I’m not a fan of Elliott wave projections. Not that there’s anything wrong with Elliott Wave Theory when used in the right context (today’s blog title borrowed from a Seinfeld skit).
I really don’t see any logic in using this theory to tell you at what level, and when, you should buy or sell. However, as I wrote in my book Sideways, I do believe that markets have a tendency to behave differently during different phases of bull and bear markets. Elliott Wave theory gives us an idea of what inning, so to speak, the stock market is in.
For example, the first wave (or inning of the game) is one of disbelief after a bear market–it can be choppy. The second wave is confirmation of their disbelief and profit taking by participants –it’s is a corrective action (“I knew that was a head fake!”). The third wave is where the crowd joins in – which tends to make it the longest wave. Then a final correction (wave 4) before a shorter, sharper wave of speculation (wave 5) ends the game. Elliott Wave analysis will not tell us when a given wave is over. Sorry, Fibonacci lovers. For more thoughts on that part of the theory—see this blog.
However, EWT an excellent tool for giving us a feel as to where we are in the cycle. And that’s what I’d like to look at today
For that final wave 5, the tendency is for something to add a “new paradigm” to the expectations of stock market participants. For example, in the past – wave 5 final market moves have been characterized by such new paradigms as “the Nifty 50” – which ended the bull market of 1950-1964. It was the new paradigm of the “Tech Bubble” which ended the greatest bull market in history from 1982-2000. And it was the new paradigm of “Peak oil theory and Sub-Prime debt” that ended the 2002-2008 market. Each one of these new paradigms ended. In other words, they really weren’t new paradigms. They were just events or developments that are part of human growth and market reflection of that growth.
Right now, I believe that the “new paradigm” has been “TINA” –There is No Alternative. Super low interest rates (historic lows) have driven investors into the stock market and out of safe investments. That, along with the low rates inspiring easy leverage to over inflated real estate—which in turn creates a “wealth effect”. People buy a better car and better stuff when they have a valuable house and a good stock portfolio. This pushes earnings higher – justifying higher valuations. It keeps going until it can’t keep going any more.
Like the other new paradigms that we thought would never end – this one will end too. Oh, and one other thing: wave 5 is often characterised by a greater angle of ascent, and tight, lower volatility moves. Note the angle of ascent since 2015 is a bit steeper,vs. the prior 2 uplegs (wave 1 &3). Note the lower price swings since 2016 (and lower VIX levels) – chart below.
We’re probably in wave 5 of the current bull market. It could run for another month, another quarter, another year, or even longer. But I think there’s no denying it. We’re in that final inning. Stay aware, and be prepared.
10 Comments
Hi Keith,
Do you think the FAANG stocks may be the Nifty Fifty of this bull market?
Good question. I’m not sure–I don’t hear “everyone” talking about them, although there is enough interest in them that could bring them to that point.
Hmmm…makes me ponder. Thanks for the thought.
Very interesting chart, Keith. But why did you assign Wave #2 to July 2011 instead of the downturn of April 2010? Hindsight always makes things easier, but…
Good question Bruce–EWT is much in the eye of the beholder-but the characteristic of the 2nd wave is that of the crowd still believing in the bear. I would think that the 2011 selloff was the final of the bear market believers selloffs. That’s because the 2011 correction peak to trough was 21%, while the 2010 correction was “only” about 14% —Thus, I’ll award 2011 with “Wave 2” status due to it being the bigger correction. You could argue on that point and I wont fight back too hard. Its more important to see that the obvious big move on the market was from either 2010 or 2011 up until 2015, making that the Wave 3 move without too much doubt. The characteristic of wave three is limited corrections, a big move with less volatility.
“FIVE WAYS TO ASSESS TODAY’S U.S. MARKETS”
1) VALUATION: OVERLY HIGH PRICING RELATIVE TO UNDERLYIND FUNDAMENTALS
2) SENTIMENT: TOO MUCH OPTIMISM
3) OWNERSHIIP: CONCENTRATION OF ASSETS
4) LEVERAGE: OVERRELIANCE ON MARGIN DEBT
5) AN ENTRENCHED BELIEF SYSTEM: THAT PRICES CAN’T GO DOWN
EXCERPTS FROM DAVID ROSENBERG, GLOBE AND MAIL R.O.B., MARCH 2017.
Thanks JP–that quote is awesome.
Hi Keith – so if we are in the final wave – yet do not know when it will end – what’s your advice on how we protect our portfolios? The tough part is – the final wave can generate great returns yet the crash and burn can be fast no? Some experts are saying a big correction could occur 2018-2020 but until then – buy, buy, buy because we are in a bubble…..
The only thing to do is to watch the chart–if we get a lower low on the weekly chart AND a break of the 200 day MA–then start to run. That’s my major sell signal. It isn’t perfect (it burned me last year in the first quarter after I got out on the signal, but then markets reversed back up) but the fact is it has saved me more times than hurt me–like in 2008. And if it does fail (like in early 2016)–you go back in once the market moves back above the 200 day MA–as I did last year. Worst thing that can happen is you miss some gains…
Hi Keith:
I was studying the Vix chart a few days ago and noted the previous time we had a Vix this low was early 2007. You have made reference to this characteristic currently as well. Just one more signal to note. I will be most interested to read how you prepare once the bearish signals become overwhelming. Thanks for the terrific blog.
When our Bear-o-meter goes officially into the bearish zone, we peel more out of the market. Currently we are 28% cash–we could easily go 50% if a bad signal comes through. Sometimes we offset existing stocks with single inverse ETF’s too–but thats based on a breakdown on the chart.