Saturday, October 30, 2010

It's the money, STUPID!

Part-II extra innings
By Joe Russo, Elliott Wave Technology | October 30, 2010

Back in May of this year, we constructed a dual paneled chart graphic to observe the effectiveness of such interventions relative to the volatility expressed in the price behavior of equity indices. That chart consisted of a monthly volatility index in the top panel, and the relative trajectory of the Dow Jones industrial average in the charts lower panel.

We presented the chart and our opinions as to its potential implications in an article entitled The Fix in the VIX. We began the article with the following:

"To measure the ongoing success or failure of massive QE "working groups" interventions, all one needs to keep an eye on is the VIX. Readings below 20 suggest, "The FIX is in", whereas readings above 20 diminish the mission control effort to reflate monopoly-saving bubbles."

A little more than a year after our money-masters-of-the-universe shrewdly averted an outright global insolvency, many investors remain utterly baffled as to how stocks can sustain a raging bull market amidst massive outflows in concert
with such dismal long-term structural imbalances.

Those in the nonprofessional category may find some clarity in our placing a concurrent price chart of the "flexible" $USD into the updated price panel mix. This simple graphic should go a long way in helping to explain the otherwise perplexing bull market, or QE hyper-reflation conundrum.

Extra innings
The chart below provides an update to our last, and includes an additional third panel illustrating the value of the US fiat currency unit, or "MONEY" as it were.

After trading in its normal range from April through August, the bulls won a key battle for Dow 10k, and the VIX submerged into QE-3 territory (readings beneath 20) amid the roaring rally of September 2010.

The VIX has remained beneath the 20 level ever since, closing out the week ending October 22 with a complacent, overly optimistic reading of 18.53.

The graph in the upper panel, which looks like an array of jumping lines produced from a lie detector test or an earthquake reading, is the monthly VXO. In this rendition, its fluctuations record the month-to-month gauge of volatility (fear vs. complacency) resident in the Dow Jones Industrial Average.

The VXO's yet established closing read for the month was 18.53 at the time of this chart capture on 22-October. Per the close on 27-October, the VXO jumped to 20.17 following the continued rally attempt of the $USD off its 76.14 print low. This minor move up in the $USD spooked the equity markets, which appear to be growing more and more dependent on its continued weakness in order to remain in perpetual levitation mode.

About the VXO/VIX
In short, the historic norm for such fluctuations rest between the horizontal lines drawn at readings of 20 and 40. Bouts of excessive complacency and optimism typically correct themselves upon readings toward or marginally beneath the 20 level, and episodes of excessive fear and pessimism are generally subdued upon readings toward or marginally above the 40 level. Cyclical fluctuations between these two extremes are normal, and viewed as the natural ebb and flow of a healthy and balanced marketplace.

The Dow Jones Industrial average is in the middle panel and the US dollar illustrated in the lower panel of our chart. We have drawn four lines vertically through all three of the benchmarks to draw specific attention to how each reacts relative to the other within specific timeframes. A strong, stable, and rising money value in concert with strong, stable, and rising stock prices are the desired optimal conditions.

The quick ten-year Blow-by-Blow
Around 1999-2000, we cite the 11500 Dow in concert with a relatively strong $USD at 105.00 as an optimal peak of accomplishment for equities and the end of a rather exceptional multi-generational run.

At present, the Dow is near to revisiting this 11500 benchmark however the $USD is now worth nearly 30% less than it was more than ten years ago in 1999.

The resultant Blowback
Looking at the Dow's value through the prism of that which measures it, US money/dollars, its 2010 October 22 close of 11132 equates to a Dow at 7792 in 1999 money/dollars.
Insofar as the alchemist is concerned, perception deception is everything. The last thing they wish to expose is any semblance of truth or reality.

What does this mean to the US investor holding equity funds or ETF's?
1. It means that America's structural and competitive advantage reached its zenith at the turn of the century.

2. Though it may give the appearance of short-term success, QE-1 and QE-2 as standalone interventionist strategies fail to remove any of the fundamental constraints that impose severe long-term structural threat to the competitiveness of the US economy.

3. Only by the falling standards of the US money/dollar shall US based equities continue to rise in perceived value, which may provide some level of protection from further $USD devaluation in the future.

4. Monitoring the VIX, Equity, US Money/Dollar relationships may assist ETF and index investors in staying on the right side of the equity markets over the intermediate and longer term.
In 2003, it became all About the Money, STUPID!
Take note that amidst the artificial Greenspan bubble recovery, which began hitting its stride in 2003, the upper panel VIX exhibited an inordinately sustained (4-yrs) and excessive level of complacency readings well beneath the generally corrected 20 level. Moreover, the $USD in the lower panel continued losing value rapidly, and was down almost 34% from its peak in 2001.

