September 10, 2012

This is quite long to be considered a briefing, but understanding the point this article makes is very important. It will be worth your time to read it carefully and absorb what it is saying. I am happy to discuss any questions you may have to clarify and explain anything that is foggy.

As you all know, we are firm believers in the fact that markets move in cycles (just like everything else on this planet). Jim Hurst developed cyclic analysis in the late 60's and early 70's utilizing the Cray Super Computer owned by the Dept of Defense where he was instrumental in helping develope sonar.

Hursts methods of cyclic analysis have been under utilized in the modern investment world since no one has been able to automate his very complex (yet simple) approach to cyclic analysis. David HIxon is the first to make the Hurst method available. I have followed his development of the Hurst System for the last 5 years and am amazed by his accomplishment.

Again, please take the time to carefully read this article. It is the bottom line to the conditions of today's market.

ST Outlook – 8 September 2012

Posted on September 9, 2012 by David Hickson

The US markets dipped a little lower this week, and formed a trough that seemed at first to be an insignificant trough for the 80-day cycle trough that we have been expecting. But then on Thursday they leapt upwards to new highs in a dramatic move that makes the 80-day cycle trough evident.

The media is full of optimistic stories about the renewed strength of this bull market, most of which take the stance that this week’s upward surge was the first move of many yet to come. It probably won’t surprise you to hear that I disagree. I am expecting a peak to form in the US markets, and this move up is more probably a last gasp than the beginning of a newly revived bull. Not that I don’t acknowledge that this week’s move was strongly bullish (taking long positions in the US markets on Wednesday night as they crossed over the 20-day FLD proved to be a good idea!), but I think that the bull is weary, and that this upwards move will be short lived because I remain convinced that the US markets are in the process of forming peaks (have I mentioned that “peaks are complicated”?)

Why do I remain convinced of this? The primary reason is because of the cycles of course. Before looking at the separate markets today I would like to present a slightly more in-depth consideration of “where we are” (in cyclic terms). I have been presenting in these pages cyclic analyses of various specific markets, but today let’s step back for a moment and consider the bigger cyclic picture.

One of Hurst’s cyclic principles is the Principle of Commonality, which basically states that all financial markets move with a great deal in common (I’m simplifying I know). Perhaps as a South African I am more aware of the effects of commonality because when trading the SA market one learns to keep an eye on the US and European markets as well. I soon learnt that markets tend to move together, as if though the cycles that are moving financial markets are a worldwide phenomenon. Of course local politics, economic conditions and so forth affect local markets, but the bigger picture is often grasped much more clearly by considering markets from all over the world. Inevitably if markets all over the world are turning down, then your local market will as well. Although markets deviate from commonality for periods of time, they will always eventually fall back in line.

And so in considering where the US markets “are” right now, let’s look at some other markets and see if we can get a sense of how the cycles that move markets are affecting the rest of the world. First of all let’s broaden our outlook only slightly to the broader US market. We discuss the S&P 500 and Nasdaq indices here, so let’s take a look at the NYSE composite index, an index which includes all stocks traded on the New York Stock Exchange, mostly US stocks, but also some foreign stocks (even some South African stocks). This will give us a broader picture than the selective indices we follow every week.

I am showing the period from 2007 until present because I would like you to consider the shapes of the cycles as they have unfolded since the early 2009 trough. In previous ST Outlook’s I have presented the case for the diminishing bullishness of the 18-month cycles that have followed that trough (18-month cycle troughs are marked by the yellow diamonds at the foot of the chart). Now let’s compare this to the chart of the S&P 500 which we have been tracking:

You will see immediately the same basic cyclic moves in both charts, but the S&P 500 has recently become stretched to the upside. Which of these two indices presents the truest picture of what the cycles are really doing? In my opinion it is the NYSE composite index (and not only because it includes more stocks, as I will demonstrate later).

Let’s look even further afield, to Europe. Here is the Euro-Stoxx index:

Again the same basic cycle moves are apparent. Look at the diminishing bullishness of the 18-month cycles that have followed the early 2009 trough.

Finally let’s step even further afield and take a look at the “emerging markets”:

Commonality even in the emerging markets

That is a very sobering chart in my opinion. Note three things in particular: there is still a very high degree of commonality between the emerging markets and the established first-world markets; secondly emerging markets generally performed better (the cycles have more bullish shapes) than the European markets; and thirdly the current 18-month cycle is looking very bearish. I think that emerging markets very often reveal more clearly the true cyclic picture, perhaps because they are more “naive” markets, less affected (dare I say manipulated) by politics, and the big banks.

And so cycles which influence stock markets in many countries around the world are looking bearish and warning of falling prices into the year end. That raises two questions: Why are the US markets distorting to the upside and looking more bullish? And will they continue to do this? (After all if they continue to distort to the bullish side, who cares about the rest of the world?)

I cannot answer the first question definitively, but I do think that the impending US elections play a big role in distorting the cycles. The answer to the second question I am clearer about: No, they will not continue doing this. Individual markets will “buck the trend” for a while, but it never lasts. Particularly if the answer to the first question is connected to the US elections, because they will soon be over, and that is when the US markets are likely to snap back into position with the worldwide trend if they haven’t already done so.

