Vertigo

Vertigo

01 March 2020

“Vertigo is a 1958 American film noir psychological thriller film. Detective Scottie who suffers from acrophobia is hired to investigate the strange activities of an old friend's wife. “

The fear of heights is a normal phenomenon, but should you get dizzy and tripped over it’s a free fall all the way down. At 12,500 nifty maybe I should have had vertigo, definitely the market got it and there seems to be no looking back. The budget was a disappointment and as the LSR before the budget noted we should get a normal 50-61.8% retracement down. 50% was done in a day then and with a 3 wave decline from 21 Jan high it looked like the bottom was in. A 5 wave decline would have turned me bearish then itself. The eventual failure has pushed the Nifty below even 61.8% retracement and damaged the monthly charts. There is no looking back. The reflation trade is dead and we are back in deflation.

Some people are comfortable counting the Nifty 2019-2020 as 5 waves and that is OK. I show them the Nifty 500 chart from my storage, the convergence of the rally from 2009 is like a wedge, the internal wave counts of many legs inside are often not certainly 5 waves. But given the umber of subdivisions you can fit something in. So even if you mark it as 12345 and then an ending diagonal at the top we have ended a Supercycle bull market starting 1934 with a long 2 years distribution. Yes the monthly momentum of the Nifty 500 also rolled over to the sell side and we closed below the 20 month average.

The daily momentum of Nifty went into sell mode last week, while the weekly momentum was already in sell mode. The Nifty chart above shows that the monthly momentum has also gone into sell mode [see first chart above], and broken the 20 month average for the first time, after trying to do so for 2 years. The Nifty however has to still develop a 5 wave decline on daily charts as a final sign that this fall is not a flash in the pan. Though bear markets can develop as a series of A-B-C that lead to W-X-Y-X-Z, a complex correction, there too wave A is first a 5 wave decline. So a 5 waves down would look like this. However on Friday markets gapped down and sometimes the gap zone is just halfway mark of the fall so 5 waves down might not just complete at 11030 as you would like but go much lower. Till complete based on the halfway calculation it would be open till 10800.

It took me awhile to get off the idea that the reflation trade was going to return quickly. But without excuses the year 2020 may be remembered as the one in which the “everything virus pricked the everything bubble”. Not the excessive debt not the margin debt in stocks, or the corporate leverage and buybacks, but a virus from nowhere. For an entire quarter from September to January the fed was fighting back the rising dollar by buying bonds in the repo markets. This kept the US markets buoyant and at all-time highs for a prolonged period of time. Prices rose far enough to come close to the top end of the rising channel for the Dow below before breaking down. Ending a 5 wave advance the first leg of the bear market will go to and attempt to break the 22585 level at the lower end of the channel.

On the Nasdaq 100 too we hit the top end of the channel. I published this chart and that we were completing a 5 wave move up toward it. The 5^th wave from 2009 up could have been larger and extended beyond the channel but that was not to happen. So wave 5 truncated for US stocks at the top end of the channel and the Nasdaq will again go the lower end of the channel at 7530. The arrows show the touchpoints on the channel. The 2018 decline did not break the lower end but the odds now are very high that it will break.

A map of how significant bear markets like this occur can often be made with the 1929 crash in the US from an Elliott wave perspective. The chart below shows wave 1 down was a 20% drop in the Dow in a month and then we got wave 2 up retracing over 50%. Wave 3 down then lost 68%, in an extended decline. The Dow so far this month in Feb 2020 lost almost 20%. Wave 1 will complete soon and we get wave 2 up. Wave 3 down could be devastating. The only difference would be wave 1 back then had some green bars or positive days. This time it was all red and fast.

On the other hand for the last 2 years despite weakness in the economy most Asian markets held the lower end of the ranges from Indonesia to Singapore or Thailand. They took a beating from everything starting with weak economic activity to the Hong Kong riots and trade wars and none of it would break the 3 year trendlines of all the lows. The entire 3 pattern ended up looking like a triangle in many cases and the corona virus outbreak finally triggered the break of these necklines.

