Reflections on the past 5 years: The FED, Central Banks and Financial Markets

There are a vast number of analysts who proclaim that the Federal Reserve Bank, and other central banks around the world, are in control, and that had it not been for the FED's aggressive and unprecedented monetary policy in the fall of 2008, and for a period of time after, the financial system would have fallen apart and collapsed completely. Further, many bears (including myself) who were vehemently against not only FED policy, but were strongly opposed to the idea that it would even be successful in preventing a financial collapse, have now been all but discredited, and many think the risk of a financial collapse and depression has evaporated and the FED has saved the day. I want to dispel two myths in this regard:

Myth # 1: The FED saved the day and prevented the complete breakdown of the financial system:

If anything, the actions of the Federal Reserve and that of Central Banks around the world have done nothing but put off the collapse, and turned an already unprecedented condition of over leveraged "too big to fail" banks and an over-leveraged system into an even more over-leveraged system, that has set up the entire financial system for complete and utter chaos once the liquidity cycle tops out and the inevitable reversion to the mean comes and natural forces of social mood take markets down. In short, the cure for too much debt is not more debt. Trying to cure the system with more debt is like trying to cure a crack patient with heroin. Instead, these geniuses at the FED and other central planners around the world have decided to do more of the same that helped get us here in the first place, and as a result have ensured an even bigger liquidity and banking crisis down the road. What has eluded me, as well as many others who are highly knowledgeable about the situation, is time. The lesson here is that extremes in financial valuations, and over leveraged systems, can go on for a lot longer, and become even more stretched, than might seem possible from the outset. In this case, the outset was the period from 1974-1982, when the biggest credit expansion in history was in its early stages. But, I must emphasize, the fact that the system has held up as long as it has, does NOT change the ultimate outcome, and, as we will see in coming years, the added leverage and debt in an attempt to prop up an already over leveraged system will only make the ultimate outcome even worse than if nature was allowed to freely regulate the financial markets.


Myth # 2: The FED is in control and "changed" the wave count.

With respect to the Federal Reserve Bank and financial asset valuations, many so-called "analysts" believe the FED sets interest rates, and, even amongst those who practice Elliott Wave Analysis, that the FED "altered" the wave count.

First with interest rates. Contrary to popular belief, the FED does NOT control interest rates. Please see the below chart, courtesy of Elliott Wave International:

As is clearly evident, The FED's interest rate targeting follows the market for 3-month U.S. treasury bills, not leads. My point in illustrating this is to prove that the FED does not decide what interest rates will be, but the global debt market does instead. And, I assert that the fact that this stock market rally and so-called "recovery" has gone on so long, and stretched so far, is not ultimately due to the FED, but rather to fluctuations in human collective social mood. If the bond market decided not to put up with the FED's unprecedented balance sheet expansion, the majority of participants would sell their financial instruments. This would drive interest rates higher, driving the value of the underlying treasury securities down, and thus the FED's balance sheet down. At the very least, it would strip them of any remaining credibility they had left, and, also quite possibly, and I think probably, forcing FED "set" interest rates higher even amidst a fragile system and weakening economy as confidence erodes away. The rising rates for already unsustainable debt levels would make both public and private sector debt unserviceable and we would see debt defaults occur in droves. In a sense, the subprime mortgage crisis is a microcosm for the entire system. It is one giant subprime mortgage, and once interest rates spike upwards, the debt will no longer be serviceable. Except this time, we are not dealing with the subprime housing market, we are dealing with the entire debt-based monetary system, and the implications are very drastic. The point in explaining these principles is to illustrate that the only reason the system has held up as long as it has, and that financial valuations and the underlying credit structure have become as stretched as they have, is that investors, who are humans, have put up with it. This, I contend, is due purely to the natural ebb and flow of human social mood, and simply serves as evidence of how big of a peak in social mood we are truly facing. These directors, which again are human beings, cannot control social mood fluctuations, no more than any other human being or group of human beings can regulate or manipulate the growth patterns of a tree. Tree growth is a system in nature, and the natural upward progression of human consciousness and social progress is also a system in nature. Contrary to many exogenous cause belief systems inherent in human beings, I believe many if not all systems in nature are endogenously regulated, or in other words self-regulated. They do not depend, nor are affected by any outside force. Since all systems in nature are subject to vibration, frequency, and fluctuation, many of them also exhibit fractal behavior, with self-similar patterns showing up in these vibrations or fluctuations at varying scales (i.e. timeframes). If one accepts the notion that systems in nature are self-regulating, then, it also seems logical to accept that financial market valuations, a result of the relative position of human collective feeling, or social mood, move on their own accord as well. Therefore, I assert that this upward trend in financial asset prices, and accompanying reflation of the credit money supply over the past five years, while encouraged by the FED, could not have happened without the trend toward a positive extreme in human collective social mood supporting it. And, the followed logical conclusion to all this, is that when the human collective social mood reverses into a trend toward a negative extreme, financial asset valuations, economic activity, and social and political conflicts will all follow toward a negative extreme.

