A 10 year new low in Australian Equities?

Weekly Chart of the ASX200, Australian Equity Index Futures:

The drop into the 2009 March low at 3109 WAS NOT the Bottom but only an ORTHODOX lowest low bottom. The low seen in Nov 2008 at 3211 was the bottom of a clear 5 wave pattern within which the 5th is an extended one with minor inner i,ii,iii,iv,v waves.

The lowest low at 3109 is ACTUALLY an irregular b wave (a correction within the counter-trend move, that dropped lower than the cycle degree bottom of 3211. Such IRREGULAR B waves have a powerful forecasting value. Common-sense approach to breaking down any market movement as comprising of a confluence of movements (waves) over different time-scales would help visualize that when a MUCH LONGER DURATION WAVE / TREND is still down, whenever a correction within a counter-trend wave would come at the first instance it would go lower than the low of the prior wave in the larger direction. Such an IRREGULAR B wave helps create a forecasting courage that whenever and howsoever higher the prevailing counter-trend move of last 4 years would get over, the next move down, will break the 2009 lows!

The rise since this Nov 2008 low to now is abc(W)-abc(X)-i,ii,iii,iv,v(C)(Y). Thats in a simpler notation a completed WXY pattern that is often the structure of a corrective to the main trend. What Next?

The reversal that has already worked out on this market in the last several weeks can:

Either drop in a straight line forming a five part C wave and take us to 3000 area!

Or, it can drop in a 3 legged structure to 4425 area to form another X wave, then rise back into a high higher than seen few weeks ago to form a Z wave and then EVENTUALLY drop to 3000 area in a cycle degree wave C.

In either scenarios, for now we are going to 4425 to begin with and we will know by the time we reach there from the emergent wave counts whether with a rebound back to the recent highs or without, we will go to 3000.

I urge, such steep forecasts be not dismissed merely because they are steep. Why? Did Gold dropping from 1800 to 1200 look like an extreme idea? But it happened. Markets have a very old wisdom that confidence is the top and fear is the bottom as reminded few days ago by a colleague. It then clearly means, things seem impossible all the time in the markets and they keep getting possible.

Beeping Red Light Alert on the US Stocks to Long Bond Price Ratio

Traditional FED Model supposes that the Earnings Yield on S&P500 and the US 10 Year Long bond are in equilibrium. To check how and if this worked in history, I created a spread chart on a weekly closing basis subtracting the 10 year long bond yield from the earnings yield of S&P500 as shown in the chart below:



This spread measures the equity risk premium which refused to go positive through 1983 to beginning of 2003. Many times this risk premium came and found resistance at the zero level during this 20 year long period.

However, from 2003 to now, there is a continuous upward "Drift" in this indicator / variable / statistic. It has refused to go down below zero few times in this new regime, but has a strong uptrend regression channel. Until this "drift" breaks down, I am comfortable to surmise that the Equity Risk Premium in the United States is on a long term incline.

Definitionally, I disagree with the too much approximation such an idea does since the Earnings Yield on S&P is arrived at by taking historical earnings divided by Market Price, whereas the Bond Yield has anticipated cash flows of future more clearly.

So I worked around and tweaked this idea RESPECTING the Market Price way more than anything and created the SIMPLIFIED FED Model by dividing the price of the S&P500 near expiration futures with the US Long Bond near expiration futures. Why?

The price of an equity index discounts all possible future cash-flows at the ever changing “appropriate” discounting rate that is market-implied. Comparing price of equity index to price of long bond thus removes the conundrum of driving by looking at the rear view mirror.

A fantastic clarity emerges on this price ratio chart, that I am naming as the Market Implied FED Model:



PRECISELY 1 week ahead of the top of 2000, 1 week ahead of the top of 2007 and 1 week ahead of the bottom of 2003 and 2009 this ratio chart had Sell and Buy signals.

For those who are more quantitatively inclined each of these prior 4 key tops & bottoms, this ratio went past +2 and -2 std deviations respectively.

This present week, Price ratio is already past 2 standard deviations, RSI of this ratio is divergent too. Hence, if in the next week US long bond price performs better than the S&P500 futures, it could be a firm shrill whistle of a market top coming for equities.

This indicator and this note are pre-emptive, only a warning sign-post. The perils of forecasting place one sometimes before a grinding road-roller too. Nothing is permanent, indicators included. But then, I must find some reason to believe why this excess in the relative performance of stocks to bonds in the United Stated will defy a 13 year long relationship now!

Until I find a rationale, I will keep a close eye on the relative performance of long Bond and SnP 500 through the next week. More or less everyone has become complacent of a world that will remain permanently healthy on steroids.

If indeed the US Long Bond starts moving up sustainably from here while FED taper is lurking around the corner, how shall we reconcile to Bond Price Rally without significant yield decline? Well when a flight to safety becomes necessary, the trouble could actually be coming to this world from an origin that is not yet on the oceanographs. Which economies will uncoil relatively stronger rate rises making the US Long Bond a safe haven?

The Market Implied FED Model is what I call my simpler and more realistic one. It is beeping a red light alert!