds to buying stocks that push up those particular underlying indexes. They could even sell other stocks to make it happen. Employing that strategy would account for the big differences in the averages over the past half-year. The low volume and volatility help serve up the opportunity. When the current plateau of optimism ends, the indexes now leading on the upside will catch up quickly on the way down. But in the meantime it’s an annoying situation, as momentum-based sell signals are flashing continually but the market has yet to succumb.

Adding to the injury is that fact that all of these indexes have been re-priced higher in dollar terms due to the temporary re-expansion of dollar-based credits since 2009. A chart on page 7 of The State of the Global Markets report shows the real path of stock values.

Most people seem to believe that the Fed has engineered the stock market rally. I also keep reading about how ECB President Mario Draghi is making stock markets go up by announcing bond purchases. This is wrong. As shown in the chart above, European stocks are below their highest level since the ECB bond-buying programs began. Likewise the largest debt-buying program the Fed ever undertook -- a $1.3 trillion binge -- occurred in 2008, and it failed to prevent the biggest bear market since 1932. The bear market ended three months after the Fed stopped the program. The Fed and the ECB are not the primary cause of optimism or rising stock prices. The rally was due for natural reasons, i.e., a swing toward more positive social mood, which our market forecasting publications anticipated. But QEs and other policies do provide big institutions with nearly unlimited credit, allowing them in optimistic times to put it to use. Doing so temporarily elevates prices beyond what they would be if unlimited credit weren’t available.

Optimism is necessary to allow the Fed and its banks to create credit for financial speculation, which keeps the market levitating. Conversely, when pessimism returns -- as it soon will -- the reduction of leverage will add to selling pressures.

Robert Prechter is the founder and president of Elliott Wave International, the world's largest financial forecasting firm. The rest of EWI's 40-page report, The State of the Global Markets -- 2013 Edition: The Most Important Investment Report You'll Read This Year, is available for download. Follow this link to download the full report – for free.

Two Signs That Deflation Is Far From Over

Two Signs That Deflation is Far From Over
A key economic index turns south

By Elliott Wave International

The federal government defines the Producer Price Index (PPI) as "the average change over time in the selling prices received by domestic producers for their output."

With help from the Federal Reserve's massive inflationary policies, the PPI has climbed even as the economy began to fall in 2008-09.

All the while, the financial media persisted with stories of an economic recovery. EWI analysts offer an independent perspective.

The New York Times declares, "Economic Gloom Starting to Lift."

Corporate America, however, is not so sure. This chart of producer prices [wave labels removed] probably illustrates why. After years of largely uninterrupted growth, the Producer Price Index appears to be on the cusp of a critical reversal that should turn into a steady decline in wholesale prices.

The latest Financial Forecast published Dec. 7, and the latest evidence reinforces the message of the chart's title. The PPI elevator has already descended to a lower floor.

The Labor Department said its seasonally adjusted producer price index slipped 0.8 percent last month, the second straight decline.

November's drop in wholesale prices was the sharpest since May.

Reuters, Dec. 13

The Producer Price Index decline is happening in tandem with a notable reversal in consumer sentiment.

The Thomson Reuters/University of Michigan's preliminary reading of the overall index on consumer sentiment plunged to 74.5 in early December, the lowest level since August.

It was far below November's figure of 82.7.

Reuters, Dec. 7

The Federal Reserve's machinations -- which includes the Dec. 12 announcement of $45-billion in monthly Treasury bond purchases -- will not stave off a developing deflationary trend.

In the second edition of Conquer the Crash (p. 114), Robert Prechter describes what generally happens, depending on the position of the Elliott waves, near the end of the Kondratieff cycle.

Near the end of the cycle, the rates of change in business activity and inflation slip to zero. When they fall below zero, deflation is in force. As liquidity contracts, commodity prices fall more rapidly, and prices for stocks, wages and wholesale and retail goods join in the decline. When deflation ends and prices reach bottom, the cycle begins again.

Can the Fed stop deflation? Should you rely on the government to protect you? Get the answers you need now -- free! See below for full details.

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This article was syndicated by Elliott Wave International and was originally published under the headline Two Signs That Deflation is Far From Over. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

[Video] Bollinger Band Basics

[Video] Bollinger Band Basics
Senior Analyst Jeffrey Kennedy shows you how these volatility indicators support pattern recognition

By Elliott Wave International

As a technical trader, are you able to view financial market fluctuations clearly and reliably?