Additionally, the fact that we as a society, unlike the financial peak of 1929, value financial asset prices in terms of debt-money IOU's, rather than real money, necessarily creates a resulting divergence between real (inflation adjusted) asset prices and nominal (assets valued in terms of debt-money U.S. Dollars ) asset prices, as should be expected. Using logic, If A is associated with C, and B is associated with C, the relationship between A and C (or ratio numerically expressed), and B and C (or ratio numerically expressed) is going to be different for the simple reason that A is not B, and B is not A. In this case, A and B represent Real Money that doesn't fluctuate in value (Gold) and credit-money (U.S. Dollars and many other central bank monopolistic currencies around the world), respectively. Continuing with this example and its conclusion, the relationship between A and C, and B and C, represent real (inflation-adjusted) and nominal asset prices, respectively. Since we have just shown that A does not equal B, the conclusion drawn from that using deduction, is that the relationship (or ratio) between A and C and B and C, will be different. Therefore, it is logical to conclude that the addition of credit-money to the system necessarily mandates, by logic of deductive reasoning, a divergence between real and nominal prices, which we clearly see present in the financial system today.

Using endogenous cause reality, the fact that we have been on a credit money system standard for decades now, rather than being a cause of how stretched the overvaluation and optimistic extreme has become, is rather a result of a peak in optimism so large, that it is concluding an uptrend in human social progress that has lasted centuries, and, looking back in hindsight, we will be telling our grandchildren about it.

 In conclusion, endogenous cause reality suggests that the extremity present in the financial system, is NOT ultimately a result of central bank action, and, if one accepts that notion, then it is also reasonable to assume, that once the trend in human collective social mood truly turns down (it has been in a topping process the past 14 years, evident by a number of different measures I have illustrated before. See prior posts), there is nothing the central banks can do to stop it, and the resulting asset price declines across the board. 

A Long-Term Elliott Wave Analysis

There is much debate in the Elliott Wave Community over the long-term count. Did the Bull Market end in 2000? Did it end in 2007? Or, did it never end, and is still in force? Remaining objective, let's take an in-depth look at three possibilities:

Preferred Count: Bull Market topped in 2000

Logic and Reasoning: As I have illustrated before, the stock market, using the Dow Jones Industrial Average as the best long-term proxy of market progress, priced in almost everything except U.S. Dollars, topped in 2000 and stopped exhibiting any impulsive price structures at that point. All rallies since then, priced in terms of most assets, have been reflective and indicative of a counter-trend, bear market rally in stocks. In addition, the advance from 1974-2000 resembles quite closely the advance from 1921-1929, the last Cycle wave V high. The rally that began in 2009 is the most extended 4-year cycle advance in stock market history, now in month 64. If there is doubt over this count due to the duration and extent of the rally, one should keep in mind that under this particular count, the 2002-2007 rally is also a bear market rally, labeled Primary wave B (circle). It ran 60 months, matching the longest 4-year cycle advance of 60 months from 1982-1987. Therefore, if one is going to call that advance a bear market rally, which seems to be the case given the evidence stated above and in previous posts, then one should not have an issue with labeling another stretched 4-year cycle, a now 64 month advance, a bear market rally as well. This count has an expanded flat pattern from January 2000-March 2009 for cycle wave a, and the rally since March 2009, cycle wave b is serving to correct this decline, in a larger expanded flat pattern.  Given this count, it would not be unreasonable to expect a new high in inflation-adjusted measures of the market, since new highs in the b-wave are often characteristic of expanded flat patterns. Another supportive feature of this count would be the fact that the rally has occured not only on low volume, but decreasing volume the entire time. This is best illustrated on a yearly chart, below:

