Undervalued US Stocks; Overpriced Bonds A bounce in Gold next The uro bottoming new high above $1.60 This Bear Market's fractal

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1 May 26, 2012 Undervalued US Stocks; Overpriced Bonds A bounce in Gold next The uro bottoming new high above $1.60 This Bear Market's fractal Sell bonds; and buy stocks As Pulitzer-prize winning Financial Times editor, John Authers points out, "stocks have not been so far out of favor, or so cheap in half a century". And according to Robert Shiller of Yale University, the dividend yield on US stocks today is 1.97%, above the yield on the 10-year Treasury bond of 1.72%. As usual in Elliott, the fundamental evidence surfaces long after the reversal has occurred. That's why now is the optimal time to get back into equities for at least a six-month "trade". While the overwhelming evidence points to stocks outperforming in the long run, you certainly don't want to get caught in a short-run collapse. Although stock's long-run performance from 1900 to 2010 beat inflation by 6.3% per annum, versus bonds at 1.8% per annum over the long run. These statistics are highly deceptive. Anyone who held stocks during the 1929 Crash, and did not sell in the 1930 bounce, would have been virtually wiped-out, and required over twenty years just to get even, assuming no holdings went bankrupt, and no stocks were liquidated near the 1932 trough, when most investors threw-in the towel for good. Barring these two conditions, there would have been no recovery. Meanwhile if you had simply stepped aside during these plunges in cash, your long-term returns would have compounded on the order of at least 900% higher. On the other-side of the coin, if we just "ride the market wave, in whatever direction it takes us" by reversing positions at points like the present, previously un-imaginable returns of several hundred percent are available in the short run alone. A Bear Market is no time to project the long-run. As John Maynard Keynes was fond of saying, "in the long run, we're all dead". Buy stocks now; we will guide you, when it s time to bail out

2 Stocks right now, relative to bonds, have not been as cheap since 1956, which in retrospect, proved to be one of the best moments in history to buy stocks. US Treasury bond yields peaked in 1981, and inversely-related global sovereign debt prices have risen ever since. They never move in a straight line, and resemble a straight line the least in a Bear Market. The tremendous Spike in bond prices ending in March 2009, sparked by a similar flight to safety, and like now was the ideal "sell point" for bonds. While such long-term turning points can only be judged clearly in retrospect, what we can do is minimize the risk at major turns, by reversing potions to their reciprocal ETFs. Therefore we sold the inverse equity funds to buy long, and sold the long bond ETFs to buy the inverse bond funds. In effect: sell your bonds and buy stocks now, or better yet our asset allocation, and we will guide you when the time comes to get out. In Gold a "dead cat" bounce Gold peaked when five waves up completed in an orthodox top (OT) in November However, the directional transition, from bullish to bearish, often traces out a slightly higher irregular top, which occurred in September 2011, for an all-time high of $1,920 per ounce, corresponding to ~457 on the S&P/Toronto Stock Exchange Global Gold index. As you see below the structure defined by two converging red lines is a bearish Diag II, which indicates the beginning of a long move down, and is distinguished from terminal Diag >s (Diagonal triangles) by the sub-divisions in 5's, identical to a bull move, whereas Diag >s sub-divide into 3's like corrections. However, first there must be a wave 2 retracement, to at least the Diag II's, first chronological touch-point, measured to the solid part of the candle, as opposed to the retracement marked by the "wicks". The likely minimum upside, which of course can be exceeded, depending on the prevailing sentiment, is approximately 390, labeled by the green dashed line. Up to this point, a trade in "long" gold is a high probability/low risk trade. Unlike stocks, in commodities, each cycle begins from scratch, without regard to its previous history or trajectory. In effect, there's no building upon a past foundation, nor the stair-step to the higher de - grees of trend, as we see in stocks. The point marked OT, or Orthodox Top marks the completion of the 5 th wave. From there an a-b-c will take it far below 270, and off this chart. After the a-b-(a); a-b- (b) transition to a higher degree of trend, the c wave in process, elongates into 5 sub-waves, in a far larger structure, than we have expected from the scale up to this point. From a fundamental perspective, the price of gold is down 20.5% from the $1,920 high, to a fourmonth low of $1,527 last week, and according to the US mint, sales of gold American Eagles were down 63% in February, from the previous year.

