The wave of pain

In previous posts, I gave a brief outline of Elliot Wave principle and how it pertains to investor psychology in stock markets (click here and here for the postings). I also spoke about the sovereign debt crisis in Greece along with the problems of the PIIGS. This post will bring together these two concepts and what is currently happening on the US stock exchanges.

Today was a massacre. The three major indexes (Dow, NASDAQ and S&P 500) all fell more than 3%. One major factor roiling the market is the continued debt crisis in Europe. Even after ~$1 trillion USD bail out a few weeks ago from the European Central Bank (ECB) and the International Monetary Fund (IMF), the European Union (EU) is still not economically stable. More debt does not solve Europe's fundemental marcroeconomic issues. The country that is the focus of attention is Hungary. Hungary is not part of the EU, but the former communist block country received significant amounts of loans from EU based banks. Hungary is threatening to default and the potential massive losses to those EU banks are both enormous and destablizing. The jobs report for May also came out worst than expected. These events contribute to the main stream media's story to why the market sell off occured.

Was this sell off predictable? It is impossible to determine the exact movement or level of the stock market on any given day. Anyone who says they can is a liar or an insider. Insiders can only predict with a certain stock for limited amounts of time (insider trading is illegal). For us average folk, it is possible to approximate the direction and pattern a market may take using Elliot Wave principle (EW) which is a technical analysis method based on the Dow Theory. EW prescribes potential outcomes. The EW community tends to believe we are in Primary wave 3 of a secular bear market. We are a heavily indebted society with a debt bubble that needs bursting. Accordingly, I believe we are at this stage in the bear market as of today:

Cycle 3 of 5 (Primary wave 3)
Intermediate 1 of 5
Minor 3 of 5
Minute 3 of 5

Remember, each wave is further divided into 5 subwaves in the repetitious fractal form. The minor 3 of 5 represents the largest 3rd wave of a fractal. I was skeptical about any waves smaller than the minors, but the last couple of weeks made me a believer. The 3rd wave is also the most violent in action. The sell off today represents the sudden movement expected in this bear market stage.

The answer for the predictability question is yes. The massive sell off was predictable being limited to approximate dates and amplitudes. I was prepared by going long on inverse ETFs or funds that respond in an inverse manner to the market movement (represented stocks go down, fund goes up). This current downturn should continue on for a least a few more trading days.

Europe stops fiddling while Greece burns!

This post is a combination of several other past blog topics. It will cover economics and the stock market.

In March, I discussed the economic crisis in Greece in the post The slippery slope of Greece. In the post, four options to Greece's crisis were presented:

Option 1: EU bails out Greece with emergency loans at low rates and Greece implements austerity budget spending.
Results: If the money comes in from the other EU members, it will give Greece a little breathing room to fix problems. This requires the most powerful EU member's, Germany, blessing. If the money does show, I rather doubt Greece will do more than superficial changes to government spending. Greece has cheated on its obligations in the past, thus, why should it change now? EU members know this. The cash influx would last about 6 months and nothing structurally would have changed. Greece would be where it started. Even if the austerity measures were fully implemented, Greeks make is a national past time to protest. The economy would face a decline in productivity resulting in further economic problems.

Option 2: Bailout from the US Federal Reserve in low rate loans
Results: Same as in option 1. The advantage of this scenario is it could be kept secret. For Europeans, it is the best option since Europe do not have to pay. American taxpayers get the bill when option 4 below occurs.

Option 3: International Monetary Fund (IMF) steps in and gives emergency loans to Greece.
Results: Same as option 1 again. Two negative aspects loom here. One, I believe this would break terms of the EU. Other EU states would retaliate, dumping on Greece in various ways. Greece might get thrown out of the EU. Two, the spending restrictions the IMF imposes during its assistance programs are harsh. Greece will enter into an economic downward spiral as socialist union workers shut the country down from mass protests.

Option 4: Greece defaults on sovereign debt
Results: It is impossible to determine what will occur after the actual fact. Greece would enter into a severe depression though. The key is membership within the EU. Will it remain a full or partial EU member? Will it keep the euro as a currency? I am guessing the IMF would step in here and impose their will. Greece would have to accept a bitter pill.

It appears as if a variation of Option 1 won. The ECB announced last night along with aid from the IMF a $955 billion rescue fund for the entirety of the EU states dependent upon the Euro. The plan is bailing out all of Europe! The intention of the rescue was to defend the value of the Euro. Really, the plan is nothing more than printing money and providing it to banks across Europe. In the long term, it is going to devalue the Euro even further. It does not directly address the crisis in Europe and especially Greece, too much debt.


