Year-End Meltdown Outlook ~ The Risk Averse Alert

Wednesday, November 06, 2013

Year-End Meltdown Outlook

Rising Treasury yields (falling prices) in the face of EM instability was integral to May/June market fragility. In short, the disappearance of Treasury safe haven status caught the marketplace by surprise. After accumulating Trillions of international reserves over recent years, the reversal of “hot money” and other speculative flows saw EM central banks selling Treasuries (and other reserve assets) as part of efforts to support their faltering currencies. This dynamic was instrumental in what was emerging as a problematic global jump in market yields.

...This week was somewhat reminiscent of the early-days of the May/June “risk off” market dynamic. EM bonds and currencies were under some pressure, while Treasury yields jumped. The U.S. dollar abruptly caught a bid and commodities were hit hard.

...There’s a decent case to be made that the reemergence of the May/June Dynamic could prove surprisingly problematic for the markets. After all, the “all’s clear”—“no taper ‘till March or even June”—siren has been blasted, perhaps erroneously. The market over recent months has given 1999 excesses more than a run for their money.

With only two months to wrap up a potentially historic market year, the calendar may prove an issue. Of course, the widely anticipated melt-up into year-end scenario remains a possibility. The markets surely could turn wildly volatile and gamey. Yet, at this point, an unexpected sharp downside reversal would be the proverbial “pain trade” catching the complacent crowd extraordinarily exposed.

The global leveraged speculating community would appear particularly susceptible to year-end performance dynamics. Funds that have posted big years might move aggressively to lock in 2013 gains and ensure huge paychecks. At the same time, there are an unusually large number of funds struggling with lackluster performance despite the big year in equities. When the Fed backtracked on tapering, even the most cautious had little alternative but to jump aboard the equities melt-up. This creates a backdrop of unstable markets and a bevy of potentially “weak-handed” traders and portfolio managers. Scores of funds would likely have low tolerance for losses, creating the possibility for a mercurial market backdrop. I suspect many view the current market environment as an accident in the making.

—"The May/June Dynamic" (Doug Noland, Credit Bubble Bulletin, 11/1/2013)
Hmmm. The calendar might prove an issue, eh? Okay, then, let's consider the following Elliott wave view on our Fed-sweetened garbage...

This works. Wave (c) completing the market's counter-trend rally off March '09 bottom is seen very near ending here. Interesting is a certain "like from like" quality displayed during wave (c)'s formation. Likewise we see an increasingly pitched effort to sustain the market's advance off early-October 2011 bottom as wave (c) reaches maturity.

First, consider the component waves (i - v) of wave 3. Notice how each successive advancing component wave loses upward thrust in contrast to its prior. Wave i of 3 was a launching shot higher and was followed by the less pitched wave iii of 3, which, itself, was followed by an even less pitched wave v or 3.

Now consider the same view toward the component waves (1 - 5) forming wave (c). Again, each successive advancing component wave loses upward thrust in contrast to its prior. The power driving wave (c)'s march higher appears to be losing steam, notwithstanding this wave's durability, particularly over the course of this year's trading.

Finally, take a look at the MACD measure of the S&P 500's momentum (bottom panel). Here we see displayed the increasingly pitched effort to sustain the market's advance. First, contrast this measure as wave iii of 3 was completing—its displaying a more exhausted underlying state—while its state as wave v of 3 was completing was more decidedly one-sided, increasingly reaching higher into the positive right up to its, and the S&P 500's mid-September 2012 peak. So, then, let's now consider MACD's state as wave 5 of (c) has unfolded since mid-November 2012 bottom. Here again we see an increasingly pitched effort to sustain the market's advance.

One other technical matter supporting this prospective view is the S&P 500's RSI (top panel). We see its peak reading was registered during formation of wave iii of 3 of (c), which display of technical dynamism is typical during Elliott 3rd waves, thus confirming this prospective Elliott wave-based view.

Over the next several days we shall seek further evidence raising the likelihood this prospective view might very well bear out, and so increase likelihood a severe market selloff might in fact develop prior to year end...

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