Chartered

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. 15 15th September 2010 Bottom Line: Financial markets appear to be in the later stages of their corrective patterns which have persisted for the past 2½ months. Major equity markets have either completed a topping formation, are completing a topping formation or are already well entrenched in the next phase of their downtrend. My expectation is that the months of September and October should see global equity markets turn down and commence the next leg down in the larger degree bear market. This next leg down should produce swift and broad declines. Limited time remains to protect yourself and profit from this opportunity!! Chart 1 – US S&P 500

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A head and shoulders pattern is a head and shoulders pattern until it isn’t. The rally since late August 2010 has now ruled this pattern out. It was so close but the pattern was not confirmed. For a head and shoulders pattern to be fulfilled and to legitimise a trade on this pattern, one should wait for the neckline (as indicated by the blue downward sloping line) to be broken. This did not occur and as such the pattern becomes void. SO WHAT IS GOING ON? Well in short, the medium to longer term patterns and trends remain unchanged and the change in trend to the downside remains in place. THIS HAS NOT CHANGED.

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What appears to be occurring is that what I currently have labelled as Wave 2 of minute degree, as depicted below, might actually turn out to be a continuation of Wave 2 of minor degree (as shown in Chart 3). All this really means is that the next leg down is likely to occur a little later than I had anticipated given the technical patterns that were being presented at the time. In the short term, the S&P 500 could be attracted to the 61.8% Fibonacci retracement around 1,140. This would provide a convenient place for the recent countertrend rally to terminate. At this stage I have not changed the wave count, but a break above 1,129.24 and what I have labelled Wave C of minor degree Wave 2 will rule this wave count out and bring into play the alternative wave count as depicted in Chart 3 below.

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Chart 2 – US S&P 500 – A closer look

Although the chart is not shown here, using volume spread analysis, the S&P 500 ETF (SPY) has shown signs of institutional testing and weakness. Once again this weakness is appearing at an area of previous resistance. The S&P 500 is also testing the 200 day moving average again, which appears to have shown its first sign of decline over the past week. These indicators continue to flash signs, not of recovery, but of a bear market that remains in its infancy. It is times like these that investors will be anxious to either get into the market if they are not in the market or increase their exposure if they are underweight. It is extremely important to make decisions not on emotion but rather on the facts at hand as these are typically dangerous times for the unaware or emotionally driven investor. Robert Prechter from Elliott Wave International described this very phase of a bear market as being the “Slope of Hope”. It is where investors who are slow to recognise that the economy is not functioning the way it should, hold out hope that markets will recover. It is only when investors reach a point of recognition and they begin to focus on the downside potential that the decline begins to gather real momentum. We saw this very phase occur between late 2007 and September 2008, until all of a sudden a point of realisation occurred and global markets lost between 30% and 40% within the space of 3 to 4 months during the Wave 3 decline.

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As per the months leading up to September 2008, once again the markets are setting up for a Wave 3 decline, although perhaps not of the same degree, but complacency and emotional reaction are dangerous.

Chart 3 – S&P 500 – A closer look – Alternative count

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Should the S&P 500 move above 1,129.24 the wave count as shown in Chart 3 above will become valid and will be preferred. I have always found labelling corrective waves problematic and although I have provided wave labels above for the corrective waves, Elliott Wave purists will probably pick apart these labels. But the message remains the same; these price moves do not appear impulsive, but rather corrective. Once this phase completes, the next leg down should begin, bringing broad and swift declines with it. Should the wave count depicted in Chart 3 become the preferred wave count, there is likely to be only a small push to the upside before Wave 3 of minor degree commences. However, the rules surrounding Elliott Wave analysis allow for a rally up to the April 2010 high, but not above it, before this interpretation of the wave count would be ruled out and the medium to longer term outlook will have to be revisited. I should point out that while a rally up to the April 2010 high is possible; it remains highly unlikely given the evidence presented before me.

Chart 4 – S&P ASX 200

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The S&P ASX 200 has risen above the 9 August 2010 high of 4,598.7 which has meant that Wave 3 of Minor degree is yet to have begun and Wave 2 of minor degree is still unfolding, as I currently label it. I can be quite confident that the price action since mid May 2010 to date is corrective because of the overlapping nature of the price movements. As with the S&P 500, what this essentially means is that we have to wait a little longer than initially expected before we see the next meaningful sell-off occur, but probably not too much longer. For investors, it also gives you a further opportunity to lock in the recovery in prices since March 2009 and position your portfolios appropriately. Given the break above the 9 August 2010 interim high of 4,598.7, as with the S&P 500, the 61.8% Fibonacci retracement level of 4,700 would provide a logical level for the Wave 2 rally from May 2010 to terminate.

Chart 5 – S&P ASX 200 – A closer look

The S&P ASX 200 is also testing its 200 day moving average which continues in its downward sloping trend.

Failure to break above in a meaningful manner will be a big sign of weakness.

