Chartered

Fortrend Securities - Wealth Management

Joel Hewish is an Investment/Financial Adviser at Fortrend Securities and manages the Wealth
Management division. The opinions expressed are his own and do not represent those of Joe Forster or
the International Advisory division.

Edition No. 19
10th November 2010

Bottom Line: The rise of the S&P 500 above the April 2010 high has now opened up several possible wave
counts. While in the short term this provides a level of uncertainty as to how long the market will continue
to rise before topping, the longer term cautious and bearish view still remains well in place. While the rally
from March 2009 has carried further than first anticipated, it still remains comfortably within the bounds of
the bear market rally thesis. The internal strength of global equity markets continues to wane and fails to
confirm the sustainability of recent global equity market increases, while the structural macroeconomic
issues in the western world continue to provide enormous challenges over the next two years. Investors
should continue to use the recent rises as an opportunity to reduce risk and position their portfolios to
profit from this opportunity!!

Chart 1 – US S&P 500

• The rise of the S&P 500 above the April 2010 high has now meant that the previous wave count,
signifying the beginning of the next leg down, has now been invalidated and a new interpretation
of the waves is now necessary.
• While Primary Wave 2, which commenced in March 2009, continues in its advance, the rise above
the April 2010 high has NOT invalidated my secular bear market view. Given the rise above the
April 2010 high, it is my view that the rise since March 2009 to date is a Primary Degree Wave 2
 cyclical bull market (bear market rally) within the bounds of the larger degree secular bear market
that commenced following the peak of the S&P 500 in early 2000.
• Various studies have shown that secular bear markets last on average between 14 to 16 years,
depending on the data set used. If this is the case and assuming the high in the S&P 500 in 2000
was the commencement of the larger secular bear market, then there remains the possibility that
the secular bear market could last for at least another 3 to 6 years.
• Chart 1 above and Chart 2 below depict what I view as now being the most suitable interpretation
of the current market oscillations and Elliott Waves, but there are a number of other potential
possibilities. If this interpretation proves correct, the market’s rise from March 2009 to date forms,
not part of a more complicated countertrend move as initially suspected, but rather a more
simplified and standard ABC correction.
• Should this interpretation prove correct, we should expect to see a pull back in the short term,
followed by one more rise to a new countertrend high before the market commences its expected
large declines.
• While there is the potential to implement a more bullish wave count interpretation, the wave
count would have to be viewed in isolation of the internal market strength indicators, preferred
valuation measures and macroeconomic environment, all which do not support this interpretation
of the bullish wave count.
• The chart above also shows in pink where the American Association of Individual Investors
Sentiment Survey produced results of approximately 25% bears or less. On 16 September 2010 this
survey displayed a reading of 24.3% bears, as I highlighted in the edition of Chartered which
followed that survey. The chart shows that there is a high level of correlation between extreme
bullish sentiment and when market tops are formed. Following that survey the readings of
bullishness subsequently subsided but we did not get the top which I had been expecting. More
recently on 28 October 2010 the survey recorded a bullish extreme greater than any reading
registered since the start of 2007, with a reading of just 21.6% bears. That reading is a higher
bullish extreme than readings registered just prior to tops in February 2007, October 2007, May
2008 and January 2010. SENTIMENT MATTERS!!

Chart 2 – US S&P 500 – A closer look

• While the above two charts indicate a pull back for Wave 4 and an advance for Wave 5, these
arrows have been provided for indicative purposes only. The actual magnitude of any pull back and
 subsequent advance is very difficult to predict, as too is the length of time for the expected final
waves, if indeed they occur.
• It should be remembered that Elliott Wave analysis is a market mapping tool with some predictive
capabilities. Where it is most effective is when the wave count is combined with the weight of
other technical evidence and macroeconomic data to help conceptualise where the market is likely
positioned with regards to its short, medium and longer term trends.
• Just a note on the above chart, some may question where the black coloured labels are placed and
whether or not there is actually a wave that can be depicted. As these labels depict waves of a very
small degree, the waves are only visible on smaller time frames such as the 4 hour and 2 hour
charts, which are not shown here, but the waves are there.

