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September issue
up a grisly trail of economic destruction that has cut
through the Continent’s other markets. In March
2014, for example, The European Financial Forecast  
illustrated a dozen of the Continent’s battered stock
indexes where peak-to-trough declines ranged from
35%-90% — from major money centers in France,
Belgium and Luxembourg to less-traded markets in
Iceland, Poland, Portugal and the Czech Republic.
By contrast, German shares nearly tripled between
March 2009 and July 2014, and the DAX has exceeded
its 2000 and 2007 peaks by about 24%. Germany
remains the only major European market to have hit a
new all-time high, which has generated a multitude of
euphoric sentiment readings and created an army of
newfound bulls. Just this week, a Bloomberg poll of
1,000 analysts showed that they expect DAX earnings
to jump another 21% in 2014. One asset manager
tells CNBC that the DAX will rally more than 50%
over the next 12 months. And even the less bullish
forecasters unanimously agree that the DAX’s 10%
dip in early August is all that the bears will get. “The
selloff is overdone,” says a London-based CFO. “For
us, it’s a buy at this level,” reported another Vienna-
 based banker. According to a wealth manager at
 Netherlands ABN Amro, “The short-term volatility ...
is an opportunity to re-enter the markets after a violent
correction.”
as “violent.” Regardless, the Elliott wave structure
shown here says that the most dangerous phase of the
oncoming bear market almost certainly lies ahead.
After rising in five waves off its 1974 low, the DAX
 peaked on March 7, 2000, and fell 73% into March
2003. The pattern since then consists of three waves —
a corrective wave formation labeledW-X-Y — with
shares now verging on Cycle wave c down.
BOTTOM LINE
The DAX’s drop from its June 2014 high at 10,051 traced out the initial waves of a larger decline. Most analysts say the
drop is a healthy correction within a long-term bull market, but the DAX broke an important support line in August, and
the long-term wave structure supports the case for a major wave down. Prices in the FTSE 100, CAC 40 and Euro Stoxx 50
have some options over the near-term, but a major reversal in junk bonds suggests that investors are shifting away from
risk assets, generally. The next long-term wave should be down for stocks across the UK and Europe.
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Relative Strength Index, which provides a long-
term picture of technical momentum. In customary
fashion, upward momentum hit a peak in 1997,
as the DAX traced out wave (3) of5. The RSI
then peaked at a lower level during wave W of b,
and the rally since March 2009, waveY of b, has
 been the index’s weakest yet. This kind of waning
upside momentum is a pattern we see time and
time again. It betrays the poor underlying health
of the rally and signals a major reversal ahead.
The three dashed lines on the chart depict support
dating as far back as the October 1987 crash. One
 by one, each of these support levels should fail as
the bear market intensifies, and most of the gains
you see depicted on this chart will disappear.
Elliott Wave Analysis
On a near-term basis, wave (C) ofY of b carried
to 10,051 on June 20, as discussed last month.
Shown here, the July-August sell-off broke the
lower boundary of a narrowly defined parallel
trend channel that contained the advance —
further evidence of the DAX’s longer-term change
in trend. Stocks spent most of August alleviating the
oversold condition that developed at the August 8
low; however, the rally should amount to a partial
retracement of the preceding decline and be fully
retraced during the next downleg.
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3
lower yesterday, and the chart at right
depicts the preferred and top alternate
wave interpretations. Under the preferred
count, stocks have traced out a series of
ones and twos down since June 2014,
implying an immediate move to beneath
the August lows. In contrast, an upside
 break of the late July peaks of 4415 in the
CAC 40 and 3224 in the Euro Stoxx 50
would promote the alternate wave labeling
to preferred status. Under this scenario,
stocks would go on to challenge the June
2014 high before the onset of the next leg
down.
out an expanding diagonal after prices
 peaked at 6895 on May 15, 2014. It’s
currently unclear how this pattern fits into
the longer-term wave structure shown on
 page 1 of last month’s issue. We can say,
though, that overhead resistance remains
formidable between 6750 and 6950, which
represent the highs from July 2007 and December
1999. We expect these peaks to remain intact.
Market Psychology
It didn’t take long for investors to abandon their big
 bets on European IPOs. In April, when IPO volume
in London pushed to its highest level since 2007,
EFF called the behavior typical for the tail end of an
investment mania,
since “euphoric
information.
