The idea of a large diagonal that takes up most of the 3 year chart is still perfectly valid. In fact I would count it among one of the cleanest and best proportioned I have ever seen and this adds to the credibility. However at this point we are less than 40 points away from having this scenario negated by surpassing the old peak at 13 662. If it does I will pack up for a month as I cannot take much more of this.
The Dow has behaved in a rather disappointing way by not dropping. But it also has not, yet, negated the outlook and it has followed the other prediction which was that this market will do just about anything to climb back up. With a lot of noise we have now substituted the “fiscal cliff” for the debt cliff with a government that is even more divided than before which , on balance, may have made matters worse.
At the same time the announced additional 40 bln per month, to 85 bln. per month by the Fed has done wonders. Instead of lowering interest rates it has had the effect of raising them by about 30 basis points. This may prove to be temporary but then again it may be the real turn (after 31 or so years). All this with a little help from the Chinese, Japanese and a whole host of others including the Swiss who, by intervening in the currency market (which is the same as easing), have managed to accumulate Euro reserves to the tune of one time their GDP ($600 bln.) Stay bearish until this wedge is proven wrong.
We first presented this idea that a large “diagonal” was forming in August or even earlier. Now that it is complete together with the first wave down and a rebound back to the trend line the pattern truly does look textbook. There are a few important characteristics about the diagonal, wedge, rising flag, pennant or whatever you may wish to call it. First of all it is an exhaustion pattern, that is it always occurs at the end of the ride (wave 5 or c in EW terms). In this case we assume that it ends wave B from the March 2009 lows and has turned. Secondly, invariable these diagonals are retraced in their entirety, that is back to the base (or further!) as a minimum. In this case that should be about 3500 points. Not only does this normally happen, it also tends to happen rather violently. Given the two years plus that it took to complete, it would not at all be surprising if the drop was accomplished in less that 1/2 year. Such a drop would be accompanied by a collective “new” insight that our present pavlovian dog approach cannot yet contemplate.
Fundamentally there are problems galore that remain unsolved. The US spends $1.40 for each $1 that it takes in and despite all the hoopla about the fiscal cliff there is absolutely no conviction anywhere that something needs to be done about it. The European union and the Euro are fraying at the edges but there is no interest at all to cut out the rot. Japan is gradually on it’s way to oblivion given the debt levels and demographics and that is without starting its own Falkland war. China with 46% of GDP coming from “investment” as opposed to consumption is working very hard to set a new world record of capital misallocation that is invariable followed by colossal capital destruction. Canada is oblivious to everything,enjoying a very long period of hibernation. With all that we do not need the ice to melt or Sumatra to blow up seriously as it did 73000 years ago, it will be self inflicted for the most part.
This may be it. It certainly looks like a nice a-b-c correction that could be complete. Tomorrow we will have the Fed. at 12.30 o’clock. According to a Bloomberg article 48 out of 49 economists believe the Fed’s FOMC meeting tomorrow will announce additional easing on a massive and open-ended basis. This is the definition of insanity. If something does not work , keep doing it in the hope of a different result! The Fed’s balance sheet is expected to reach 4 trillion in the next little while. All of this largely due to the double and contradictory mandate of price stability and full employment first mandated in 1977 just 36 years ago and never tested. Then there is the fiscal cliff which is little more than a red herring on a similar scale as Y2K. The slightest disappointment from these two factors or from any other issue could do the trick. The high today was 13306.