DAX Close, Links

Probably some more modest upside early next week. 

DAX 60

DAX 10

Italy Pays Higher Yields at Debt Sale  (OK, so if I can't hedge my portfolio with CDS, then I'll either liquidate it or demand a higher risk premium to hold it!)

Fitch: Greek Debt Deal a Default  (Yeah, but not enough of one....)

Swiss Cheese

I have decided not to write up a detailed review of the Euro summit results, as there is really nothing concrete to write about.  They basically took everything the market wanted to hear and said that's what will do.  All that is missing are the details.  I could burn up a good deal of my time and energy going on about why some of those details are so crucial, but there is already a plethora of excellent commentary out there in just one day.

Instead I want to point out that some crucial targets have been hit by Intermediate (2) at this point.  If we are going to turn into a (3) wave, this is as good a point as any.  Most obviously, the psychology has changed to one of much greater bullishness.  In fact, it has changed so much so that I feel somewhat foolish even posting these counts.  BPSPX is well into bullish sentiment territory, as is the AAII survey.

AAII

More importantly, the EUR/USD has hit and reversed (for now, anyway) at a very strong looking fib confluence and lateral resistance level.

EUR/USD 8 HR

EUR/USD 15 MIN

TNX appears to have completed a five wave move up from its all time lows, which I interpret as the top of a [c] wave of 4.

TNX 60

TNX 10

The DJT, which sports one of the cleanest five waves down of all indices from its July all-time peak, has now retraced .618 of that decline.  It has also challenged its 200 DMA.

DJT WEEKLY

DJT DAILY

DJT 60

The DJI has a reasonable looking count to show a complete rally.  The SPX does not have the same structure, but may conform more to the red 30 min RUT count I'll show below.

DJI 10

The RUT has closed an important gap and has fulfilled the criteria for an expanded flat (2).  The green count would imply that there is some more to go in C.  However, the red 30 minute count shows a very viable double three.  (The red count does raise the question of whether an x wave can extend beyond the origin of the pattern, but I can find no rule saying it cannot.)

RUT 60

RUT 10 GREEN

RUT 30 RED

On the other hand, besides these key levels in the EUR/USD and TNX, I am watching NYSI.  Rally failures at a level below 500 have some significance as a reversal indicator, although I am not overly impressd.

NYSI

I am also closely watching a developing bulling engulfing candle on the monthly SPX chart.  It is evidently the largest monthly rise since 1974.  The bearish case would seem to require that this rally reverse soon enough to cut that candle down to size.

SPX MONTHLY

However, what may really be the nail in the coffin for this rally is that Blankfiend will be on vacation for a week, starting Saturday!

Good luck all!

Beware the NPV

So, we have a plan.  Just a few minor details to fill in now.  Riiight!

I am particularly curious about the 50% write-down in theprivately held notional value of Greek debt.  The IIF statement reads:

"The specific terms and conditions of the voluntary PSI will be agreed by all
relevant parties in the coming period and implemented with immediacy and
force. The structure of the new Greek claims will need to be based on terms
and conditions that ensure an NPV loss for investors fully consistent with a
voluntary agreement."

So what does this really mean for Greece?  The real key here is the forward discount rate on the bonds.  If you write down the face value of a bond by 50%, but then increase the discount rate (interest rate) from 9% to 20% over the remaining maturity, you:
1.  Maintain the NPV (net present value) of the bond, which prevents a write down on bank ledgers.
2.  Do nothing for the debtor in the longer run.

I have many other questions, and will dive in some more later, but here is my sense of levels to watch.

TNX 10 MIN

DAX 60 MIN

RUT 10 MIN

EUR/USD

DJT 10 MIN

Europe - No Way Out

As the world awaits some miracle to emerge from the latest EU crisis summit tonight, I want to review some issues.

1.  Greek haircuts.  The latest is a push to have banks "volunatarily" write down Greek bonds by 50% of face value.  The voluntary part is to avoid triggering CDS and having a credit event.  (see footnote)

• a 50% haircut is insufficient.  For Greece to have a prayer, it would need to be upwards of 70%.  50% would actually be a premium to the way this debt is priced today.
• Banks are unlikely to "voluntarily" do such a write-down.  Even if they did, credit rating agencies are unlikely to score a write-down of this magnitude as voluntary.
• Banks that are hedged via CDS against their Greek holdings are motivated to seek a Greek default so that they can (theoretically) recover losses via their hedges, assuming counterparties will be able to pay.  If these same banks are forced to write-down voluntarily and have to suffer a 50% loss on their Greek debt without being able to exercise their hedges, the precedent is set that hedges against potential losses on other sovereign debt are likely worthless.  This would lead to liquidation of that other sovereign debt and major escalation of contagion.
• Unless Greece gets a meaningful degree of debt forgiveness, it is going to default - hard.  Ask yourself why it wouldn't.