At Elliott Wave International, we hold that the Elliott Wave Principle is the most effective tool for analysis. Yet the Wave Principle works well with other technical tools. If you are ready to trade with Elliott, our educational subscription editor Jeffrey Kennedy can teach you how to integrate ancillary technical indicators -- such as Bollinger bands -- to build high-confidence setups in the markets you trade.

Bollinger bands identify periods of increased and decreased market volatility. Learn about the significance of these fluctuations in this video about Bank of America Corp. (BAC) taken from Jeffrey's Elliott Wave Junctures service:

Here are Jeffrey's notes from the lesson:

Bollinger bands form a two-period standard deviation channel based on a 20-period simple moving average. This channel will contain 95% of all price action with the moving average acting as a center line, which often provides support and resistance. The width of the Bollinger bands increases and decreases with market volatility.
Narrow Bollinger bands coincide with low market volatility, which often leads to big price moves. Option traders like this because option prices are low at this time. Conversely, wide bands imply that market volatility is high, which translates into expensive options.
The recent narrowing of the Bollinger bands in BAC signals decreasing volatility. Since periods of low volatility precede periods of high volatility, look for a big move in the days to come.

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The Secret Word: Deflation - And the Next Five Years of Financial Turmoil

The Secret Word: Deflation - And the Next Five Years of Financial Turmoil

By Elliott Wave International

The following is a sample from Elliott Wave International's new 40-page report, The State of the Global Markets - 2013 Edition: The Most Important Investment Report You'll Read This Year. This article was originally published in Robert Prechter's July 2012 Elliott Wave Theorist.

In the first five months of 2012, there were 20 times as many Google searches on "inflation" as there were on "deflation." This is down from a ratio of 50 times in June 2008. If any theme has been overdone over the past six years, it is the theme of inevitable inflation if not hyperinflation.

Inflation reigned for 75 years, from 1933 to 2008. People are so used to it that they cannot imagine the opposite monetary environment. Bullish economists have been calling for recovery, which means more inflation, and bearish advisors have been calling for a crash in the dollar, which means hyperinflation. No wonder those are the terms on which most people have been searching.

But only one word allows you to make sense of what's going on in the world, and inflation is not it. The secret word is deflation.

Deflation explains:

• why interest rates on highly rated bonds are at their lowest levels in the history of the country;
• why the velocity of money is the lowest since the 1930s;
• why huge sectors among investment markets are down over 40%;
• why the Consumer Price Index (CPI) just had its biggest down month since 2008;
• why Europe is in turmoil.

Here are some details: Ten-year Treasury notes pay out less than 1.5% annually, their lowest rate since the founding of the Republic. Treasury bills yield essentially zero, their lowest level ever. The velocity of money failed to rise during the past three years of partial economic recovery, and it recently made new lows. Real estate prices have fallen 45% in the past six years. Commodity prices -- as measured by the CRB Index -- are down 39% over four years. This group includes oil and silver, two of the most hyped investments of the past decade. Remember in March when articles quoted analysts calling for $5, $6 and $8-per-gallon gasoline? In just three months since then, gas prices have fallen 15%, knocking the CPI into negative territory.

Deflation also explains why European loans are at risk, why Germany is tapped out, why Greeks are protesting in the streets, and why U.S. corporations' overseas profits are down. Deflation lets you make sense of the world.

What is deflation? Economists define it three different ways, but I find only one definition useful: Deflation is a contraction in the overall supply of money and credit.

Why must deflation occur? Answer: There is too much unpayable debt in the world.

As argued in Conquer the Crash, it ultimately does not matter what the authorities do; they can't stop deflation. This prediction is being borne out. Since 2007, the Fed has monetized $2 trillion worth of debt; the federal government has borrowed another $7 trillion; and it has pumped out $1 trillion worth of student-loan credit. Yet real estate and commodities slumped 40% anyway.

These drunken-sailor-type policies have indeed succeeded in nearly maintaining the overall volume of money and credit. But in the long run you can't fight a systemic debt overload by piling on more debt. The Fed and the government are shifting the burden of trillions of dollars' worth of debt obligations from reckless creditors onto innocent savers and hapless taxpayers. The ploy might work if the public's resources were infinite, but they aren't. Perhaps this policy temporarily prevented a series of big institutional disasters, but it was only at the ultimate price of a gigantic public disaster.