In two previous posts, Markets and psychology along with Market observations, I present Elliot Wave Theory and how equity markets are driven by investor sentiment. It is time for a Dr. Coffee's Market Update.

In February, I was predicting that we had begun Primary Wave 3, AKA the Ponzi wave. The market had a mind of its own and recovered after the sell off in January and February. It continued on the ever appreciating march to the moon. Primary Wave 2 had not yet finished and had me fooled into a sudden crash as expected in Primary 3.

Well, things have changed. The sudden drop and high volume accompanied with the sell off starting on April 27 is more characteristic of a 3rd wave. Last Thursday had the Dow Jones Industrial Average briefly drop almost a 1000 points! Today, after the European bailout was announced, all of the US indexes shot up over 4%. This is typical of a bear market rally and indicates that Primary 3 has launched. I believe this is where we are at within the wave structure:
Cycle 3 of 5 (Primary wave 3)
Intermediate 1 of 5
Minor 2 of 5

If this is true, expect significant downside to the US stock market. If not, the market may fool me again!! I reserve the right to be wrong.

Slippery slope of Greece

The mainstream US media tends to emphasize stories that often bring about passion from their directed audience. Americans are often disconnected from important world events. The cause of this international detachment is our relative large size or isolation from the largest Europe/Africa/Asia landmass is a topic of long debates. In either case, economic events in Europe may be powerful enough to reach our sovereign shores soon. It has to do with national debt of the commonly referred to PIIGS, (Portugal, Italy, Ireland, Greece and Spain) and its influence on the economic entity the European Union (EU). We are going to specifically focus on the current hot spot, Greece.

Greece is facing debt on the order of 120 % of its gross domestic product (GDP). It would take over 1 year and two months of the country's complete economic output to pay off this whopping total. This is one of the highest debt loads in the world. It grew to this large size through many avenues, some of them legal and others illegal underneath the Treaty of Maastricht forming the EU. Greece was supposed to limited its yearly deficit to just 3 % GDP by treaty terms. It seems the the Greece government has been cheating on this promise in many ways. I will avoid details here. What I am going to discuss are potential international responses to this mess from best case scenario to worst case scenario. I call into question any "best case" options though.

Option 1: EU bails out Greece with emergency loans at low rates and Greece implements austerity budget spending.
Results: If the money comes in from the other EU members, it will give Greece a little breathing room to fix problems. This requires the most powerful EU member's, Germany, blessing. If the money does show, I rather doubt Greece will do more than superficial changes to government spending. Greece has cheated on its obligations in the past, thus, why should it change now? EU members know this. The cash influx would last about 6 months and nothing structurally would have changed. Greece would be where it started. Even if the austerity measures were fully implemented, Greeks make is a national past time to protest. The economy would face a decline in productivity resulting in further economic problems.

Option 2: Bailout from the US Federal Reserve in low rate loans
Results: Same as in option 1. The advantage of this scenario is it could be kept secret. For Europeans, it is the best option since Europe do not have to pay. American taxpayers get the bill when option 4 below occurs.

Option 3: International Monetary Fund (IMF) steps in and gives emergency loans to Greece.
Results: Same as option 1 again. Two negative aspects loom here. One, I believe this would break terms of the EU. Other EU states would retaliate, dumping on Greece in various ways. Greece might get thrown out of the EU. Two, the spending restrictions the IMF imposes during its assistance programs are harsh. Greece will enter into an economic downward spiral as socialist union workers shut the country down from mass protests.

Option 4: Greece defaults on sovereign debt
Results: It is impossible to determine what will occur after the actual fact. Greece would enter into a severe depression though. The key is membership within the EU. Will it remain a full or partial EU member? Will it keep the euro as a currency? I am guessing the IMF would step in here and impose their will. Greece would have to accept a bitter pill.

Reviewing the four options above, unfortunately they all will lead to option 4. The amount of debt Greece has accrued is too much. Greece is not positioned towards a future booming economy in their current political and economic position. The bailouts (options 1-3) lead to just more debt down the road, thus, they default eventually. To put in prospective, if they pay 4.5 % annual interest on their 120 % GDP debt (~$340 billion USD according to Wikipedia) that translates into $18.4 billion (5.4 % of all economic activity) annually to service their debt interest alone. This value does not include debt principle repayments (much higher value). In recent Greek bond issues, the interest was north of 6%. They are paying significantly more than just outlined!

We are just using Greece as an example of the debt problems facing all the PIIGS. The other oinkers are much larger nations and have similar debt problems. How this will effect world bond, commodities and equity markets will be determined over the next few weeks to months. The time frame depends on if one or more of the initial three options occur, delaying the event.