Roast Pork

BOTTOM LINE: Collectively, Portugal, Italy, Ireland, Greece and Spain are 1.3% above important, multi-month long head and shoulders neckline support. Italy is already through that support. Medium and long-term tops are very close for most asset markets.

Below is a weighted daily chart of stock indices of Portugal, Italy, Ireland, Greece and Spain. This is a very, very bearish picture, and it will likely resolve to the downside fairly soon.

Divergences

BOTTOM LINE: Some indices took out their November highs (DJI), some are hovering around those levels, and some have retraced about 62% of last week's drop (expected), and some couldn't even manage that (Italy). On the one hand, this week is very positive, from a seasonality point of view. On the other, patterns on medium- and short-term charts appear bearish. This warrants a cautious bearish stance.

This is an hourly chart of the SP500, with projections as they were made about two weeks ago. The Monday rally to challenge November highs appears to have taken an impulsive shape, which suggests that it could be a failed fifth wave higher, as originally projected. In any case, upside is severely limited. Downside remains large.

This is a daily chart of the Italian index, and it is very weak. So far, the corrective rally retraced less than 50% of the decline last week, and thus this index is a prime candidate for a short.

PIIGS!

BOTTOM LINE: Western equity markets sold off in what appear to be impulsive waves from their November highs, suggesting that yet another top might be in. This has bearish short and medium term implications, while allowing for a brief (48 hours?) correction higher of about 2%. These corrections, if they materialise, should be sold into.

Below is a daily chart of the Italian stock market index. For a lot of reasons, I believe that it is unlikely to see 2009 year highs for a long, long time. The index is trading below the ascending trendline, in blue; it has been unable to hold above the 55 day moving average; the length of its "C" leg (from red "B" to red "C") is related to the length of the "A" leg (from red "V" to red "A").

I will use any bounce, if it happens, to increase short exposure to this index.

This is one of my favourite synthetic indices. It is a market cap weighted index of Portuguese, Italian, Irish, Greek and Spanish indices (abbreviating to "PIIGS"!). The analysis here is the same as for the Italian index, except here the patterns are even better. PIIGS account for 25% of EU GDP, and their stock market indices are going down hard.

Really Vulnerable

BOTTOM LINE: Evidence is mounting that asset markets are getting ready for some serious corrections in favour of the USD and against everything else!

EuroSTOXX50, on an hourly chart below, could still mount a ~3% rally that I believe would be final for this cycle. However, I must stress that the structure from November lows is now complete, and could very easily fall apart here.

Same applies to the SP500, shown here on an hourly chart. While a new high for 2009 would be most welcome, it doesn't have to materialise - stocks could fall from here, and patterns would still look great. Any strength into 1120 should be sold into, in my opinion.

Vulnerable

BOTTOM LINE: Risk is vulnerable on the downside.

SP500, on an hourly chart below, has followed projections well. The last leg higher is a little short, and might therefore extend for a bit, however, the risk is now very much on the [extended] downside.

DAX failure?

BOTTOM LINE: There are signs of a top in European (and specifically EURO area) equity indices.

Below is an hourly chart of the German DAX. I think chances are high that an impulse that began at the November 5316 low is very close to completion. This should result in, at the very least, a correction to that impulse, which could take us about 4-5% lower from current levels. I believe, however, that we are setting up an intermediate term top.

BOTTOM LINE: So far, equities are moving along the lines established last Wednesday. If these patterns are to play out, I expect a volatile week (it is OPEX!), as waves 4 and 5 complete. There is a chance that for European indices, waves 4 and 5 have finished.

This is an hourly chart of SP500 e-mini futures. The structure is maturing, and will soon be ready to reverse down.

Short and Caught?

BOTTOM LINE: Well, what do you know, the broader US market is at new highs for 2009. It is led by blue chips and large caps. It is held back by European indices, small and medium caps, financials and other "canary" sectors. I honestly cannot be buying here, but it is likely that we advance a few percent further, and therefore have to prepare for that.

