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Edition 22 - Chartered 22nd December 2010

Edition 22 - Chartered 22nd December 2010

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Published by Joel Hewish
Chartered is a free fortnightly publication from Fortrend Securities investment/financial adviser Joel Hewish.
Chartered is a free fortnightly publication from Fortrend Securities investment/financial adviser Joel Hewish.

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Published by: Joel Hewish on Jan 03, 2011
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Fortrend Securities - Wealth Management
Joel Hewish is an Investment/Financial Adviser at Fortrend Securities and manages the Wealth Management division. The opinions expressed are his own and do not represent those of Joe Forster or the International Advisory division. Edition No. 22 22nd December 2010 Bottom Line: Global equity markets appear to be tracing out the final upward move of what I view as being a countertrend rally since March 2009. At the conclusion of this final upward move, the highest probability outcome argues for the resumption of the secular bear market. Investors should continue to use the recent price strength from May/June 2010 as an opportunity to reduce risk and position their portfolios to profit from this opportunity!! Chart 1 – US S&P 500

• •

The S&P 500 has continued to etch its way higher over the past fortnight, but yet again momentum is declining. Since the rise above the April 2010 recovery high, the S&P 500 appears to have put in a 4th wave decline and is now subdividing out the final 5th wave upwards. If this wave count is correct, the market shouldn’t have too much further to go until we see the high of the recovery rally which commenced in March 2009 and the resumption of the larger secular bear market. Over the past 8 weeks the American Association of Individual Investors’ Sentiment Survey has produced very low bearish sentiment readings of less than 25 on three different occasions while at the same time producing extreme bullish readings of greater than 50 on four occasions. The level

of bullish optimism and complacency from investors is almost unprecedented and we are still some margin below the all time highs. • Something of interest that was brought to my attention this week was the fact that a new confirmed Hindenburg Omen was triggered last week. I’m not all that familiar with the Hindenburg Omen but according to Wikipedia, it is a combination of technical factors that attempt to measure the health of the New York Stock Exchange and by extension, the stock market as a whole. The goal of the indicator is to signal an increased probability of a significant stock market decline. The rationale is that under "normal conditions" either a substantial number of stocks may set new annual highs or annual lows, but not both at the same time. It is assumed that a healthy market possesses a degree of uniformity, whether up or down, and the simultaneous presence of many new highs and lows may signal trouble ahead as the market displays a degree of fracture (http://en.wikipedia.org/wiki/Hindenburg_Omen, 21 Dec 2010). While I am not all that familiar with this technical model, Dr Robert McHugh from technicalindictorindex.com had this to say about the model: o o While Hindenburg Omens have occurred without market crashes, over the past 25 years, no market crash has occurred without the presence of a Hindenburg Omen. Given we have a confirmed Hindenburg Omen, there is now a 28% probability of a 15% or greater panic sell-off over the next four months, there is a 39.2% probability that a 10% or greater sell-off will occur, a 53.5% probability that a decline of 8% or greater will occur and a 74.9% probability that a stock market decline of at least 5% will occur. Approximately only 1 in 14 of these signals will fail. August 2010 produced a Hindenburg Omen but it only resulted in a minor correction of 2% to 5%.

o o • •

According to Dr Robert McHugh, we should take this Hindenburg Omen seriously as the Elliott Wave pattern, internal strength indicators and sentiment indicators all suggest the same. Only time will tell but the indicators I look at suggest that the markets internal strength is waning and is not performing the way a normal bull market should.

Chart 2 – US S&P 500 – A closer look

The S&P 500 appears to be in the final 5th wave advance of what looks like an ABC correction. While there are still several possibilities in terms of wave counts, this wave count appears to have the greatest level of evidence supporting it.

At this stage the Oscillator is confirming the assessment of the current move being a 5th wave as it is yet to have breached its November 2010 peak strength reading. 5th waves tend to exhibit less Oscillator strength than 3rd waves as institutional support tends not to be as great in 5th waves as for 3rd waves. The S&P 500 is currently trading within the 1,200 to 1,300 significant resistance zone. A top in the recovery rally is most likely within this range.

Chart 3 – S&P ASX 200

The S&P ASX 200 has strengthened over the past fortnight but not by much. At this stage the S&P ASX 200 continues to trade below its November 2010 short term peak and remains some margin below its recovery high in April 2010. The S&P ASX 200 continues to appear as though its recovery from May 2010 is corrective. The likelihood of the S&P ASX 200 rising above its April 2010 recovery high over the medium term appears low.

• •

Chart 4 – S&P ASX 200 – A closer look

There is not much to report on the S&P ASX 200. It has been moving higher but without conviction and this has pretty much been the case for the S&P ASX 200 for the best part of the second half of 2010. There continues to be a lack of strength in this market. The fortunes of our market will be highly correlated with the fortunes of overseas markets.

• •

Chart 5 – USD/EURO Cross Rate

(Sentiment Source: trade-futures.com) • • The best count for the US dollar versus the Euro dollar appears to be that the USD is now in a 3rd Wave advance against the Euro. USD strength against the Euro should be watched as this has implications for the strength of the AUD and will likely weigh on the AUD’s ability to advance significantly against the USD.

Chart 6 – AUD/USD Cross Rate

(Sentiment Source: trade-futures.com) • The AUD’s wave structure suggests the AUD has the potential for a rally to $1.05, but the USD’s strength versus the Euro adds some uncertainty around this. A rally to $1.05 is by no means a high conviction call as it is also possible to count the decline from November 2010 through to December 2010 as an impulse move and this could mean that the AUD might have already commenced its decline against the USD. For the moment, more time is needed to gain a greater understanding of the AUD’s current position.

