As I was analyzing historical charts recently, I discovered a new potential wave count for the U.S. stock market’s performance during 2009-present. This wave count could imply that the market correction’s end is imminent, or it could suggest that substantial downside lies ahead. Either way, we are likely to get a rally soon but whether the rally develops into a new uptrend depends on how the macroeconomic situation evolves as I discuss later in this post.
What makes this Elliott Wave count different from the one I have been previously using is that, is puts the Primary II correction in 2010 as opposed to 2011. The count then labels July 2010 – Dec. 2015 as an extended 3rd wave. The idea behind an extended wave is that you get subwaves which are the magnitude of the higher degree waves.
Now that I have discovered this wave count, for the NASDAQ-100 (NDX), I prefer this count to the one I was previously using.
In the 2010 correction, the NDX had a decline of 17.5%. In the current correction, the drop has been 18%. So, on that basis, the bottom could occur any time now. However, this wave count could easily allow more downside to occur. A full return to the August 2015 low at 3878 would imply a drop of 6% below current levels. Furthermore, a Fibonacci .382 retracement of the rally from July 2010 – Dec. 2015 would imply a drop to 3578, which is 11% below current levels.
One factor that supports the more bearish interpretations is the observation that the drop from the Dec. 2015 highs on the NDX has been a five-wave decline. Typically, Elliott Wave Theory expects that a five wave decline does not signal a complete correction. However, a bullish counterargument could be that the five-wave decline was driven by the Dow and S&P 500, for which the five-wave move appears to be completing a correction rather than initiating one.
For the Dow and S&P 500, I still prefer labelling the 2011 correction as Primary II and then labelling 2015-present as Primary IV, given that they did not make new highs at their Nov. 2015 peaks. For this bull market, I use the Dow and S&P 500 as “secondary” sources for wave counts given that they have exhibited murkier patterns, but their movements are still worth noting to provide additional perspectives on the market’s situation.
What we have on the S&P 500 is a very typical Flat from May 2015-present in which you have three waves down, three waves up, then five waves down. As with the NDX, the correction could be over any time now, but it could go somewhat lower before turning positive.
So, from an Elliott Wave perspective, I think the odds are tied between an imminent bottom and a continued correction. Thus, the macroeconomic situation will decide which outlook comes true. Regardless of which outlook is correct, we are almost certain to get a rally soon given the clear five-wave pattern down from the late-2015 highs. On the first 3-5% pullback following that bounce, we need to consider what the macroeconomic situation looks like.
The fact that U.S. economic growth has slowed is not new news. The slowdown started 6-9 months ago when the manufacturing sector began contracting and S&P 500 earnings started declining. But the key question is whether the economy has continued to deteriorate since then. There is some provisional evidence that it has; for instance, Q4 GDP came in at only 0.7% annual rate, and job growth (according to the BLS report) came in at only 151,000 for January, which is below the average of 205,000 that we have seen over the past five years.
It could certainly be that these weaknesses are transient (as we have seen many times in this economic recovery), but after the stock market bounces, for the rally to evolve into a new uptrend we need to see signs that the economy is reaccelerating. We are starting to see some preliminary signs of a reacceleration now as the Atlanta Fed’s GDPNow forecast is for 2.7% growth in Q1 2016, but after the stock market rallies, evidence needs to continue pointing this direction in order for a new uptrend to materialize.
New York Fed
BEA Q4 2015 Report
Atlanta Fed GDPNow Forecast
FactSet S&P 500 Earnings Analysis
BLS Employment Data