Last week started off with a big bounce after the S&P held support at 1120 the week before, only to finish the week with heavy selling. The volatility remains extremely high as Greek default/bailout rumors remain a daily event. In times like this it is important to focus on the primary trend and avoid getting too bullish or too bearish. Traders can take advantage of the large swings within this sideways trend but investors should remain short or in high levels of cash. I would advise that any buying should be to cover shorts rather than to get long.
I have made my position clear over the past few months that I believe we entered a bear market in early August and, contrary to what many economists and strategists are claiming, we are most likely already in recession. Last week I received some confirmation from the Economic Cycle Research Institute, or ECRI, on my recession fears. The ECRI was out Friday calling for a new US recession. The ECRI focuses on leading indicators of the business cycle and has an extremely good track record in calling recessions and recoveries. They are not sure whether a recession already started or was about to start, but are confident things will be getting worse. It is safe to say, I completely agree.
As this plays out, deflationary pressures will continue and most assets will remain under pressure. In a deflationary environment the Dollar and Bonds will rise. We have already been witnessing this in Bonds for most of 2011 and more recently in the Dollar. Also, contrary to what most investors believe, Gold is also a hedge against deflation. To be clear, I am not in the deflation camp longer-term, but if we are truly headed back to recession, deflationary pressures will grow. It is my belief that the Fed will print money to ease these pressures and create lots of inflation, but deflation is here now and most assets will fall before the Fed acts. This will most likely set up a great buying opportunities in commodities, as well as any assets that benefit from money printing, at some point down the road. This will be the only defense the Fed can put up. They are already at 0% Fed Funds rate and unemployment is over 9%, heading into recession. They will fight deflation at all costs, not before things get worse though. What does this all mean for assets as we head into year-end and 2012?
Equities
Clearly, stocks will not do well in a recessionary environment. I have pointed out the Dow Theory sell signal many times. This changed the primary trend from up to down, which means stocks should now be sold and shorted on rallies vs bought on dips. Of course there will be rallies in a bear market, and most times these rallies are very sharp, but they should be short-lived. The S&P will most likely remain below the 1250-1260 level.
A new closing low in the Industrials will confirm the Transports and forecast lower prices ahead. Until this does occur, I would be cautious shorting the low end of the trading range, as this is a non-confirmation. Looking at the S&P, I do not see many encouraging signs. The long-term chart shows the 2 1/2 year bull channel breaking in September. Also,the monthly MACD has now turned bearish. This has occurred in the previous two bear markets as well. The pattern is looking very similar to the break in 2007. This would call for some more downside followed by a rally for a few months, to re-test the broken trend line, before heavy selling follows. This is the roadmap I have been following, and so far it has been working. 
My Elliott Wave count has also supported this scenario. I continue to feel that wave 5 has started and will take the stock market to new lows. At which point, investors will get overly bearish, setting up the rally to follow. This rally will be a fantastic shorting opportunity before the selling resumes, but I will discuss that at it unfolds.
Wave iii looks to be extending. This should be the most powerful part of the selling within wave iii. Looking at the near-term daily chart of the S&P, I also see weakness. 
The rising flag, that so many technicians having been talking about, was broken the week before last. As is typical, there was a rally back to the broken trend line that failed. The daily chart is looking more bearish and is now lining up with the larger trends. This is suggesting that the lows are now ready to be broken.
Gold
The recent selloff in Gold has stabilized around the $1600 level. I continue to expect a rally from these levels, but I do not think Gold will race back to the highs around $1900. I can even argue that Gold has better odds of trading lower, rather than higher, for a while. Looking at the long-term chart of Gold, $1600 is a key trend line from the 2009 lows, but the larger bullish trend line comes into play a bit lower, around the $1400 level. 
Based on the deflationary environment and possible liquidation of all assets, this level can not be ruled out. If we were to see a move down to the long-term trend line, this would set up a great buying opportunity for longer-term investors because I still believe we will see much higher gold prices in the years to come based on all the money printing that should done. A shorter-term look at gold displays how overbought Gold was when it was trading above $1800.
You can also see the trend trying to hold at $1600, but there is some strong overhead resistance around $1675. Shorter-term traders will want to sell a rally towards this resistance level in Gold. Silver looks even weaker than Gold. This is based on Silver being viewed as an industrial metal, rather than a monetary metal. Just like Gold, Silver is attempting to hold the trend line off the 2009 lows.
A bounce in Silver doesn’t look like it can rally much past 33-34. There was some big support broken there and a rally back to this break will probably run into supply. A larger rally can potentially re-test the broken trend line near $38-$40. This seems less likely but is still a possibility. Silver will most likely not a be good investment for a while, but will do well over the longer-term. I can not rule out a move to the low 20′s under a mass asset liquidation. As with Gold, if we should get lucky enough to these prices in Silver, it would be a great buying opportunity.
Dollar
The dollar has started to benefit from the deflationary pressures throughout the world, as well as the problems facing Europe. In a recessionary environment, the Dollar should remain strong. The UUP looks to have double bottomed at 21 and has broken the 15 month downtrend.
Bonds
The Bond market has been strong for most of 2011 as investors flee risk and expect slow growth. Although I am not bullish on US Bonds in the longer-term, I understand that deflation and recessions are bullish for Bonds. The long-term uptrend is still intact.
In the shorter-term, bonds do look to be overbought and a pullback seems likely, so traders may be able to capitalize. The TLT has risen sharply above the upper end of the long-term bullish channel. This makes buying bonds at present prices risky. The last time bonds were this overbought, in 2009, there was a severe sell-off. A break on the shorter-term uptrend may be the key that prices are ready to pull back.
Strategy for the week: Continue to use rallies in equities as a selling opportunity. The short-side of the equity market looks to be the correct side. You must be careful as to where you short stocks though. I expect very sharp rallies as this bear market unfolds. Those rallies would set up better to sell short, rather than selling into weakness. Bottoms seem to be in for Gold and Silver but, I would use rallies as a chance to lighten up trading positions and get back down to long-term core positions. In the coming months, there will be great buying opportunities in Gold, Silver and a host of different commodities, but before we get there, we should witness continued pressure on all assets. Gold should act much better than Silver and the Gold miners should do much better than general equities. Only the Dollar and Bonds should do well in this environment.
All Charts courtesy of http://stockcharts.com
