Is the stock market following the Elliott Wave playbook?

It is a natural tendency for serious market participants to look back at history when major events happen. The question on everyone’s mind is what precedence do we have. When the markets fell more than 33% in less than two months, the reference many were making was to 2000-2002, 2007-2008 and 1929.

The S&P 500 was down more than 50% in the first two instances and in 1929 when the Great Depression happened the DJIA fell by 89% (the S&P 500 didn’t exist then). All these declines took a much longer time.

For the 2000-2002 period, it was 31 months and for 2007-2008, it was 17 months. In 1929, it didn’t bottom out until 1932 - almost three years later. So, when markets fell 33% in two months, many were expecting the trend to continue but soon the market found a bottom and started to rally. The rally since then has been breathtaking. As we mentioned before, the purpose of a countertrend rally is to fool you and lull you into a belief that the bull market is still on.

As regular readers must have noticed, we use a version of Elliott Wave Theory in our analysis. Many dismiss it as voodoo, but I assure you - it is not. It is founded on the principles of nature.

To give you an example, one can recognize a mountain or a beach from anywhere. From a distance, they all look the same but when we come closer, we find that they are all different in terms of measurements in peaks and troughs.

Likewise, in the financial markets, we can look at a chart and make educated inferences by adding cycles, sentiments, volume, breadth, Fibonacci measurements, timing tools, the three cardinal rules of the theory and various guidelines to gain an edge on the markets.

Each instrument has its own personality and behaviour. Well, you may argue that you still have not met a billion-dollar Elliottician hedge fund manager. That’s a topic for a discussion at another time. Many are using it; just that we don’t know. Fund managers will not discuss their real edges in the markets. With that, let’s take a look at the markets.

Equities

The 5 wave impulse moves and 3 wave corrective moves are fundamental to the theory.

So far it is playing up to that. The move down from Feb 19 to Mar 23 was a primary five wave down move which took 27 working days to complete. The corrective up move since then has taken 26 days and was in three waves completing 58% correction for the Dow and 63% for the S&P 500 giving an average of the important 61.8% fib retracement. We think the coming down move will be the significant of everything that we have seen so far and eventually it should challenge the low of 2192.

Bonds

Bonds are in the initial stages of a major decline so it may take time to resolve the current sideways action.

Euro

As suspected the Euro challenged the previous recent high of 1.0992 (Apr 15) and traded to 1.1019. There could be more sideways activity around current levels and even make a high above 1.1019 before Euro will turn down again.

Gold

Bullish articles and videos on gold have increased now than any other time that I have been in the markets (that is an exceptionally long time). I have yet to see a single bearish report. I don’t think all can be right.

Having said that, gold has provided great trading opportunities with particularly good volatility if one were to take advantage of the critical levels that we have mentioned in our past reports.

Believe there are two outcomes from the current price action as we see it. It will continue to make one step up, two steps back movements and suddenly starts to turn down or it will make one more final attempt to rally and get all bulls sucked in before it turns down. The key levels on the downside will be 1660 to 1665. If those levels break, we will be more excited about the downside.

Let’s take a look at the major stocks that reported earnings last week. First with Amazon.

Amazon disappointed the markets on its profits. But don’t be so upset. Bezos is much farsighted, and he has a strategy. Profits tumbled 29 % while sales surged 26 %. Stocks were down 6.5 % for the day but it had already risen 30 % since the pandemic. First, there’s the real economy; then there’s the stock market and finally we have Amazon.

Bezos wants to make hay while the sun shines. As Churchill said, “Never let a good crisis go to waste”. As millions of Americans have filed for unemployment benefits, Amazon has hired 175,000 new workers so far this year more than it has done for the whole of last year.

They are signing up new leases in many parts of America from existing real estate deserted by insolvent retailers at extremely attractive prices to expand their grocery store presence. They surely want to dominate in all forms of delivery. Physical, online and drone.

Listen to what Bezos said, “If you’re a share owner in Amazon, you may want to take a seat, because we’re not thinking small”. Having said that we should see better buying opportunities in Amazon based on our down expectations in the general markets.

Clorox beat street expectations and rose more than 4%. Thanks to President Trump. It has risen 20% since Feb when the S&P 500 index is down 11%. Really not a stock that we want to be involved in.

Apple beat analysts’ expectations by sizable margin in both earnings and revenue.

CEO Tim Cook said “we have great confidence in the long-term prospects of our business. In the short-term, things are not clear”. In fact, most companies are unable to make any immediate guidance due to the lack of visibility and uncertainty.

Google was expected to disappoint in its earnings with its lower ad revenue in this lockdown period, but it wasn’t as bad as many feared. CEO Sundar Pichai said “people are relying on Google’s services more than ever “

Berkshire Hathaway just released their Q1 earnings. While their earnings were supported by their insurance income, they have taken big hits in their airline investments. In fact, they are out of their investments in Delta, United, Southwest and American Airlines.

70% of their investments are concentrated in five companies namely Apple, Coca-Cola, Bank of America, Wells Fargo and American Express. Warren Buffet doesn’t think a cash holding of 137 billion dollars is not that much compared to the worst-case scenarios ahead.

They don’t see any compelling buying opportunities now. While Buffet was positive about the swift actions by the Fed, I doubt he is appreciative about the Fed’s involvement in buying assets of sick companies. We think going forward Berkshire will get into more of the major digital stocks as they are going to rule in areas of medical, education and entertainment.

Be safe. Be small. Be home.

Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.