Global Market Outlook

Fear and panic becoming predominant sentiments among global investors

The positive adjectives used by the financial press over the past year to describe the world economic outlook—words such as "strong," "powerful," and "optimistic"—are giving place to a new set of buzz words—like "concern," "fear," and "flight to quality." This new trend in the financial press serves as an excellent indication of widespread market sentiment and provides evidence that investor psychology is taking a turn for the worse. When this trend become firmly established, widespread financial panic cannot be far away.

For several months now we have expressed a pessimistic view of the global equities markets. Certainly our outlook hasn't changed in recent weeks and if anything has only become more solidified. With Japan facing the very real possibility of an outright economic meltdown, along with the rest of Southeast Asia, with Russia on the verge of another revolution as its mobs of angry, hungry soldiers and civilians suffer the effects of economic chaos from its collapsing stock market, and with the stock markets of the United States and most of Europe beginning to teeter, traders and investors with heavy exposure to these markets (on the "long" side, at least) have every reason to fear. However, there are many wondrous opportunities for finding economic shelter from the fallout ahead, with many of them providing not only a means for capital preservation but also for immense capital appreciation. After all, with crisis always comes opportunity, and in fact, most of the fantastic opportunities we will ever experience in our lives come in the face of severe crisis. We will discuss many of these opportunities below (and yes, some of them involve being on the long side of the gold market).

Stocks

Interesting action taking place in our benchmark Dow Jones Industrial Average as this is being written. We have written in recent weeks of our expectation for a severe collapse in the Dow that should commence sometime this month. We still hold firmly to this conviction, based on technical factors, yet the action leading up to this expected event has been nothing short of baffling. We have followed a bearish technical formation in the Dow's chart—known as an "ascending wedge"—over the past month. These formations, which imply a sharp move to the downside upon culmination, usually take up to three weeks to form (as did this one), and it did in fact break sharply to the downside once the apex was reached. Yet the Dow has proven to be strongly resilient in the face of growing selling pressure and has found support at the 7500 range for the third time in a two-month period. This type of action can usually be expected as a market crashes—old support levels almost always provide at least some downside support before being broken—but in this case it elicits some cause for concern.

Edwards & Magee (the authors of the classic book, Technical Analysis of the Stock Market) always said that a support level that checks a falling trend three times without being broken should be watched as a possible intermediate-term or long-term bottom. Already, this is the case that present itself in the Dow, as the support level at approximately 7500 has stopped the market's downward course three times and counting. So the pressure is on for the bears of Wall Street to take the ball and run prices below this crucial support level. This week will probably let us know who will prevail in this latest bout between the bears and the bulls. However, every other technical measure continues to show a stock market on the verge of collapse. Breadth on the NYSE has been horrid, with declining issues far outpacing advancing issues on almost a daily basis. The major indices continue to trend below their respective 200-day averages. Institutional "smart money" has been doing more selling than buying. And mutual fund money flow has greatly abated over the past several weeks. All of these are negative factors for the Dow.

More good news (for bears) is the fact that the Dow Jones Transportation index is pointing decisively downward at this time and this provides a Dow Theory confirmation that the larger trend, as well as the immediate trend, in the stock market is also downward. The NASDAQ is also experiencing extreme weakness and has been falling hard of late—much harder than the Dow and S&P 500 have been. Investors should consider buying shares in the Rydex Arktos fund (inversely correlated to NASDAQ) in order to take advantage of this falling barometer. The OTC sector is extremely overvalued and is probably experiencing the inevitable implosion that occurs whenever a bubble is pricked. The bubble for technology stocks on the NASDAQ has clearly been pricked. Shelter from the storm developing in the U.S. equities markets has been perceived by investors to exist in the Dow Jones Utilities. This index has seen a meteoric rise in the past two weeks alone. The index currently stands at 310—an all-time high. This should not be surprising, however, as utilities tend to follow the bond market, which is experiencing an extremely bullish trend. However, we advise investors to steer clear of this sector. We see this latest bullish trend in the Utilities as nothing more than a "blow-off" top and a precursor to the crash in Wall Street equities. Rest assured, when the Dow collapses, everything associated with it will fall, including the Utilities.

Meanwhile, in Japan the Nikkei index is performing exactly as we forecast in last week's GMO. Just today (Oct. 5) the Nikkei registered its lowest level in 12 years. It currently rests below the critical 13000 level. If Nikkei cannot find support above 13000 in the next few days then watch out below. Our forecast of a Nikkei 10000 before the end of the year may come true sooner than we think.