It’s early, but the losses are piling up across many of
2014’s most heavily anticipated IPOs. Shown below,
the UK’s largest pet supplier, Pets at Home, is down
more than 25% since its March 2014 debut, while
Spanish testing and inspection company Applus and
travel agent eDreams Odigeo have plunged 32% and
69% from their respective peaks. The following chart
shows the share price of King Digital Entertainment,
the London-based mobile–game maker behind the
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EFF observed the “delusional optimism” behind
the company’s $7 billion IPO and argued that the
“company’s bearish saga is probably just beginning.”
It took a few months, but the crush part of the equation
 began on August 12, when King reported that in-game
upgrades dropped sharply and also cut its sales outlook
for the year. Investors sent the stock plunging 20% on
August 13, and shares have lost almost half their value
since their July 2 all-time high.
This year’s poor IPO performance hasn’t gone
unnoticed, either. On August 6, Blackrock, the
world’s largest investment management firm, warned
clients about the “failure of companies to achieve
stated financial and business targets even after one or
two quarters.” Bloomberg reports that at least eight
European companies postponed or withdrew their
listings in the second quarter of 2014, up from zero
withdrawals in the first quarter. “I feel genuine IPO
fatigue,” says one portfolio manager. But as the full
weight of the bear market presses down on sentiment,
many more companies will pull their listings, and the
IPO market will enter a deep sleep rivaling that of Rip
Van Winkle’s.
ending in misfortune and regret:
High-Yield Hangover Hits Investors
losses after the busiest month for junk debt issu-
ance in the British currency in 1½ years.
 —Bloomberg, 8/7/14
In July 2014, UK companies sold investors more than
£2 billion of debt, up from just £800 million the year
 before. Tellingly, too, the lowest-rated bonds attracted
the strongest demand. In 2013, investors bought a
record £475 million of the UK’s lowest-ranked debt,
and, this year, they’ve purchased another £425 million
of notes rated CCC+ or below — a full seven steps 
 below investment grade.
Change is in the air, however. Below is the British
equivalent to the euro-denominated junk bond index
that we published last month. It shows another sharp
upward reversal after yields bottomed at 4.6% on
June 20, 2014. According to Bloomberg, junk notes
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5
sold in the UK in July lost an average of 3.3%, and,
over the first week in August, investors pulled more
than $1 billion from exchange-traded funds that buy
 bonds. That exodus followed the largest monthly
withdrawal ever  from Pimco’s short-term junk-rated
ETF. “Performance has been rubbish over the past
month,” says a London-based high-yield strategist,
 but the sub-par performance of junk bonds is also
 probably just beginning. In time, mounting pessimism
will force even the most principled gamblers to purge
all risk assets from their portfolios. At some point,
many stocks and stock indexes will see the bottom of a
garbage bin, too.
Over the past four years, Europe has sketched out a
 blueprint for financial rescues that will likely guide
 bailouts across much of the world’s over-indebted
 banks, corporations and sovereign governments. In
September 2013, EFF described it like this:
Much of Europe is de facto bankrupt already....
The only question is, who will get stuck with the
 bill. The Greek and Cypriot templates say that
authorities will first inflict losses on bondholders
 — as they should have from the start. Ultimately,
however, they will force ordinary bank depositors
to pony up.
 —  European Financial Forecast ,
To be precise, taxpayers picked up the initial tab, as
the EU organized a series of taxpayer-funded rescue
facilities following the 2008 financial crisis. The
real impact to bondholders began in February 2012,
when Greek debtholders accepted a 50% haircut on
the face value of their bonds in exchange for rescue
funding. Ordinary depositors were spared until March
2013, when Cypriot authorities capped daily ATM
withdraws, limited overseas transfers and levied bank
deposits in response to
the country’s banking
Call for Junior Bondholders
declared immune from loss-sharing. The one-
week 75% plunge in a subordinated note is-
sued by the lender vividly depicts the rate and
severity of bond losses for any bank investor in
cases where solvency requirements have been
 breached.
