It’s almost crunch time for Greece

It has never been a question of if Greece would default on its payments, but when. And now, the day of reckoning has suddenly loomed closer. Greece’s banks will be shut all week, and capital controls have been imposed on its citizens. That act is always the first step towards default – and is, of course, deflationary, with a negative influence on stockmarkets.

There is no way in the rational world that Greece’s economy could be expected to grow at such a rate that it could maintain its massive debt payments while still in the euro. And while the country is gripped by austerity.

It seems the immovable object (ie, the policy of ‘extend and pretend’ by the eurozone authorities) has met the unstoppable force (ie, eurozone breakup).

Make no mistake – with Greece’s creditors’ attitudes hardening, the mood music has changed. This signals that asset markets are in deep trouble, having grown on the stimulus of cheap and easy money/credit. No longer do they seem intent on the ‘extend and pretend’ policies of the past. And if they have decided not to throw good money after bad, that is a very negative signal for asset markets.

The global debt pile is so large that total outstanding debt is reckoned to have grown from $53trn in 2009 to today’s pile at $59trn. With interest rates on the cusp of rising, much of this debt will never be repaid – let alone maintaining interest payments.

Debt it soaring, but US investors are still bullish

Why are stock markets so vulnerable? For one thing, bullish sentiment among professional US advisors is in extreme territory:

Investor sentiment chart

Chart courtesy of www.elliottwave.com 

Not only that, but US retail investors have been largely sanguine about the market (it has been a professional’s market for some time and trading volumes have been subdued). The latest AAII data shows ‘mom and pop’ investors have suddenly got the urge to invest – and they have turned very bullish.

Data (from aaii.com) to 24 June show that the bulls/bears ratio has risen to 35%/22% (1.6), whereas the historical average is 39%/30% (1.3).

This ratio seems to be fulfilling its usual function, as a contrary indicator, in spades.

The stockmarkets’ reaction over the weekend has been decisive, and today promises to be a very volatile session. I can’t help but wonder whether the ‘plunge protection team’ has been hastily convened to stop a massacre in US markets?

This is how I anticipated a big reversal in the Dow

The Dow is one of my favourite trading markets. I’ve attached its latest daily chart, which shows today’s break. With the Dow down over 300 pips at one point, the market is testing the chart support provided by the recent lows (pink bar). But the interesting thing is that my wedge line has been broken, with the market rallying up to plant two kisses on the lower wedge line.

Now, with the market falling hard, it has bounced swiftly off the second kiss in a classic scalded-cat bounce. This is one of my favourite patterns in which the market breaks the support of the wedge line, tries to get back above it, but can only manage a kiss because this line has been transformed into resistance. It then moves sharply away, as a cat would when scalded!

Dow Jones spread betting chart

If indeed I have caught the top, do the waves off it tell me anything instructive?

Below is the hourly chart, showing a close-up of the two kisses, with the second kiss turning at the meeting of the Fibonacci 78% and wedge line. This was strong resistance. Also, the market was rapidly losing momentum into that event, giving me warning to expect a turn.

So now I can attach labels to the waves off the top. If I am correct, we are at the start of a large wave 3 – and the gap down this morning adds to this interpretation, because third waves are long and strong – and this morning’s action is certainly strong.

Dow Jones spread betting chart

But did I anticipate this plunge? The latest rally occurred within a small rising wedge:

Dow Jones spread betting chart

When the lower wedge line was broken on 23 June, that was my signal to go short.

You may have noticed that I have been describing several wedge patterns in the stock indexes. These are often ideal forewarning flags of big reversals up ahead – and so it is proving.