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November 02, 2008

Rebound
by David Chapman

Investors must be breathing a sigh of relief. The rebound last week has taken some pressure off what has been the worst decline since the 2000-02 high tech/dot-com collapse. More importantly, we believe it signals at least a temporary end to the collapse. But is it the absolute end? Probably not, but relief rallies can be quite impressive.

There is the old saying of "sell in May and buy in November". It is now November. Is it the time to buy? Well, according to the Stock Trader's Almanac November is the best month of the year for the S&P 500. Since 1950 there have been 39 up Novembers against only 18 down Novembers. And in an election year, which this is, the S&P 500 puts in an above-average up performance. The stars appear to be aligned and we would agree.

We wouldn't blame if investors could be forgiven for having had a nervous breakdown through this collapse. It ranks right up there with the worst bear markets. Ned Davis Research Inc. recently highlighted the worst bear markets since 1900 (Institutional Hotline - October 28, 2008). We noted in our Technical Scoop of October 13 that the two-week collapse that got underway on September 29 and ended October 10 was comparable with the two-day collapse of October 28 and 29, 1929 and the one-day panic of October 19, 1987. While those latter two were impressive because of their fierceness in a short period, this one was just as fierce even if spread over several more days.

Below we table the worst bear markets since 1900. As Davis notes, all but four resulted in recessions. Four of them related the Great Depression. The four that did not result in a recession were the build-ups for WW1 (1916-17), WW2 (1939-42), and for the Iraq and Afghanistan war (2002). The latter was accompanied by huge tax cuts and interest rates slashed to one per cent. 1987 resulted in only a financial panic and no recession was seen - at least not immediately. While there was a few years' lag it turned out to be a precursor for the early 1990s recession.

As you can see, this has not been the worst bear market by any stretch. The 1930-32 bear remains the Grand Daddy of them all. Nor is it the longest with the 1939-42 bear stretching over two and a half years. Of course we can't swear we have seen the bottom of this bear so we may be premature in signalling its end. But if it is the bottom of this particular phase of the bear, then it would be sixth one that ended in either October or November.

Still, we can't help but note that two others (1917 and 1974) both of who had lows in October followed by a rally in November collapsed once again to make their final low in December. The November highs in those years were seen in mid-November 1917 and early November in 1974. The rebounds can be impressive as the 1917 rebound was up about nine per cent and the 1974 rebound jumped about 15 per cent.

So will this be a pop like in 1917 or 1974 or will we get a more sustained rebound that could last for a few months? Unfortunately it is too early to tell. Bear market rallies are not unusual and can at times be quite spectacular. One noteworthy example was the rally out of the 9/11 lows in 2001, when we rose 29 per cent (or 21 per cent close-to-close) into March 2002. Another was the sucker rally that got underway in November 1929 and lasted until mid-April 1930. That rally gained 48 per cent.

If we are closer to the 1974 and 1917 rebounds we would look at some interim rallies during the 2000-02 decline. One lasted roughly two months from March to May 2001. That rally of about eight per cent was more in line with the 1917 rally. It was short, swift and dramatic. Eventually of course it led to new lows. Most other rallies during that period were of shorter duration and added fewer points.

The nature of the rebound will be determined by whether we are at an intermediate bottom C wave down to form a C wave of higher degree, or whether the big collapse was merely a 3 wave down of a five-wave decline from the highs seen last May.

Thus far from our highs in October 2007 we note a five-wave decline into March 2008 for our first or A wave down. This is followed by the rally into May 2008 for our second or B wave. If the current wave is the third wave of the current decline as we note only three waves down then there remain fourth and fifth waves to complete the structure. A rebound of this type would be short and swift and would take us into late November, followed by another wave to the downside to make new lows. The final wave down should only be about 200 points from wherever we top because that was about the length of the first wave decline from May to July 2008. The low would come in December or early January.

If the intermediate decline is a large ABC decline then we should have completed the wave with the October lows. We then should embark on a corrective wave pattern that could last months and proceed irregularly to the upside. This could regain anywhere from 50 to 60 per cent of the entire decline. Either way, whether we are about to embark on an intermediate rebound or we have a quick rebound followed by new lows which would then put the final downdraft in place, we are not far from a rebound of some substance.

Our chart of the S&P 500 shows the entire bear market since the 2000 highs. The huge decline into 2002 was our large A wave and the huge rally to October 2007 was our large B wave. This one should be a huge ABC type of decline and take years to complete although we note that these patterns can unfold in a huge ABCDE type of pattern as we witnessed from 1929 to 1949. All we have accomplished thus far is an A wave, and as we note we have either completed it or are only a few months from doing so. Elliott Wave analysis is very subjective and is subject to revisions and different interpretations. Irrespective of our interpretations, targets on the S&P 500 this month are somewhere between 1,050 to 1,100 as a minimum, which would be a 16 to 22 per cent gain from the lows.