The terms of the rescue call for BES’s junior
 bondholders to share in the losses with stockholders,
as Portugal will tap the  €6 billion credit line that was
set aside in 2011. For now, the rescue won’t affect
senior bondholders or bank depositors, but, like before,
this arrangement should change at some point in the
near future. Already, the crisis has ensnared several
BES-affiliated holding companies, and, on August 19,
the Wall Street Journal reported that Swiss banking
conglomerate, Credit Suisse, had gotten “caught up in
the Espirito Santo mess.” (WSJ, 8/19) According to the
Journal, Portuguese regulators have uncovered at least
four offshore investment vehicles that Credit Suisse
used to sell billions of dollars of debt-laden securities
to BES’s retail customers. Predictably, those customers
want BES to buy back the worthless securities. They
say that they didn’t understand what they were buying,
and we don’t doubt them. It’s precisely the kind of
financial carelessness that accompanies a major mood
 peak.
outside European borders. The following chart, which
comes from John Hussman of HussmanFunds.com,
depicts a near-record number of global junk bond
offerings (red line) in the second quarter of 2014,
while proceeds from high-yield debt (blue bars)
 jumped to an all-time high over the same period.
courtesy HussmanFunds.com
6
that Espirito Santo’s collapse “affected neither the
 banking sector in Portugal, nor Portugal at large, nor
other markets,” and, so far, he’s correct. Amazingly,
Lisbon’s Public Credit Management Institute just
locked in  €800 million at 0.216% in 12-month treasury
 bonds — the lowest rate for this type of security since
the euro’s introduction in 1999 . Meanwhile, the
Portuguese government can still borrow10-year funds
at just 3.2%. Investors remain convinced that, when
 push comes to shove, Europe’s stronger economies
will rescue its weaker ones. We think it’s one of the
most dangerous gambles going.
a quick return to the Continent’s safest debt. On
August 28, German 10-year notes hit a record low
 yield of .089%, while Switzerland’s 10-year debt now
yields less than 0.5%. In time, investors will question
all of the Continent’s borrowers. For now, though,
the demand for German and Swiss bonds speaks to
investors’ growing level of risk aversion that should
intensify alongside a falling stock market.
In a related phenomenon, the press has now jumped
on the slew of similarities between Europe’s flagging
economy and Japan’s. Japan is the most recent case
of sustained deflation in the world. If you remember,
we drew our own comparison with Japan back in
July 2012, pointing out that Europe is traversing the
same deflationary territory two decades later. Clearly,
the parallel paths of the two regions have become
impossible for the press to ignore. “First Japan, now
Europe — bad news for the world economy is piling
up,” reads an August 14 CNN Money article. A
Bloomberg headline reports, “German Yields Falling
Toward 1% Shows Japan-Style Risks Building.”
According to the article, deflation “still haunts Japan”
despite the fact that, since April 2014, the central bank
has purchased 7 trillion yen ($68 billion) in sovereign
 bonds per month.
If it all sounds familiar, it should. The European Central
Bank initiated bond purchases back in May 2010. Little
more than a year later, the ECB announced its new
Long Term Refinancing Operations (LTRO), extending
nearly half-a-trillion in three-year loans to banks at
negligible interest rates. The central bank’s most recent
deflation-fighting contrivance is a  €400 billion package
of targeted LTRO loans, which are designed to compel
 banks to lend to ordinary business owners. Also like
Japan, the ECB has slashed its main refinancing rate to
0.15% and now charges for banks’ overnight deposits.
The result? Shown below, Europe’s largest economy,
Germany, just contracted 0.2%; French economic output
has ground to a halt; and Italy just entered its third
recession since 2008. As we’ve long said, economies
weaken naturally when society’s collective mood state
transitions from optimism to pessimism; government
action simply cannot reverse it.
e602464
7
It’s early, but the reality of deflation has dawned
across many classes of investors. In August, a 17%
 plunge in German 10-year breakeven rates sent this
important gauge of inflation expectations to its lowest
close since at least 2009. Recall that breakeven rates
measure the spread between conventional bonds
and their inflation-linked counterparts, providing a
quantitative view of bondholders’ judgment about
the likelihood of inflation. In the past, the spread
has proved to be a worthwhile contrary gauge of
the economy’s inflationary potential, as breakevens
typically peak alongside consumer prices and mark
important inflection points in the economy. Back in
October 2013, however, we observed a telling disparity
 between Britain and Europe, as inflation fears had
subsided on the Continent, while UK bondholders
remained “widely indifferent to the prospect of
sustained deflation.”
 psychology has gained the upper hand: Both UK and
German breakevens are now trending down together.
As stocks fall and deflation presses down on consumer
 prices, bond investors will see no need to protect
themselves against inflation, and both of these spreads
should fall below zero. In time, the idea of even
linking government bonds to a gauge of nonexistent
inflation might just die altogether.
 A Few More Sanctions for Deflation
The increasing pace of Europe’s economic weakness
has left pundits scrambling to find a cause.
The headlines below illustrate one of the most
 popular contenders: The lobbing of sanctions and
countersanctions over Russia’s incursion into Ukraine.
