Elliott Wave Principle : Chapter 8

Chapter 8

Elliott Speaks

.1 Elliott Speaks

The Next Ten Years

While it may be quite dangerous to attempt the “impossible,” a long term prediction for the stock market, we have decided to run the risk, if only to demonstrate the methods we use to analyze the position of the market in terms of the Wave Principle. The risk lies in the problem that if our thinking changes course during the next few years along with the stock market, this book will remain unaltered in its presentation of our analysis, which is based on our knowledge as of early July, 1978. We can only hope that our readers will not reject outright the theory of the Wave Principle because one rather daring prediction happens not to work out. With our reservations stated at the outset, we proceed directly to our analysis.

In Elliott terms, the Super cycle bull move that began in 1932 has nearly run its course. Currently, the market is within a bull phase of Cycle degree, which in turn will be composed of five waves of Primary degree, two of which have likely been completed. Several conclusions can already be drawn from the long term picture. First, stock prices should not develop a bear market downswing similar to 1969-70 or 1973-74 for several years to come, most likely not until the early or middle eighties, at least. Next, “secondary” stocks should be leaders during the entire Cycle Wave V, [but to a lesser degree than they were in Cycle wave III]. Finally, and perhaps most important, this Cycle wave should not develop into a steady, prolonged 1942-66 type of bull market since within a wave structure of any degree, generally only one wave develops an extension. Therefore, since 1942 to 1966 was the extended wave, the current Cycle bull market should resemble a simpler structure and a shorter time period such as the 1932-37 and 1921-29 markets.

With the DJIA in a persistent downtrend until just recently, pervasive pessimism has worked to produce several distorted “Elliott” interpretations that call for a calamitous decline to emerge from what is only a Primary second wave correction. Targets below 200 DJIA have been forecast for the near future by taking Elliott’s principles and twisting them into pretzels. To such analyses, we can only quote Hamilton Bolton from page 12 of the 1958 Elliott Wave Supplement to the Bank Credit Analyst, in which he states:

Whenever the market gets into a bear phase, we find correspondents who think that “Elliott” can be interpreted to justify much lower prices. While “Elliott” can be interpreted with considerable latitude, it still cannot be twisted entirely out of context. In other words, as in amateur vs. professional hockey, you can change some of the rules, but basically you must stick to the ground rules, or else you are in danger of creating a new game.

The most bearish allowable interpretation, as we see it, is that Cycle wave IV is not yet over, and that the final wave down is still in progress. Even given this case, the maximum expected low is 520 DJIA, the low of wave ④ in 1962. Based on the trend channel we have constructed in Figure 5-5 however; we have assigned this scenario a very low probability.

Basically, two plausible interpretations present themselves at the current time. Some evidence suggests the formation of a large diagonal (see Figure 8-1) that could be constructed entirely by stampede-type swings and persistent intervening declines. Since the October 1975 low at 784.16 was broken in January 1978, leaving behind what could be a three-wave Primary advance, the diagonal seems quite a plausible Cycle bull market scenario, since in a diagonal each of the actionary waves is composed of three waves rather than five. Only because this Cycle wave beginning in December 1974 is a fifth in the Super cycle is it possible that a large diagonal is being formed. Since a diagonal is essentially a weak structure, our ultimate upside target may have to be reduced to the 1700 area if this case indeed develops. To date, the drastic underperformance of the DJIA relative to the rest of the market seems to support this thesis.

Figure 8-1

The most convincing alternative to the diagonal scenario is that all of the action from July 1975 to March 1978 is a large A-B-C expanded flat correction similar to the 1959-62 market pattern. This interpretation is illustrated in Figure 8-2 and suggests a very strong upward thrust to follow. Our target should be easily met if this interpretation turns out to be correct.

Our price projection for the Dow comes from the tenet that two of the impulse waves in a five-wave sequence, especially when the third is the extended wave, tend toward equality in length. For the current Cycle wave, semi logarithmic (percentage) equality to wave I from 1932 to 1937 puts the orthodox high of the market close to 2860 [2724 using an exactly equivalent 371.6% gain], which is quite a reasonable target, since trend line projections suggest highs in the 2500–3000 area. For those who think these numbers are ridiculously high, a check of history will verify that such percentage moves in the market are not uncommon.

