Emerging Markets Bashing, Sending Warnings Of Bear Market.

Bear markets begin when something fundamental breaks. Usually the sector initially affected will roll over before the general market and tends to be a warning sign of what lies ahead.

The last bear market was triggered when the credit bubble created by Alan Greenspan's foolish monetary policy burst. It was exacerbated by Ben Bernanke's foolish attempt to debase the currency and reflate the bubble. All he succeeded in doing was to inflate oil to $147, which put the finishing touches on an already crumbling economy.

The market gave us a warning when the financials began to diverge from the rest of the market. Considering that the banks were one of the leading sectors during the '02-'07 bull the fact that they couldn't follow the rest of the market to new highs after the February '07 correction was a big red flag that the bull was on its last legs.

I've been saying for more than a year now that the unintended consequences of quantitative easing would be to spike inflation, which in turn would poison the global economy. I knew all along that Bernanke was never going to create any jobs by printing money and of course he hasn't.

So if inflation is going to sink the economy and kill the stock market we should see warning signs from the sectors most affected by rising inflationary pressures, just like the banks warned us in '07 that the fundamentals were broken.

Sure enough I think we are starting to see those warning signs.

Emerging markets have been hit hard by food inflation. We are now seeing food riots in many third-world countries. Emerging markets, just like financials during the last bull, were one of the leading sectors. The iShares MSCI Emerging Markets Index (EEM) is now starting to diverge from the rest of the global stock markets. It's now on the verge of breaking back below the November cycle low.

The other sector that is extremely sensitive to inflation is the transports. When energy costs spike, shipping companies' profit margins are squeezed. The last two days have seen the Dow Transports fold under the pressure of surging oil prices. Keep in mind oil is only on the 17th day of its intermediate cycle. That cycle lasts on average 50 to 70 days. I think we are going to see $5 gasoline by the time the dollar collapses into its three-year cycle low later this first quarter.

If the market can recover from the recent correction and make new highs I don't expect the transports will be able to follow. That will set up a Dow Theory non-confirmation and most bear markets begin with a Dow Theory non-confirmation.

China is already in a bear market. I think most emerging markets have probably topped and I doubt the rest of the global markets have more than two or three months left before the next leg down in the secular bear market begins.

I think the brief party created by Bernanke's printing press is about to come to an end.

The Asset Class to Avoid.

Whats the worst asset class to invest in right now?

Research suggests the asset class that offers the poorest long-term returns from today’s valuation levels is commodities.

Historically, commodities have generated astonishingly low returns. Based on the Foundation for the Study of Cycles data, from 1264 to 2010 commodities went up 0.70% on an annualized basis. That is rather unattractive.

Using data obtained from measuringworth.com spliced with modern day US CPI figures, over the same time period inflation increased by 0.75%.

After looking at different data sets for inflation indices and commodities over different time periods (spanning centuries in some cases), a pattern begins to emerge. When viewed over very long periods of time, there is a very high correlation between commodities prices and inflation indices.

Perhaps this is not so surprising when one considers that the commodities are a significant component of inflation indices. However, it is always nice to run the data and observe the actual correlation. It is real.

Now this may sound like a rather elementary deduction. But understanding this seemingly simple phenomenon is the key to unlocking the mystery of the commodity cycle.

The commodity cycle is as follows: Commodities do not do much for a long time. Then there is a fantastic spike up for a number of years. Then there is a crash. Lather, rinse and repeat.

What causes these spikes?

The most dramatic catalyst for commodity spikes occurs when a country takes itself off the gold standard. This occurred in the US Civil War, in 1933 when FDR took the United States off of the gold standard on a domestic basis and in 1971 when Nixon cut the final ties to the gold standard on an international basis.

Commodity spikes also often occur when a country runs big deficits. This almost invariably occurs during wars. Since 1900, there have been nine years when the deficit/GDP was above 9%. All were during times of war. All had commodity spikes. The quintessential example of this would be the World War I commodity spike. The most recent nine-year spike would also fit into this category. The US also had big deficits in the Civil War and World War II which contributed to those commodity spikes in addition to being taken off the gold standard which produced a “double whammy” effect.

What causes the crashes?

The high profit margins (due to the spike in prices) attract competition. Competition causes overproduction. Overproduction causes crashes. Eg . like what had happened to Tin prices in the 70s!

Another reason why commodities are poor investments is they have no yield. Actually with storage costs and security costs they have negative yield. This stands in marked contrast to pretty much almost all other asset classes which provide some sort of return on investment.

So after reading all this why would anybody ever buy commodities at all?

Well this is a good question. You can do just fine if you avoid commodities entirely for the rest of your life. However, one can argue you may do even better by keeping all your options open and wait for a time when commodities are poised for a big run.