For a while it looked like the fed the reflation trade might have the muscle to carry all the ships with it. More than that was the commitment that Japan and Europe would also follow up with stimulus measures that they were announcing in the media, but they never did. The failure than has been the slow pace of their actions to respond to the hopes they created. In the meantime the DAX index believed that narrative and ended up at an all time high. The recent crash has ensured that the rise was only 3 waves in wave E of an ending triangle pattern in wave 5. The lower end of the channel for wave E broke and we are now heading back from an all time high that did not manage to touch the top end trendline of the highs. Now back to the lower line and then below it at 11060. 

What you would have least expected is that not of financial event but a global pandemic would trigger the start of the next Deflationary cycle. So instead of getting a hyper bubble prompted by fiscal and monetary stimulus we are now most certainly headed into an outright recession. This does not mean that the government will not act eventually to attempt a stimulus or MMT [modern monetary policy]; the risk now is that it might not have the same impact that it could have had earlier.

The reason for this is a change in the social mood. Social mood, as explained in great detail in the 2002 “conquer the crash” by Robert Prechter, is the elephant in the room, and it permanently changes behavior of lenders and borrowers of capital and consumers and producers of goods alike. The best example of this is how Indian lenders and borrowers backed off from new loans during the last few years. Credit growth in India had come to a halt for quite a while primarily because of the fear of lending not just to bad corporates but also the fear of being caught in a CBI investigation for making those loans if they turn bad. MSMEs therefore failed to get follow up lending making their cash flow situation worse. Similarly corporations did not want to invest in new projects and taken for the debt in view of a slow economy. The combination of these factors were highlighted in that book as the primary reason why a deflationary depression does not reverse on its own till the social mood itself changes and that takes time. In the interim stimulus measures attempt to reflate and change the mood.

So what happens to the idea that pandemics occur during bear markets? While it is true that they follow a bear market, but what is not always the case is them occurring at the end of one. At times they may occur in early stages of one as seen in this chart from EWI discussed on YouTube recently, in 1968 the Hong Kong Flu occurred after the start of that bear market for the Dow in inflation adjusted terms. That entire period saw lots of ups and downs..

Therefore it cannot be used as a bottoming indicator as discussed in an earlier post related to China. In most cases epidemics have followed the late stages of a bear market. In this specific case you may even say that many markets especially those in Asia were already in a bear market given that their all-time highs occurred almost 2 years ago. This time it has occurred at the beginning of a bear market in some places and spread and caused bear markets elsewhere, like contagion.

What the occurrence of this event is definitely likely to do is change behavior for weeks or months to come based on the degree of outcome. So far studies already show that it is an extremely infective virus even though many cases may survive it. The high rate of contagion and the 14 day gestation period during which symptoms do not show up in the infected, ensure that it can spread far and wide before detection. The ideal situation is that the quick actions by various governments will contain it in certain locations however the impact of social actions are likely to affect economic activity in daily life.

The following measures are already apparent at many multinational corporations [MNCs]. Most of the management has been asked to stop travelling; revenues are taking a hit because orders are not being booked at the same pace. Even though India has no live cases at this moment people are suspect and are keeping their business travel plans on hold. Eating patterns as reported in Mumbai have already changed towards non-vegetarian food.

I could go on but coming to the main point, once mood changes, changing it back is not easy till the environment changes. In other words lower interest rates may not help if revenues collapse. Cash flow and circulation and come under pressure easily. Government efforts to stimulate can be less effective if nobody wants to invest or spend or even move out of their homes. This may still not be true in India but is true in many parts of the world already.

