Go Johnny, go!

Today I’d like to present a bit of an “epiphany” I’ve had recently. It’s regarding where we are in the investment cycle and when we might see a final washout, assuming there is one to come. I believe this is one of those “highly important” blogs that I post once in a while. Its a bit detailed (long), but the message I present today, IMO, is vital stuff!  I’ll draw on some market history, and build in some “Elliott Wave Lite” analysis for context (like lite beer- not as good as the real stuff, but passable).

Bear markets typically end in capitulation.

To start: True bear markets (as opposed to corrections) typically end in extremes of fear and capitulation. It is my view that the current bear has not seen that capitulation and fear phase. Here’s why:

Quantitatively, we can measure sentiment indicators to spot a bear market’s “puke phase”.  I covered most of these tools in my book Smart Money, Dumb Money. Some of the best indicators measuring sentiment extremes include the Put/Call ratio, the Smart Money/Dumb Money (sentimentrader.com) indicator, and the VIX.  All are useful in spotting that wonderful moment of fear & loathing in the market. The VIX, in particular, is a favorite tool of mine to spot those glorious moments. It’s actually quite predictive. The VIX basically illustrates option premiums. More volatility, which typically happens in declining markets, means option writers want more premium. The chart below highlights moments of the VIX levels exceeding 35 as opportunistic. That said, a level of 45 (top black horizontal dashed line) is the more reliable level signifying the bottom of true bear markets.

See my red boxes on the VIX chart highlighting the moments of extreme fear during the major selloffs over the past quarter century. Sometimes, we will see quick tests of that 45 level. That’s typically when the market has seen a short or fast correction. Eg–

  • 2015 (summer commodity selloff),
  • 2018 (December selloff)
  • 2020 (COVID bear market – crash in March, recovery by August .

Now, note the prolonged “true bears” of the 1999-2003 period, followed by the 2008-2011 period.

During  significant corrections, or bear markets, we saw single or multiple tests of 45 on the VIX at bottoms. In other words: it ain’t over until the VIX sings.

Note: We have barely seen 35 exceeded in the 2022 bear market (green commentary on chart). Every “true bear” has tested 45. I believe that we are setting up for the final washout to 45+ on the VIX in the coming months. We have not likely seen the bottom of the current bear, if history is a guide.  More on that below. And, by the way…history has been, in the case of the VIX, a darned good guide!

Part 1: Some backdrop

How ValueTrend “knew” that the summer and fall rallies were head-fakes

Truthfully: Nobody can actually “know” future market moves! However…ValueTrend uses studies, like the VIX noted above, to guide us. We utilize PROBABILITY analysis. I’ve often told investors, we cannot time the markets. But we ABSOLUTELY CAN quantitatively measure the approximate risk/reward tradeoffs using our proven 3- factor probability model. This is not market timing, or sure-thing fortune telling. This is about understanding the risk vs reward potentials. We use that probability model – which incorporates Trend rules, Risk/ “Bear-o-meter” rules, and Fundamental factors to make assessments.

We can also do qualitative “observational” analysis. For example:

Many investors speculated that the bottom had been seen during the two 2022 bear market rallies  – first in July, then in October. Again…Bear markets end in fear, loathing, all hope lost, capitulation puke phases. Did you get that vibe before these two rallies? We didn’t. The media didn’t:

Bad news is good news

The optimistic attitude of hope by market participants seems to be changing. Its becoming more pessimistic, more despondent. The end of the bull is farther away than previously hoped. Such bad news. So sad.  So depressing. Why stay invested, they ask?

That’s good news!!

We need some good, wholesome fear, loathing and despondency! Case in point: Open your favorite investment news site now, and read the headlines quoting the experts. Almost everyone is calling for a continuation of the bear market (now that we’ve been in one for an entire year). And that’s good news! History shows that a crowded trade, where everyone agrees, is soon to end.

We’re now into the traditional “Yearly outlook” writeups. Predictions for 2023 are coming out suggesting a weak or declining market in 2023…. such as this. And this one:

Another example: Most of the first half of last year saw market pundits suggest that:

  • inflation would be transitory,
  • recession would be unlikely or mild,
  • the afore mentioned trough & rallies were the bottom.

