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Gloom Today, Boom Tomorrow?

The crash which I called for in my June reports came a month later than expected and the wave count has developed very much as anticipated at that time.  In my favored count, SPX is nearing the end of its initial A wave decline of a large 3 part E wave which should end the bear market.

Here's my long term monthly SPX chart:

A significant portion of market participants believe that the decline represents a good long term buying opportunity.  Already there is widespread chatter in the financial news media that a bottom is at hand or nearby.  While the B of E rally may have already begun, wave structure and other technical indications tend to suggest that we are now seeing a final wave of capitulation selling before the "buy the dip" rally begins.

We are very likely in a period in which the news cycle will be sufficiently negative on an ongoing basis to catalyze the underlying technical weakness of the market into successive waves of selling pressure.  The sovereign debt crisis is probably in its early stages and some degree of "double dip" recession is also apparently in the cards.

The situation at hand is a maelstrom of countervailing forces as it has been since 2000.  This is one of the reasons why I have never allowed myself to self identify as an "inflationist" or a "deflationist".  Beyond that fact that mental attachement to a fixed viewpoint is a decided negative for a trader, it also does not conform to the facts at hand to adopt either dogmatic school of thought.  The period since 2000 has been a pitched battle between these forces as recorded in the wild swings in market prices both up and down. 

On the one had there are intense inflationary and growth forces.  Historic, worldwide monetary and fiscal stimulus is still making its way through the global markets and will be present in the system for some time.  No doubt additional measures will be forthcoming, such as a Eurozone bond.  There is also the force of globalist economic expansion, as the build out of two-thirds of the planet continues at breakneck speed. Technological innovation and efficiencies are also spreading throughout the world economy and new developments will naturally continue.

On the other hand there are strong deflationary forces.  Markets have tended to bubble, creating unstable structures subject to rapid downward adjustments.  Unprecedented debt and leverage have created malinvestment and misallocation of capital resulting in bankruptcy in both the public and personal spheres.  Barring a total socialist command economy, market forces will eventually correct these imbalances violently.

For over a decade, markets have been caught in the twilight zone between the "End of the World" and the beginning of a "New World".  While there certainly is a potential setup--both fundamentally and technically--for a deflationary super crash, my current favored interpretation of the overall environment and the message of the markets as revealed in the price action is for a relatively brief final deflationary capitulation.  During this period, market psychology should almost universally accept that the end of civilization is at hand (almost literally).  Think "Death of Equities" on steroids.

After periods of retrenchment, human progress tends towards renewed vigor.  Keynesian monetarist socialism is being largely discredited and a renewal of free market capitalism should be the hallmark of the subsequent era.  The Collectivists have had about 100 years to prove themselves wrong.  With any luck the advocates of Individual Freedom will have at least a quarter of that to prove themselves right.

S&P 500 corporations are currently operating with very low debt and high cash on their balance sheets.  Fiscally, they are in a very good position to take advantage of opportunities in the operating environment.  Favorable changes to the regulatory and tax environment are likely nearby.  US domiciled corporations are still by far, as a group, the world's leading companies.  Going forward, these companies are well positioned to invest and lead coming out of a market and economic bottoming process.

Below is Robert Shiller's inflation adjusted S&P 500 PE Ratio chart.  It's currently trading a bit higher than its historic average:

I've marked it up to show a potential 5 wave decline since 2000, which would correlate with the proposed five wave ABCDE corrective triangle in the price of the index during the same period.  Wave V could potentially take PE ratio down to levels comparable with major long term buying opportunities in 1932 and 1982.  If corporations maintain their fiscal integrity and profits don't slide too much during the next economic contraction, stocks could represent a very good value in the not too distant future.  At that point most market players will have been forced out and a significant deleveraging process will have been completed.  There may even literally be "blood in the streets" as social unrest grows.  Such is the stuff of major long term buying opportunities.

 

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