3 Gold is not a safe haven The most salient point is that gold is not a safe haven from financial turmoil, and only makes sense in times of high inflation, as a long-term holding. Fed-induced inflation is transitory, while the end product of a Supercycle Bear Market is a severe Deflationary Depression. In a Bear Market the price of gold value drops right along with everything else including Real Estate, diamonds, Fine Art and bonds. As the supply of Dollars shrinks from a Crash, far fewer dollars are available for purchases of any kind, while the demand for dollars surges, due to everyday needs, such as paying the rent and utilities. When investors need to raise cash, they sell concurrently with everyone else at "fire sale" prices, resulting in downward price spiral, while the value of remaining dollars surges in the "deflationary" climate. Those who still hold gold, would be wise to bail out in this likely final rally, scaling out, beginning at the $1625, in $25-30 increments. While you will never "top tick" gold by this method, your average price, will likely be higher, and the risk gold drops far below your original purchase price before you're able to sell is negligible. The uro bottoms The Euro has likely bottomed or is bottoming in the next several days, rather than a bounce the next move up should reach a new high, as wave 5, concurrent a dollar drop, as you can see in the public

4 dollar chart in Stockcharts. The Market Fractal What I have described is in essence the market fractal, or basic pattern which occurs at every degree of trend. This means that as it is occurring on the monthly chart, a similar pattern is occurring in the weekly, the daily, the hourly and the 10-min charts, oftentimes in opposite directions. Since Bear Markets are defined by a log step in volatility, or a factor or 10, they offer far more opportunities to trade. Even when the market ends the year at the same level as it started, the interim wide swings will have allowed us to earn a generous profit, each time long-term investors take a round-trip, form a profit, to their original purchase price, and often below it. Most Elliott practitioners see only impulse fractals, or those of highly regular "impulse waves" 1, 3 & 5. Since a Bear Market is simply a correction big enough to show up on the Monthly chart, the relevant fractal, echoed at lower degrees of trend, provides a glimpse of the larger structure. That structure is a complex A-B-C, with a Diag II in the A wave to indicate the beginning of a long correction. Twenty plus years certainly ranks as a long correction. This Bear Market's Fractal Since the Market is a fractal, the basic structure, repeats over and over. The Diag II introduces a long move in either direction, and therefore found at the beginning of a structure or wave. Since it must sub-divide into 5 waves, it cannot occur in the B wave, which is always a 3-wave structure. A waves

5 can sub-divide into either 3 waves or 5 waves, and terminal C waves also always sub-divide into 5. That's why the final C segment of a correction is so often mistaken for a new bull move by most amateurs, since it has the identical structure as an impulse wave. When a Bear Market begins with a Diag II, it indicates a protracted duration. The Diag II was discovered in the 1950's by Hamilton Bolton, editor of the Toronto-based Bank Credit Analyst. Just as Elliott identified the A-B transitions as uniquely occurring from a "base", Bolton identified the Diag II as solely a bullish phenomenon, to indicate the beginning of a long "bullish move". While a Diag II, in either direction, is a structure that occurs at the beginning of a pattern, a Diag > occurs near the end, after the 4 th wave. When the degree of trend concurrently switches gears & direction in a complex a-b-(a); a-b (b) structure or as part of the "directional transition". However when we apply the principle of fractals to their logical conclusion, it becomes obvious that what occurs in one direction, must also occur in its opposite, if it is indeed a true fractal. In the Diag II wave A below, you see two of Elliott's rules simultaneously broken: wave 4 overlaps wave 1, and wave 3 is the shortest of 1, 3 & 5. Of course, if we omit Elliott's a-b transitions, as the Elliott establishment does, the result is allot of "unidentified patterns" the wave counts make no sense. Operating in characteristic fractal form, the whole is contained in its parts, and the parts of its parts, at every degree of trend, no matter how much it is magnified or shrunk down. Degrees of Trend are comparable to an earthquake, who's severity is measured on the Richter Scale. A Supercycle Bear Market occurs approximately every years, and is comparable in devastation to an earthquake registering 8-9 on the Richter scale. The pattern below is the basic bear Market fractal, in its 3 rd repetition inverted. That is to say this represents the entire bear Market, which won't be completed until the final tough. However in the interim, this pattern was echoed in the upside-down a-b-c concurrent with the Lehman crisis, through the 2009 trough, and the mirage recovery to Once again it is being re-

6 peated inverted. As you see in the Monthly S&P, the a wave should complete near S&P 1475 before reversing into the b wave down in an irregular bottom near S&P 925. In the Monthly S&P below Waves A & B, of an A-B-C have completed. Wave C in process, is once more tracing out and a-b-c, with a Diag II in the a wave to indicate a an extended trajectory. If you look closely you will see the identical a-b-c fractal as the 4 th wave of the larger Diag II labeled c, ended June This a wave is likely to complete near the green dashed line at S&P 1475, before reversing into the b wave, analogous to the Lehman bust, likely plunging to the area of S&P A European Credit Crunch Ahead