Chart 6 – USD Spot Gold

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Gold rallied to break above its 21 June 2010 high of $1,264.80 last night. What does this mean? Given the Oscillator did not confirm the new price high, it is likely that gold’s rally from late July 2010 is a continuation of a larger degree Wave 5 and Wave 5s of multiple degrees. From the evidence provided, it is hard not to come to the conclusion that gold’s rally is very long in the tooth and while a rally or upward thrust into the USD$1,300s is possible in the short term, gold is nearing the completion of a decade long rally and should decline in line with declines expected in financial markets. The 200 day and 50 day moving averages do not confirm a change in trend yet but as mentioned last week, these indicators are confirmatory not leading.

Chart 7 – Gold ETF - GLD

GLD, the gold exchange traded fund, a good derivative of the physical gold price was indicating a number of institutional tests at an area of previous resistance and we had seen prices ease as a result of those tests, until last night. Last night’s bar showed selling into the market by institutions at these higher prices as evidenced by the spike in volume, the wide spread of the price bar and the close of the bar in the middle. Higher prices are still possible in the short term as the trend remains in an upward move, but I seriously question the likelihood of significantly higher prices given these institutional tests. Gold is now very vulnerable to a significant change in trend if global financial markets turn down in the near term.

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Chart 8 – AUD/USD Spot Cross Rate

Since May 2010, the Australian dollar’s performance versus the US dollar has been very strong and momentum in the short term remains to the upside, although overbought conditions are starting to arise. Using the Elliott Wave methodology to analyse this market is proving extremely problematic in the short term as there are a large number of potential wave counts that could be used suggesting both upside and downside potential. Unfortunately confidence is not high in any of the wave counts. As such I’m putting the Elliott Wave methodology to the side for the moment until the picture becomes clearer from a wave counting view point. But that doesn’t mean we can’t still have a look at some of the other methodologies to provide some insight into the shorter term and medium term outlook for the currency. The 50 day moving average has recently crossed above the downward sloping 200 day moving average. This provides a mixed signal at this stage but a change in direction of the 200 day moving average would cause me to seriously rethink the upside potential of the AUD. The AUD is also now testing resistance around $0.94. What happens here will be very interesting. This level has proven to be a very reliable level of resistance in the past. A significant break above will require close attention in the short term.

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Chart 9 – AUD/USD Spot Cross Rate – Since December 1983

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With the short term outlook looking a little murky, let’s review the investment thesis in the USD versus the AUD. What we know about the AUD is that when global growth slows down and uncertainty arises, since the Australian dollar’s float in December 1983, the AUD tends to weaken as less funds are borrowed from overseas and repatriated to Australia and lent to Australian borrowers, less resources are sold overseas and less revenue is repatriated back to Australia, safety is sought by investors in the largest and most liquid currency being the US dollar and a reduction in risk appetite tends to see debt levels reduced, which puts further pressure on the US dollar to the upside in such times. Since the AUD’s float in 1983, when the AUD is above approximately USD$0.90, the AUD tends not to remain above that price too long before weakness appears.

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An AUD above USD$0.80 tends not to be sustainable for too long either. The longer term trading range appears to be somewhere between USD$0.70 and USD$0.80. What we also know is that the AUD does not always move in step with financial markets and from a time sequence point of view, the AUD does peak and trough independently of financial markets, but when it moves it moves quickly and decisively.

Chart 10 – AUD/USD Exchange Traded Fund - FXA

Using the exchange traded fund FXA as a proxy for assessing the strength of the Australian dollar versus the US dollar, we can see that the price rise since late August is not being met with strong volumes and as such caution in this rally’s strength is warranted. While the shorter term movements and oscillations are providing some difficulties in shoring up the short term outlook for the AUD, there is little to suggest that longer term, the AUD should not weaken again, if and when the next downward decline in share prices ensues, which at this stage still remains very much a high conviction call.

Chart 11 – AUD/USD Spot Cross Rate Since Peak in 1972

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What about the longer term wave count of the AUD/USD? Since the AUD’s interim peak in the early 1970’s, it is possible to count a 5 wave move from that interim peak to the trough in 2000. From that trough it is also possible to count a 5 wave move up to the high of 2008. Should this interpretation of the wave count be correct, it appears that the rally from 2008 to date has been a Wave B countertrend rally. That suggests that while the AUD has the potential to rally higher in the short term and even higher than parity, there is still one more wave down needed, being Wave C, before Wave 2 is complete and the AUD can continue its progress upwards. I should state that given the fundamental and technical evidence before me, a rise higher than the previous high in 2008 of approximately USD$0.98, before Wave C down ensues, appears on the balance of probabilities unlikely, but cannot be ruled out. However, if the interpretation of the wave count above proves correct, and I have no reason to think otherwise, this means a meaningful sell-off during the period between now and the end of 2012 is still very much on the cards and remains my base case expectation.

Financial markets are now approaching important levels and the next fortnight should provide significant insight into the overall direction of the market for the rest of the year and into next. Investors should be prepared to be nimble and adjust their portfolios to suit the conditions which prevail. 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 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.

Until next time, have a great fortnight!!! 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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