Given that we measure the Dow in points, and the 30 corporations that comprise it are valued in money/dollars per share, the Dow was not making nearly the amount of bullish progress that it appeared to be making. Such is the cunning seduction and effectiveness of false incentive traps as intentionally deployed from an alchemist's powerful toolkit.

In the period from mid 2007 to date, we have drawn two parallel vertical lines between the Dollar and the Dow. Note that upon the threatening reemergence of strength and buying power in the dollar from its 70.70 print low in March of 2008, the Dow continued crashing hard into the abyss.

The current bull market in stocks did not commence until the $USD quickly reversed lower and resumed its degrading death spiral. This occurred in March of 2009, the time at which the dollar peaked just north of 90 and Dow bottomed around the 6500 level.

After plummeting for most of 2009, in the first quarter of 2010, the US money/dollar began showing some signs of life and future value. The mere prospect of a strong currency and stable measure of value brought the contrived 70% bull market run in the Dow to a screeching halt by late April.

The inability of industrial and transnational corporations to operate profitably with a sound, stable, and strong sovereign currency is a HUGE part of the foreseeable problem. For the balance of June, the mere threat of a stable and secure currency expressed itself in a relatively modest but rapid 15% downward adjustment in equity values into early July of 2010.

August was another pivotal month as the Dow failed a recovery attempt and appeared headed back down to retest or breach beneath its July low, conceivably to more adequately correct the massive 70% bailout rally that took place behind it. As the Dow approached its July lows in late August, bulls and bears drew a showdown line in the sand at Dow 10K.

Much to the bears chagrin, the $USD money/dollar began another hard move down. In the first three days of September, the equity bulls took advantage of this and unleashed the big artillery in exacting a concise victory in that key battle for Dow 10K.

Since then the US money/dollar continued to lose value rapidly, enabling the Dow along with a host of other equity indices to rise in persistent vertical advances without the slightest correction of commensurate merit.

The Dow companies then resumed their QE reflationary advance from their August retest of the July lows as their sovereign fiat currency unit and valuation metric began once again plummeting rapidly in value.

Apart from the international currency translations that boost a transnational corporation's level of profitability and competitiveness, a very simple way to understand this MONEY phenomenon is to understand the flawed metrics inherent within the fiat money system.

Think of it in this way:

The Magic Yardstick
If the stock of a given company possesses a real intrinsic value but the metric or yardstick that measures that value (money/dollars) is unstable and can rapidly degrade, it then becomes necessary for the stock price to adjust upward in relation to its new measuring rods weaker standards, which in this case is the US money/dollar.

The reverse is true (stock prices will adjust downward) if a corporations sovereign money standards suddenly rise in relation to where the lower standards had previously valued them.

How does an element of fluctuating unstable value (money/dollars) price and effectively measure another element of fluctuating value (a corporation's intrinsic value and future prospects of profitability) accurately?

It does not, and that is the very basis from which monetary alchemists are able to concoct the wide variety of tools they use to control economies and by default, the masses.

Think about this. Would you trust a team of engineers to design/maintain a bridge, car, or airplane that you and your family will use regularly if an imposing inescapable influence intentionally or inadvertently coerced them to accept the assignment using flawed measuring devices that radically changed from week-to-week?

I.e. this week, 1" = 1", then next week, last week's one inch parity standard changes and is now reset at 2 ½" = 1". Then the following week, the original one-inch parity standard is re-benchmarked at ¾" = 1" and so on.

You get the idea. The secure reliability and fundamental soundness of your bridge, car, or airplane is sure to eventually fail with such erratic engineering metrics, and bring with it the inevitability of fatal disaster. More or less, this is exactly how the global system of Fiat money is structured.

Yet astonishingly, civilization at large continues to accept these fluctuating, intentionally flexible, easily manipulated concoctions of global fiat money as the best we can come up with to foster efficient, fair, and balanced trade productivity within national and global economies.

Come on - give us a break. More likely, this type of arcane monetary system was purposely engineered this way to conceal all of the underhanded alchemy necessary to maintain authoritarian power, trade advantages, and various forms of monopoly controls.

Time is running out for our wizards of Washington and Wall Street. It will not be long before civilization reaches a point of critical mass and collectively rejects such a willfully ignorant, destructive, and fraudulent system of monetary and economic governance.

We hope that the wizards of Washington and Wall Street take this message from the growing masses seriously. The same message extends to the rest of the G-20 nations.

No, it is not the economy, jobs, unemployment, terrorism, trade deficits, border control, racism, progressives vs. tea partiers', democrats vs. republicans, or Mosques at ground zero.

It's the money, STUPID!

Until next time,
Trade Better/Invest Smarter
Publisher and Chief Technical Analyst
Elliott Wave Technology