Important Clues To Watch

For those not familiar with
Elliott Wave analysis, it simply means that lows significantly below this
week’s will likely mean a full retest of the September lows in the indexes,
and possibly new lows. The internals are
also at an important point. New lows were
above 20 each day this week (as were new highs), and this was the first week
that new lows on our Bottom RS/EPS New Lows list outnumbered highs on our Top
RS/EPS New Highs list the majority of days in the week.
Yet new highs came back on top on Wednesday.
From an internal breadth standpoint, if new highs can continue to
dominate the market, it looks like the leaders will only consolidate and then
move higher here — BUT if Bottom RS/EPS New Lows
break above 52 AND Top RS/EPS New Highs break below 20 late this week or next
week, then internals will favor the downside for the first time since the
September lows were made. 

Investors should watch
carefully for internal and price clues as to what the indexes will do.
For most of this correction, the major indexes have had little effect on
the leadership of the global recovery that we have highlighted:
EM Asia (x Japan), EM Eastern Europe, EM Latin America (x Argentina),
small-cap value, and junk bonds. However,
recent weakness in the major indexes has STARTED to
pull all markets down, and with a significant break of this week’s lows, we
would advise aggressive investors to take most profits even in these leading
sectors until the tech and major indexes don’t exhibit such negative influence
on the global markets. We’re not yet
there, but we’re close, so watch carefully. We
don’t want to let double-digit gains turn against us in these markets that
have been so good to us.

Economically there has been
evidence of what we remarked on several weeks ago — a softening in the
strength of the recovery. There is NO
evidence yet of a return to recession, a double dip.
However, there is some evidence that the pace of the recovery is set to
slow, particularly in the U.S. How much
it slows will help determine how soft the market will be.

With the Fed having little room
to ease policy via lower rates (because rates are already so low), the dollar
is becoming the vehicle of stimulation for the economy.
Especially strong have been the AUD
and NZD, but also the Euro
has rallied sharply. All three currencies
are close to resistance levels now. If
the AUD can rally strongly above 54, the NZD can rally strongly above 45, and
the Euro can rally strongly above 91, then a new era of dollar weakness will be
upon us, probably for some time. The weak
dollar will help stimulate the domestic economy, but will not be good for the
rest of the world, particularly if it happens very quickly.

Another pillar of the old bull
market, a strong dollar, bears close watching by investors.
Along with the dollar’s recent runaway decline, gold
has popped a bit, and gold stocks have been quite strong.
It is troubling that neither silver, platinum, nor palladium has
confirmed the move in gold. Gold will
really show that it is ready for a mini-move up further if it can break above
330, its multi-year resistance level. From
the anticipatory move in gold stocks, we suspect this will eventually occur.
Gold’s pop may be signaling a small later move up in inflation that
will eventually force the Fed to raise rates.

Right now service inflation is
heading higher, but goods inflation is offsetting it with some deflation
leftover from last year. However, a move
by inflation slightly higher along with a move by gold over 330 will signal that
the Fed will HAVE to move later this year to begin
a tightening phase — and this will not be good for the recovery or for
overvalued stocks. The days of this
sub-standard mini bull move may be numbered. And
what is frightening is that the global recovery, while leading to increased
profits in EM companies, has been relatively profitless for U.S. companies so
far.

Fortunately, we have limited
our purchases to leading groups, where there have been some dynamic moves.
But unfortunately, the breadth of Top EPS/RS New Highs has been far below
real bull market levels, and so the number of opportunities has been quite low,
as has our allocation. We’re making
money at a 20% rate so far this year, which is OK, but not exactly wonderful.
Investors may have to adjust to a lengthy period of global multiple
convergence, where overvalued U.S. stocks have trouble rallying en masse for
many years, while certain sectors present limited but good opportunities, such
as we’ve seen in the homebuilding industry this year.Investors should also continue
to closely monitor the commodity markets. Economically
sensitive commodity indexes and markets are on the whole still positive the
recovery scenario, though weakening. Lumber’s
response to import tariffs is a one-time reaction that should be overlooked.
Economically sensitive currencies continue making new highs as the NZD
and AUD have approached critical resistance levels.
Weakness now in copper, cotton,
lumber, and commodity currencies, accompanied by further strength in global
bonds, would signal a softening in growth and a change in scenario.
Remember to let the plurality of markets be your guide.