Sayonara Abenomics

~reprinted from pebblewriter.com

Those who have followed this blog for any length of time know about our focus on the Japanese economy and the yen.  I presented this chart in December, which shows the impact on stocks of the last three USDJPY reversals off a trend line (or top of a channel, depending on how bearish you are) it recently tagged a 4th time.

The latest out of Japan is the BOJ deciding to hold easing at current levels (60-70 trillion yen or $590-690 billion.)  This surprised many, given that exports have fallen off a cliff on the eve of a 60% consumption tax increase (from 5 to 8% on Apr 1.)

This article from Reuters sums up very well the problem Japan faces: trashing the yen can't undo the systemic economic imbalances of a stagnating economy with way too much debt on its hands.  Japan exports have leveled off, producing record trade deficits (in spite of a weaker yen), while the cost of imports continues to rise (thanks to the weaker yen.)

Japan's CPI conveniently leaves out fresh food, which has soared over 17% since the Nov 2012 assault on the yen (Japan imports 40% of its food.)  Is it any surprise that consumer confidence is moving in the opposite direction?

And, fuel prices have soared -- exacerbated by the continuing fallout (pun very much intended) from Fukushima.  The consumer, who also faces next month's 60% tax hike mentioned above, is already getting crushed by QE.  So, why not scrap it?

If they do, rates will skyrocket.  Outstanding debt is 242% of GDP, and annual debt service (23 trillion yen) is already greater than 50% of tax receipts (43 trillion.)  With QE of 60-70 trillion yen, the BOJ is essentially monetizing all of Japan's debt directly or indirectly (issuance of 41 trillion yen is anticipated this year.)  In short, QE is the only thing keeping rates "manageable."

In sum, the BOJ is in a box from which there is increasingly no escape.  They can make ends meet by issuing much more debt to fund the 43% of expenditures not covered by tax revenues.  Issuing that debt keeps rates low enough to be able to pay the interest.  But, a rock bottom yen bites the consumer in the ass and, in the end, means tax revenues go sayonara, increasing the need for more debt...   Wash, rinse, repeat.

As BOJ's Kuroda put it in his latest "let's play make-believe" press conference:

When the sales tax hike was raised to 5 percent from 3 percent in April 1997, Japan's economic growth turned negative in April-June but rebounded in July-September. But, the Asian currency crisis erupted in the summer that year and Japan fell into a recession as it faced its domestic banking crisis in the autumn.

He assures us that this time will be different, but I think it's wishful thinking.  I think Japan is very much on the path to default or depression, and there's no amount of debt issuance that can alter that outcome.  When the money spigot turns off, the primary beneficiaries of Japan's QE hot money (Thailand, Singapore, Philippines, Malaysia, Korea... not to mention China, Japan's biggest trading partner) will go tapioca.  The Asian currency crisis will come roaring back in a big way.

Mucking About

~reposted from pebblewriter.com~

ES came within .09 of our interim target from Monday [see: CIW Oct 21] and is reversing nicely, though we're a day behind the schedule discussed on the 17th.

The implications are that this sell-off might be a little less deep than I originally thought. Still, as we discussed yesterday, it should be steep enough to flesh out the red channel within a few days.

The dollar reverted to the pale blue .886 before falling back to a higher low, having been rebuffed by the falling wedge's lower bound.  It'll be interesting to see whether the equity plunge is frightening enough to produce a real dollar rally -- or merely slow the bleeding.

SPX's 90-pt plunge in late June (1654 to 1560, in yellow on the chart above) produced a dramatic spike in DX -- which then continued to rally with stocks until they had recovered their losses.  For now, at least, the dip below the critical 78.725 has been averted.

I'm often asked why, if the larger harmonic patterns are so clear, one should muck about with the smaller patterns, channels, etc.  The rally from 1640 to 1754 demonstrates the value quite well.  The 110 points, alone, would have been a 6.7% return -- not shabby for a 12-session holding period. 

Yet, as the chart below shows, there were several reversals that were fairly "by the numbers."  The purple .786 (yellow .618) provided a 20-pt reversal, and the purple .886 another 11 points.

Adding in those extra 62 points alone (the reversals and their retracements) would have boosted the 6.7% return to about 10.5%.  But, more importantly, the harmonics alone don't tell the whole story.

Consider our forecast from July 15, when SPX was about to register a new all-time high.  Based on harmonics, I expected a reversal at 1712 (it came at 1709) and subsequent rally to 1765, followed by a 45-point retracement on the way to 1823 -- all by late August.

A buy-and-hold investor would have done reasonably well with that forecast.  SPX came within 6 points of that 1765 target before reversing yesterday -- a modest 4.6% gain from 1682.  There's nothing wrong with 4.6% for three months (about 18% annualized.)

However, by simply paying attention to the channels, we were able to spot the trend shift in early August that signaled a deeper dip than originally anticipated.  That deviation provided an additional opportunity of 54 points (27 X 2.)  The September dip from 1729 to 1646 provided another 166 points of potential return.

Suddenly, a 77-pt or 4.6% potential return becomes a 297-pt or 17.7% return (about 70% annualized) -- from simply tossing channel analysis into the equation.  By considering many other chart patterns, coincident developments in other securities and currencies, analogs, RSI channels and other, more traditional technical analysis, we've been able to do even better.

Let's be clear on one thing: it is highly unusual for anyone to catch the absolute top and bottom of every major move.  We've done better than most, but I still miss a lot more than I care to admit.  But, that's not important...because, it's not our goal.

Our goal is simply to catch "most of the moves most of the time."  This means developing the very best forecast we can and following it until it stops working.  Sometimes, it works for days or even weeks.  And, sometimes it works for all of five minutes.

The key is acknowledging when it's not working -- which means (1) having a discrete price level or chart pattern that provides a clear signal, and (2) setting aside one's ego and admitting that the forecast was hogwash in the first place (by far the harder of the two!)

continued on pebblewriter.com