Chart 3 – S&P 500 Alternative Wave Count

• One possible alternative wave count that could be utilised is a variation on the wave counts as presented
above. The variations of the wave count above have been put forward by other Elliott Wave technicians,
whom I respect highly, and the arguments for the above interpretation are convincing.
• In short, they argue that the decline in the bear market actually completed in November 2008 and the
subsequent waves following that market bottom actually form part of a larger double zigzag correction.
• If this interpretation is correct, the market top is just around the corner and it would coincide with a
number of technical (Sentiment and Divergence) and market relationships (Currencies and Commodities)
that appear to support this interpretation of the wave count.
• Time will tell but prudence and risk management should still remain your number one priority in the current
market environment.
• It could also be possible that a double top could have recently been put in place. In this instance we would
look for a break below the 2010 low and for a fall to extend at least 200 points below the July low before
finding support.
• It should be mentioned that almost no one in the financial media is expecting a decline in the markets at
present and it is exactly this environment which preceded market tops in October and November 2007 in
the US and Australian markets.
Chart 4 – S&P ASX 200

• The S&P ASX 200 continues to take its lead from Wall Street but the performance since the lows in
May 2010 has lagged those of the larger market.
• For the moment I continue to maintain the above wave count, which has been displayed over the
past several months, however, with the more bullish short term wave count of the S&P 500 now in
play, I provide below a potentially more bullish short term wave count alternative. Importantly, the
larger secular bear market should once again take control proving 2011 and 2012 to be extremely
volatile and risky investment propositions.

Chart 5 – ASX 200 Alternative Wave Count

• As depicted above, the more bullish alternative wave count allows for one more pullback and then
a rise to a new recovery high before topping.
• The Oscillator shows the divergent strength of the S&P ASX 200 since August 2009 and the new
highs registered since then.
Chart 6 – ASX 200 Alternative Wave Count – A closer look

• At this stage the Oscillator continues to show divergent strength in the recent price move.

Chart 7 – USD/EURO Cross Rate

(Source: Elliott Wave International, trade-futures.com)

• The performance of global equity markets tend to correlate negatively (inversely) with the
performance of the USD. This is particularly true when looking at the US and Australian equity
markets. It is therefore important to closely monitor what is occurring in the currency market
when analysing what the probabilities are for large movements in both the US and Australian
equity markets.
• Using the Daily Sentiment Index from trade-futures.com, it is possible to see that when sentiment
in the US dollar reaches levels of bearishness of approximately 5% bulls or less, this has tended to
coincide with bottoms in the USD versus the Euro. Bullish sentiment extremes of approximately
95% bulls or above tend to coincide with tops in the USD.
• Given the above relationship and the extremes in sentiment in both equity and currency markets,
it remains extremely difficult for me to be convinced that significant further weakness in the USD
and significant further strength in US and Australian equity markets is likely.
 • Furthermore, the decline in the USD against the Euro appears to have completed a 5 wave
decline to complete a C Wave corrective pattern.

Chart 8 – AUD/USD Cross Rate

• If we applied these same sentiment readings to the AUD/USD relationship, the same relationship
holds true and the current positioning of this market is not AUD and equity market bullish over the
medium term.

Chart 9 – 10 Year Irish Government Bond Yield

• In trying to determine what might be the excuse for the next expected pull back or round of
weakness, perhaps it could be the sudden loss in confidence in Irish sovereign debt.
• The above chart shows the yield demanded by investors to purchase Irish Government 10 Year
Bonds. The 10 year bond has been progressively sold-off since May 2010, with momentum in the
declines gathering pace in August and again in October 2010. WATCH THIS SPACE!!
 Analysing Secular Bull Markets and Secular Bear markets

Chart 9 – S&P 500 Composite Inflation-Adjusted Regression to Trend

(Source: dshort.com, seekingalpha.com)

• Thanks to the work of Doug Short from seekingalpha.com, the above chart shows the inflation
adjusted performance of the S&P 500 displayed on a logarithmic scaled chart since 1870.
• The following hyperlink http://seekingalpha.com/article/202431-monthly-update-secular-bull-and-
bear-markets, connects you to the article which this chart was pulled from and makes for an
interesting read. The chart is useful in determining whether or not stocks make for a good medium
to long term investment given the current environment and whether or not March 2009 was in
fact the actual market low in the secular bear market. While the article was written in May 2010,
the remarks are still relevant.
• In short the article makes the following points:

The annualised rate of growth since 1871 is 1.96%, inflation adjusted.