This begs the question: How do you tell when commodities are dramatically undervalued? While the question is simple, the answer is complicated. The main problem, once again, is commodities have no yield, which makes it difficult to compare them to other asset classes. However, perhaps the mere fact that it is difficult to value commodities because they have no yield is telling you something. Moving forward, another valuation alternative is comparing ratios. This also presents issues as well because the ratios between other asset classes and commodities exhibit a secular upward creep. That is because most asset classes outperform inflation and therefore commodities. This makes timely buy and sell signals by this method impossible in most instances.

There are actually some ways of figuring out when it is a good time to buy commodities for a secular buy and hold strategy. A pretty good time to take a look at commodities is when they have been in a bear market for many years. Since the US was founded, commodity bears have lasted 11-33 years. Another good buy indicator is a lack of investment demand.

Clearly the current situation does not fit either of the above criteria at all. Rather than wasting time trying to figure out whether or not one should still be buying commodities, perhaps people should focus their efforts on figuring out if this is a good time to sell. As mentioned earlier, a telltale sign of the end of a commodity bull is a spike. History says you don’t want to buy them after a nine-year spike such as what we just had. While it is possible that the spike can go higher and longer, the laws of probability simply are not in your favor at this point.

In every instance without exception over the last three quarters of a millennium, if you had bought commodities when they had at least a 176% rally over the last nine years, you had extremely unattractive returns over the next 13-50 years.

1613-1622: Up 254%. Commodities went immediately into a 50-year 78% bear market.

1938-1947: Up 240%. Commodities went down 16% in 1948, 19% in 1949, up 58% in 1950 and peaked in February 1951. Then they had a 37% 18-year bear market. Therefore, in the quarter century after 1947 the upside was 12% (early 1951) and the downside was 32% (August 1968).

2001-2010: Up 238%. (???)

1910-1919: Up 202%. Commodities went immediately into a 13-year 66% bear market.

1971-1980: Up 198%. Commodities went immediately into a 19-year 45% bear market.

In all four prior instances since 1264 when commodities went up 176% in nine years, they went down the next year AND the year after that. If history repeats commodities will go down in 2011 and 2012. I am shorting the CPO big-time, @ RM3900/MT!

Egypt, And Its Ramifications On Global Oil Supplies.

Before the Egyptian revolution,I thought that if successful, it could spawn similar uprisings in oil-exporting countries.So far, it appears to have been successful. And it has heartened groups fighting for democracy in other lands. And now, following uprisings there and in Tunisia, we hear of growing unrest in Algeria, Iran, Jordan, Libya, Morocco, Saudi Arabia and Yemen.

The situation has become so troubling that Obama dispatched his most senior military officer "to discuss the events in Egypt, convey best wishes from Obama and welcome Abdullah's "recent reaffirmation of Jordan's ambitious modernization agenda". That must have been an interesting discussion -- like what was said about whether or not the US military would help or hinder an overthrow of the monarchy.

But all of this warrants another examination of where the wave of democracy might lead and its impact on global oil supplies.

The Wave of Democracy

Let us now look again at the major oil exporters and where further uprisings might occur. In Table 1, listed the 24 leading oil exportersalong with their freedom status as judged by Freedom House. Of those 24, I view only Russia, Canada, Norway, Mexico and Argentina as likely to be free of any political disturbances moving forward. That leaves 82% of the oil exports of the countries listed at some risk. And unlike Egypt and Tunisia, major disturbances in any of these countries could cause an immediate spike in global oil prices.

Oil Dependencies

What countries are at greatest risk if there is "an oil supply disruption"? Table 2 is relevant here. It lists the top 20 countries in terms of oil imports. It also indicates what percentage of global oil traded they import along with what percentage of domestic consumption comes from imports.

Political leaders of all countries will do whatever is needed to insure oil supplies for their citizens.

Investment Implications

Looking at Table 1, it is highly likely there will be one or more serious disruptions in the next 12 months causing a super oil-spike. In light of this, risk oriented imvestors should have some form of oil hedge in their portfolios.

Correction? - Minimum 5%.

Is it getting better....?
Or do you feel the same...? - U2.

The relevance of trading with time and cycle may alone be less accurate than forecast with price; however its relevance increases as forecasted times approach, price patterns and momentum wanes showing signs of reversal.

When taken together, time/price harmonics have accurately predicted significant market turning points.

Numbers don’t mean anything until they turn the market, but numbers, not fundamentals, turn the market. It was not the fundamentals that turned the market in March 2009.

One of W.D. Gann’s major methods for market timing was to use fractions of a circle, specifically into quarters, eighths, and thirds, to count the number of days, weeks, and months between highs and lows.

For example, the circle has 360 degrees, 90 is one-quarter, 45 is one-eighth.

Rounding, one-eighth of 90 is 11, two-eighths is 22, three-eighths is 33, and four-eights is 45.