So while the dollar did fall between September and January helping me in the reflation trade pushing up commodity prices and some of the emerging markets to an all-time high, now the dollar is back to getting stronger as the contraction in the economy is creating a shortage of cash flow and putting upward pressure on the dollar taking back the entire impact of the fed’s repo operations. In short the coronavirus has ensured that the Fed has lost control as far as the currency market is concerned. The Repo operations were to go on till April but the dollar does not care anymore. Thus to reflate the dollar down it will take further huge sums of money to be deployed and for all you know that’s what is coming. Hong Kong has been the 1^st to announce that every citizen would receive 10,000 HK dollars. What I’m not sure of is how many other governments will respond as fast. It is also uncertain how well this may work because large sums of money would attempt easing smaller size of goods and services only creating inflation from the demand supply mismatch. This will be a true test of whether helicopter money can change the social mood.

Right now India is not reporting any cases and so we can avoid all the above somber comments and hope that this will soon pass. I have felt the same and hopes to to, but what the recent events might have done is change the technicals of the market for now making it important to go back to the wave counts that I held on to up till August 2019. The reflation trade lasted only for 4 months and failed to get any bigger. The coronavirus popped the everything bubble pushing us into deflation mode back again. Till fresh signs of an inflationary cycle come back you need to be positioned for deflation instead of inflation. This involves a combination of being bullish on the dollar and bearish on commodity prices, bearish on equities, and mixed on precious metals. I will go over each of the charts and asset classes to bring more clarity to these opinions.

Lastly India missed its Alan Greanspan momentum last year. With the RBI easing rates and a stock market that remained elevated despite an economic slowdown and a crash in stocks the set up was similar to the US 1994 recession. The saviour was the FEDs new miracle governor, to be remembered as the most loved for doing away with reserve ratios and allowing banks to lend exponentially. The RBI was cutting rates last year and did attempt LTROs but went short of being as aggressive as Dr.Greenspan. The new government also was promising after the tax breaks and then all of a sudden chickened out in Budget 2020 from going over-budget, or should I say they caught the virus? Now with the new global crisis we have missed the bus to join in on creating hyper bubbles. Maybe it was a good thing but we have to suffer the pain of completing the economic winter bear market before we get back on track of a new economic up cycle. This is just how it is going to be.

That's the Story line

Now just the Charts

So I am back to this wave count held out till Aug 2019, that the 5th wave long term is an ending diagonal. Wave E of 5 itself ends with an ending diagonal now and the lower line of this long term 5th is at 10830 odd. Note the high volumes that first accompanied the Jun-Aug sell off in stocks and then was absorbed miraculously and then after the tax breaks lead to a buying climax at the top on maximum optimism about the governments ability to reform. But as is with all sentiment extremes this volume is the only signal that was over bullish. Most of my readings like Client positions or market wide open interest never went back to new records meaning that traders were not committing that much as investors were. Investors have been the most optimistic about the Indian bull market. Traders and FIIs cautious.

On nifty the final confirmation of the ending pattern will be a 5 wave decline. Even if we get a 5 wave decline from the lower high made after the budget we can say that that lower high at 12246 is the final top for wave E, something we call an orthodox top. From there 5 waves down would be wave A of the new bear market. If so a small bounce in the next 2 days and a final sell off in wave 5 down to 11000 or lower should complete it. Friday's gap maybe a recognition point of the market and usually that marks halfway point of the fall. Then we are open to 10800-10750. Wave B would be not more than 61.8% of A when it happens. Wave 4 in the next few days should be 38.2% of wave 3 and usually does not fill the gap above 11384. After wave A we get wave B up as the first bounce for this bear market. The gap left behind on Friday should not get surpassed in wave 4 of A as a sign that this pattern is developing. This 5 wave formation once complete would mark the start of the winter bear market for India in equities. The winter bear has already been around in the economy for years. Wave A down may also continue to the previous swing low near 10657

For everyone who has been asking me during the last quarter about my winter thesis, this is it. The Economic winter never went away. Governments were ready to stimulate and I played along. Wrongly expecting it to not fall early. But the virus has ensured that failure become imminent. One indicator that is now confirming my case is the USDINR. The USDINR as you all know is in a long term bull market. However Sep’19 to Feb’20 it did nothing. Even after the budget and this weeks crash the INR was not falling fast enough and then all off a sudden, it broke out on the upside. Friday night it confirmed the start of wave 3 of 3 of 5. This should be a big deal, we should go past the wave 1 of 5 high at 74.48 and head toward 81 near the top end of a broader channel. The breakout on Friday saw a very huge single day expansion in Open Interest and also the highest volumes since 2013.