But there is another very important consideration. Why do the above charts differ? We can see the commonality between them, but what causes the differences? I have mentioned local politics, economic conditions and so forth, all valid reasons, but there is a very important reason why they differ which is mostly overlooked. And that has to do with the base level against which the values represented by those price charts can be compared. Here is the problem: there isn’t one!

The cycles which move financial markets are in fact cycles in our perception of the value of something. And so for instance the cycles evident in the price movement of gold have nothing to do with gold per se, they have to do with the collective perception of the value of gold. Of course the value of something is never absolute. It is always relative. In the example of the value of gold, we usually quote that value in US dollars, and so we are not stating an absolute value when we quote the gold price, but the value of gold relative to the US dollar (or any other currency we choose).

And so the above charts are not an expression of absolute values, but of relative values. Because they are indices, they represent the average value of a collection of stocks relative to the currency in which those stocks are traded. The S&P 500 is a number, not a dollar value, but it is the average value of a collection of stocks, which are themselves quoted in US dollars, and so effectively the S&P 500 index represents a value relative to the US dollar.

The problem of course is that the value of the US dollar itself is always changing, relative to whatever else you choose as your “base value”. And that is one of the major contibutors to the differences between the above charts.

What does all this have to do with whether the US markets are going to keep going up, or whether they are going to peak soon and turn down towards year end? The answer lies in whether the general perception of the value of the stocks that make up the S&P 500 is going to turn. I believe it is, in fact I think that it has already turned. Here is why:

I live in Europe at the moment, and so I value anything that I could buy (such as stocks) relative to the Euro currency, not the US dollar. It is possible for me to buy US stocks, something that I would only want to do if I believed that they were going to rise in value relative to the Euro. Many years ago I discovered the benefit of analyzing markets relative to each other (it is why Sentient Trader has an “export data to ASCII” feature). Here is a long-term chart of the S&P 500 relative to the value of the Euro:

In simple terms when that chart shows rising prices I should be invested in US stocks (or the S&P 500 index to be exact), and when price is falling I would increase the value of my capital by simply holding it as cash in euros. What does this tell me about what the US markets are doing now? Note how price has risen very close to the resistance level of the peak in 2007, and it has done so in a very clear three-wave move with nearly equal first and third legs. From a purely cyclic perspective we are expecting price to turn down, and in fact despite this week’s big upwards move, a peak was formed last month.

Let’s explore this idea a little further. Many people consider Gold to be a base value for comparison. Here is the S&P 500 relative to the price of gold (in US dollars):

There is the same commonality that we saw in the first four charts. There is an intersting difference in this chart: the 2011 low formed below the 2009 low, in other words the value of the S&P 500 expressed in gold was lower last year than it was in 2009. This is one of the reasons that I keep an open mind toward the possibility that last year’s trough might prove to be a straddled trough of the 54-month cycle (as discussed in previous ST Outlooks), but that is a discussion that we will have to explore in a future ST Outlook. Here is a closer look at the price action since the 2009 trough:

That is a weekly chart, and it is clear that the S&P 500 peaked three weeks ago, relative to the value of gold (relative to the value of the US dollar).

That is why I believe the US markets are forming a peak: they have already peaked relative to the Euro and to Gold, indicating that the perception of the value of a basket of US stocks has already turned downwards. It should not be long before that turn down is reflected in the values of the indices themselves.

Let’s take a look at the individual markets, because after all you are probably not really interested in the value of the S&P 500 in terms of gold!

S&P 500

The new high in the S&P 500 this week makes it seem likely that the 80-day cycle trough has formed, probably at the low of Tuesday 4 September 2012. The strong bounce up from that trough makes it likely that the trough is of 80-day magnitude, but the alternate analysis that we have been watching is still possible, and I will show it in the Nasdaq. Of course I am expecting price to peak soon, and fall into the year end.

Nasdaq

Here is the alternate analysis, which places the 80-day trough at the end of July, with the current bounce the move out of a 40-day trough.

This analysis has a less satisfying look to it because of the relative strengths of the bounces out of the 80-day and 40-day troughs, but it is quite viable.

Euro/US Dollar

Last week I suggested that the trough of Tuesday 4 September 2012 was probably “too subtle to be a trough of 40-day magnitude”, but this week’s price action put paid to any subtlety. I have previously presented three options for the magnitude of the July 2012 trough, and this week’s strong move shifted the odds towards the least bearish of those options, with the 18-month cycle trough in July:

Gold

Two weeks ago I suggested that gold could reach up to the $1750 level, and this week’s move all but accomplished that, reaching just above $1745:

I have been warning that gold is approaching its 40-week cycle peak, and it is worth remembering that peaks in gold tend to be sharp isolated affairs (as opposed to the rounded complicated peaks of the stock market), and so be prepared for a sudden turn down.

Again, if you have any questions regarding this guest article, please let me know.

Have a great day!!

John Norquay
CEO PivotPoint Advisors

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