A PROPHECY: 2012-2015

In our previous article NOTHING IS OLDER THAN OUR HABIT OF CALLING EVERYTHING NEW we presented the outlook for a 20-30 year sideways market in equities. Let us have a closer look today at the structure of these moves, pinpoint where we are today and more importantly, where we are going. Let us start out with Neowave structure:

Since 2000 a three-year decline has cut the SP500 to a price level of half of its price peak. This decline has consisted of many different waves, with price hesitating up and down continuously. Additionally, in 2001 the September WTC terrorist attacks are included in this chart, with price dropping vertically for several days and afterwards just as quickly recovering into the X wave. Price action can best be explained as an ABCDE-x-ABCDE formation, with the last part taking half the time of the previous two parts combined and ending at an approximate 61% extension of the first ABCDE formation.

From there on a 5 year slow rally began, with price ultimately reaching a slightly new high. This formation can best be described as two ABCDEFG-diametrics with an x-wave in between. Again, the ending of this pattern could be perfectly timed through half of the time of the initial two formations and a 61% extension. 

At the end of 2007 price was peaking out, initiating what we would call today “The Great Recession”. As always, price action was forward-looking, dropping way ahead of the upcoming fundamental problems. An ABCDE-cascade was initiated, which led to the failure of Lehman Brothers and raised awareness and panic of the economic problems and issues. Price ultimately bottomed out at on the suspiciously precise 666 “Mark of the Beast” level in May 2009.

As time has moved on, today we are again in a slow and painful upward drift, which has brought price almost back into the upper 1/8^th of price and 2/3 of the time range. Looking back in time, it seemed impossible to expect or predict price regain of so much of its price territory over the last two years; yet, here we are. Whether the constant injection of liquidity by central banks into the market has been the cause of this move or cyclical factors is irrelevant. All we know is that we are again approaching a sensitive point in price and time where the odds favour a new three-year bear market.

Zooming in further into this 8-year segment, which should last until 2015, we can see that when the cascade came to its end, a move started, which has so far lasted more than four times the time of the initiating ABCDE-formation. Such a time duration is unusual and gives us a hint for an unfolding FLAT correction. Looking closer at the structure, we see three triangles (in blue) currently repeating their behaviour. Most striking are the rapid B-wave declines, which were the causes for the so-called “Flash-Crashes”, which raised awareness of the problems with High-Frequency-Trading, market instability and evaporating liquidity.

Comparing those three segments gives us a striking resemblance. The initial two have taking 275 and 263 days respectively, separated by a similar 73 and 80 day correction. If this structure continues, then we should still have another 70 trading days and at least 100 points ahead of us, before we enter the next phase of this market.

So let us see where we are going: Comparing the three analogous D-waves, we should still have another 20 SP500 points to drop until the end of the month of April, before we start a rally towards 1500. From there on we start approaching major time resistance, with an important astronomical date on the 15^th of May. Price should consolidate for a while, preparing for the next stage of a three-year bear market during this summer. Rapid declines should commence, which should last for a couple of months. Investors will believe that this is simply another repetition of the Flash Crash and will buy into the ensuing consolidation into the end of the year. Few people will have noticed the change in outlook and will be surprised by what the new year 2013 will bring us: a return to a new crisis. It will remind us that we cannot cover up structural problems and that the market is stronger than policy makers and politicians. Mass selling pressure will culminate in unstemmable declines and a new liquidity crisis, which will bring down the fundamentals and all risk assets. Capital will be scrambling for “riskless” assets, but if there is one thing that we have learned in the last couple of years it is that there is no such product. Risk has simply been shifted from the finance industry to the government (and they are not exactly risk management professionals). When we reach this inflection point all the added dangers will come crashing down again. Social unrest, anti-government and anti-central bank protests will become the norm in the Western World, as more people wake up to the fact that they are again poorer, thanks to other people’s decisions. If our Euro Analysis (NO MORE EASING?, THE EURO DEBATE) is correct, then the major game changer will be a loss of confidence in the US dollar – this time, the flight to safety will not be to towards the United States. Since no asset will hold its value only speculation will be able to produce positive returns.

Rahm Emanuel has said “You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before.” Whether this prophecy will turn out to be correct, time will tell. But an awareness of the underlying fundamental problems and cyclical forces will help us weigh this possibility into our decision making framework. In this train of thought the next year should turn out to be a major game changer and the people who are prepared to seize the opportunity will do so. You can choose to ignore the lessons and dangers of history or, alternatively, you can profit from them – the choice is yours.