Figure 8-2

It is a fascinating comparison that like the nine years of “work” under the 100 level prior to the bull market of the 1920s, the last fifth Cycle wave, the Dow has currently concluded thirteen years of work under the 1000 level. And, as the Dow’s orthodox peak in 1928 occurred at 296 according to Elliott’s interpretation, the next peak is estimated at about the same relative level, although an expanded flat correction could carry the averages into even higher ground temporarily. We expect the terminal point to be close to the upper Super cycle channel line. If there is a throw-over, the ensuing reaction could be breathtakingly fast.

If the interpretation of the current market status presented in Figure 8-2 is correct, a reasonable picture of the 1974-87 market progression could be constructed by attaching a reverse inverted image of the 1929-37 period onto the recent March 1978 low at 740, as we have done in Figure 8-3. This picture is only a suggestion of the profile, but it does provide five Primary waves with the fifth extending. The rule of alternation is satisfied, as wave ② is a flat and wave ④ is a zigzag. Remarkably, the rally that would be scheduled for 1986 would halt exactly on the dotted line at 740, a level whose importance already has been established (see Chapter 4). Since the 1932-37 Cycle bull market lasted five years, its addition to the current level after three years of bull market gives a length of eight years (1.618 times the length of wave I) for the current Cycle wave.

Figure 8-3

To bolster our conclusions with regard to the time element, let us first examine Fibonacci time sequences from some of the major turning points in the market, starting with 1928-29.

The reverse Fibonacci timetable in Chapter 4 points to the same years as turning point years.

The above formulas relate only to time and considered alone pose the question of whether 1982-84 will be a top or a bottom and whether 1987 will be a top or a bottom. From the context of the previous market structure, however, one would expect the 1982-84 period to be a major top area and 1987 a major low. Since the third wave constituted an extension, the first and fifth waves will be the shortest in this Super cycle. Since wave I was five years long, a Fibonacci number, wave V could well be eight years long, the next Fibonacci number, and last through the end of 1982. A certain symmetry, often evident in wave structures, will be created if waves IV and V are each eight years long, since waves I and II were each five years long. Furthermore, the total time length of waves I, II, IV and V will then be approximately equal to the entire period of the extended wave III.

Another ground for concluding that the 1982-84 zone is the probable terminal area of the current Super Cycle V is purely arithmetical. An advance within the trend channel containing the price action of the current Super cycle should reach the upper parallel line at our price objective near 2860 in about 1983.

Some additional perspective may be gained from the Benner-Fibonacci Cycle chart shown in Figure 4-17 which, as we demonstrated, was used quite successfully in forecasting broad stock market movements from 1964 to 1974. At least for the time being, Benner’s theory seems to substantiate our conclusions about the future, since at this time it clearly calls for a high in 1983 and a deep low in 1987. However, while we expect the projections to hold for the next decade, like all other cycle formulas, it could very well fade in the next down Super cycle.

Even the fifty-four-year economic cycle discovered by Nikolai Kondratieff, which we discussed in Chapter 7, suggests that 1987, being fifty-four years from the depression depths of 1933, would be well within a reasonable time period for some kind of stock market bottom, especially if the current plateau period generates enough optimism to allow for a strong stock market prior to that time. One of our objections to the “killer wave” occurring now or in 1979, as most cycle theorists suggest, is that the psychological state of the average investor does not seem poised for a shock of disappointment. Most important stock market collapses have come out of optimistic, high-valuation periods. Such conditions definitely do not prevail at this time, as eight years of a raging bear market have taught today’s investor to be cautious, conservative and cynical. Defensiveness is not in evidence at tops.

O.K., what next? Are we in for another 1929 to 1932 period of chaos?

In 1929, as bids were withdrawn, “air pockets” developed in the market structure, and prices tumbled precipitously. The best efforts of the leaders of the financial community could not stem the panic once the tides of emotion took control. Situations of this nature that have happened over the last two hundred years usually have been followed by three or four years of chaotic conditions in the economy and the markets. We have not seen a 1929 situation in fifty years and, while it is to be hoped that it never recurs, history suggests otherwise.

In fact, four fundamental changes in market conditions may be part of the basis for a real panic sometime in the future. First is the increasing institutional dominance of the market, greatly magnifying the impact of one man’s emotions on the behavior of the market, since millions or even billions of dollars may be under the control of one man or a small committee. Second is the birth of the options market, where many “little guys” will have their stake as the market approaches its peak. In that situation, billions of dollars’ worth of paper assets could disappear in a day’s trading on the NYSE. Third, the change in the holding period from six months to one year for declaration of long term gains could exacerbate the “can’t sell” syndrome of those who insist upon logging only long-term gains for tax purposes. Finally, the SEC-mandated abolition of the specialists’ role on the NYSE, which will force the securities industry to operate a dealer’s market, could necessitate some brokerage firms to assume very high equity positions in order to maintain a liquid market, thus leaving them quite vulnerable in a precipitous decline.

