This article was first published on Friday morning, January 21.
I have been writing for Seeking Alpha for over a decade now, and I have also been running a service for investors for over a decade as well. And, I think I have seen it all.
One of the things that still strikes me is the extent to which investors will go to cling to their market perspectives no matter how much you try to explain to them how their old perspectives are not accurate or how much you attempt to open their eyes to new perspectives. You can present as much evidence as you want, you can provide as many examples as you want, yet there will still be a huge number of readers who are unwilling to accept anything beyond their own views. There are truly a lot of closed minds out there who simply love the way their blinders fit upon their eyes.
Well, after my last week’s article, wherein I outlined why I do not believe news, earnings or fundamentals drives the overall stock market, I had someone email me on Seeking Alpha telling me that:
“You miss the point in your article that the primary drivers in the market are earnings and news. You have it backwards in your article. Sentiment does not drive earnings and news.”
Did this person read the article wherein I outline my view in detail? No. Did this person read the book I challenged people to read? No. I have 66,000 followers on Seeking Alpha, 8,000 members to my services, 1,000 money manager clients, but this reader tells me that I “miss the point.”
So, allow me to make my point again. I understand what this reader understands when it comes to news, earnings and fundamentals. But, when I challenge this reader to also learn what I know, well, I'm met with the response “I miss the point.” He does not even both to understand what I'm trying to explain. And I simply cannot have an intelligent conversation with such a person.
Therefore, I'm going to reiterate my point, and I will try to go a bit slower and provide a bit more depth to my points.
Folks, I understand what you fundamentalists understand. But, until you understand what I do about market sentiment, how can you challenge me as to what is the more pervasive power in the market? How can you have an educated and meaningful debate with me if we are not working on the same plane of knowledge? How can I take your challenges or critique seriously if it's not based upon the same knowledge that I have about sentiment? Would you walk into an operating room and tell the doctor that he's “missing the point?”
Let me go into a bit more detail about my view on market drivers, and I'm going to be paraphrasing what I learned from the author of the book I challenged you all to read: The Socionomic Theory of Finance.
The main issue that we must address is that it is unworkable to apply analysis of economics in the forum of finance. In fact, it has been an abject failure at the times when it was most needed.
After the analyst community failed to foresee the market swoon off the 2000 market top, on October 6, 2002, Paul Samuelson, a co-founder of modern economics, admitted “[w]e are at a loss for words. If nothing else, this baffling economy has defeated the vocabulary of economics.”
As an aside, it's interesting to note that Samuelson’s admission came within several days before the market bottomed and began a multi-year rally into 2007. Yes, his exasperated admission wherein he effectively threw his hands up in the air in submission marked a multi-year bottom at an extreme in negative market sentiment. He was being driven by market sentiment and likely did not even realize it.
But the failures of 2000 have not stood alone. While there were many admissions of failure after the analyst community’s inability to also recognize the impending market meltdown which began in 2007, I will list a few that were cited by Bob Prechter in The Socionomic Theory of Finance.
In February of 2009, the Kiel Institute noted that “the global financial crisis has made clear a systemic failure of the economics profession. In our hour of greatest need, societies around the world are left to grope in the dark without a theory . . . The corner stones of many models in finance and macroeconomics are rather maintained despite all the contradictory evidence discovered in the empirical research.”
Also in February of 2009, Paul Volker, former Fed Chairman, said regarding the economy: “It’s broken down in the face of almost all expectation and prediction. Even the experts don’t quite know what’s going on.”
In May 2009, the Wharton Business School noted regarding the analyst community that “[i]t’s not just that they missed it, they positively denied that it would happen.”
In the New York Times in August of 2013, we read that “[t]he trouble with economics is that it lacks the most important of science’s characteristics – a record of improvement in predictive range and accuracy. In fact, when it comes to economic theory’s track record, there isn’t much predictive success to speak of at all.”
And, finally, in January of 2010, Eugene Fama, the father of the Efficient Market Hypothesis, told the New Yorker “I’d love to know more about what causes business cycles. I used to do macro-economics, but I gave up long ago. Economics is not very good at explaining swings in economic activity. We don’t know what causes recessions. We’ve never known.” Yes, my friends, feel free to read that again. The father of EMH came out and told us that it does not work, and he gave it up long ago.
Mr. Prechter went further, as he then outlined the reasons why such analysis has been an absolute failure in chapter 15 of his book. Whereas the law of “supply and demand operates among rational valuers to produce equilibrium in the marketplace for utilitarian goods and services . . . [i]n finance, uncertainty about valuations by other homogenous agents induces unconscious, non-rational herding, which follows endogenously regulated fluctuations in social mood, which in turn determine financial fluctuations. This dynamic produces non-mean reverting dynamism in financial markets, not equilibrium.”
Moreover, since the efficient market hypothesis (the basis for fundamental analysis in financial markets) is an outgrowth from the world of economics, it has become quite commonly viewed as an unworkable paradigm for financial markets (as noted above) for various reasons. Understanding that an underlying assumption within economics is ceteris paribus, and an underlying assumption in the efficient market hypothesis is that all investors act rationally and with the same knowledge, you can easily understand why it is simply unworkable in financial markets.