2.  Bank Recapitalizations:  The idea is to force banks to attain a 9% Tier 1 capital ratio without selling assets.  The figure in circulation is 108 billion euros.  Theoretically, banks would do this through an equity raise.  Failing this, they would go to their parent governments next, and the EFSF as a last resort.

• There is no reason to believe that banks would be able to successfully raise equity on favorable terms in this environment.
• Many of the parent governments of these banks, particularly France, are unable to extend funds or guarantees without putting their own sovereign ratings at great risk.
• The EFSF has about 300 billion euros left uncommited.  Every additional drawdown to recapitalize banks diminishes the amount that could be levered to support sovereign debt issuance.
• Most EFSF money is German money, and the German taxpayer will not be amused to see his money going to recapitalize some French bank.  Nationalism still reigns in Europe and, IMHO, is making a comeback.
• The 108 billion euro figure is grossly low to begin with.

3.  Levering the EFSF.  The idea is to somehow lever the remaining 300 billion euros in such a way as to provide some type of first loss layer for new bond issuance by distressed sovereigns, particularly Spain and Italy.  I have covered much of this before, most lately in this post.  The latest iteration of this idea is for the IMF to establish a Special Purpose Investment Vehicle (SPIV) that would combine EFSF resources, its own resources, and contributions from sovereign wealth funds and other investors.  The EFSF capital would be the first loss layer in this structure.

• The EFSF has no capital - it is all in the form of guarantees.  In other words, the first loss layer of this SPIV would be money that the Germany, France, Italy, Spain and others "promise" to pay if the crisis escalates.  "Just call us if we need to pay you.  We promise we will.  No, really, we DO!"  Nobody is going to put any confidence in this type of funding for a first loss layer.
• IMF funds are super senior debt.  They will not serve as a second loss layer, or any loss layer.
• That leaves the contributions of investors to essentially take all of the losses incurred, unless of course the EFSF really were to pay up in event of disaster.  Even if it did, losses would likely far exceed the advertized 20% "protection."

4.  The Role of the ECB.  The Germans have insisted that the ECB NOT be a participant in any scheme to lever the EFSF, and are highly resistance to ECB bond buying via its SMP (securities market program).  Germany appears to have gotten its wishes in this regard, as the ECB has insisted that it will NOT help lever the EFSF, nor will it support the EFSF in obtaining a banking license.  This stance is very unlikely to change, at least in the near to medium term.

• Mario Draghi, the incoming ECB president, is Italian, and was endorsed for the job by the Bundesbank based on his reassurances that the ECB would not be used to monetize sovereign debt.  An about face now, especially with considering his nationality, would not be acceptable to Germany.
• When the Eurozone was established, Germany ardently insisted that debt monetization via the central bank not be allowed to occur. As you well know, it will primarily be the Germans who will get the capital call to recapitalize the ECB in such a scenario, essentially establishing a transfer union without democratic process. Is the Eurozone experiment now so important that the democratic wishes of Germans and others should now be overridden by an unelected bureaucrat from Italy?

5.  The Euro.  When I think of the role of a currency, I think of three functions:

1. A unit of accounting
2. A medium of exchange
3. A store of value

One of the core concepts in the establishment of the Euro as a currency was of German origin. That concept was of a currency as a stable store of value, #3 in the list above. That concept has been the mandate of ECB operations, and is a key element in the German image of the Euro to this day. 
In this sense, the Euro truly is a currency.  This is in sharp contrast to the US dollar or the British pound, which are only two/thirds currencies, in that they are NOT stable stores of value.  Rather, the dollar and the pound are funding vehicles for structural deficits.  Hence, in real terms, US and British debt is a guaranteed loss.  Only through this magic of ongoing, continuous, and insidious default do the US and Britain not default on their debts in the classic sense.  That the world continues to tolerate this simply astounds me, but I digress...

EDIT:  Apparently now Europe is looking for a 30% "voluntary" haircut on Greek debt.  While the banks may agree to this, and can pretend to not need as much recapitalization of loss on HTM Greek debt, this will drive Greece to default - soon!

