Have you ever seen…a cloud of flying midges…hovering apparently motionless in a sunbeam? Well, did you ever see the whole flight–each mite apparently preserving its distance from all others– suddenly move, say three feet? Well, what made them do that?
But, try to recall–did you ever see them move directly back again in the same unison? Well, what made them do that?
Extraordinary Popular Delusions
and the Madness of Crowds
Out on my afternoon walk again. This time it’s Richard’s wife, Martha, walking Kara, the beautiful black lab. “The economy’s strong, Rod,” she says, “the whole neighborhood is busy with renovations. There are projects on every block!” “I see that,” I reply, “But I’m bearish.” “I know,” she says, ” I thought of you when I noticed all this activity.”
We had this talk last Monday. By the end of the week the Dow was down 600 points, the biggest drop in six years. Indications are very strong that we have begun the final leg down in the bear market. Not that I’m possessed of special forecasting powers–I’ve been bearish for years. But the conversation was not entirely coincidental. The market, and, consequently the economy is extremely vulnerable to a renewed crash, but most people see it in quite the opposite way.
Projecting a strong economy when we see lots of activity seems reasonable until you understand what drives the markets and the order in which financial decisions are made.
Baruch aptly took note of the erratic, but all in unison shift in the flight of midges, and compared it to the behavior of people acting as a crowd, all doing the same thing at the same time in the stock market. He wrote this in October, 1932, five months after the market made its bottom with the Dow Jones closing low of 41, an 89% loss over the previous high in 1929 of 389.
A short time after that, Ralph Elliott observed that the ebb and flow of crowd movements in and out of stocks was patterned. The pattern exhibited characteristics of a fractal, in that the patterns repeated in degrees of trend, from the smallest trends lasting a few hours to very large ones that took centuries to complete. He then announced that the bear market had ended and that a huge bull market lasting decades was underway. Nobody believed him.
In the late seventies, Robert Prechter, having become the leading expert in the Elliott Wave Theory, advanced the theory by observing that the pattern in the stock market reflected a host of actions, fashions and behaviors that occurred in tandem with the rise and fall of the market, leading him to hypothesize that social mood was the driving force behind all social activity and that the pattern in the popular stock market averages accurately reflected social mood. Prechter labeled the market top in 2000 as the final top of the bull market Elliott had forecast sixty-five years previously. It was a measurable top in social mood, speculative market activity, and the general trend to excess in many behaviors, including consumption.
Bear markets decline in two waves with an intervening counter trend rally. The first wave down bottomed in March, 2009. The rally since then is labeled a countertrend rally. The averages have made new highs, which, while deceiving, is acceptable as a countertrend move. The evidence that it is actually a part of a bear market is that the stock market is speculative, but not widely popular, and many sectors of the economy have not only failed to fully recover, they are starting to falter again.
The home renovation activity in our area, and probably others, is a very recent development. This is normal. It takes a lot longer for homeowners to ponder doing renovations and get comfortable making plans, getting financing and getting the project underway than it takes to buy stocks. Long time market observers like to say the market makes the news. So stocks usually are ahead of financial activity that is more complicated. And, when social mood turns down, stocks will be sold way before an actual slow down in business or homebuilding is apparent.
It is understandable, then, for people to walk around the neighborhood, take stock of all the activity and project that the economy will be strong. Conventional advisors, being part of the crowd, make the same mistake. Today, they tell us not to worry because things are good. When the market and the economy are in the toilet a couple of years from now they’ll be telling us to worry because things are bad. How much good does that do us?
Analysts at Prechter’s Elliott Wave International, on the other hand, have projected a top in the countertrend rally that could occur at any time. The recent action satisfies this forecast. The next leg down is expected to be the most severe one.
How severe? Ralph Elliott’s forecast was two-fold: The market would stage the bull market to end all bull markets, which it has, and, after that it would fall off in a bear market that would see the averages back in the area of the range between the 1929 high of Dow 389 and the 1932 low of Dow 41. He explained that bear markets always fall back to the area of the fourth wave of one lesser degree. The ’29-’32 bear market was a fourth wave of Supercycle degree which preceded the fifth wave Supercycle degree bull market that completed the Grand Supercycle bull market that began in 1722.
Nobody in the midst of the Great Depression of the thirties could imagine a bull market that, with intermittent pullbacks, would rise from Dow 41 to Dow 16,000+. Not many folks today can fathom a trip all the way back down to Dow 400 or below. But that is definitely the forecast of the Wave Principle. The major trading cycles of this era all bottom sometime in mid 2016, so the next couple of years should be painful to the unprepared.
No one should consider any part of this presentation as a recommendation to buy or sell any securities whatsoever.