 

Now, we witness headlines like this one from Time Magazine:

Lesson: Most experts aren’t experts, except at getting paid a lot to waste your time. They are reactionaries with track records that leave much to be desired. 

Part 2: The bullish setup

  • The headlines are gloomy. Experts are predicting flat, or lousy market returns- even negative returns for 2023.
  • The “transitory inflation” cult has lost its voice. Now, we are seeing acceptance of entrenched inflation. Something that I have been telling you for almost 3 years. Old news for me.
  • We’re also seeing Canadian and US governments, you know–the ones who were vehemently denying the likelihood of recession for the past 12 months (while I was suggesting it was almost impossible to avoid one..) are now saying “well, of course we are about to have a recession…”. Again: Old news for me.

Dr. Doom has entered peoples headspaces, and he’s just getting started messing with their minds. Fear is in the air, and its growing. That negative headspace is necessary for the bullish follow-up. Fear will continue to grow. “Get me out!”, says Johnny Dumb. Now he wants out, a year after the top (when he was bullish). Go, Johnny, go! We need him and other Dumb-money investors to panic and sell now that they’ve lost 20%. This creates the final washout. Run, Johnny Dumb, run! You too, Forest.

This panic will drive sentiment indicators like the VIX to uber-high levels – like 45, or more. And therein lies the opportunity.

If you are not excited now, you are not paying attention. The puke phase is coming! Rejoice, those of you who continue to hold cash and defensive’s! With your cash, and Johnny’s panic selling, soon your greatest opportunity to earn profits will arrive.

Part 3: The Playbook. Its all been seen before

OK, here comes the deep stuff. I need to go over some history for you to get a handle on when Johnny Dumb’s panic selling is over and done with. The fear & loathing phase will afford you, the more informed investor, a magnificent opportunity to buy equites cheap. But only when Johnny has finished upchucking his portfolio into the toilet.

To start: One of the greatest investment books I have ever read (and I’ve read plenty), is  The Wave Principle of Human Social Behavior and the New Science of Socionomics: Prechter, Robert R: 9781946597021: Books – Amazon.ca

The book compares general societal mood swings with stock market movements. In a nutshell, mood and markets are correlated. Markets are a reflection of everything. We’re talking: the types of movies being produced, baseball attendance, tobacco usage, alcohol consumption, even war. Social mood, government policy, discontent & happiness are reflected in the stock market. These moods coincide with the traditional Elliott Wave phases on the market.

I’m not going to cover each wave and the socio-economic correlations described in the book right now. But I do recommend you read it – you will love the book if you are like me, a student of human behavior. Instead of covering each wave, I am going to cover the final wave of a bear market, which is “Wave C”. That, I believe, is what we are entering right now. Prechtor noted that Wave C is characterized by falling markets roughly coinciding with:

  • War(s)
  • Social unrest, fear, declining hope, discontent
  • New levels of unprecedented or abnormal government control – the crowd allowing such controls when looking for direction, and driven by fear & despondency.
  • Often inflation or recession (or both)
  • Finally, the bottom of Wave C–coinciding with or within the approximate timeline of a move away from the controls, fear, discontent, unrest, and war.
  • Note the washout lows within each period.

This pattern results in “EXTRODINARY OPPORTUNITY’, as Prechter puts it, for investors who wish to earn profits.

Lets take a look at Prechter’s observations applied to significant bear markets over the past 100 years. Here’s the Dow since 1900, bears & C-Wave washouts highlighted:

 

1929 -1932 Bear

Typical Wave 3 socioeconomic coincidental backdrops:

  • Fear & Discontent: The great depression in the USA.
  • Massive inflation and discontent in Germany.
  • Hitler’s rise to power & new levels of  government control – accepted as Germany looked to the new Nazi government for relief.
  • Stock market bubble & pop in 1929.
  • Communist party enrollment peaks in the USA.
  • War: WWII breaks out 3 years later.