W.D. Gann was the greatest student and researcher of the market ever but he was very secretive about what he revealed and how he revealed it. He never chose his words without a distinct reason.

For example, one of Gann’s books was called 45 Years in Wall Street. Note that the title was not 45 Years on Wall Street, but in Wall Street.

The book was not about his career on Wall Street but about a cycle on Wall Street.

As well as regular cycles, there are random fluctuations in things too. The random occurrences can camouflage the periodicity of cycles and also generate what appear to be new, smaller cycles… which they may not be. This is one of the problems with market-timing signals.

In addition, many things act as if they are influenced simultaneously by several different rhythmic influences, the composite effect of which is not regular at all.

Cycles may have been present in the figures you have been studying merely by chance. The ups and downs you have noticed, which come at more or less regular intervals, may have just happened to come that way. The regularity, the cycle, is there but in such circumstances it may carry no significance.

Cycles can invert, appear and disappear, and elipticalize.

When forecasting stock market cycles, they can be influenced by random events. The predictive value of cycles provide only specific probabilities when the suggested time period is approached.

Fixed time cycles are apparent in stock market tops and bottoms. But, eventually a cycle may cease to continue. For example, the four-year cycle in the US stock market held true from 1954 to 1982, producing accurate forecasts of eight market bottoms. Had an investor recognized the cycle in 1962 he could have amassed a fortune over the next 20 years. But in 1986, the cycle’s prediction of a low failed to provide a bear market and in 1987 its rising phase failed to prevent the largest crash since 1929.

When the market doesn’t do what is expected it is talking, but ultimately the regression to the mean is vicious.

Long-term cycles, such as the Kondratieff Cycle as well as Elliott Waves, suggested that the big-picture bull market was coming to an end in 2000.

The Kondratieff Cycle is a common, often-quoted cycle of financial and economic behavior that lasts about 54 years. This 54-year cycle is close to the Fibonacci 55 number.

One year is a little less than 55 weeks.

Fifty-five was an important count for W.D. Gann. He called a period of 49 to 55 days the Death Zone. February 8 was the 49th trading day from November 30, the day prior to the December 1 kickoff of this last leg up.

A Synodic Period is the length of time two planets meet in Conjunction, which means revolving 360 degrees to each other. The 360-degree period is divided into fractions known as the Sextile (60 degrees), Square (90 degrees), Trine (120 degrees), Opposition (180 degrees), and back to Conjunction again.

Many of the Synodic planetary cycles conform to the Fibonacci Summation series. Their relationship to natural harmonic vibration is not by chance.

For example Venus revolves around the sun in 61% of one year, or 225 days. Two-hundred-twenty-five was an important number for Gann because 180 + 45 = 225. These two planets possess the unique Fibonacci relationship of the 0.618 Golden Mean.

Every other conjunction of Mars/Jupiter is four-and-one-third years, or 233 weeks, another Fibonacci number. This ties to the four-year cycle mentioned above. While the four-year cycle went out of whack in 1986, there was a significant low in the fall of 1990 and late 1994, which began the parabolic move into 2000. There was a shakeout into 1998 and of course there was the 2002 low. There was a two-month shakeout into June/July of 2006 from 1326 S&P to 1219, which marked the low prior to the advance into the all-time high. Then there was the summer low in 2010. It's interesting that these same numbers from the last cycle 1326 and 1219 are so prominent four years later.

The recent S&P high this week was 1325 and the big April top in 2010 was 1219.

The Synodic period for the Saturn/Uranus combination is 45 years. One-eighth of the 360 degree circle and one-half of 90 is 45.

I bring this up because 45 years ago marked the top of the secular bull market in 1966. That bull market began in June 1949.

The powerful two-year advance from March 2009 may have been a result of the 60-year cycle exerting its influence.

One cycle of 45 years back from 1966 gives 1921, which was the big low prior to the run up into 1929.

If the four-year cycle holds up the next trough should be in 2012. Somewhere prior to then we should see an important peak. Will a two-year advance be followed by a two-year decline?

It is interesting that it was eight years from the 1921 low to the vertical peak in 1929 and that it was eight years from 2000 to the vertical drop into 2008. I can’t help but think that a mirror image foldback of sorts may be playing out with the market, making an important peak three years following the 2009 low, just as it made an important low in 1932, three years following the 1929 peak.

Conclusion: 1320 ties to March 6 and squares the 666 price low for a potential square out. The market has respected this level for two days and is gapping below 1320 on 10th Feb.

The pattern looks reminiscent of the November top, which was a grind up followed by a climatic spike.

Monday we saw a spike on the heels of a grinding move up.

The November correction was between 4% and 5% and 152 points. I think another 4% to 5% correction is going to play out quickly into the anniversary of the March 6/9th 2009 low.