Still Flat

I am torn between two potential counts, as shown.  I still carry the pain of my call from late July for further upside, just as we were rolling over, so I don't want to insist either way (not that it would make a difference in what would happen anyway...)  So, personally, I remain on the sidelines. 

The red count would gain credence should we go below 1197.34, and some fib relationships in the SPX and the DJI would certainly suggest that Intermediate (2) may have run its course.  However, the RUT has yet to trade above its A wave highs, and some EU indices are not showing any signs of impulsive decline, although that could change tomorrow.  Furthermore, the retrace of (1) in the DAX, DJT and RUT seems uncharacteristically weak.  Hence, the blue count remains viable.  If we do call this recent three day rally (i) of [v], per the blue count, I do notice a three wave look to (i) that could mean [v] would be an ED.  That would be a gift from God, should it occur.

SPX 1 MIN

IMF considering participation in EU bailout fund  (Reuters)

Brief Update (Updated)

This is my sense of where we are.  I am flat now, possibly early, but at a very nice profit.  We have reached the point where I will NOT hold overnight.  Yes, I do think Europe has some room to run yet in the CAC and the DAX, but I am not one bit confident that I would be able to get out during US trading hours.

DJT 10 MIN

RUT 1 MIN

SPX 1 MIN

DJI DAILY

DJI 10 MIN

UPDATE:  Just wanted to add a chart showing what I consider to be key EUR/USD levels.

EUR/USD

Mixed Signals

In some indices, I see us quite far away from the levels I would have expected this Intermediate (2) retrace to attain, while, in others, I find us dangerously close.  That could mean:

1.  The underperforming indices are about to outperform temporarily to play catch-up.
2.  The underperforming indices are going to have a rather shallow (2).
3.  My count is wrong.

I will start with the indices that seem to be close to reasonable targets for (2). 
Firstly, the DJI.  We are very close to the .618 retrace of (1) AND the 200 DMA, both in the upper 11900's.  Furthermore, my count has us in a five wave C, and placing [iv] at .618 of C gets us just about to the 119xx level as well.  Looking back, (2) of Primary [A] did poke above the 200 DMA twice before rolling over into (3) in 2008.

DJI DAILY

DJI 10 MIN

The SPX is in a similar spot, although seems to have more running room vs the DJI.  Here, the 200 DMA is somewhat further away, although the .618 retrace is closer.  The .618 retrace is obviously somewhat subjective, and mine is certainly different than most.  I've been through why I have an orthodox top in July, and my 60 min chart gives an abbreviated version of that reasoning.  For fib purposes, I am placing the bottom of my retrace at the deepest point achieved by 3 of (1) rather than the truncated bottom of (1) itself, or the absolute low, which I consider to be the bottom of Minor B of an expanded flat (2).

SPX DAILY

SPX 60 MIN

(Note here how the SPX has been rising with each thrust, while the RUT can't seem to.  The RUT is one of my underperforming indices.)

SPX 10 MIN

SPX 1 MIN

This chart should put to bed the idea that [v] of C could be evolving as an ED.

Another relative outperformer is the FTSE.  I see a resistance band in the 5600-5700 range.  A longer term chart is shown for perspective, and additional chart notes justify target levels.

FTSE MONTHLY

FTSE DAILY

FTSE 60 MIN

FTSE 10 MIN

The DJT is sort of in between.  Monday will be very interesting to see how the current wave up develops.  Its C wave has exceeded its Minor A wave, meeting the criteria for an expanded flat.  However, it does not appear to be painting an ED for [v] of C, so I am interested to see what follow-through Friday's action gets here.  As per the 10 minute chart, there is a valid target around 4915, which would be the .50 retrace of Intermediate (1).  However, there is also a gap target around 5000 that may prove irresistable, and could drive a push up to the .618 retrace near 5083, or higher to where C = 2.618 * A at 5212.  The 200 DMA is currently at 5029.

DJT WEEKLY

DJT 60 MIN

DJT 10 MIN

The DAX is shown with two potential counts.  My preferred is the black.  I see major lateral resistance in the 638x range, but I see no uncovered gap targets in the DAX until we get all of the way up to 6934.  I would NOT expect to see us get close to that level if my count is correct.  My target range extends from 6350 to the .618 retrace at 6546.