The long term channel suggests the moves in wave 5 have to eventually get closer to 100. While all this happened for the month ended Feb’20 the 20 month average support that was holding finally propelled USDINR monthly momentum indicator into buy mode and so with that the daily weekly and monthly momentum are all aligned on the buy side. The long consolidation phase has seen the USDINR not only test the weekly and monthly averages but the long term channel lines lower end as seen below. With time the upper channel line continues to rise and is now above 100.

Now what might amuse you is that the dollar is getting stronger against EM currencies but not DMs. The dollar index may even be falling. First look at it from an India perspective. During the Y2K bear market the dollar index was not going up vertically. But making an ending pattern or long term top. USDINR however went from 43 to 49

In 2008 when the dollar was still making a double bottom into June of 2008 USDINR had moved from 38 to 44, later both rose together.

In 2017 the dollar index fell in 5 waves and rallied in wave B/2 up during last year in which the USDINR made a new all time high. During periods of crisis we see in these charts that the INR will fall much more and not always correlate with the Dollar index. During last week you saw a repeat. The dollar index fell during last week after topping out as expected but that did not stop Commodities from falling along with it in a deflationary sell off in all assets. The INR and all other EM currencies went the other way. Last month I published this chart after a while showing that the EM currencies index was starting its third wave. I was expecting this last year too but then it paused and wave B went on to form a flat, but not we see a 5 wave decline in the index so wave 3 down is on. Can the dollar and EM currencies fall together? It just happened and is a function of flows. Who needs money from whom. The Chinese and Europeans were sending their money to the US and now need it in their own crisis and are taking it out of the US. The US needs money invested in EM funds and needs it back. This is causing divergent movements in each currency group and you need to look at each independently and not correlate.

What the dollar index will do is now an open case. Falling commodities prices is typically a bullish sign for the dollar even though it fell last week. So it might not be ready to crash yet. It may wait it out for more stimulation action from central banks. So let me not jump to any conclusion but expect the dollar to deviate from all other assets and correlations as we do not know what is going on below the surface. Every chart on its own now. As of now even after this weeks sharp fall in the DXY the weekly momentum remains in buy mode so wait and watch here. So what we should be concerned about is the trend in EM currencies as seen on the MSCI EM currency index below. Wave 1/A down occurred in 2018 and after that they were in wave B up that recently completed a flat [A-B-C] corrective structure. The next wave down has started and 3=1 is still much lower. A 5 wave decline has started in the index with a series of small impulsive declines that fit this analysis so expect falling EM currencies for months to come now.

In the meantime USDINR Broke out this week for a major move up and that is all that matters. It confirms that we are in trouble in India virus or no virus. FIIs are selling 3000 crores a day and unless that changes we have a problem.

Yes FIIs ended this week with the highest record short in index futures ever. So doesn’t that mean we are at a bottom? Short term that might be true and we should get a bounce back. But when I noted the record longs by FIIs in 2016 they continued to be long for several days and Nifty went up another 3-4% before a top. So I will not rule that out 200 points down then a short covering rally. But after that? The wave count will give us clues as it develops.

Even on a % basis FIIs are short in options. The client % of long to short however at 26% is still not above 35% where it would be oversold but close.

While thinking of the performance of the Sensex in USD Terms, look at the chart of the Dollex or Sensex/USDINR ratio chart.

