Are We There Yet?

The bad news just kept rolling in over the weekend. One of the more salient reports was that Warren Buffett’s Berkshire Hathaway posted a 96% drop in fourth quarter net income.

Berkshire shares have fallen 44 percent in the past year as the value of the firm’s top equity holdings dropped and losses increased on the derivatives. Nineteen of the top 20 stocks in Berkshire’s U.S. portfolio declined last year.

However, the real kicker for me was Tom Russo’s response to the news:

“You can call it the worst year ever if you want, but the fact is, the results compared to the 30 to 50 percent declines in the world stock markets show just how defensive Berkshire is,” said Tom Russo, a partner at Gardner Russo & Gardner, whose largest holding is Berkshire shares. “In the face of the maelstrom, he did alright.”

Pay attention investors – we now got ourselves a new Gold standard! Seems like losing money on 19 out of 20 positions is considered ‘doing alright’ these days. Boy, I can’t wait putting my money into one of those funds. Seriously now, I can guarantee you that I can do a better job throwing darts at a finviz stock map….. blindfolded…..with my teeth and two arms tied behind my back.

Congratulation rats – we just beat Oracle of Omaha at his game. If you traded along during the past quarter you have been on the opposite sides of Buffett’s trades – and thus have profited while many of our famous ‘market wizards’ lost a substantial portion of their assets.

I think this picture illustrates how easy it’s been for us bears in the past year. Like swarms of juicy pink salmon investors kept swimming upriver – valiantly defying the raging currents of financial markets and macro economics. All we bears really had to do was to catch them during their little leaps, at whichever degree of the wave cycle we preferred to play. Some very smart bears simply positioned themselves right around the 2007 peak and rode this thing all the way to the bottom. They ignored all the lamenting, all the misleading news, all the bailout attempts, and all those bottom calls by our mouth breathing friends over on CNBC (excluding Mr. Santelli of course). Those bears are now resting comfortably in their winter lairs – fat and happy, waiting for the next salmon season to arrive.

Anyway, if I was trading the news I would be shorting the index futures right now. Fortunately I never trade the news (actually that is not completely true – I often fade them) and the growing amount of negative sentiment is actually a clear warning sign that this year’s salmon season is drawing to an end. We shouldn’t complain – it’s been profitable and (often) fun, but we don’t want to overstay our welcome.

Before we get to the forecast for next week I would like to take a step back and review where we are in the larger degree wave count. The circle on the image above marks our current position in this secular bear market: We are in Intermediate (5) of Primary {1} of Cycle wave c. More precisely we are in Minor 3 of Intermediate (5), thus there are only two more Minor waves separating us from the conclusion of the larger degree Primary wave {1}.

Minor waves are traditionally measured in days to weeks, so we should take note and mentally prepare for what’s next, which is a multi-month consolidation that will give our bullish colleagues ample ammunition to declare this bear market dead. Of course nothing could be further from the truth – this cycle of the bear market is just getting warmed up. As a matter of fact what comes after the looming Primary wave {2} is of course Primary wave {3}, and if you have learned anything here in the past few months, then it is that bear market third waves are the nastiest of them all. If you think that 3 of (3) of {1} was bad, then prepare yourself for 3 of (3) of {3} – it’ll be a beauty. But that’s probably a year or so away, so back to the present.

On a more short term basis we are now facing two scenarios:

Orange: We are completing Minute {v} of Minor 3 of Intermediate (5). A good target for the bottom of {v} is the 703 region, as this would bring Minor 3 to a 123.6% Fibonacci multiple of Minor 1. 700 is also a psychological level that I expect to be defended. The target for Minor 4 for this scenario would be the 765 area.

Blue: We reached near completion of Minute {v} of Minor 3 of Intermediate (5) on Friday and are now dropping a few more points and then ascend into Minor 4. The target for the Minor 4 in this scenario is the 790 level.

Now take a quick note of the green vertical lines I’ve drawn. It just so happens that at the Friday close Minor 3 was almost precisely the length of Minor 1 of (5). There are important implications here in that a third in a motive wave can never be the shortest. Actually in equities it happens to be most often the longest wave, but that is not always the case. The big EWT rule is that a third wave is never the shortest among 1, 3, or 5 – meaning that if 1 is longer than or equal to 3, then 5 must be shorter than 3.

So, knowing that we also know what to expect should we embark on the blue scenario over the coming week. If Minor 3 of (5) ended on Friday then we should expect a rather short 5 of (5). it is even possible that we might see some sort of truncation and that 5 of (5) may not even reach its 680 target and complete near or slightly below the Friday low.

We won’t have to wait long for clarification however – if we drop further then we’ll probably see the 700 teens – otherwise we’ll push towards 790.

The CBOE Put/Call Ratio seems to be supporting the orange scenario as there is plenty of upside potential (downside potential for equities) remaining.

The NYSE McClellan oscillator, a medium term measure, has snapped back after last week’s extreme lows but managed to actually hold up a bit on Thursday and Friday, despite the fact that the SPX broke the November 21 low. There are two ways at looking at this – either we’ve got ourselves a bullish divergence, leading into the blue scenario. Or there is a bit more bottom potential left, thus leading into the orange scenario. Pick your poison 😉

The NYSE Bullish Percent index also seems to have faded the new lows in all indices, and remains above the 20 mark, which by traditional measures is bearish and considered oversold territory. But in the context of what we’ve seen in the past six months I believe that there is ample more downside potential supporting a final drop into 5 of (5) of {1}.

The U.S. Dollar has remained on course and is getting close to breaching its November highs, just as promised. My count indicates that we are in a 3 of (3) wave, thus I expect us to reach 90 and higher.

The Yen on the other hand has been a glutton for punishment while skating down its 2.0 BB like Tony Hawk. We are again pushing up in early Sunday night trading (relative to the U.S. West Coast) but it did that last weekend and then got killed again all week. Thus, I do not have any estimation as to when it will truly bounce back and retrace some of the lost territory. What I do know however is that when it does it’ll be massive – that’s a trade I’d love to be in. It might be worthwhile to take out a small speculative position in FXY as I frankly don’t know how much further this thing can stretch. However, as a trend trader I also know that once a trend is in progress it can last a lot longer than anyone expects, which trend traders happily can attest to. So, be cautious and don’t ‘go all in’ here.

Last but not least – Gold is making a tiny bit of a come back which I see as a good opportunity to reload on puts or pertinent short positions. I’m actually sitting on Silver, which has been treating me nicely last week. If we get a final drop into 5 of (5) in equities it’s not unreasonable to assume that Gold might retrace some. Again, the line in the sand for me is the prior high of 1007.5 in ZG – should we breach that I’d probably cover and wait for further instructions.

However, judging by last week’s tape it’s possible that any further weakness in equities will only partially be exploited by Gold, in that it might merely halt its decline or go sideways. The probabilities in my mind are now clearly on the bearish side. But, as always, when it comes to precious metal futures, I am prepared to expect to unexpected.

That’s it folks – I see you tomorrow morning on the side. Next week should be interesting – that much I can promise.

Cheers,

Mole