Below is an hourly chart of SP500 e-mini futures, and I offer a bullish count. While I expect some consolidation around previous highs, it is highly likely that we see 1120 or so tested soon.

Crude Oil (on a daily chart below) will now finally get a chance to make that much needed new high above $82 (with a scope to extend as far as $86). Since peaking at $82 on 21 October, it has traced out a triangle pattern, which should resolve to the upside. I expect Oil and risk to peak together, sometime next week.

Correction higher (now even) close(er) to completion

BOTTOM LINE: Corrections higher in risk and related assets are likely very close to completion. While major US indices advanced about 1.5% higher than expected, EU indices, notably EURO area indices are moving along the expected lines. Internal structures of these indices suggest that the next leg of the decline is imminent.

Below is an hourly chart of the Italian MIB index (Italy is seventh largest country, in GDP terms - one below the UK). The MIB has been much weaker than most EURO area indices, and currently retraced just about 50% of its 11.3% decline. The internal structure of the decline and subsequent rally appears to conform very well to wave guidelines, with the correction finishing (?) with a clear impulse higher (15 minute chart below the hourly chart).

This is a very short-term, 15 minute chart of the Italian MIB.

Correction higher close to completion

BOTTOM LINE: The expected correction higher is in its final stages. Risk and related assets should turn lower today/tomorrow.

Below is a daily chart of the German DAX. The expected correction materialised, and is very likely close to completion. I now expect weakness that should at least test the Friday 30 October low. It is also highly likely that that low will be breached and we head much lower.

Fireworks

BOTTOM LINE: The minimum conditions for a correction higher in "risk" and related assets have been met. It is now highly likely that we will see substantial moves to the downside.

Below is a four hourly chart of the SP500 (futures, including GLOBEX sessions). I believe that equity markets across G10 will sell-off. It is possible that we have only just finished building the first part of a longer (in time) correction higher in risk. Under this scenario, we will see volatile, overlapping price action for a few days, followed by a final attempt at the 1060-1070 level, possibly into the end of next week. However, looking across other markets, notably FX, where the USD is set to strengthen substantially, I believe that the impending sell-off will easily take out last Friday lows, and rapidly continue lower.

Right Shoulder pt IV

BOTTOM LINE: Expected corrective strength in "risk" and related assets and corrective weakness in USD materialised. I expect these to continue into early next week, as the "right shoulder" is market on the charts. This will set up the plateau for some serious weakness into end of November and December.

Below is a daily chart of the German DAX. This index, along with most G10 equity indices, will probably correct higher for the next few days. Given the nature of the decline from the October 20 top, it is very likely that another sell-off is ahead of us, which should be at least as big in terms of price as the first one. Longer-term, it is likely that the bull market of 2009 is over, and prices will work their way towards and beyond March 2009 low.

This is a daily chart of EUR/USD. It is likely that EUR topped against USD, and will trade substantially lower into December.

This is a daily chart of Crude Oil. As I repeatedly said, I expect at least a marginal high above $82, possibly extending to $85. This will likely happen soon, and set up a plateau from which crude should decline back to at least $65. In all likelihood, this will add as additional pressure on equities, and will coincide with a strengthening USD.

Right Shoulder pt III

BOTTOM LINE: The market was very weak on Friday, unexpectedly so. This reinforces the case for a substantial shorter-term rally to ease off the oversold condition. This rally could last most of this week, and possibly into mid-next week. Action last week substantially increased the odds that a medium-term top is in. There is now a possibility that a long-term top is in as well. Should the markets rally along expected lines, a very neat "right shoulder" would be built - likely to be recognised by a greater number of market participants.

The German DAX, shown on the daily chart below, will likely rally for some time. I cannot see this rally exceed 5700, and expect it to end between 5600-5700. Similarly for the SP500, I expect the topping range to be between 1055 and 1070.