While we have seen a prolonged bear market in small stocks during the 1990s we never did see that afterward. The market and its participants are used to the idea of 21 month bear markets in stocks that ends and gets followed by another bull. I played into that view at the lows of Sept as the market was too oversold and it worked for a while, but the rally and breakout by midcap Midcap indices failed miserably. If the BSE midcap index below falls below the 14493 low next week it will be the final confirmation that the 3 months rally ended in 3 waves and was corrective and an X wave. Meaning that it was only halfway down for the bear market and a lot more is left to go. Eventually if this goes on we may end up in a similar situation where stocks with throw away valuations are languising due to lack of buyer demand and a negative modd towards investing.

The ADR index took a very long time to complete wave 2 up and with some markets making new all time highs it looked like this would not happen anytime soon, but all of a sudden the world index of stocks is in wave 3 down resuming it's wave C bear market that started in 2018. Wave 2 was a 3 wave rally in a channel that retraced 66% of wave B. Wave 3 of C should break below the large triangle now towards the previous lows.

Such a larger degree bear market fits the economic winter perspective and should tell us about the best asset class to outperform the market. It maybe defensive sectors like Pharma, given that drugs will always be in demand and that the sector has already been in a 2 year bear market. But history shows that the real winner of bear markets is gold. For this reason the Kondratieff cycle is measured in 3 different charts. Inflation adjusted equity indices, currency adjusted equity prices [like the sensex/usd chart above], or the gold adjusted price of equities. This last one is relevant as gold gains over equities irrespective of where its own prices go. For this let us start by looking at the Dow/Gold ratio. Does it surprise you that the ratio peaked in 2000? Yes it did with the tech bubble and even in 2018 it peaked at a lower high. from there so far it has made a series of lower tops and bottoms and would appear to be in a downtrend. Eventually before this bear market is over the ratio goes back to where it was in 1980.

Similarly I have often published the Sensex/Gold ratio [remember the Sensex has more price history than Nifty]. It has been my long term forecast for the Sensex gold ratio to go much lower in wave C for the ration itself. Wave B was a 50% retracement of wave A. Note the ratio peaked in 2008 for India 8 years after the US. You will remember how I have explained in detail that India's economic cycle lags the US by 8+ years. Now both above and below both ratios are starting wave C down relative to equities. The Sensex/Gold ratio should go below the 2000-2008 double bottom and long term neckline at that level before it is over. This is an economic deflationary cycle where gold will hold out relative to equities up or down.

However, my long term forecast however suggests that Gold will be bullish during this phase. I do have concerns for Gold in an environment where the dollar is getting stronger especially for gold in dollar terms. But my case for Gold in Rupee terms is stronger because the USDINR will make up for that loss more than completely as it did in the 1980s. This long term chart of Gold INR prices with Mcx prices from 2004 gives you a glimpse of the big picture. We maybe in wave 5 long term but 5=1 is closer to 135,000 rupees for gold. Two channels come in at 63000 and 90000 along the way.

The MCX price of gold shows a 5 waves advance that just completed. I was hoping for one last hurrah to 1700 but now that it has closed down for the month not anymore. Note the 2016 top saw record Long positions by traders based on the COT report, however this monty we surpassed that record to a new all time high in the data, meaning that traders were the maximum long positions in the history of the contract. This is never good and the reason for the volatility in gold and silver in the last 2 days. Silver too has very high long positions open relative to previous highs. On the other side commercials are short. So till these positions unwind a bit we need to correct or retrace this most recent 5 wave rally from 1160$ in 2018. This rise was 5 waves and maybe wave 1 of the next longer term bull market but we are now due for wave 2 down that can test the wave IV low near 1445 at least. A 61.8% retracement would retest the breakout point near 1365.

The big picture for Gold however should remain bullish as the lont term chart shows that wave 3 of 3 up has started. Wave 2 that ended in 2001 was a zig-zag over 20 years. Now wave 2 of 3 ended in 2018 in a complex pattern that made a higher bottom in an orthodox bottom. The five wave rally from there shown above is the first clear impulse marking the start of a new bull market. But the over bullish long positions by traders need to unwind in wave 2 down for wave 3 up to start. The strong dollar will also impact prices downward in the meantime. Wave 3 maybe accomapnied by all new monetary and fiscal action that will be announced to fight the new crisis. This gives you more time to consider your options. But do not lose focus as the asset class of precious metals will fall less than equities and other asset bubbles and gain on a relative bsis anyway. The other reason to not lose focus is that wave 3=1 goes to 8000$ and the rising channel at this time stretches toward 5000$.