Such actions have become politically less palatable. Some observers realize that the student-loan program of lending at below-market rates is exactly the model the government used for housing loans, which ended in a spectacular bust. Others know that the government cannot continue to borrow at the current pace and expect to stay solvent. Politicians on both sides of the aisle are tired of the Fed's bailing out of highly leveraged financial-speculation institutions. But whether these policies continue or are curtailed is irrelevant to the outcome. If the government slows its borrowing, the overall value of debt will fall. If the government maintains or increases its present pace of borrowing, interest rates will eventually turn up, and the overall value of debt will fall. There is no escape from deflation.

Ironically, investors in the past decade have been doing exactly the opposite of preparing for deflation. Convinced of perpetually rising prices, they have bought every major investment. They chased real estate up to a peak in 2006. They bought blue chip stocks into the high of 2007. They pushed commodities up to a peak in 2008. They chased gold and silver up to highs in 2011. And through spring 2012, they continued to buy stocks and commodities on any rumor that promised inflation: European bank bailouts, Operation Twist, the Greek election, Group-of-8 summits, Fed meetings, Bernanke press conferences, improved economic numbers, predictions of QE3, central-bank interest-rate cuts, you name it. Meanwhile, the U.S. Dollar Index hasn't made a new low for four years. During deflationary times, cash is king, and by far most investors have chosen to own anything but cash.

Deflation is still not obvious to the majority. Even now, most economists expect continued recovery, mild inflation and a rising stock market. But the essays on deflation.com are 180 degrees apart from conventional thinking. It may be too late for you to get out at the top, but there's still time to learn how to sidestep the worst of the crunch.

People will be using the secret "d" word much more often over the next five years. By the end of that time, they will also be using its cousin "d" word, depression.

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Robert Prechter is the founder and president of Elliott Wave International, the world's largest financial forecasting firm. The rest of EWI's 40-page report, The State of the Global Markets - 2013 Edition: The Most Important Investment Report You'll Read This Year, is available for download. Follow this link to download the full report - for free.

This article was syndicated by Elliott Wave International and was originally published under the headline . EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Risk Management for Technical Traders [Interview Excerpt]

Risk Management for Technical Traders [Interview Excerpt]
Tips from EWI Senior Analyst Jeffrey Kennedy's Stocks and Commodities interview

By Elliott Wave International

If you trade with Elliott wave analysis, your trading decisions are all about the difference between where the market is vs. where it will be. According to Jeffrey Kennedy, editor of our Elliott Wave Junctures service, risk management skills are vital to being a successful technical trader.

Here's what Jeff had to say in a recent interview:

Risk management is all about consistency. It is all about longevity. It is like going back to the story about the tortoise and the hare. You want slow or small consistent profits...

Being an analyst and trader involves two totally separate skill sets. As an analyst, you are a master of observation. You are focusing on what could happen. As a trader, your primary focus is on what is happening. Regardless of whether you think the market's about to top, if the trend is up, as a trader, you've got to play it. Divergence is a great example of what I am referring to.

As an analyst, if I am looking at a momentum tool, and I see divergence, well, that is suggestive of market weakness. As a trader I have to focus on what is happening, not what could happen.

If I see the daily trend is up, I have to buy the market. How do I resign myself to the fact that I have divergence, which means a decrease in momentum, a possible weakness, and a possible trend change? I have to focus on what is happening as a trader and the trend is up. How do I reconcile that?

This is where risk management comes into play. For example, you are allowed to play the buy side to the tune of $100,000. If you are seeing divergence begin to enter the market, you may say to yourself, "I have to trade the trend, and the trend is up, but because of this divergence, I am not going to go all in." ... [and] you have to have a very tight stop on the position.

... That is how risk management comes into play, and how you focus on what is happening and reconcile what is happening as a trader. But you also have to take into consideration what could happen when you are wearing your analytical hat and see that potential for divergence because there are markets I have seen where the divergence continues for six months. Analysts trade what could happen, whereas traders trade what is happening.

Effective risk management is indispensable to successful trading. Ultimately it doesn't matter how accurately you spot divergence or label your waves if you risk too much on your trades.

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This article was syndicated by Elliott Wave International and was originally published under the headline Risk Management for Technical Traders [Interview Excerpt]. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.