Again, we reiterate the urgency of Japan's predicament: As the veritable "hub" of the global economy, how this country fares economically will greatly impact the health of the entire global economy. With the Nikkei pointing downward and with the recession in Japan deepening into a depression, we expect to see general worldwide recessionary/depressionary conditions developing to a noticeable degree by the end of the year. This, of course, includes the United States.

Hong Kong's Hang Seng index has been in a consolidation period that can best be described as a "rectangle" formation under classical technical analysis. This pattern portends a sharp move to either the upside or downside upon completion. Its measuring implications are found by multiplying the number of times the line on the chart touches the upper and lower boundaries of the rectangle by the number of points between the support and resistance line that form the rectangle. That number is then added to the price level on the stock index at the time of the breakout from the rectangle. In this case, we can probably expect a sharp move of a few hundred points. Judging from its general trend and from recent market action we would expect this ultimate breakout to be to the downside. Thus, we predict a continuation of the bear trend for this index.

No need exists to comment in depth on Russia's stock market outlook. In a nutshell, the outlook is bleak. No sign exists on the immediate horizon that the bottom has been seen in its stock market, and until it is, the downtrend is firmly in place. Social, political, military and economic conditions in Russia can be expected to continue to deteriorate until its bear market is halted. Unfortunately, however, the ongoing bear market will only serve to exacerbate the breakdown in each of these aforementioned areas thereby compounding the country's problems.

Bonds

Somewhat surprisingly to us, the general trend in the U.S. bond market continues bullish despite the overall loss of faith in other investment instruments among global investors. By default, the bond market has become the investment vehicle of choice among U.S. and global investors and is the proverbial "last Indian standing." Yields on the 30-year U.S. Treasury bond have fallen to new lows as panicked investors flee to the perceived safety of this instrument. But alas, so small a raft in so vast a sea can only hold so many refugees. Our long-standing assertion that bonds are due a spike in yields (and therefore a drop in price) remains unchanged and we are undaunted in our stance, notwithstanding the seemingly boundless strength of this sector. The bearish technical formation we have pointed out countless times over the weeks—known as a "falling wedge"—is still very much in evidence on the chart showing the long-bond's yield. Bond prices are quickly approaching the apex of this wedge, and when they do we should expect a sudden upsurge in yields that will probably serve to shake-out the "safe haven" buyers and further exacerbate the general worldwide financial panic. This, of course, is good news for gold bulls as it will no doubt strengthen the emerging uptrend already evident in the yellow metal's chart. Bonds may be "king" for the day, but gold will soon reign supreme in the financial kingdom.

Short-term bond traders, however, have the bullish all-clear signal for now. The candlestick chart for T-bond futures on the CBOT shows a very bullish pattern, previously a "three white soldiers pattern," but now shaping up to become an "eight new price highs" pattern. However, traders should keep a very close eye on this index in anticipation of sudden pullbacks in the days/weeks ahead.

Currencies

The downward trend in the U.S. dollar is accelerating and we expect the collapse in the dollar index to intensify in the coming weeks. Prices on the dollar index have been vacillating in a narrow range of late, but this should be viewed as nothing more than a consolidation phase that will shortly be resolved in a continuation of the newly established bearish trend. At the same time, a chart pattern that could be perceived as an obtuse "falling wedge"—a bullish pattern—appears to be forming in the candlestick chart of the dollar's future index. As well, a bullish "harami" candlestick pattern has formed on the chart, so these two factors could be pointing to a short upward rally before the overall falling trend re-commences. But any rally in this index will probably not last more than a couple of days before bearish sentiment once again asserts itself.

Eurodollar futures (basis March) on the CME have shown a slow, steady progression over the past couple of months and are in a bullish uptrend. The Eurodollar chart has given the bullish "all clear" signal for traders who want to go long.

Energy complex

The chart for crude oil (West Texas Intermediate) shows a clearly defined "head and shoulders" top that formed between 1995 and the present. Only in the past year has the pattern's neckline been broken. The oil complex has experienced a rally of late after several months of falling prices but we do not expect this bullish trend to last long. For the next several weeks, however, there are opportunities to be made on the long side of crude oil futures and options.

Crude oil's future chart (basis November) shows a bullish "half mast" formation that points to even higher prices in the days/weeks ahead. The chart is also coming out of a three-month "rounding bottom" which is also a testimony to crude oil's near-term strength. This doesn't, however, negate the intermediate downtrend in the oil market, which should continue once this latest pocket of bullishness has been exhausted.

The candlestick chart for light sweet crude oil futures (basis November) was trending in an upward sloping trend channel until late last week when it registered a very bearish candlestick pattern that could mean a return to falling prices is at imminent. Futures traders should watch this index carefully over the next few days. Any failure to rally above immediate overhead resistance at $15.80 means the rally in the oil market is likely over for now.