Fifty percent of the range from the November 1173 low to this week's 1325 high is 76 points. A decline to 50% of the last swing projects to 1249. There is some good DNA and symmetry there as this was the projection for the big inverse head-and-shoulders pattern from 2010. Moreover, 1248/1249 represents a 180-degree decline on the Square of 9 Chart.

A study of market history shows that corrections against the main trend are much more uniform while impulse legs in favor of the main trend can have a large degree of variability. Said in another way, it is easier to define and anticipate corrections not in favor of and against the primary trend that it is to judge the extent of the primary trend itself. In my experience, this is one of the most important lessons revealed in the study of stock market history.

Looking at the form of the advance from the September 1 kickoff, there are two legs separated by the November correction. Because of the persistence of the advance, which has seen no more than one 2% move in the last five months (compared to 14 moves of 2% or more in the preceding five-month period), the normal expectation would be to see a similar, uniform near-5% correction be bought with both hands by market participants. At the maximum I would expect the correction to extend to a backtest of the April/November 2010 highs of 1219/1227 respectively.

If the correction overbalances the November decline in time and price then the high was more significant.

If a uniform correction plays out it would give rise to a possible third drive up. Whether such a third drive into the anniversary of the April high if it plays out is a marginal new high or a significantly higher high remains to be seen.

Strategy: It looked like James Brown had left the building following the decline of January 28. However, after a genuine sell signal that players pounce on, there is often times a final squeeze. That may have been the run to 1320.

Fifty percent of the range from the 1275 low on January 28 to this week's 1325 high gives a midpoint of 1300. Any break of 1300, especially on the weekly closing basis (Friday) confirms a correction is underway from where I sit. This 1300 level ties to 1296, which is 6 X 6 X 6 X 6, resonating of the 666 price low. 1296 is in the upper right-hand corner of the Square of 9 Chart and aligns with May 6, the flash crash, so I would not underestimate how quickly a reversion to the mean in the persistency of the advance and a revulsion to sentiment could take place if everyone tried to get out of the door at the same time.

A Dow Theory non-confirmation has been ongoing for three and a half weeks now, which is long in the tooth while the market has been overbought for months -- a situation where the chickens could come home to roost violently and quickly, despite the fact that the market has proven to be a Shrine of Boys Crying Wolf.

It may be time to yell wolf.

The $ignal Is In The Dollar Cycle.

It has been my contention all along that the Fed would print until something breaks. Once that break occurs we will enter the next leg down in the secular bear market. This time I don't expect it to be the credit markets, although we will almost certainly have trouble in the municipal and state bond market. Some may even default.

I actually think the greater risk is from massive layoffs by American state and local governments in an effort to cut expenses and avoid default. When that begins we will see unemployment levels start to spike again.

The real danger is going to come from inflationary pressures unleashed by the Fed's QE programs. We are already starting to see severe inflationary pressures in food and energy and it's already causing social unrest in many third-world countries. Expect this to continue and intensify as we move into the summer months.

Besides starting an inflationary spiral, QE is also "stretching" the stock market cycles.

To explain: The 2009 yearly cycle low occurred in March. The 2010 yearly cycle low should have arrived in the early spring roughly 12 months after the March '09 bottom. We did have a decent correction in early February. That should have marked the yearly cycle low. However, because of QE1 that cycle stretched into July, and was more severe that it should have been absent Fed meddling. We even witnessed another mini-crash -- a direct result of the extreme complacency generated by the QE-driven rally in March and April.

It's now clear that QE2 is going to stretch this cycle also. I now look for the next intermediate bottom to arrive this summer sometime around July (roughly 12 months after the 2010 bottom).

This should correspond with a violent dollar rally as it blasts out of the three-year cycle low.

This should mark the beginning of the next leg down in the secular bear market. Confirmation will come if the correction is severe enough to test the July 2010 lows. In a healthy bull market each intermediate correction should bottom well above the prior low (higher highs and higher lows). A move down to the 1050-1000 level will be a clear sign the bull is in trouble.

We should also see the dollar rally out of the three-year cycle low force the CRB down into its three-year cycle low (actually the cycle runs about two and one-half years on average).

And, gold will go down into a severe D-wave correction. (We still have one more parabolic leg up before this D-wave starts.)

Even though I have been expecting the market to correct (into the normal yearly cycle timing band) I've been warning readers not to short the market because the dollar is dropping down into a major cycle low. I suspected there was the possibility the dollar collapse would stretch the cycles and make selling short very risky.

The time to short will come once the dollar puts in the three-year cycle low and all markets begin the move down into the timing band for the next yearly cycle low this mid-year.

I will be watching for a sign the dollar cycle has bottomed sometime in April or even as late as early May. At that point one might consider looking for a sector, or sectors, that are extremely stretched above the mean to sell short. (Not precious metals though. I never short a bull market.)

Until that time it’s still too early to play the short side. The odds are better positioning for the final leg up in gold's massive C-wave advance.