It’s a tempting yet completely bogus rationalization.
The charts above show that Europe’s biggest
economies faltered long before March 2014, when
Russia annexed parts of Ukraine and when western
officials retaliated by imposing banking restrictions on
top Russian officials. As for the sanctions’ purported
negative effect on Russian stocks, observe that the RTS
index reversed from a countertrend peak more than
three years ago (see next page). Russian shares fell
50% into the March 2014 low, and every ruble of those
losses occurred before that recent turmoil. In fact, the
RTS has pushed higher over the past four months, as
economic sanctions increased.
To be clear, Russian sanctions are relevant to our case
for global deflation. Emerging trade wars, economic
disputes and overall geopolitical tension are critical
aftereffects  of declining stocks, and so these conflicts
will unquestionably serve deflation’s cause. In 2002,
Bob Prechter described the relationship between social
mood and economic warfare like this:
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8
again often act on impulse, without full regard
to reason. One example of action impelled by
defensive psychology is governments’ recurring
drive toward protectionism during deflationary
 periods. Protectionism is correctly recognized
among economists of all stripes as destructive,
yet there is always a call for it when people’s
mental state changes to a defensive psychology.
If one country does not adopt protectionism, its
trading partners will. Either way, the inevitable
dampening effect on trade is inescapable.
 — Conquer the Crash, 2002
 protect a domestic economy. Rather, they want to
 punish what they see as foreign aggression. However,
the resulting financial damage will be the same. In
 just four months, foreign banks have entirely cut
lending to Moscow, as “no single dollar, euro or Swiss
franc was lent to a Russian company in July [2014].”
(Bloomberg, 8/17/14) In response, Russian officials
 banned imports of fruits, vegetables, meat, fish, milk
and dairy products from the United States, Europe,
Australia and Canada. In August, EU officials set aside
 €125 million to pay farmers to destroy crops — yes,
destroy them — so “prices don’t drop to crisis levels.”
(European Commission, 8/18/14)
McDonald’s restaurant last week, while Coca-Cola,
Carlsberg, Adidas, Volkswagen, Ford, Renault, BP and
Danone have all reported some negative effect of the
sanctions on their bottom lines. The sanctions have
even crimped the livelihoods of Russian oligarchs. In
August, construction billionaire Gennady Timchenko
told reporters that luxury jet maker Gulfstream had
refused to provide spare parts and navigation services
for his Gulfstream G650.
In one more sign of the Continent’s widening cultural
divide, the sanctions have already generated their
first rifts among EU member states. On August 15,
Hungarian Prime Minister Viktor Orban openly
criticized the sanctions, arguing that they cause more
harm than good. The Slovak Prime Minister is likewise
critical, while the Czech PM says, “Neither for the
European Union nor for Russia is it favorable to get
into a drawn-out trade war....”
It’s true: Sanctions are akin to an economic poison that
 politicians prepare for someone else, but then make
their own citizens drink. The sanctions won’t stop
Vladimir Putin any more than they will help Ukraine,
 but they will certainly worsen the economic misery for
everyone. Sadly, any remaining voices of reason will
soon get drowned out by the chorus of negativity that
rolls in with the new mood.
CULTURAL TRENDS
documented socionomic outcome: When stocks go
down, walls go up, and once-friendly political partners
splinter into factions of quarreling adversaries. In May
2011, when the Scottish Nationalist Party (SNP) swept
to victory on a platform to break Scotland’s three-
century union with England, EFF discussed the steady
 progress of political rifts in Europe:
At this point, 13 years of downtrending mood
isn’t only exposing the rivalries among the
member nations of the European Union; it’s
also prying apart the provinces, principalities
and semi-autonomous regions within the nation-
states themselves.
had turned violent in Italy’s semi-autonomous regions
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9
Scotland, Alex Salmond, set a referendum on Scottish
independence for the autumn of 2014.