DAX WEEKLY

DAX DAILY

DAX 60 MIN

DAX 10 MIN

The RUT is where things get interesting.  This index has truly been underperforming of late.  If the mood turns more bullish, I would expect it to outperform and make up some lost ground.  The RUT (and the MID) are also two of the only indices with a potentially valid ED down to the early October lows. However, I do not believe that those Minor 5 of (1) lows were formed by an ED because I do not accept that the first wave of (1) was a leading diagonal. 

RUT TOP OF [B]

That would make the count shown below INVALID.

RUT WRONG COUNT

I feel pretty good about what the right count actually is here, but am really looking forward to Monday to get a sense of what follow-through Friday's bullish action gets.  I think the RUT will break out of its trading range here, and I do expect it to surpass its Minor A peak near 737 before (2) is over.  However, I am completely unsure as to whether it will just squeak above 737, or blow past it.  What particularly disturbs me for the RUT is the fact that putting [iv] of C at .618 only brings C up to 728 or so, which would not meet the criteria for an expanded flat (2).  This makes me wonder if [v] of C might not extend, which potentially could take us all of the way up to 806.  That would be well past the 200 DMA, so I consider it unlikely.  In any case, I am left with a very wide (synonym = worthless) target range for the RUT.  I will endeavor to refine that range as we go along.

RUT WEEKLY

RUT DAILY

RUT 60 MIN

RUT 10 MIN

MID is shown here just to bolster my long-term counts, and will not be discussed further.

MID WEEKLY

MID DAILY

Finally, I want to look at TNX and the EUR-USD.  For TNX, I see us approaching the top of a Minor 4 of the final impulse wave down for a loooong time to come.  A potential target for the top of 4 is around 23.8, although I am not sure we get quite that high.

TNX MONTHLY

TNX 60 MIN

TNX 10 MIN

As to the EUR-USD, I have sworn off trying to put EW counts on currency pairs.  However, I do see two potential reversal ranges for the current Euro rally.  This first is around 1.403 or so, and is a loose confluence of fib resistances.  The second, and perhaps more likely, is at 1.425. and is a very tight confluence and lateral resistance zone.

EUR-USD 8 HOUR

EUR-USD 4 HOUR

The weekly EUR-USD chart shows a trend of lower highs and lower lows, with choppy looking advances, and impulsive looking declines.

EUR-USD WEEKLY

And, from Zero Hedge, I grabbed the chart below, which shows the type of strong short interest in the EUR that could lead us to a quick advance toward that 1.425 range.

EURO SHORT INTEREST

A final scatalogical remark, regarding the dog and pony show to rescue the Euro.  The market rallied on Friday because someone suggested that the European Stability Mechanism (ESM) could be brought forward and combined with the European Financial Stability Fund (EFSF).  As you (should) know, the EFSF is the temporary measure with 440 billion of lending capacity and funding via callable capital guarantees.  The ESM is the permanent mechanism that was to replace the EFSF in 2013, and would have 500 billion of lending capacity funded by paid-in capital.  It is quite clear from the ESM Treaty that the ESM was never supposed to be additive to the EFSF, as you can read below:

TRANSITIONAL ARRANGEMENTS

ARTICLE 34

Relation with EFSF lending

During the transitional phase spanning the period from June 2013 until the complete run-down of

the EFSF, the consolidated ESM and EFSF lending shall not exceed EUR 500 000 million, without prejudice to the regular review of the adequacy of the maximum lending volume in accordance with Article 10. The Board of Directors shall adopt detailed guidelines on the calculation of the forward commitment capacity to ensure that the consolidated lending ceiling is not breached.

__________________________________________________________________________________

Changing this restriction to make the two programs additive would:

  1.  Require approval in all 17 Parliaments again (ain't happening)

  2.  Nearly double the budgetary bailout commitments of Eurozone sovereigns, to include Italy, Portugal/Ireland (which do not pay into the EFSF, but are slated to contribute to the ESM), and FRANCE!

  3.  If combined with a 50+% haircut on Greek debt and a substantive government funded bank recapitalization, could be enough to cost France its AAA.

I am preparing to be overwhelmingly underwhelmed by the results of this extended Euro summit.

Euribor-OIS

Dramatic rise in last one year.

Euribor-OIS

Still nowhere near 2008 levels.

GERMAN-FRENCH 10 YEAR SPREADS

Highest in 5 years

IMPORTANT VIDEO WITH LARRY FINK OF BLACKROCK:  http://video.ft.com/v/1231242136001