A panic is an emotional problem, not an Elliott problem. The Wave Principle simply warns the investor of impending changes in the trend of the market for better or for worse. Deciding what to look for in the next ten years is more important than trying to predict what definitely to expect. No matter how we struggle with long term future probabilities, our interpretations must remain tentative until the fifth Minor wave of the fifth Intermediate of the fifth Primary is under way from the 1974 low. As the “fifth of the fifth” nears its terminal point, the Elliott wave analyst should be able to recognize the end of the Cycle bull market in stocks. In analyzing market movements under the tenets of the Wave Principle, remember that it is always the count that is most significant. Our advice is to count correctly and never, never proceed blindly on the assumptions of a preconceived scenario. Despite the evidence presented here, we will be the first to discard our predictions if the waves tell us we must.

If our scenario proves correct, however, a new Grand Super cycle will get under way once the current Super Cycle V has terminated. The first phase could end about 1987 and bring the market down from its peak to about the 1000 level again. Eventually, the Grand Super cycle bear should carry to its expected target within the range of the previous Super cycle fourth wave, between 41 and 381 on the Dow. However, we certainly do not make any definite forecast, despite our suspicions, with respect to a panic occurring directly after the peak. The market often does move impulsively during A waves, but precipitous action more assuredly develops in C waves of A-B-C formations. Charles J. Collins, however, fears the worst when he states,

My thought is that the end of Super Cycle V will probably also witness a crisis in all the world’s monetary hijinks and Keynesian tomfoolery of the past four and one-half decades and, since wave V ends a Grand Super cycle, we then had better take to the hurricane shelters until the storm blows over.

8.2 Nature's Law

Why does man continuously have to shelter himself from hurricanes of his own making? Andrew Dickinson White’s book, Fiat Money Inflation in France, examines in great detail a time in the past when “experience yielded to theory, plain business sense to financial metaphysics.” In consternation, Henry Hazlitt, in the introduction to the book, ponders man’s repeated experiments with inflation:

Perhaps the study of other great inflations — of John Law’s experiments with credit in France between 1716 and 1720; of the history of our own Continental currency between 1775 and 1780; of the Greenbacks of our Civil War; of the great German inflation which culminated in 1923 — would help to underscore and impress that lesson. Must we, from this appalling and repeated record, draw once more the despairing conclusion that the only thing man learns from history is that man learns nothing from history? Or have we still time enough, and sense enough, and courage enough, to be guided by these dreadful lessons of the past?

We have given this question due thought and come up with the conclusion that apparently it is one of nature’s laws that man at times will refuse to accept the rest of its laws. If this assumption were untrue, the Elliott Wave Principle may never have been discovered because it may never have existed. The Wave Principle exists partly because man refuses to learn from history, because he can always be counted upon to be led to believe that two and two can and do make five. He can be led to believe that the laws of nature do not exist (or more commonly, “do not apply in this case”), that what is to be consumed need not be first produced, that what is lent need never be paid back, that promises are equal to substance, that paper is gold, that benefits have no costs, that the fears which reason supports will evaporate if they are ignored or derided.

Panics are sudden emotional mass realizations of reality, as are the initial upswings from the bottoms of those panics. At these points, reason suddenly impresses itself upon the mass psyche, saying, “Things have gone too far. The current levels are not justified by reality.” To the extent that reason is disregarded, then, will be the extent of the extremes of mass emotional swings and their mirror, the market.

Of the many laws of nature, the one most blindly ignored in the current Elliott Super cycle is that, except in cases of family or charity, each living thing in the natural setting either provides for its own existence or is granted no existence. The very beauty of nature is its functional diversity, as each living element intertwines with the others, often providing for many others merely by providing for itself. No living thing other than man ever demands that its neighbors support it because that is its right, as there is no such right. Each tree, each flower, each bird, each rabbit, each wolf, takes from nature that which it provides and expects nothing from the efforts of its living neighbors; to do so would reduce the flourishing beauty of those neighbors and thus of the whole of nature in the process. One of the noblest experiments in the history of mankind was the American structure of human liberty and its necessary environment of free enterprise capitalism. That concept freed men from being bonded by others, whether they be feudal lords, squires, kings, bishops, bureaucrats or mobs demanding free bread and circuses. The diversity, richness and beauty of the experiment have stood out in the annals of history, a monument to one of the greatest laws of nature, the final burst of achievement in the Millennium wave.

