Chartered

Fortrend Securities - Wealth Management

Joel Hewish is an Investment/Financial Adviser at Fortrend Securities and manages the Wealth
Management division. The opinions expressed are his own and do not represent those of Joe Forster or
the International Advisory division.

Edition No. 17
13th October 2010

Bottom Line: Financial markets appear to be in the later stages of their corrective patterns which have
persisted for the past 3 ½ months. Major equity markets have either completed a topping formation, are
completing a topping formation or are already well entrenched in the next phase of their downtrend. Global
equity markets are now showing similar extreme technical and bullish sentiment readings to those
displayed just prior to market tops registered in April 2010, January 2010, May 2008 and October 2007. The
technical and investor sentiment evidence now overwhelmingly supports the resumption of the next leg
down in the not too distant future. Limited time remains to protect yourself and profit from this
opportunity!!

Chart 1 – US S&P 500

• The S&P 500 continued its rise higher over the past fortnight, albeit at a much slower pace.
• Piece by piece the evidence continues to line up for another significant decline in share markets in
the not too distant future, but predicting when has been troublesome.
• The rally from the June 2010 low to date has been surprising in the face of the technical evidence
supplied to date, but still remains well within the boundaries of the rules of the current wave
count, but we will have to see how it all pans out.
 • I continue to reiterate that stocks remain highly susceptible to a change in sentiment as technical
and sentiment indicators continue to flash red at extreme levels.
• Higher prices cannot be ruled out, nor can a break above the April 2010 highs, despite the warning
signs, but I seriously question the logic of continuing to remain overly exposed to equity markets
without taking out some form of insurance against these risks.
• The risk/reward trade-off continues to remain significantly skewed in favour of further market
weakness over the medium term.

Chart 2 – Chicago Board of Options Exchange - Volatility Index (VIX)

Chart 3 – S&P 500

• Yet another piece of the bearish picture has fallen into place this week with the Chicago Board of
Exchange’s Volatility Index (VIX) slipping into complacency territory.
• Since October 2007, the VIX has been an exceptional indicator of imminent market weakness.
Since that time period, when the VIX has fallen into the 16 to 20 region and bottomed, it has
signified the commencement of another leg down in the S&P 500.
 • The past several days have now seen the VIX move into this region. Investors should continue to be
on high alert.
• The green circles above outline each of these instances and the ensuing market declines that
followed.
• A turn in the VIX to the upside, now, would be a clear signal that the next sell-off is underway.

Chart 4 - S&P ASX 200

• The S&P ASX 200 continues to move largely in step with the S&P 500, however, yesterday saw a
1.7% decline which appeared to have occurred on little news.
• We continue to look for guidance as to where the Australian market is likely to head by looking at
the US market, and as per the S&P 500, the S&P ASX 200 wave count remains intact.
• As with the S&P 500, a rise above the April 2010 highs will rule this wave count out and a
reassessment of the wave count will be necessary.
• The question from there then becomes, would that alter the bearish view of the markets and
global economy.
• So let’s review what is currently being experienced in the US economy at present.
 A look at the recent economic data
Chart 5 – The US Unemployment Rate

(Source: shadowstats.com)
• The release of the jobs data last week showed that the US economy is once again shedding jobs.
The official unemployment rate remained steady at 9.6% but overall it lost 95,000 jobs for the
month of September, up from 57,000 the month before. If you take out the impact of census
workers it was more likely around 18,000 jobs lost for September (bloomberg.com).
• The number of people who are unemployed, underemployed or have been discouraged from
looking for work rose to 17.1% in September (Bureau of Labour Statistics, 8 Oct 2010).
• Also of concern is that the number of people, who are working part-time involuntarily, because of
economic reasons, rose by a staggering 612,000 for September. This category has increased by an
enormous 943,000 in just the past 2 months. These individuals were working part time because
their hours had been cut back or because they were unable to find a full-time job (Bureau of
Labour Statistics, 8 Oct 2010).
• For an economy that is in recovery, the above numbers are moving severely in the wrong direction.
• Interestingly, the National Bureau of Economic Research dated the commencement of the last
recession as December 2007. If I remember correctly, it chose that date because it was December
2007 when the US economy began shedding jobs.
Chart 6 – US Non-Farm Payrolls

(Source: tradingeconomics.com)
• When looking at the non-farm payrolls, the US economy has only added jobs in 5 out of the past 10
months and most of the jobs that have been added appear to be largely attributable to the short
term employment of census workers, which have now largely finished their tenure.
• While it appears the private sector is continuing to add jobs (+66,000), albeit anaemically, this is
being more than offset by the jobs being lost in the public sector as stretched federal, state and
municipal governments look for ways to reduce the money bleed due to falling revenues and over
exuberant spending during the boom years. In September, the government sector shed 159,000
jobs of which 77,000 were temporary census workers.
Chart 7 – US Consumer Confidence

(Source: tradingeconomics.com)
• The part of the economy that represents approximately 70% of US Gross Domestic Product, the US
consumer, is not recovering. Throughout the entire recovery, US consumer confidence has failed to
move above recessionary levels and this index has begun to decline again over the past 2 months.
• Once again, this trend is not moving in the right direction for a sustained recovery.
• The widening between the economic reality and the stock market continues.

