Sunday, January 9, 2011

Let's Think About This For A Minute

I am really trying to get a handle on the apparent success of the consensus view of the markets as compared to my expectations for a still ongoing (B) or [B] wave scenario.  The function of B waves is to bring market sentiment back to and beyond the sentiment seen at the origin of wave A just like with 2nd waves, and that certainly is the case now.  I am truly amazed at how homogeneous the forecasts have become.  Just about everyone I read or listen to has capitulated to the view that the market will only be going up with QE2 coupled with the 3rd year of the presidential cycle.  There are a few elliott wave practitioners that are still holding on to the P3 interpretation, but many have also switched to a more bullish view.  Some, in fact, are calling this a primary bull market.  I have only seen one other, perhaps there are others, that see the current action as part of a much larger intermediate wave (B) or primary wave [B] as I have proposed.

As far as the idea that we are in a primary bull market is concerned, there simply is no real justification for that view.  Even a basic understanding of secular bull and bear market cycles suggests that the current secular bear market has much further to go in time than has transpired so far.  The minimum expectation is for a real (inflation adjusted) or nominal low in 2016/17 and a real low as late as 2026.  Thus, any elliott wave counts showing a primary bull market must be discarded in favor of larger corrective counts.

At the same time, we should not discount the impact of QE2.  The Japan experience shows quite clearly that the equity markets will rise during the QE process and tend to top at its conclusion.  In fact, recent analysis supports the view that the Fed's only real impact on the economy is by manipulating the stock market via bond purchases and sales.  We know full well that the Fed is no where near the completion of QE based on the recent congressional testimony and Fed meeting minutes.  So, we certainly should expect that the equity markets have much further to go on the upside before a top is seen.  This fact rules out the case for a beginning to primary wave 3 down.

Given the above the only question at this point is whether or not we are already in wave (C) or [C] up or whether we are still in wave (B) or [B] down.  You know my view on this is the latter, but either way, traders and investors need to know what actions to take.  One bit of personal experience that I will share with you is that I have tended to be overly aggressive in attempts to short B waves and 2nd waves.  What I have learned from these attempts is that it really is a fruitless endeavor.  One would be much better served sitting on the sidelines and waiting for new long entry opportunities rather than trying to short the market.  The whipsaws and friction offset the potential gains in most cases.  This is in contrast to the excellent potential in shorting C waves such as the decline from the 2007 high to the 2009 low.

Until proven otherwise, I am maintaining the view that we are currently in wave B up of wave (B) down.  So, wave C down is due.  Given this is likely a C wave within a (B) wave of intermediate degree lessens the potential benefits of shorting, but that said, I am looking to be short wave C as the last opportunity to do so prior to the top of wave (C) sometime in late 2012 or early 2013.  After the next leg down is concluded, whether it proves to be wave C of an expanded flat or wave C of a running triangle, in my view, traders would be well served to only be long the market or in cash until the final top of the current cyclical bull market is over.  If we get 3 waves down from the current high, then we cannot know if it is a triangle or wave 2 of (C) until much time has passed, and we should take a bullish stance in either case, which is why this will be my last shorting campaign for some time barring a major change in the outlook.

One thing about expanded flats and running triangles is that we have some reasonable limits on how far wave B can exceed the high of wave A.  It is rare for wave B to longer than 1.618 x wave A, which puts the limit on the Qs around 56.14, the SP500 at 1348.89 and the Dow at 12273.81.  The Qs have pretty much met this objective limit.  We can allow a little wiggle room, but not much.  So, we need to see the Qs begin to rollover soon.  We could allow some more upside for the SP500 and the Dow.  The Russell 2000 actually has some upside room, too.

It won't be long now before we can discard some of the potential outcomes.  Once any potential upcoming shorting opportunity has either been realized or negated, there will be little reason to risk the short side for quite some time unless we see some major changes in the pattern of market behavior.

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