7 As Tony Jackson points out in his column in the Financial Times, Europe's corporations are facing a longer-term credit crunch. According to an S&P study, Eurozone corporations must refinance a "mountain of debt", and raise new capital totaling approximately $11 trillion in the coming years. Competing for scarce capital, are requirements from mostly the US and China of are another $33tn. While the US has a long-standing, well-developed bond market, to efficiently aggregate low-cost capital, no such highly-liquid, deep market exists in Europe. According to the IMF, 90% of long-term financing in the US comes from the bond market, and only 10% is sourced from banks. Because of the way the European financial system is structured, only 15% of capital is bond-funded, while 70% of corporate capital is bank-financed. Since European Banks are augmenting capital by 7%, a concurrent offsetting 7% shrinkage in bank financing of $2.3tn, seems likely, just as capital requirements are expected to bulge. In anticipation of such a crunch, European corporations are hoarding cash and cutting back on investments in plant & equipment. With no growth to fund, much of the funding problem would appear to have resolved itself. However as Reinhart & Rogoff assert in This Time is Different, recessions triggered by bank collapses tend to be protracted and far deeper than most. As the Greeks default on their sovereign debt, the contagion effect will likely have investors pulling more money out of the Eurozone. Sovereign debt defaults are rarely isolated incidents, but rather occur most often as a cas - cade of defaults, one setting off another, like toppling dominoes. Europe's financial system is far more concentrated than the US, with over 90% of capital concentrated in less than 10% of banks. The corporate sector is overly-dependent on these behemoths. Extend & Pretend Despite the worst financial crisis and deepest economic recession in recent history, Central Banks easy money policies by have artificially kept many companies afloat, resulting in few corporate failures of late. Lenders are unwilling to recognize the full extent of their non-performing corporate loans, preferring to "extend, hope & pretend". Besides in recognizing these defaults, they would also have to admit they're insolvent, similar to lenders of US Commercial Real Estate. From 1981 to 2011 the average 5-year default rate for corporate issuers has been 1.17%, compared the 16.8% for speculative-grade companies, yet speculative-grade companies world-wide failed at just 1.17% in Investors reaching for yield have been suckered-in to these "likely to default" investments once government largesse is withdrawn. While in the intermediate-term the dollar should benefit, for now its on a tumble lower due to the "dead cat" bounce just off the starting blocks.

8 The min retracement is just below 1300 before the S&P climbs higher Timer Digest S&P SPXU Inverse S&P 500; UPRO long S&P 500 Full pos UPRO average cost 75.5 Sell ½ UPRO limit 74 w/ proceeds Buy ½ UPRO limit 66.5

9 Timer Digest Bonds TMF 20-Yr long Treas Bond; TMV 20-Yr inverse Treas Bond Full pos TMV cost 71 Sell 1/2 pos TMV limit 68; CXL 74 Sell 1/2 pos TMV limit 79

10 Bond Allocator TMF 20-yr. long Bond; TMV 20-yr inverse bond Pension 2/3 pos TMV cost 70.5 Sell 1/3 pos TMV limit 68; CXL 74 Sell 1/3 pos TMV limit 79 Traders Full pos TMV cost 71 Sell 1/2 pos TMV limit 68; CXL 74 Sell 1/2 pos TMV limit 79

11 Equity Allocator 35% DRV Inverse Real Estate; DRN Real Estate One Fund Strategy Pension 2/3 pos DRN cost Traders Full pos DRN cost Sell 1/3 DRN limit 69; CXL 66 Sell 1/2 DRN limit 69; CXL 66 35% EDZ Inverse Emerging Markets, EDC Emerging Markets Pension 2/3 EDC pos average cost Sell 1/3 EDC limit 75

12 Traders Full Pos EDC pos average cost Sell ½ EDC limit 75 30% FAZ Inverse Financials; FAS Financials Pension 2/3 pos FAS cost sell 1/3 FAS limit 92.5; CXL 95.5 Traders Full pos FAS cost sell 1/3 FAS limit 92.5; CXL 95.5

13 Alternate position long (VIX) TVIX, inverse (VIX),XIV Full pos XIV average cost 10.6 Sell 1/2 XIV limit Sell 1/2 XIV limit Buy 1/2 XIV limit 8.65

14 To view the long-term public charts, where you can view the full long-term charts shown magnified above, click: if you are a subscriber to stockcharts, I would appreciate your vote, voting now is or subscribers to stockcharts only, and found at the top of the first page, at the right corner.