As is clearly evident from the chart, volume was increasing into the 2000 top, which is indicative of a true bull market. Volume tends to increase with each price bar in the direction of the prevailing trend, and decrease with each price bar counter-trend. As price declined into the 2002 low, volume increased year-over-year from 2000-2002. Then as the rally out of the 2002 low began, volume once again dropped off in 2003 and 2004. It picked up in 2005, but that was a slight down year for the Dow Jones Industrial Average. 2006 was the exception, as volume picked up on the rally. 2007 saw decreased volume on an up year, and volume spiked dramatically on the decline in 2008. Since the 2009 low, every year has been an up-year, and every year saw decreased volume from the prior year. This is NOT characteristic of a true bull market, but rather of a liquidity-driven bear market rally.

Further evidence that the bull market ended in 2000 is found in the true measure of market valuation, the Dow Jones Industrial Average priced in terms of Gold. If in fact the bull market ended in 2000, then the rally that began in March 2009 is of a higher degree, cycle degree than the rally from 2002-2007, primary degree. Commensurately, the market has rallied further in percentage terms, and for a longer period of time, than it did during Primary Wave B. Also to be expected, while the Dow priced in gold was actually falling during the 2002-2007 rally in nominal terms, this time, the ratio bottomed in association with the 2011 low, and has been rallying along with nominal stock prices since that low. As a result, the Dow priced in Gold has exhibited a larger rally during Cycle Wave b than it did during Primary Wave B. This is also indicative that the current rally is of a higher degree than the 2002-2007 rally.

 

On October 9, 2002, the day of the closing low in the Dow Jones Industrial Average, the Dow was trading for 23.74 ounces of gold. On October 9, 2007, the day of the closing high in the Dow Jones Industrial Average, the Dow was trading for 19.06 ounces of Gold. So, during the longest 4-year cycle advance in history at the time, in which the nominal Dow gained 94%, the real value of stocks actually lost -19.71%. This is certainly indicative of a bear market rally, and is further evidence supporting the fact that the 2002-2007 rally was NOT a bull market, but only a rally within the context of the larger bear market that began in 2000.

This time, the Dow priced in ounces of gold bottomed on August 10, 2011 at 5.96 ounces of gold, and reached a high of 13.76 ounces of gold on December 31, 2013. This represents a gain of 130.87% and is far stronger than the 2002-2007 rally in real terms on a relative basis. This again suggests that the March 2009 rally is of a higher degree than the 2002-2007 rally. 

Please also consider charts below of the Dow Jones Industrial Average adjusted for the M1, M2, and MZM money supply measures, respectively. All of these measures of market valuation rallied strongly in the 1990's, very similiar to the nominal averages. However, unlike the nominal averages, these measures adjusted for money supply topped in 2000, and are significantly below their all-time highs and further suggest both the 2002-2007, as well as the rally that began in 2009, have been bear market rallies in an ongoing secular bear market.

                          

 

 Alternate Count: Bull Market topped in 2007

Logic and Reasoning: One possible argument for the Bull Market having topped in 2007 is that the 2005-2008 period was the peak in public speculation, from real estate, to stocks, and then to commodities. Both real estate and commodities remain below their respective all-time highs. What followed the 2007 top was the largest market decline and financial crisis since the great depression, including significant contractions in the supply of money and credit. One could argue that the bull market topped in 2007, then, on the basis of the peak in public speculation, which clearly has not returned to it's prior levels of 2005-2008. On a technical note, should this count be correct, the resulting wave c down should be very swift, as a common trait of c waves in expanded flat pattern is that wave C is steeper than wave A. Given the swift nature of the decline from October 2007-March 2009, this is a particularly ominous count would portend an all-out collapse in investment prices across the board in a great panic that could very relatively short lived in time, but very destructive in price.


