Cyprus? Whodda Thunk It? Pretzel Logic

In Friday’s update, I noted the charts were suggesting a turn was approaching, and I speculated that there would be some type of “bad news” event hitting the press this week; I went a step further and speculated that the source of the news event might well be the FOMC meeting on March 20.  Score one for my interpretation of the charts — but score zero for my speculation as to the source of the pending bad news (though, to be fair, my speculation regarding the Fed could still pan out — to be determined).

As it turns out, the source of bad news was a tiny country known as Cyprus, which is apparently part of the European Union, and in need of a bailout (act surprised!).  I’m not going to berate myself for failing to include “bad new from Cyprus” in my speculations — prior to this weekend, if someone had asked me to relay the totality of my personal knowledge regarding Cyprus, I would have said it was “probably some kind of tree.”  If pressed, I’d have added, “Or maybe a rap singer and/or the latest new car from Hyundai.”

What’s unique and frightening about the goings-on here is that the EU has asked Cyprus to levy a tax on the bank accounts of private citizens to help fund the bailout.  Todd Harrison has written an excellent piece discussing all this in more detail (See: Cyprus: Has the Next Phase of the Global Crisis Arrived?).

There are legitimate concerns this will set off bank runs across the Eurozone.  One thought I would add to this discussion is that it’s my belief that — short of systemic failure, anyway — European instability is actually bullish for U.S. markets.  This may be counter-intuitive, but if the EU experiences bank runs, it’s not as if European investors are going to withdraw all that cash and simply bury it in their backyards.  The cash has to go somewhere.  Ask yourself:  If you were a European who felt your money was unsafe in Europe, where would you put it?

Right or wrong, bubble or not, the U.S. treasury market, and blue chip equities, are still perceived as “safe havens,” especially when seen in contrast with Europe.  So some portion of any massive capital flights out of Europe is almost guaranteed to find its way into U.S. markets.  That means even more liquidity coming in, on top of the Fed’s existing support.  More fuel for the fire would help drive down treasury yields, and help drive up equities.

It’s all relative, after all — and basically, we’re still the prettiest ugly kid on the block.

If you are truly aware of the challenges facing the world, it’s logical to have a tendency to be bearish these days.  The danger for bears is it’s tempting to view events like this as “confirmation” of a pre-existing bias, which can lead to over-trading one’s convictions.  Believe me, my “inner bear” wants to pounce all over these types of events, too.

Could this be a watershed event that leads to a prolonged bear market?  Sure, anything’s possible — but given how much liquidity is still flowing from the Fed, I think this event is probably simply yet another warning signal of an approaching storm.  I suspect the storm hasn’t actually reached us yet… in fact I suspect it’s still quite a distance away.

If you’re prone toward a bearish bias, just remember to consider both sides of the equation.  Bears tend to look at events like this and think: “Storm coming!  And nobody wants to be the last guy standing on the beach when that hurricane rolls ashore!”  But bulls think differently.  A bull would say, “Sure.  But then, nobody wants to cut short their vacation for a false alarm, either!”

I covered this psychology quite well in what was, in my opinion, one of my best articles of the year.  It’s titled A Survival Guide for Bears in a Bull’s World.  If you’re aware of all the trouble in the world and are thus prone toward an intelligent bearish bias, I’d highly recommend giving it a quick read.

Let’s move on to the charts.  The charts have been hinting that a correction was looming, which is what led to my speculation last week that bad news was forthcoming this week.  I was expecting about 7 more points out of this rally, but it remains to be seen if we’ll get it or not.  A peak that falls 7 points shy of a wave as large as this rally would be well within the margin of error.  On the chart below, I have kept Friday’s the alternate count unchanged in the labeling, but the odds on that count must be considered at 50% after the overnight futures sell-off.

Since the two counts are being viewed as equals, the chart below shows how the wave could be viewed as entirely complete.  We’ll simply have to see how the cash market responds today.  In any case, hopefully my warnings of the past several days have helped readers lock-in profits.

In conclusion, the wave structure has been hinting at a pending turn (in fact I wrote on Friday that I was on high alert for such a turn), so the bad news out of Cyprus isn’t entirely unexpected.  The news fits the charts, so bears may get a solid, scary correction.  It’s still to early to determine much in the way of probable target, but if we’ve indeed seen the completion of the fifth wave in its entirely, then the high 1400’s would be entirely reasonable.  Ultimately, however, I presently do not believe this will mark a long-term peak.  After we see how the cash market responds, I may be able to generate some targets as soon as the next update.  Trade safe.