Correlation patterns at the asset class level stem from two sources, that is discounting factors and the way sectors and industry groups absorb higher or lower interest rates based on their respective impacts on earnings and company cost structures. Interest rates, on the other hand, result from a combination of perceived macro and micro credit risk and overall inflation expectations. Math essentially governs the first part through the time value of money; collective investor attitudes towards risk and return, largely patterned according to the Wave Principle, generally govern the second part. In general what tends to happen is that there is always a winner asset class, a loser asset class and a somewhere-in-between asset class. This is not what we currently see AT ALL and we believe it is reason for at least short-term concern.

A look at the 30 year yield chart above will reveal a few interesting things. First off, the rally from 83 bp to 1.942% is a bit leaner than the chop lower from 1.942% to 1.100%. The repel at the purple / longer moving average did lead to a cross over in the shorter MAs though not much follow through to the downside could be seen from that situation. Finally, the resistance line of the past month’s descent is much steeper than the corresponding support line of the same move. This suggests that for all the central bank intervention the bond market rally attempt isn’t the strongest. The yields are having difficulty moving any lower.

Meanwhile the SP 500 index appears engaged in a sluggish, technically selective push higher. The support line looks steeper than the resistance line, near-term momentum is overbought and the rise is for the most part supported by 5 stocks at this point. It begs the question, if the stock market isn’t yet on strong enough footing to rally in a more meaningful way, why are the bonds – as per the previous chart – looking vulnerable too?

Finally, a similar picture is to be seen in Gold. Here too support lines are steeper than resistance lines coming off the march lows. Here too near-term momentum appears a bit overdone; and here too initial tests of the longer average did not really lead to the meaningful, sustained advances above the shorter averages we’d normally get.

I am not going to bother anybody with our wave counts in SP500, bonds and metals because that may be a bit too technical. Needless to say, they’re all aligned suggesting the risk right now is both paper and hard asset vulnerability; this is compatible with the basic trend analysis explained above. Based on this, we aren’t convinced at all the moment of huge opportunity to deploy may have occurred a few weeks ago, in fact our stance right now is very defensive and we will require either substantially improved valuations, more friendly technicals or a combination of both before we commit to anything. Fundamentally, we believe it is largely under-appreciated how severe the next wave of defaults could end up being; and make no mistake about it, there is a limit to which all these things can end up on Central Bank balance sheets and not become systemic threats at the same time. To conclude, in the face of seemingly abnormal relationships between asset classes, we remain largely skeptical that the markets and the economy will have seen the entire amount of damage there is from the coronavirus crisis.

The wave principle is unique in the perspective it can give on market trends. Many technicians find themselves confused with Elliott and present as criticism the subjective nature of wave counts and how they must always be adjusted. It’s a fair point but it’s based on a practitioner flaw rather than an EWP flaw. The important thing to understand is that like any other technical tool, Elliott must not be used in isolation and must be combined with other elements of market behavior pertaining to flow, momentum, ratio, basic trend analysis, sentiment and related market confirmation. If this is done within the framework proposed by the wave personalities the results can be absolutely remarkable.

Much like the Elliott Wave Principle is an evolution of the Dow Theory, the wave personalities are a more detailed description of major trend phases. The difference really is a subtle one, in the sense that the Dow Theory’s major trend phases are distinguished in up versus downtrends – in other words the criteria here is trend direction; whereas the wave personalities are distinguished in motive versus corrective waves which can both unfold as either uptrends or downtrends – that is to say the criteria under the Wave Principle is wave function.

The Dow Theory’s third tenet suggests primary trends have three phases and they are slightly different from bull to bear markets. Rallies begin with disbelief, are dominated by trend follower interest in the middle and suck in the public at the end. Declines start with complacency, degenerate in concern in the middle portion and end with capitulation. The Dow Theory thus proposes opportunity arises somewhere where capitulation morphs into disbelief and it’s easy to see why that comes to be the case. Capitulation leads to an intense wave of selling that pushes assets to more attractive valuation levels. Also, capitulation is the final exhaust phase where everybody throws in the towel - so once it’s all done the selling pressure naturally dries up because there is nobody left to sell. The disbelief is the natural mental state of the market in the aftermath of a vicious wave of selling and is where the market is beginning to rebuild precisely because of the scars left by capitulation. Astute investors are enticed by great valuations – which creates buy flow - and the activity expands only on the rallies simply because of a complete disappearance of sellers. It makes total sense.

Elliott on the other hand proposes that opportunity arises during 2nd waves. Second waves are so called “retests of lows” and can be confirmed in two simple ways - they subdivide in a corrective a-b-c structure and do not carry to a new extreme (retracement is contained at 100% and in most cases 61.8-78.6% but sometimes 38.2-50% of wave 1). The fact that the 2nd wave doesn’t carry to a new low is a fundamental and very concrete change in market behavior because the sequence of lower highs and lower lows that will have defined the previous downtrend is now in the early stages of being broken. The inability to push to a new low despite the fact that psychology is often more extreme than at the actual market turning point and fundamentals look almost hopeless is the classical example of the market disregarding current negativity and discounting the more positive picture that will suddenly surface in the ensuing wave 3. As the say goes, the best news for a market is a market that doesn’t fall on bad news.

If you do a checklist of all these items and evaluate the current environment you will see that many things are lined up for a short-term reversal here. Calling for a bull market would be a different thing because rebuilding after black swan events takes time and frankly with this volatility and time compression, we just don’t have to do so to make a buck. Suffice is to say the negativity and the desperation we see in the news in the context of the currently prevailing technical picture IS NOT BEARISH. Consider this

• Fear at the march low almost matched the levels reached in 2008;
• The fear build up now took 3-4 weeks vs 9 months – this is an intense burst of sharply focused emotion;
• The spike in volume suggests capitulation occurred – at least for now;
• The recent rebound is largely technical and we can’t explain through fundamentals what the market seems to be doing but the immediate downtrend has been violated;
• Activity seems to be drying up during declines;
• The leg down from 2640 seems to have an a-b-c corrective form;
• Previous structural levels and initial percentage retracement seem to prop the market up pretty well so far;
• Everybody, including the media and the officials seem unable to see any hope despite the fact that tough containment measures have been instituted at this point. This is the exact opposite we had a month ago when everybody was complacent and nothing was being done against an accelerating breakout;

Bottom line: we may all have shivers on our backs but if you look on the chart below the technical evidence we see is a bit more balanced than that. In our portfolios we are now at our lowest cash position in months as we’ve deployed a bit near the low and a bit more in the past 48 hours. Let’s see what happens.