A rally in risk and related assets will likely coincide with about a 10% rally in crude oil. If oil were to top around current levels, without making at least a new high above $82 (2009 high), it would look unfinished and "strange" on the charts... much like I thought stock markets would look had they topped in late September.

Cycles in ISM PMI

I would like to share some ideas that I have been following for a while and lately modelled developed myself on the cyclical nature of oscillations in the Purchasing Managers' Index, measured and published by the Institute of Supply Management in the US. While this will be the main point of the post, I will briefly give some background to the study of cycles in Economic activity.

It is of course known that the business cycle influences just about everything in the economy. Mainstream economics primarily focuses on inventory cycles and frequently accompanying cycles in monetary policy. These usually last no longer than 3-5 years. However, mainstream economics tends to ignore fairly apparent cycles that span decades. Brian Berry described and analysed roughly 30 year cycles in US economic activity, centred around infrastructure investments and capital stock replacement. For more information, please refer to his brilliant book (Long-wave Rhythms in Economic Development and Political Behaviour, 1991). In the future, I will aim to write up a brief introduction into his work and illustrate with examples by analysing roughly 30 year cycles in US Industrial Production (IP). For now, I will just say that there is some evidence that a 30 year Berry cycle finished with a collapse in US IP into June 2009. A new 30 year Berry cycle has thus likely begun, and will be most similar (again, for reasons which I will aim to elucidate in the future) to the 1921-1946 cycle. Note that the cycle that has just begun will be most similar to the one that spanned the Great Depression and the second World War. If this analysis is correct (and it was very useful to predict both the downswing in 2000, upswing in 2003 and the most recent collapse), then we can expect an early peak in US IP, likely around 2012, followed by bleak "teens".

Now on to the ISM PMI.

First, the charts. As mentioned above, I see US economic activity unfolding in cycles roughly 30 years in length. The most recent cycles are 1980-2009 and 1946-1980. These cycles are clearly evident in US IP data and in ISM figures (chart 1)

Chart 1: ISM PMI 1946-present

The chart presents two complete time series: ISM PMI levels from 1946 to 1980 in red and 1980 to 2008/9 in blue. Major peaks and troughs are clearly aligned. The last drop in the blue line came earlier than expected, but was well telegraphed by IP charts and other indicators. What is important now is that the very sharp rise in the index since December 2008 (shown in green on the far left of the chart - the third and incomplete time series) probably signals the start of the new cycle.

Interestingly, the cycles above can each be divided into three roughly equal (in time) parts, of about 10 years each. It makes most sense to compare like with like, so I will compare the 10 year cycles that began their respective 30 year cycles. However, comparing 10 year cycles that are in the middle of the longer cycle with each other or even with other 10 year cycles (placed elsewhere in the longer cycle) yields similar results - major peaks and troughs overlap.

Chart 2: ISM PMI (selected) 10 year cycles

Chart 2 shows three complete time series of ISM PMI: 1946-1958, 1980-1991 and 1991-2001. It also shows the incomplete cycle that began in December 2008. It is again clear that major peaks and troughs align across the cycles. What is of note is that cycles that begin their respective higher order (30 year) cycles, such as the 1946-1958 and 1980-1991 cycles experience deeper retracements to the initial surge off the cycle low, compared to the 1991-2001 cycle (which is in the middle of its higher-order 30 year cycle).

According to the cyclicality thus established and demonstrated, we can expect either protracted stalling of ISM PMI around current levels (basically, hovering around 50) for the next 12-15 months or, with higher probability, a rather deep retracement, possibly as far down as low 40s or high 30s. Needless to say, this will be a very big surprise to risk and related markets, which are priced for a rather ambitious 3.5% or so growth for 2010. Again, if the economy proceeds to develop along the lines that are typical, we should expect the ISM PMI to drop into late 2010, and then rise into mid 2012. After that, we should have anaemic "teens".

In summary, we can expect continuous weakness in the ISM PMI from now on, for at least 12 months.

I hope this was enjoyable, informative and clear.

If you have any questions, please write to me.

Thank you and have a great week,

Aidyn.