In fact, Benoit Mandelbrot outright stated that one cannot reasonably apply an economic model to the financial markets:
“From the availability of the multifractal alternative, it follows that, today, economics and finance must be sharply distinguished . . .”
From an empirical standpoint, consider that, within economic theory, rising prices result in dropping demand, whereas rising prices in a financial market leads to rising demand. Yet, most continue to incorrectly apply the same analysis paradigm to both environments.
So, I will repeat my premise. As most of you, I started my investing career with fundamental analysis. Yet, I have abandoned it when analyzing the overall market because analyzing market sentiment has been a much more accurate lens through which to view the machinations of the stock market. And those who have followed me through the years can attest to this fact.
“March 2020 I stopped doing what everyone else was doing, stopped doing the same thing over and over and blowing up accounts, and started listening to Avi. My IRA has experienced 300% return since then.”
So, let’s now turn our focus toward what we have found to work quite well in prognosticating the markets.
We came into 2021 with the market at 3750SPX and our plan well laid out for the members of ElliottWaveTrader.net. My expectation was to see a rally to the 4440-4600SPX region from 3750, followed by a 200-300 point pullback (with an ideal support level of 4270SPX), followed by a rally to an ideal target of 4882SPX. After we completed that rally, then I expected us to re-test the 4440SPS region before we continue to rally to 5500SPX.
As we know, the market rallied to a high of 4544 into the end of the summer, pulled back to 4270SPX (that was the low struck in the futures before we began the next rally), and we have recently topped out at 4819SPX. While we came up about 60 points shy of my ideal target, I recently suggested to our members to raise cash near the recent market high in preparation for the pullback I expected to see in the first quarter of 2022 (an expectation which I wrote about publicly last year). So, while we were not “perfect,” I think our record suggests we have done quite well for our members as we called both sides of the trend within the market. And, it seems our methodology certainly well outperforms anything else I have seen.
While I have been giving the market every opportunity to try to reach that ideal target in the 4882SPX region, this past week has made it much less likely that we see 4882SPX before we begin the rally to 5500SPX.
But please recognize that there are two different market approaches I'm outlining here. While I maintain ideal targets based upon our Elliott Wave analysis, which are hit a great majority of the time, we also use our analysis to provide context to the market action. This tells us where risks have risen to the point that we suggest people should step aside as a pullback has become much more likely.
We did it last year in the summer where we warned that the market will likely see a pullback toward 4270SPX before we begin the next rally phase in this bull market. We did it on the long side as well when I explained to the members of ElliottWaveTrader.net that I was layering into long positions as we approached the 4270SPX region, as the market context as outlined through our analysis suggested that we were in a bottoming phase before the next rally takes hold. Both provided excellent opportunities for repositioning accordingly.
Then, last week, as we were around 1% off the all-time high, I again noted to our members that I was raising cash for the potential pullback I expected in the market in the first quarter of 2022, as it became clear that the risks for a larger degree pullback had risen and it was no longer worth the risks to wait for the ideal target to be struck.
So, as you can see, even though the market did not provide us the exact targets we like to see every single time, the market still provides us with an extraordinarily valuable piece of information - market context. In fact, I even provided these general outlines for this region over half a year ago for those willing to read carefully. I know of no other methodology that can provide the same as accurately as does our Fibonacci Pinball method of Elliott Wave analysis.
But, this leads me to another problem. Often times, I see comments to my public articles by those who do not read my analysis carefully. Many impute their own perspectives and overlay them upon my analysis. This bastardizes what I actually say, and they then post this as their perception of my analysis. This is not how to use my work. Rather, one has to approach my analysis with an objective mind, especially since my analysis is objective in nature, and providing you goal posts for both sides of the market action. And, it is your responsibility to view it objectively rather than overlay your expectation upon mine.
Lastly, I want to remind you that a 4th wave structure is the most variable wave within Elliott’s five wave market structure. That means that there is significant whipsaw to be expected, and it takes time for it to provide a clearer picture as to exactly where we reside within the 4th wave structure. I often joke with my members that trying to set an exact path for a 4th wave structure is akin to throwing jello for distance.
Therefore, I'm going to patiently await the market’s resolution in this region before I will re-deploy the cash I have recently raised. While there are some individual opportunities I have noted that I already deployed some of the cash, I still think we may see a higher probability buying opportunity as we move through the first quarter of 2022. But, make no mistake about it. This pullback is a high probability buying opportunity as there's a lot of support below the market, and our next higher target is 5500SPX which can be hit as early as the end of this year or by early next year.
As far as the bigger picture, nothing has changed based upon my expectations that I laid out when we were down in the 2200SPX region in March of 2020. After the next rally to 5500SPX, I expect a large pullback (potentially 15-20%) to take shape, which will likely set up the last rally to complete the bull market from the 2009 lows.
See charts illustrating Avi’s wave counts on the S&P 500.
Avi Gilburt is a widely followed Elliott Wave analyst and founder of ElliottWaveTrader.net, a live trading room featuring his analysis on the S&P 500, precious metals, oil & USD, plus a team of analysts covering a range of other markets.
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