What the deflationary collapse is doing now is crashing not just equities but commodities as well. The CRB index that I considered as a running triangle for months finally broke the neckline on the downside. This changes the wave counts back to the one I held till June'19, that wave C down kicks in, wave C of Z, the final wave of a bear market, a final wave of deflation in commodities prices. What this does not consider however that this downward wedge like formation is a leading diagonal of large degree. Very hard to say for me and we will think about those possibilities later. At this point from here to the lower line is itself a long way and a major contraction.

The implications for commodities like Oil are that the case for 22$ oil is back on the table. After expecting it to go back up, the case no more exists. Last week I changed my near term view for 42$, and now I think that the neckline at 41.8 can break and give way to 22$ near the trendline of all the lows of the last decade. I am not thinking about the case that prices can go below that as of now but would be open to it as we get there.given the downward slanting structure.

One reason why wave Z maybe true is when you look at commodities relative to stocks they are way low and have underperformed for too long. On the other hand this ratio adjustment can also happen as stocks fall. But then too on a relative basis commodities may have less to lose than stocks. This chart was origianlly published by Incrementum AG in its annual publication ''In Gold we Trust".

What about Value wave investments?

The investment thesis was based on a return of broad market participation the the RS of nifty to midcaps. The failure of midcap indices pushes that back. The end of the reflation trade ends the moves in metal stocks for now. That leaves only defensive pharma stocks on the table. The long term inverse correlation between oil and oil marketing companies in India is a dark horse and so I would keep an eye on them for momentum to return at some point. See the chart below to see that falling oil prices have mostly been followed by support for OMCs and they went up later. In 2008 then did not fall much during the crash as Oil prices crashed and then rallied later. This is a chart of HPCL and Crude Oil together.

Gold and gold miners are great investments long term but are going to be subject to a correction because of the rising dollar near term. Everything else is at risk of falling together as the everything bubble pops. All asset classes fall near term though it seems in the first rout. In some cases the selling in one asset will put pressure on others due to margin calls. This is why this week you see HPCL and Oil falling together. The following chart of the HUI index also shows the failure of the gold bugs index of gold mining stocks from breaking out too far. It may now pullback in wave 2 down again. A 2nd wave 2 since the 2015 bottom.

The following chart I received from Sprott Inc shows you why longer term the gold mining index is at the lower end of the range and not the top end or in a bubble. This is an updated Barrons gold mining index they sent me and you get the picture.

Conclusions

Those waiting for me to announce the next winter cycle down maybe happy. In my mind it is better late than never in a week that USDIN confirms and Monthly charts of equities confirm. There maybe no place to hide in the first wave of selling but even relative strength will be limited to a few sectors for reasons that are bizarre at least. Broadly speaking this is no time to own any equities and maybe keep SIPing into gold and gold mining stocks. The currency markets maybe the big movers this time and you must consider being bullish USD pairs as the dollar comes back into demand in a crisis. So the dollar wins first, gold will win later, and defensives are in Pharma and OMCs/Energy. Value will go from cheap to cheaper till it makes no sense. Expesive will go back to fair value. The only thing I do not have a clear view on still is interest rates. Logically they should rise again as high yield credit spreads expand all over again. That has already started for US High yield. Outright Deflatinon and all its effects are back on the table for the next 12-24 months. Nifty 9000 and lower eventually are back on the table and will further confirm with the wave counts in the coming week. Stay tuned. The ending diagonal and a break of 11000 shall however mark the end of a Supercycle degree bull market in India and a generational correction in the Financial sector and how we do business.