1965 – 1975 Bear

Typical Wave 3 socioeconomic coincidental backdrops:

  • Prior setup- 1962 Cuban Missile Crises.
  • Watergate Scandal
  • New levels of government control in the budget process, personal information, and oversight of the intelligence community
  • War: USA sends troops to defend S. Vietnam.
  • Russia/China send weapons & supplies to support N. Vietnam
  • Fear & Discontent: Russia / USA “Cold War” peak
  • USA decade of high inflation
  • Stock market bubble & crash in 1975

2000 – 2002 Bear

Typical Wave 3 socioeconomic coincidental backdrops:

  • Terrorist attack on USA soil Sept. 2001
  • Fear & Discontent: consumers afraid to travel, shop, go anywhere public.
  • War: “War on Terrorism” & Al-Qaeda
  • Stock market “tech” bubble & crash
  • New levels of government control at USA airports, etc as country looked for relief to fight terrorism

2008 – 2010 Bear

Typical Wave 3 socioeconomic coincidental backdrops:

  • Massive housing inflation, oil inflation
  • Sub-prime mtg. & stock market bubble & crash
  • Fear & Discontent: Real estate prices collapse, houses abandoned, and banking collapse
  • Dodd-Frank Act –New levels of government control as country looked for relief after traumatic banking and real estate losses
  • War: Russo-Georgian War (Russia & Rania republics)
  • “Operation Scorched Earth”, Yemeni offensive on Saada

2020 Short Bear

Typical Wave 3 socioeconomic coincidental backdrops:

  • COVID virus.
  • Fear & Discontent: Stay inside.
  • Unprecedented levels of government control. “Vaccine” passports & mandatory masks. Lockdowns. Travel restrictions. Civil liberties aborted. Government overreach.
  • Divisive propaganda. “War” on those who questioned “the science”. Questioning medical professionals censored. Get jabbed, or lose job.
  • Stock market crash, then FAANG / ARK, etc bubble (reversal!). “Stay inside” stock profits

2022 – ? Bear

Typical Wave 3 socioeconomic coincidental backdrops:

  • FAANG, ARK bubble followed by broad market crash
  • War: Russia/ Ukraine.  Divided nations supporting each side.
  • Fear, Civil unrest, Discontent worldwide:  CUI (Civil Unrest Index) record highs worldwide.
  • Chile, Brazil, Europe government upheaval.
  • Social unrest: Canada Freedom Convoy, global freedom protests (Canada, China, Sri Lanka, etc). Dutch farmers protests.
  • Divided political extremism.
  • Extreme government control & overreach. Canada catches the worlds eye with War-measures Act, bank account seizures, abusive government rhetoric.
  • Inflation, new era of higher prices  – food, gas, etc. Massive post-COVID housing boom & bust
  • The rise of Global Authoritarianism and government control: WEF “The Great Reset”, WHO global mandates. Think of the cartoon “Pinky & The Brain” where The Brain wants to control the world, but he needs Pinky to buy into the vision in order to do so.

Part 4: Putting it all together

Whew! That was a whack of information for you to absorb. So let me bullet point the things you need to understand from this rather deep dive into bear market history:

  • Historically, bear markets coincide with some combination of socioeconomic factors.  Fear, social unrest, war, inflation, government control / over-reach.
  • This historic pattern is repeating now.
  • As that socioeconomic pattern reaches a crescendo, the stock market coincidingly begins a final washout.
  • This washout starts with broader acceptance of doom & gloom, aka the broad acceptance of more stock market downside to come. This attitude is now just beginning to appear.
  • The bear market finale leads or coincides with pushback against government, resolution of social unrest, resolution or end /reduction of war activities.
  • Technically, the bottom is typically signaled by extreme fear/pessimism illustrated via sentiment indicators. VIX, Put/Call, Smart/Dumb Money Studies, AAII, etc.
  • It can also be spotted via extremes in longer range momentum studies such as monthly chart RSI, MACD, ROC. See my Online Technical Analysis Course. If you haven’t taken the course, now is a good time, given the circumstances…
  • We are beginning to see the first signs of a Wave-3 finale. It is likely the bear market will complete Wave 3 in the coming months.
  • Watch for sentiment extremes (read Smart Money/Dumb Money). Watch for momentum oscillator extremes.
  • Important: I don’t buy aggressively (beyond a potential small leg-in) on sentiment / momentum signals. You can be burned by a follow-up complex bottom test. Instead – I watch for a technical base and or trend reversal (break above 200 day SMA, higher peak/trough) before aggressively investing capital. Again, take the Online Technical Analysis Course for full details
  • Socioeconomic conditions of fear, unrest, war etc. can extend past the stock market Wave-3 trough. That’s why at ValueTrend, we use Technical Analysis to determine the market washout and trend direction. We don’t wait for the inevitable resolution stage of the socioeconomic stress, which are historically re-occurring backdrops that can surround a bear market bottom (before, during and after).
  • Conclusion: With the backdrop presented here, you know that we are likely in Wave-3 of the bear market cycle.  You know what to look for to potentially spot a washout. You know to wait for a trend reversal signal (see the Online Course) before acting aggressively on the washout signals coming from momentum and sentiment. You want to play this massive opportunity, but you recognize the risks. You will do so prudently, and in stages, so as not to be head-faked by a complex bottom formation.

