Market Summary

I was surprised after my last post that the market rallied instead of crashed as I thought it would. Last week however appears to have been a retracement rather than a rally as the market went up before it continues on its way down. The S&P 500 has been in a sideways channel for the past 6 weeks in what appears to be a 4th wave and a bear flag. While some markets did appear to put in a 5th wave bottom, for example, the financial sector index XLF on August 23rd, the S&P 500 did not put in a lower low than the 3rd wave and so did not technically put in a 5th wave bottom. While it is possible that the market could rally up from here it would have to be news or event driven to give the market a lift and I believe the higher likelihood is that the market will fail here and go lower. All eyes will be on Greece whose two-year notes rose for the first week in two months last week. The yield had climbed above 80 percent on September 14th but has currently come back to 54 percent. As the risk of default increases so does the costs to borrow money.

The current situation feels somewhat similar to the 2008 crash in the market following the Lehman Brothers bankruptcy. In keeping open to other points of view I read a very interesting article by Prof. Mark Blythe titled How to Turn a Continent into A Subprime CDO which I hope you find insightful.

The chart below shows the open after the weekend of the Euro / US Dollar showing how the Euro has fallen after retracing partially back up last week from its previous move down. The Euro appears to be headed towards the 1.30 area and could go much lower. When the Euro falls the US Dollar rises which puts downward pressure on the stock market. This week the Fed will hold a two-day meeting to discuss monetary policy and interest rates and lets hope they are able to help the market from falling off a cliff. Click on chart to enlarge.

Market Summary

It now appears that a Greek default is imminent and that the banks that hold Greek debt/bonds will now have to write down that debt on their balance sheets. Greece has recently imposed a new property tax in addition to other austerity measures in order to qualify for the distribution of a second portion of a bailout package put together by the European Central Bank (ECB), the European Union (EU), and the International Monetary Fund (IMF). If Greece does not receive this second tranche of the bailout package it will be unable to pay its pensioners or interest on its debt which is currently 57% on a two-year note. From my reading German and French banks are most at risk however the contagion risk could spread to the global financial markets. Among the safe havens are gold and US Treasuries. As foreigners convert their currencies to US dollars in order to buy US Treasuries the dollar rises in value and that is what we are seeing. The chart below shows the Euro bank notes falling below the 1.40 level and to the lowest level in the past six to seven months and headed towards the 1.20 level. We see a series of lower highs and lower lows over the last three years which is bullish for the US dollar. As the Euro falls the US dollar rises which makes it more expensive for foreigners to buy US goods. This hurts exports and the stock market. The S&P 500 futures are currently at 1138 well below the 1150 support area and most likely headed to the next level of support at the 1100 area. Click on chart to enlarge.

Happy Labor Day

Continuing with the theme from my last post that markets make reversals in trend after 3-day weekends, the first chart below shows a 2-month daily chart of the S&P 500 that follows up with the first chart from my last post. The market did continue the rally after the 4th of July with two seeming doji-like days up to the 7th of July with a high of 1356.48 but sold off after that to the low on August 9th of 1101.54 and showed extreme volatility with a spike in the Volatility Index (VIX). With a brief bounce and pullback to form a double bottom the market appeared poised to rally and indeed there was both a higher low and higher high, the classic definition of an uptrend. In many markets there was put in a 5th wave bottom, or so it seemed, but not in the S&P 500 suggesting that the move off the August 9th low was a 4th wave and that the 5th wave has just begun with the August 31 high. Futures markets are poised to open significantly lower with initial support at the 1150 area and below that at the prior low near 1100. As to the theory that the market makes trend reversals after 3-day weekends, while it is true that the market did so on last Memorial Day weekend, the 4th of July did not fit the pattern exactly and as September 1st and 2nd were both down days it appears that the trend has already reversed to the downside and is not fitting the pattern either. Click on chart to enlarge.

Again as a follow up to my last post the second chart below is a 3-year monthly chart of the S&P 500 showing that we are in a 4th wave on the monthly chart. The 61.8% Fibonacci retracement level is at the 1150 area which should act as support. The problem is that if this level gets taken out with a close below this level then the whole wave count would come into question and we would no longer have a classic Elliott wave pattern. I think this level will hold and that the Fed will step in to support the market at their next meeting with some kind of further quantitative easing. The real problem is the European banks and sovereign debt. Greek two year bonds are yielding over 50% as can be seen here indicating a high likelihood of default. Compare that to the German bond yields here. Also, bonds of both Spain and Italy soared to record highs last week. Banks that hold these bonds could fall like dominoes taking one another down. The good news is that inter-bank lending as measured by the Libor has not spiked to the high levels seen after the Lehman Brothers collapse in 2008. The risk of recession has significantly risen with the last Employment Report showing no net jobs created in the month of August. Lets hope the markets don't continue with a downward spiral as shown by the left side of the chart below. Click on chart to enlarge.