The Founding Fathers of the Republic did not choose the pyramid capped by an all-seeing eye as the seal of the United States on a whim. They used the Egyptian symbol of cosmic truth to proclaim the organization of the perfect society, a society based on the knowledge of human nature and the workings of natural law. Over the past one hundred years, for political reasons, the meanings of the Founders’ words have been distorted and their intentions perverted, eventually producing a social framework quite different from that established. It is ironic that the decline in the value of the dollar bill, which bears the seal of the United States, mirrors the decline in values within its social and political framework. As of this writing, in fact, the dollar’s value relative to that in 1913 when the Federal Reserve Board was created is twelve cents. Depreciating currencies have virtually always been accompanied by declining standards of civilization.

Our friend Richard Russell describes the problem this way:

I firmly believe the world’s troubles would be solved (and the earth would resemble heaven) if everyone would take total RESPONSIBILITY for himself. In talking to hundreds of people, I don’t find that 1 in 50 holds himself up, takes responsibility for his own life, does his own thing, accepts his own pain (instead of inflicting it on others). This same refusal to take responsibility spills over into the financial sphere. Today, people insist on their right to everything — as long as you and I pay for it. There’s the right to work, the right to go to college, the right to happiness, the right to three meals a day. Who promised everyone all those rights? I believe in freedom of all kinds, except where freedom becomes license and inflicts damage. But Americans confuse freedom with rights.

Lord Thomas Babington Macaulay, British historian and statesman, whom we quote in part, correctly ascertained the root of the problem over a hundred years ago in a letter to H. S. Randall of New York dated May 23rd, 1857:

I heartily wish you a good deliverance. But my reason and my wishes are at war, and I cannot help foreboding the worst. It is quite plain that your government will never be able to restrain a distressed and discontented majority. For with you the majority is the government, and has the rich, who are always a minority, absolutely at its mercy. The day will come when, in the State of New York, a multitude of people, none of whom had more than half a breakfast, or expects to have more than half a dinner, will choose the legislature. Is it possible to doubt what sort of legislature will be chosen? On one side is a statesman preaching patience, respect for vested rights, strict observance of public faith. On the other is a demagogue ranting about the tyranny of capitalists and usurers, and asking why anybody should be permitted to drink champagne, and to ride in a carriage while thousands of honest folk are in want of necessaries?

I seriously apprehend that you will, in some such season of adversity as I have described, do things which will prevent prosperity from returning; that you will act like people who should in a year of scarcity devour all the seed corn, and thus make the next a year, not of scarcity, but of absolute famine. Either some Caesar or Napoleon will seize the reins of government with a strong hand, or your Republic will be as fearfully plundered and laid waste by barbarians in the twentieth century as the Roman Empire was in the fifth; with this difference, that the Huns and Vandals who ravaged the Roman Empire came from without, and that your Huns and Vandals will have been engendered within your country by your own institutions.

The function of capital (seed corn) is to produce more capital as well as income, assuring the wellbeing of future generations. Once squandered through socialist spending policies, capital is gone; man can make jam out of berries, but he can never reconstitute the berries.

As this century progresses, it becomes clearer that in order to satisfy the demands of some individuals and groups for the output of others, man, through the agency of the state, has begun to leech off that which he has created. He has not only mortgaged his present output, but he has mortgaged the output of future generations by eating the capital that took generations to accumulate.

In the name of a right that does not exist within the laws of nature, man has forced acceptance of paper that represents nothing but costs everything, he has bought, spent and promised at an exponential rate, creating in the process the greatest debt pyramid in the history of the world, refusing to acknowledge that these debts must ultimately be paid in one form or another. Minimum wages that deny employment to the unskilled, socialization of schools that smothers diversity and discourages innovation, rent control that consumes housing, extortion through transfer payments, and stifling regulation of markets are all man’s political attempts to repeal the natural laws of economics and sociology, and thus of nature. The familiar results are crumbling buildings and rotting railroads, bored and uneducated students, reduced capital investment, reduced production, inflation, stagnation, unemployment and ultimately widespread resentment and unrest. Institutionalized policies such as these create increasing instability and have the power to turn a nation of conscientious producers into a private sector full of impatient gamblers and a public sector full of unprincipled plunderers.

When the fifth wave of the fifth wave tops out, we need not ask why it has done so. Reality, again, will be forced upon us. When the producers who are leeched upon disappear or are consumed, the leeches who remain will have lost their life support system, and the laws of nature will have to be patiently relearned.