Dow 20,000 – now on to the moon, and beyond?
As US stock indexes (and not many others) are making all-time highs with the Dow famously topping 20,000, the chorus of doubters gets louder and louder. The vast majority of conventional analysts/gurus/pundits simply cannot believe their eyes. While US company earnings have declined for many quarters on the trot, valuations are rocketing. How can this possibly happen, they ask with a certain modicum of incredulity.
Yes, indeed – conventional economists have no rational answer except to say that it is the unearthly animal spirits working that drive buyers to buy stocks whatever the price. Actually, they are perfectly correct in this assumption. But what these people fail to do is take that thought to its logical conclusion – and use it in their analysis as I do.
Why do traders/investors keep buying stocks regardless of price (or value). What drives them to keep buying with P/E ratios zooming into the stratosphere and where on a logical basis, they should be selling not buying? After all, isn’t the basic investment rule: Buy Low, Sell High? They appear to be doing the opposite.
If bread suddenly tripled in price, what would happen to bread demand? Of course it would fall as more consumers would seek cheaper alternatives or cut back on consumption – and consumption would fall.
But the financial markets do not operate on these rules, even though conventional analysts believe it does. If a stock price is rising and it is three times what it was, demand would rise! This is demonstrated all the time by noting the trading volume data. When stock prices are low, trading volumes are low as few investors want to trade and vice versa. But that is the very opposite of what happens in the bread example.
Most of us (except politicians) know the ‘right’ price of bread and milk when we go shopping. But there is no such yardstick of value that can be placed on financial assets. None. Throughout history, the prevailing P/E ratios, which is a common measure of value, have varied all over the map.
And that is why financial markets swing from the lows of deep pessimism (end of the world) and low P/Es to the highs of manic optimism (brave new world) and high P/Es. And there is no better system that analyses this process than the Elliott Wave Theory.
A rival theory that has been popular for a few decades is the Efficient Market Hypothesis which states that investors/traders will act rationally in buying and selling. They will react rationally to news and developments as they emerge. A ‘bullish’ GDP increase for example will result in higher prices and vice versa.
This is pure hokum and always will be, but it is the basis on which 99.999% of market analysis is based. My advice: read it only for laughs, or to get a picture of prevailing sentiment.
I have shown my Elliott wave labels for the Dow and since then, the market has followed my roadmap well. Last Saturday, I posed this picture of the Russell 2000 and predicted that we were at the start of a major wave 5 up that would move swiftly into new highs:
I wrote: ” That means the stock markets will advance again near-term, barring a Black Swan event of some sort.”
So let’s see how far they have moved this week
Nice move – and thankfully,no Black Swan. Back to the upper blue tramline, in fact within just a couple of days. That’s what I call a third wave – and as the current dip is a small wave 4, I expect a new rally in wave 5 to new highs above the wave 3 high.
That is the power of using the Elliott wave model. No need to scrutinise the financial pages, review the mountain of data, wonder what Yellen and all the other Fed members meant in their speeches, and so on. Unless you are disciplined to not have even the most persuasive guru’s opinions affect you, it is best to avoid it altogether. That is what I encourage my VIP Traders Club members to do.
My analysis above took all of one minute, incidentally.
Gold is falling off its perch, as I intimated
On 19 January I asked if the gold rally had run out of steam. And to date, it has fallen $40 off its recent high at $1220. But is that it? Remember, gold/silver were utterly despised by mid-December. But in a little over a month, gold has rallied by $100 as shorts were squeezed.
The curious fact is that a gold rally, which is normally seen as a flight to safety, took place as stocks were racing upwards in a flight to risk! Conventional analysts would have no rational explanation for this, of course. It goes against the ‘normal’ convention. And that is why it is a terrific example of why markets do not behave like machines – pull one lever here and you get the same result there, no matter how many times you do it.
Each market has its own internal dynamics that follow the Wave Principle which is governed by changes in sentiment that originate in the unconscious urgings of the herd. What makes one pop star rise head and shoulders above everyone else (no matter how talent-less!)? What makes one women’s fashion trend and colour for next season dominate all others? It is the unconscious herding effect at work.
When we are in a herd, we don’t realise what we are doing consciously (or very few of us do). We get swept along in the buzz. And in the trading/investing world, this can be a very dangerous thing especially at major market turns when the buzz is at its most intense.
Personally, I have always liked to leave a party when in full swing – and that is the quality successful traders/investors have.
Here is the gold rally off the December low
The pattern is a clear five up that has travelled in the channel contained by my tramlines. Now the break outside the channel last week was a clear signal that the uptrend had terminated and the near term trend was down.
I have drawn in T3, which is the third tramline set at equal distance away from the lower line. The market rapidly descended to it as many sell stops were hit especially at the wave 4 low. And then the resistance zone at the Fibonacci 38% level came into play and yesterday the market staged a bounce back to kiss T3.
Because I believe the medium term trend remains up, this initial decline could be the A wave of an A-B-C down which should take the market to at least the Fibonacci 50% support at around $1170 and perhaps lower. That would set up waves 1 and 2 of what will be a five up to take gold above the old high at $1375.
The alternate scenario is that yesterday’s low is wave 2 and gold will continue its rally. But that would make wave 2 very shallow which is fairly unusual. Most second waves trace out a deeper retracement of wave 1. But if the euro stages a steep recovery, odds would swing to this outcome.
At this stage, I place this alternate option at lower odds.
VIP Traders Club members are now short gold (after taking huge profits on the way up) with Protective Stops at Break Even.