Calm Before the Coming News Storm

Market is beginning another sideways move, most likely to digest a flurry of economic news this week, including the FOMC meeting Wed. Both the USD and Dow have similar patterns – a flat correction before the next sharp move. This can be counted a number of ways – the easiest is that after a sharp wave 1 drop, wave 2 is breaking as a flat that should take it to the Sp1061 +/- 5 pt range tomorrow or Wed.

This chart of the VIX (courtesy yesterday’s STU) shows how dramatically the the investor climate has changed to “global warming” from a mild cooling of risk and volatility. The VIX measures volatility which represents itself as a higher premium for options. The risk premium had been steadily dropping ever since the start of the Obama Hope Rally, and now has spiked two standard deviations the other way, breaking the trendline of the downslope. Fear is coming back.

It is an interesting question as to how much news moves the market. The trader’s aphorism is “buy on rumor, sell on news.” Prechter is fairly adamant that news does not move the market except as a short term jink. Neely is more sanguine and thinks news affects the market all the time, but the impact is incorporated in the wave pattern.

To Prechter’s point, you always have examples like 9/11, where the market was falling hard before the event and when markets re-opened after a sharp reaction down, rose after almost back to the all-time highs of two years early in May 2002. But most of the time news is not some attack out of the dark, but can be anticipated as a policy change or economic transformation. Doesn’t that pendency of change affect the wave structure?

My own experience is that the wave pattern begins to change in anticipation of news – not the shots out of the blue like 9/11 but the policy changes and economic news that one sees brewing. One example is the E leg of a triangle, which EWI often describes as being jinked by news. Thinking of a triangle starting as a flat ABC then breaking into a new wave; but a news comes and jinks the market briefly in the opposite direction before settling back into the direction of the break. After the fact we designate the intial break as Leg D and the momentary jink as Leg E.

A more interesting example is the ending diagonal, or contracting terminal in Neely parlance. It is as if an impulse has been foreshortened by expectations of some policy change. The growing need for a policy decision causes the market to enter a different structure, the change occurs, and off the market goes in the other direction. We had ending diagonals last year at the Bear Stearns moment in Mar08 and at the bank bailout moment in Oct08.

A great example is the Iraqi War Triangle of May02-Mar03. After the rise off 9/11, we fell hard to a low in Jul02, then bounced far back in Aug02, then fell again into Oct02. But we weren’t done – the fever pitch of noise around the pending Iraqi invasion caused a further up/down move. We didn’t end the pattern until we started the invasion. Looking back the whole pattern looks like a large triangle with bottoms around the same level in Jul, Oct and Mar. A triple bottom. Of course, orthodox wave counting would put the end at Oct02 and make the next up/down a wave 1-2; but an alternative that is where Neely and Zoran came out is to see the move as a terminal pattern like an ending diagonal, a large triangle of indecision while the policy decision (to invade) was pending.

Similarly, we just had a interesting news item – higher than expected GDP – and a spiky bounce down/up/down and now somewhat up surrounding it. The GDP report has an intriguing aspect that I have not seen picked up in the broader financial news: if global GDP is now on the rise, the demand for Dollars should increase. Maybe the drop in the Dollar was influenced by a lowered need for it as global commerce dropped. Hence a rise in economic activity would be bullish for the Dollar.

This week we have a slight risk of another major change in the assumptions of the current situation. There has been a huge short interest in the Dollar, brought on in part by turning the mighty Dollar into a carry-trade currency like the Yen (borrow Dollars at low rates, lend at high rates in other currencies). If the Fed at the FOMC were to raise rates (surprise!) or signal a coming change of policy beyond the vague hints of recent meetings, it could cause a massive short-squeeze in the Dollar as carry-trade players scramble to cover their short positions. Odds are low but impact is high. Hence a pause to assess two sets of data this week:

• change of Fed policy on rates
• insight into whether a global recovery is real or is but government life support

This type of pause would be reflected in sideways patterns, such as flats with spiky ups and downs, and triangles. As we are having. So stand aside for the next few days.

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