Factoring in the dividend yield you get an annualised return of 6.64%.

The nominal annualised return (not adjusted for inflation) is 8.85%.

Average inflation adjusted returns during secular bull markets averages 415%.

Average inflation adjusted returns during a secular bear market averages -65%.

Adding a regression line to the data series the slope of the regression line equals
1.70% annualised.
• Based on this analysis, previous secular bear markets have bottomed at levels of -34%, -59%, -66%,
-58% and -54% below the regression line for an average distance of -54.2% below the regression
line.
• The most recent low in March 2009 finished at just -8% below the regression line, well and truly
short of the shallowest bottom and the average bottom since 1870.
Chart 10 - S&P 500 Long Term Price to Earnings Ratio (CAPM)

(Source: RJ Shiller, Matthew Claassen, seekingalpha.com)

• But the evidence doesn’t stop there. Chart 10 above dates back to the 1880’s and shows the
trailing earnings Price to Earnings ratio of the S&P 500 since that period. At each major secular
bear market low during that period, before the market commenced a new secular bull market, the
trailing Price to Earnings ratio for the S&P 500 has always receded below 10x and has twice
approached P/Es closer to 5x.
• At the low of March 2009, the Price to Earnings ratio fell to around 13x not even close to breaking
below 10x let alone the near 5x Price to Earnings ratio that has occurred at two of the previous
secular bear market lows.
• With the current trailing P/E around 20x, this valuation appears well in excess of previous P/E highs
in past bear market rallies and appears to be approaching levels more consistent with secular bull
market peaks.
While the above two charts provide a convincing argument that the lows in this secular bear market have
not yet been seen, when you combine the evidence of those two charts with other important
characteristics associated with bear market lows, you need to take notice. And what are the other markers
that come to mind? Well at each major secular bear market low, the S&P 500 trailing dividend yield has
been in excess of 6% dating back to 1880. It was just 3.2% at the March 2009 low and it is now closer to
1.85%. Furthermore, S&P 500 mutual fund cash levels have always peaked at approximately 10% or higher.
S&P 500 mutual fund cash levels peaked at just 6% at the March 2009 low and are now close to an all time
low at 3.5% (3.4% is the all time low). And finally the wave structure and internal strength of the S&P 500’s
rise since March 2009 is not consistent with the onset of a new secular bull market.
As such I strongly encourage you to contact us to discuss your portfolio, how it is positioned, how you
can manage the risks and prosper during these uncertain economic times.
I hope you have enjoyed this edition of Chartered and found the content of interest. If you would like me
to analyse a particular market or chart from a technical point of view, please email your requests to
jhewish@fortrend.com.au and I will endeavour to look at any requests in upcoming editions.
In the meantime, if you would like to arrange a time to discuss your portfolio and some of the strategies
which can be used to help you navigate the prevailing market conditions and profit from this opportunity,
please do not hesitate to contact me on 03 9650 8400 or 0401 826 096.

Until next time, have a great fortnight!!!

JOEL HEWISH B.Bus (Bank & Fin), GDipAppFin, GCertFinPlan, SA Fin

Investment / Financial Adviser
FORTREND SECURITIES - WEALTH MANAGEMENT
Australian Financial Services Licence No. 247261

Chartered is a fortnightly publication from Fortrend Securities – Wealth Management and is provided for the
purpose of general information only. The views and opinions expressed in the publication are those of Joel
Hewish and do not necessarily match those views of Joe Forster and Fortrend Securities – International
Advisory. This publication is provided as general information only and does not take into account your
personal circumstances, aims and objectives and should not be considered personal advice. You should first
consult a licensed Investment or Financial Adviser before acting on any of the information provided in this
publication.