A look at bond markets
When looking at most of the problems which have arisen over the past 4 years, the bond market tended to be a good indicator of where the next round of trouble was likely to eventuate from. In the case of Greece and Ireland, it was their respective bond markets which forced the hand of these governments and the European Union as investors lost faith in their ability to repay debts. Given this, it’s probably a good idea to have a quick look at a couple of bond markets of significance.

Chart 7 – Barclays Capital Municipal Bond Exchange Traded Fund

Since late August 2010, US Municipal Bonds have started to decline in capital value. Many US municipalities are struggling to balance their budgets under the weight of 9.8% unemployment and 17% underemployment. It is clear from the chart above that investors are starting to become a little concerned about the state of US municipal finances. As such they are now demanding a higher yield to reflect the higher risk inherent in holding these investments. Unfortunately, higher yields mean higher financing costs for US municipalities and this only serves to exacerbate their budget problems.

Chart 8 – iShares 7-10 Year Treasury Bond Exchange Traded Fund

Since the announcement of QEII, there has been a rapid decline in US Treasury Bond prices. The above 7-10 year Treasury Bond ETF reflects this sell-off. Curiously this sell-off is occurring at the same time the Federal Reserve is buying bonds with printed money with the objective of raising bond prices and keeping interest rates low.

Chart 9 – Vanguard Long Term Government Bond Exchange Traded Fund

• •

The above Vanguard Long Term Government Bond ETF shows US long term government bonds are also declining at a decent clip. At this stage Federal Reserve buying appears to be having little impact.

Chart 10 – Government Debt and Deficit Analysis

(Source: Claus Vogt and Roland Leuschel, Money and Markets, Bank of International Settlements) • Taking a look at the above table, it is not hard to see why investors in US bonds are a little concerned. When comparing the debt and deficit problems of the US government with those of other heavily indebted nations, the picture is bleak at best. According to the Bank of International Settlements, the central bank of central banks, the value of US government debt as a percentage of GDP is forecast for 2011 to be greater than that of Ireland, Spain and the United Kingdom. To add fuel to the fire, it is also expected that the US government’s budget deficit as a percentage of GDP is forecast to be greater than all but two of the above countries, including being greater than that of Greece and Ireland. And the significance of this is.... while I have been unable to get my hands on actual data, I have heard reports that somewhere between 30% to 60% of US government debt is expected to mature over the coming two year period. This is debt that will need to be refinanced. If US government bonds continue to come under pressure, in spite of the Fed’s efforts, the refinancing of this debt could be extremely troublesome and have huge flow on effects around the world. Consider also that the 10 year US government bond yield is often the benchmark yield used in determining US mortgage rates, corporate bond rates and the “risk free rate of return” for the valuation of stocks. A rise in mortgage rates, corporate bond rates and an increase in the discount rate of stocks is not supportive for asset prices in these markets. If the trend continues it won’t be long before the impact of rising bond yields start to filter through to these peripheral markets.

A look at Quantitative Easing
Much has been said about the Fed’s ability to influence markets and improve the US economy. Given so many investors are banking on the Fed’s ability to help improve economic growth, lower the unemployment rate and achieve a number of other outcomes, Elliott Wave International make the following points with regards to the Fed’s claims about Quantitative Easing and its success to date: Quantitative Easing will help create jobs – since QE 1 began in September 2008, unemployment in the US has increased from 6.2% to 9.8% today. Quantitative Easing will devalue the US dollar – despite the large ups and downs in between, the US dollar index is currently trading slightly higher than it was in September 2008. Quantitative Easing will help improve inflation – underlying US inflation is currently at 0.5% (revised lower last night from 0.6%) the lowest inflation rate since records began in 1959. Quantitative Easing will help improve loan creation – Since September 2008 to June 2010 a $2.46 trillion ($1.43 trillion in assets and $1.03 trillion in excess reserves) increase in the Fed's balance sheet coincided with a decline of $296 billion in total US credit market debt outstanding. Consider also that up until 2008, total credit market debt rose for 63 consecutive years. This raises the question, does the Fed really have the level of influence over financial markets and the economy to the degree that many investors are banking on? This will be the last Chartered for 2010. The next edition will be out 2nd February 2011. In the meantime, investors should consider the significance of the challenges to be faced during 2011 and 2012. While it is my expectation that volatility should increase fairly significantly during this period, if you are prepared to be nimble and have a plan to navigate your way through this market, this coming period of time could present some of the most compelling investment opportunities we have ever seen, irrespective of whether the market is moving upwards or heading down. As such I strongly encourage you to contact us to discuss your portfolio, how it is positioned, how you can manage the risks and prosper during these uncertain economic times. I wish everyone a very happy Christmas and a wonderful and prosperous new year!!! I hope you have enjoyed this edition of Chartered and found the content of interest. If you would like me to analyse a particular market or chart from a technical point of view, please email your requests to jhewish@fortrend.com.au and I will endeavour to look at any requests in upcoming editions. In the meantime, if you would like to arrange a time to discuss your portfolio and some of the strategies which can be used to help you navigate the prevailing market conditions and profit from this opportunity, please do not hesitate to contact me on 03 9650 8400 or 0401 826 096. Kind regards, JOEL HEWISH B.Bus (Bank & Fin), GDipAppFin, GCertFinPlan, SA Fin Investment / Financial Adviser FORTREND SECURITIES - WEALTH MANAGEMENT
Australian Financial Services Licence No. 247261

Chartered is a fortnightly publication from Fortrend Securities – Wealth Management and is provided for the purpose of general information only. The views and opinions expressed in the publication are those of Joel Hewish and do not necessarily match those views of Joe Forster and Fortrend Securities – International Advisory. This publication is provided as general information only and does not take into account your personal circumstances, aims and objectives and should not be considered personal advice. You should first consult a licensed Investment or Financial Adviser before acting on any of the information provided in this publication.

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