Fast-forwarding, the vote is less than three weeks
away, the FTSE 100 is retesting its all-time high,
and the once-popular idea of splitting up the United
Kingdom has hit a big snag. By all accounts (and by
a wide margin, too), Alex Salmond lost his August 4
televised debate against Alistair Darling, the leader of
the movement to keep Scotland in the UK. Viewers
gave Salmond a win in Monday’s final debate, but
none of the major surveys show pro-independence
voters leading. And while the “Yes Scotland”
campaign says it has more than 1 million registered
voters, an August 9 poll in the Scottish Daily Mail
shows that “no voters” have been gaining ground for
months. Meanwhile, based on patterns at the website
PoliticalBetting.com, economist David Bell from
Scotland’s Stirling University puts the probability of a
yes vote at just 21%. (UK Guardian, 8/7/2014)
Then there’s the “Let’s Stay Together” campaign,
which just picked up a ringing endorsement from
influential Rolling Stones front man Mick Jagger. On
August 7, Jagger added his name to a list of more than
200 celebrities who have urged Scots to vote to remain
in the UK. The growing roster now includes actors
Patrick Stewart and Michael Douglas, musicians David
Gilmour and Sting, and cosmologist Stephen Hawking.
The letter reads in part, “We want to let you know how
very much we value our bonds of citizenship with you,
and to express our hope that you will vote to renew
them. What unites us is much greater than what divides
us. Let’s stay together.”
It may be a ringing endorsement for the United
Kingdom to stay united, but it’s also a perfect
socionomic expression to kiss the old bull market
goodbye. We’ll see what happens on September 18.
 An Anti-Social Sell Signal 
13, 2014, ruling by Europe’s top court, which grants
citizens the “right to be forgotten.” Back in January
2014, when the European Parliament accused Google,
Microsoft, Yahoo!, Facebook, Apple and LinkedIn of
“large-scale mass surveillance of EU data subjects,”
EFF called for the burgeoning mistrust to turn “far
more peculiar and obsessive.” On the surface, Europe’s
 preliminary ruling merely allows EU citizens to
request that search engines like Google remove their
 personal information. As a practical matter, however,
Indiana law professor Fred Cate tells Bloomberg,
“It’s just such a mind-bogglingly impossible decision.
Courts aren’t responsible for the practical implications
of rulings but this really staggers the imagination.”
Tech companies may soon stagger alongside the
 professor’s imagination. Days after the bill passed,
hundreds of people — from doctors to ex-politicians to
accused pedophiles — applied to have their personal
information erased from Google’s search engine.
Within a month, Google was bombarded with 41,000
removal requests, forcing the company to establish
a dedicated “removals team.” By July, Google had
removed at least one BBC article and removed links
to commentary from three British news sites: the
Independent, the Guardian and the UK Telegraph.
Last month, as removal requests pushed past 100,000,
Google deleted its first Wikipedia page, prompting
founder Jimmy Wales to pronounce the legislation
“completely insane.”
another U.S. technology company that has slammed
into Europe’s new mood. Problems first erupted in
April 2014, when hundreds of German workers began
to protest low wages at Amazon logistics centers in
Leipzig and Bad Hersfeld. In July 2014, just after EU
regulators added Amazon’s Luxembourg operation to
its list of multinational firms suspected of tax evasion,
French legislators passed the “anti-Amazon bill,”
which prohibits large online retailers from offering
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10
the protectionist policies that always find a fertile
 breeding ground in a bear market. In France’s
case, the bill dates back to 1981, when
the “Land Law” forbid booksellers to
sell titles at more than 5% below the
 publisher’s price.
thrift will force retailers to compete
on price whether they want to or
not. Amazon’s “messy, public battle”
(WSJ, 7/8/14) with Hachette Book
Group, France’s largest publishing
company, perfectly captures the oncoming
 price wars. Amazon wants Hachette to shave
 between $3 and $5 off the price of its digital titles,
and it has blocked pre-orders and delayed book shipments
until the two companies reach an agreement.
The clash spilled onto American cable TV outlets in
July 2014, when comedian and Hachette author
Stephen Colbert encouraged viewers of
his show, The Colbert Report, to shun
Amazon in favor of independent
retailers. On August 10, more than
900 best-selling authors, including
ad in the New York Times, calling
for Amazon to “stop harming the
livelihood of the authors on whom it
has built its business.”
success, but Amazon has yet to budge, and
Hachette is fighting a losing long-term battle. As
mood declines at Cycle degree, a full-fledged depression
will favor only the most ruthlessly efficient corporations
and business models.
The European Elliott Wave Financial Forecast  is published by Elliott Wave International, Inc. Mailing address: P.O.
Box 1618, Gainesville, Georgia, 30503, U.S.A. Phone: 770-536-0309. All contents copyright © 2014 Elliott Wave
International, Inc. All rights reserved. Reproduction, retransmission or redistribution in any form is illegal and strictly
forbidden, as is continuous and regular dissemination of specific forecasts or strategies. Otherwise, feel free to quote,
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