Second Alternate Count: Bull Market never ended, still ongoing

Logic and Reasoning: Many measures of investor sentiment have exceeded their prior all-time highs, tech IPO's are booming again, and the Stock market is trading at all time highs.

Issues with this count: The reason I have designated this count as second alternate, is due to the fact that the bear market and recession of 2007-2009 was the largest since the 1930's depression. That means it was larger than the entire cycle wave IV bear market between 1966-1974. To say that this is still part of an ongoing bull market, from the 1974 low, would be, in my estimation, omitting this data and it's logical followed conclusions. While I would favor this count over one that suggested the bear market ended in 2009, and this was a new bull market, it still has many logical and statistical issues with it, not the least of which include the fact that this rally has occurred on extremely weak technicals, as illustrated above, as well as the state of the general economy. Many pundits termed this the most jobless recovery ever. Well, I contend that the relatively weak job market throughout the entire rally, and more recently, GDP, which just contracted at an annual rate of -2.9% in the first quarter of 2014, as opposed to the consensus of -1.8% by economists, is hinting that this is not a recovery at all, but rather a reflationary period in an ongoing depression. Even economists, which have been calling this a "recovery" expected negative growth in the first quarter. These readings are not bull market material. I have said all along that this is NOT a recovery, but early in an ongoing depression that began in 2000.

Whichever of these three counts turns out to be correct, all the evidence points to the conclusion that once this rally terminates, the outcome will be nothing short of a financial disaster that takes the market below the lows of March 2009.


When all the evidence is concatenated, the most logical conclusion in my view is that the greatest bull market in history topped in 2000, and this rally since 2009 has been a massive, liquidity induced bear market rally, and the second since the bear market began in 2000, the first being 2002-2007. However, it is quite clear that the topping process is still ongoing, with investor optimism at extremely high levels, while the underlying economy is slowly slipping into depression. Although the bull market in stock valuations ended in 2000, and thus the bull market in stocks themselves, what didn't end, was the bull market in credit. It has been the reflation of the credit money supply that has allowed the nominal stock averages to register new all-time highs. And, just as the tech bubble, housing bubble, and commodity bubbles all ended in a collapse, so to will the credit bubble itself. Except this bubble represents the nature of the credit money system itself, that has simply been the medium through which we have seen an unprecedented number of consecutive bubbles in different asset classes in the past 30 years. I believe the evidence also points to the fact that when the reflation ends this time, it will not be simply one or two asset classes that collapse, but the entire debt-money system. Decades of credit expansion will reverse into credit contraction as people become more cautions and social mood really starts turning negative. We will see this manifest itself in lower prices for assets across the board, even in nominal terms, a severe contraction in economic activity, as well as social unrest. It's a Grand Supercycle Bear Market, and the ultimate downside resolution is going to be breathtaking.

Tim Wood Interviews Ed Dowd 5/27/14

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Real Dow Jones Industrial Average Elliott Wave Count

Upon opening up a newspaper, or logging on to Yahoo Finance, one will find a quote for the Major Indexes  (Dow Jones Industrial Average, S&P 500, and Nasdaq). However, what most people do not understand is that these measures are not true measures of stock prices. They are nominal values only, which means they are not adjusted for inflation, or, put another way, they are not adjusted for FED currency debasement. The most honest measure of stock prices out there, is the Dow Jones Industrial Average priced in Gold. Gold's history as money goes back thousands of years, and it's not going away any time soon. Indeed, the United States was using Gold as its official money for quite a long time before the Federal Reserve system was established. Had society continued to value stocks and other assets in terms of Gold, we would be seeing a very different picture in the newspaper today. Instead, because of the massive credit inflation scheme of the past 100 years, and especially since Nixon completed severed the U.S. Dollar's link to Gold in 1971, and more recenlty since 2000, when the true bull market in valuations ended, people collectively have been valuing assets in terms of inflated Dollars, distorting the true valuation of companies' balance sheets, and thus their stock prices. What would the stock market look like today if we had stayed on honest money? Please see below a chart of the Dow Jones Industrial Average priced in ounces of Gold, with Elliott Wave labeling:

Should this Elliott Wave count be correct, the next leg of the bear market in real terms is upon us. The "Bull Market" from 2002-2007, was actually just a bear market rally, and hardly a bounce in the real valuation of stock prices, and quantitative evidence supports the notion that 2009 marked the first leg down of the Grand Supercycle Bear Market that began in 2000. As such, the real value of stock prices, illustrated here by the Dow priced in ounces of gold, has had the largest rally since the high in 1999. This suggests a bottom of significance was made in 2009. However, it was not THE major bottom, but rather just a intermediate term low, separating the first leg of the bear market from the second. Historically, secular bear market bottoms have occurred with the Dow/Gold ratio between 1:1 and 2:1. Because this bear market is of Grand Supercycle degree, I would expect the first Supercycle low to occur with a Dow/Gold ratio below 1:1. This means, at the ultimate secular bear market bottom sometime this decade, an ounce of Gold should be worth more than the Dow Jones Industrial Average.

Quarterly RSI 5 respecting downtrend line

         This chart speaks for itself:

Market Update: March 2009 in Reverse

Back in March 2009, when markets worldwide were bottoming after the most severe bear market since the 1930's, we had some of the lowest sentiment readings on record. The DSI, daily sentiment index, which polls futures traders, printed a reading of only 2% bulls. Fear was dominant, and articles calling for Dow 5,000 were not hard to come by. Now, let's fast forward almost five years, to January 2014. The U.S. stock market is registering new all-time highs, and it feels like 1999 all over again. The question is some technicians minds is: Is this a new bull market, or just a continuation of the old one? From my standpoint, the answer is, neither. Although virtually nobody believes this anymore, I am still calling this a bear market rally. Many people are probably scratching their heads wondering how one can be calling an almost 60 month advance that brought the market to a new all-time high a bear market rally. The answer lies in a number important factors, but perhaps the most important distinction is the failure of the market to reach new highs in terms of purchasing power. Back in 1999, if one examined the Dow Jones Industrial Average, the most well known measure of stock prices, it was making new all-time highs in terms of just about every commodity. Now, however, these measures are failing to do so, even with commodities in a bear market.

Dow purchasing power in terms of Real Money (Gold):

                                 Dow purchasing power in terms of Oil:

 

Dow purchasing power in terms of Copper:

As is clearly evident from the charts above of the Dow Jones Industrial Average priced in various industrial commodities, the actual purchasing power of the stock market has been in a persistent downtrend since 1999. The only measure that has held up since 1999/2000 is the nominal Dow. Further, the only reason it has held up has been massive inflation, which has decimated the value of the U.S. Dollar, through a massive credit inflation scheme that has been going on since the inception of the Federal Reserve in 1913. However, it is my sincere belief that even in nominal terms, the stock market will experience a dramatic collapse, as the value of dollar-denominated credits, worldwide, trend lower. Please find below an updated chart of the Dow Jones Industrial Average in nominal terms. 

Although the upper trendline of the monthly broadening top on an arithmetic scale has been broken, the market is respecting the upper trendline on a logarithmic scale.Because logarithmic scale represents relative percentage movements, rather than on an absolute basis, longer term moves are best illustrated in this form.

Now examine the same chart close up to today's prices:

                                         Big Picture Elliott Wave Count:   

                         

                               

                                   
                                        Cycle wave b internal wave structure:

                         
  If my long-term analysis is correct, cycle wave c down is next, and it's going to be accompanied by severe deflation across the board. It will truly be one for the record books.

Tim Wood interviews Ed Dowd 1/23/2014

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