Chart 8 – US Gross Domestic Product

(Source: tradingeconomics.com)
 • Looking at US Gross Domestic Product, the annualised rate of growth has slowed from 5% at the
end of 2009, to 3.7% at the end of March 2010 to 1.7% at the end of 30 June 2010.
• Of the recovery in growth, it is estimated that 2/3s of the recovery in growth is attributable to one
of the largest restocking cycles of inventory on record.
• This is not a sustainable driver of growth.

Chart 9 – US Industrial Production

(Source: tradingeconomics.com)
• It now appears that the largest gains in industrial production as a result of the inventory restocking
cycle are now over and perhaps so is the inventory restocking cycle.
The concern with the evidence above is that even after the enormous level of fiscal and monetary stimulus
already provided to the economy, there does not appear to be the second leg of the recovery kicking in.
The obvious reason for this is that the US consumer is not recovering. So long as the US economy continues
to lose jobs, not gain jobs, and there are still too many consumers that are overburdened by debts which
are backed by assets that are worth less than these debts, then a sustainable recovery will be extremely
difficult.
Much has been stated about the use of quantitative easing for a second time (QEII) but the primary reason
we are talking about QEII is because apart from the sugar high it provided over the past 15 months, it has
failed to hold off the forces which are dragging on the recovery of the US economy.
In order for quantitative easing to have a meaningful impact on the economy, it relies on the bank’s
lending the newly created money that it has lent to them. Unfortunately this is not occurring as there
remains approximately $1.2 trillion of QE1 still sitting on deposit with the Federal Reserve as excess
reserves. Either the banks don’t want to lend or the consumer doesn’t want to borrow.
The Fed does have the option of buying Treasuries and engaging the US government to spend the funds,
perhaps on infrastructure projects or one-off cash hand outs, and perhaps we will have another sugar hit
bounce, but unless the consumer recovers and the pay down of debt occurs, the recoveries won’t be
sustainable and the US and most western economies face the prospect of a long and drawn out decline,
perhaps such as that experienced in Japan.
The US and most western economies need to deleverage first before a sustained recovery can ensue. Until
that happens markets will remain extremely volatile and an unhealthily risky prospect for investors,
particularly those in the later part of their working years and in retirement.
But that’s not all, we also have one further problem to deal with..............

Chart 9 – US Monthly Mortgage Rate Resets

The US economy is now likely feeling the initial stages of the next wave of mortgage resets and US banks
are likely on the cusp of having to deal with yet another round of increasing loan defaults. We are all too
well aware of the impact that the last wave of resets had.
Using the last cycle as a proxy for the effects of the next wave, it is estimated that it takes 90 days of
payment arrears for a loan to go into default based on the experience on the GFC, another 90 days for
those houses to be foreclosed on and the loan to be written down through the banks profit and loss.
During the GFC loans were marked to market, this rule has now been removed, so it may take a little
longer for the loan write down to be reflected or booked as losses this time around, but write downs
should be expected. If the number of write downs starts to pick up again, one needs to consider the effect
this will have on investor confidence.
Investors should be prepared to be nimble and adjust their portfolios to suit the conditions which prevail.
As such I strongly encourage you to contact us to discuss your portfolio, how it is positioned, how you
can manage the risks and prosper during these uncertain economic times.
I hope you have enjoyed this edition of Chartered and found the content of interest. If you would like me
to analyse a particular market or chart from a technical point of view, please email your requests to
jhewish@fortrend.com.au and I will endeavour to look at any requests in upcoming editions.

In the meantime, if you would like to arrange a time to discuss your portfolio and some of the strategies
which can be used to help you navigate the prevailing market conditions and profit from this opportunity,
please do not hesitate to contact me on 03 9650 8400 or 0401 826 096.
Until next time, have a great fortnight!!!

JOEL HEWISH B.Bus (Bank & Fin), GDipAppFin, GCertFinPlan, SA Fin

Investment / Financial Adviser
FORTREND SECURITIES - WEALTH MANAGEMENT
Australian Financial Services Licence No. 247261

Chartered is a fortnightly publication from Fortrend Securities – Wealth Management and is provided for the
purpose of general information only. The views and opinions expressed in the publication are those of Joel
Hewish and do not necessarily match those views of Joe Forster and Fortrend Securities – International
Advisory. This publication is provided as general information only and does not take into account your
personal circumstances, aims and objectives and should not be considered personal advice. You should first
consult a licensed Investment or Financial Adviser before acting on any of the information provided in this
publication.