The gains in the gold and the oil and gas sectors could be even more dramatic. That's because both sectors suffered considerably more in this collapse even though they had nothing to do with the financial crisis. They are most visible innocent victims of the financial crisis. There was a perception that the two sectors and commodities in general were in a bubble. We dispute that because neither sector saw the huge overvaluations and a market just going up and up with a lack of logic, like the NASDAQ of 1999-2000. While gold and oil and gas prices were high, there were some clear reasons why they were going up: gold because of a declining US$ and oil because of the falling US$, the pressure of demand and supply and the threat of war with Iran.

When the US$ began to recover and then turned into a sharp run to the upside the commodities sector became unglued. Demand pressures were also perceived to be waning with a looming recession and the threat of war with Iran has faded into the background. It is these reasons more than anything else that helped shift things against the commodities and when the fall got underway it turned into a route.

The sectors were favourites of hedge funds, and it was the unwinding of the funds due to huge margin calls that forced them to sell the good with the bad in order to raise cash. In the early stages of the financial crisis in the early part of 2008, both these sectors were clear safe havens as both went to new highs. Not so this time around. Gold fell roughly 30 per cent from its highs and silver almost 60 per cent, and the stocks as measured by the TSX Gold index fell roughly 54 per cent. The HUI Gold Bugs Index fell 67 per cent. The TSX Energy Index fell 56 per cent but the AMEX Oil & Gas Index fell 50 per cent as oil prices fell almost 60 per cent.

Both TSX sub-indices fell in clear ABC corrective patterns. The result is we know we are not starting a new major decline but merely going through a sharp correction within the context of a longer-term bull market. When the corrective process is complete we will embark on a new bull.

Minimum objectives for the TSX Gold Index are back to the top of the bear channel near 240, roughly 40/45 per cent above the recent lows. There is major support from the 2007 lows at the recent lows. We can't rule out one more low though in the TSX Gold Index before our rally. Our wave count is subject to change.

It's a similar story with the TSX Energy Index. The major support zone coincides with highs seen in 2004. Resistance on the bear channel is up around 280. That zone also coincides with the lows of 2007 and a two-year consolidation pattern prior to the breakout earlier in 2008. This would seem to be as well a minimum target for any rebound on the TSX Energy Index - a move of about 40 per cent from the recent lows.

As we said at the outset - it is "sell in May and buy in November". It is now November. Investors should be buying.

Goodbye Bush

(Beware this contains political commentary of which everyone may not agree).

The US elections on Tuesday should mark the beginning of the end of the days of the George W. Bush era. We hope. The frat boy President who should have never made it this far and who should have been impeached long ago along with most of his administration is finally on his way out the door. While we can cite the September 11, 2001 attacks as his defining moment we will remember him more for his illegal invasion of Iraq that has led to over 1,000,000 Iraqis dead, 4,000,000 displaced refugees and a country pushed almost back to the middle ages, thousands of dead and wounded US soldiers, at a cost thus far to the US taxpayer of over $600 billion; Abu Gharib, Guantanamo Bay, the Patriot Act and a steady decline in civil liberties, extraordinary rendition, torture, redaction, the Scooter Libby/Plamegate scandal and, the complete disregard of the Geneva Convention; the questionable invasion of Afghanistan and 7 years later they are still there just as 5 years later they are still in Iraq; massive tax cuts, increased spending primarily on the military, laissez faire economics that primarily benefitted the rich, the biggest deficits in US history, the deregulation of the banking system (begun under Clinton) that led to the biggest financial crisis since the 1930's; the seizing of the 2000 elections with hanging chads and a conservative Supreme Court that stopped the count as he won by just over 500 votes in Florida although he lost the popular vote overall; questions surrounding the 2004 election in Ohio and Florida where touch screen voting machine counties went to Bush even though the counties were primarily Democrat in the previous election and exit polls indicated that Kerry should have won; the Hurricane Katrina debacle, turning health care over to the insurance companies, a repudiation of the Kyoto protocol on the environment and the breaking of the Anti-Ballistic Missile Treaty; and as we end his Presidency we can't help but note the illegal attacks against Syria and Pakistan and his administrations ongoing attempts to paint Iran in the same vein as Iraq all of which combined with the illegal invasion of Iraq and the questionable invasion of Afghanistan has done nothing but arouse the Arab and Muslim street to hate America even more than it was before; and finally the decline of American prestige in the world and quite possibly the beginning of the decline of the American Empire.

Not pretty. For investors his legacy was the financial panic of 2008 which will forever be associated with him just as Herbert Hoover continues to wear the 1929 stock market crash and Great Depression. It will be even more bitter if the coming recession cuts very deep.

We can only hope that the upcoming four years will be better than the past eight of George W. Bush. Unfortunately while America may elect a new President on Tuesday we have to wait until January until the Presidency is officially handed over at the inauguration. Two months is a long time and anything can happen.

Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2009 David Chapman

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