Good luck in 2023! Go Johnny, go!

15 Comments

  • An excellent article Keith.

    Is there an “inter-rater” reliability about the Elliott wave counting? Any Elliott wave specialists agreeing or disagreeing with your thesis?

    Reply
    • Mano–you sure read this fast–just posted it! Re EWT–I use the attitudes and conditions to determine which wave we are in. I do not use Fib numbers etc–they are of less use than the attitude of the crowd when determining where we are.
      I only follow David Chapman (see my video interview with him) re EWT people. Of note-I am an armchair EWT guy not a specialist or expert – I use it for context only. But David’s analysis coincides with mine for what that is worth.

      Reply
  • Thanks for the excellent Bear Markets review…I’ll have to read Prechter’s book. Appreciate your blogs.

    Reply
  • I understand that a normal Santa Claus rally ends tomorrow January 6th and that may be why markets have not fallen further than they have. Is it too late to sell tomorrow at the top of the “C” wave and buy when things turn?

    Reply
    • All I can say Paul is that we raised a bit more cash the other day. We are about 1/3 cash–with the stock focus in commodities, value, defensives.

      Reply
    • Commodities mostly. Unique value stocks–picking stocks will be important rather than just sectors. Also, see my “innovation” video–I think there are going to be some short termed trades in oversold stocks that I wouldn’t want to own for long – but could trade for an oversold pop. At this point I would say that its best to wait until the washout is over, and market shows technical signs of rebound and THEN look at sector rotation (if you took my Online Course you will know how to do a month over month sector rotation model). Beyond commodities, too early to make predictions for sectors.

      Reply
  • Hey Keith wonder if in the next few weeks you might offer your opinion on the US$ vs the Cdn$.
    I have a need to buy us$ in the next 6 months, and hope the spread will narrow during this time.
    I understand one major factor could be how the BOC aligns interest rates with the US fed.
    Thanks

    Reply
    • C$ looks like a nice base. If it breaks out, and it is showing momentum to suggest it might, it will have a good chance of seeing 2-4 cents upside vs USD. Note that in my most recent blog I mentioned we have reduced USD exposure (although it is nearly impossible not to have some USD securities in a managed portfolio). So we are in the camp that feels the USD will decline, against a world basket of currencies – and likely against the C$ as well.

      Reply
  • what do you think of the big head and shoulders formation on tslas weekly chart. looks to point to Tesla bottoming out in the $20 dollar area.

    Reply
    • I won’t put a target on it. Only to say that I won’t buy anything until it stops going down and bases/reverses trend. TSLA is still in the hurt-locker.

      Reply
  • Congrats Keith! I think this Blog “Go Johnny, Go” is one of the best you have ever written, at least over the past few years that I have followed your musings.
    I agree with your thoughts regarding the current bear market bottom yet to happen. Negative cycle could extend longer given the latest economic news re jobs growth pace, etc. causing the N.A. Central Banks to hike rates further and hold them for longer thru 2023.
    Sorry, as a retired Bay Street Equities Analyst, I’m more of a fundamentalist. But I really appreciate the insight I gain from your Technical blogs giving me the pulse and nuances of the markets.

    Reply
    • Appreciate that Ross. To us at VT, both disciplines work together–we have a CFA (Craig) and a CMT (me) approach–aka looking at both sides–absolutely imperative these days!

      Reply

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