2018 Stock Market Commentary (1/8/2018)

2018 is a difficult year to predict because of a potential divergence between the stock market’s cycle and the underlying economic cycle.

The U.S. stock market appears to be nearing the top of the bull market that began in 2009. Evidence for this comes from two sources: Elliott Wave and George Lindsay’s Counts from the Middle Section. The latter model projected a top by the end of last year. Although the top did not happen, the model nevertheless serves as evidence that the top could occur soon. However, it is likely that before the ultimate top, there will be a drop of 7-10% followed by a rally to at least a marginal new high.

My long-term Elliott Wave count allows for the bull market to run higher from its current levels as shown on the chart below.

ndx jan 3 2018

I consider the NASDAQ-100 (NDX) to be in Primary Wave V of the 2009 bull market. Primary Wave I was a 98% rally from March 2009 – April 2010. After the Primary Wave II correction during April – July 2010, an extended Primary III took place during July 2010 – Dec 2015, in which the largest subwaves had the magnitude of primary waves. After that, Primary IV was the correction during Jan – Feb 2016. Primary Wave V began from the Feb 2016 low and is still underway.

If Primary Wave V has a magnitude equal to Primary Wave I on a percentage basis, the target for the ultimate bull market top would be 7,700 on the NDX.

While it is well known that the stock market often tops out before the economy does, in the last 100 years, there has never been an instance in which a bull market ended amid economic acceleration beyond the levels previously seen in the expansion cycle. Typically, bull markets end when the rate of economic growth levels out or starts to slow down.

In order for the bull market to continue beyond the first half of 2018, we will have to see economic growth stronger than the norms of the last nine years. It is possible that the tax reform recently passed by Congress could serve as the catalyst for stronger economic growth. Going forward, for the bull market to continue, the average annualized rate of GDP growth would need to be at least 3%.

Regarding the job market, I think that, with the current socioeconomic environment taken into account, the economy is near full-employment. I reference the “current socioeconomic environment” because there are some constraints on employment at this time in history which are more significant in the current economic cycle than they were in the expansions of the 1980s, 1990s, or mid-2000s.

The biggest issue I see regarding employment is that the depth of technical knowledge required by many employers today due to automation of labor (including many job positions not traditionally considered tech-savvy) is difficult to firmly attain through the current educational systems.

That said, it is possible that with lower corporate income tax rates, business executives may decide that instead of putting the heaviest workloads possible on a few employees with extensive technical knowledge, it would be worthwhile to hire more employees and train them on tasks to enable more division of labor. This could enhance the sustainability of the business’s operations, and also provide more opportunities for experienced employees to contribute to business expansion.

The official unemployment rate (U3) is 4.1% (as of Dec 2017). The lows of the previous three economic expansions were 4.4% (Dec. 2006), 3.8% (Mar. 2000) and 5.0% (Mar. 1989). The broader, U6 unemployment rate, which includes part-time workers who need full-time work and people only marginally attached to the labor force due to economic reasons, stands at 8.1% (Dec 2017), vs. previous cycle lows of 7.9% (Dec. 2006) and 6.9% (Dec. 2000). U6 was not tracked prior to 1994.

Economics is not a precise science; thus, comparable numbers, occurring at different times in history, probably do not tell the same story about the underlying situation. Ordinarily, with an unemployment rate as low as it is today, there would not be much room for job creation to outpace population growth. To find a U3 rate lower than the 2000 low (which we are getting close to), you would have to look all the way back to 1969. Although the U6 rate in 2000 was about 1% lower than it is today, there were many cases of companies “over-hiring” in 2000 in response to the dot-com boom, leading to unsustainable job positions and new hires with questionable competence or reputations.

However, due to circumstances described earlier, I think that there is potential for the unemployment rate to fall further without overheating the job market, and that such a decline would be necessary in order for the bull market in stocks to continue throughout 2018.

Another factor to consider, when assessing the bull market’s continuance in 2018, is the state of public sentiment regarding the stock market and economy. In this area, I am seeing very conflicting signals.

Prior to 2017, public sentiment about the stock market had a definitively negative bias. Although a lot of negativity came from political conservatives who were critical of the Obama administration and the Federal Reserve, there were also people who did not see their own financial situation to be improving and were suspicious of the stock market’s rise. Political progressives, who supported the Obama administration’s policies, were generally not focusing their attention on the stock market.

The big question now is whether overall public sentiment started to turn in 2017. I was surprised by the number of politically conservative commentators who suddenly began speaking positively about the economy and the stock market in 2017, despite the lack of major legislative accomplishments by Trump and the Republican-controlled Congress. Perhaps I should have expected this enthusiasm, given the highly partisan nature of basically everything these days, but in 2009, after Obama took office, progressives were more subdued in their talk of economic and market recovery, opting to praise the social aspect of Obama’s politics while sometimes expressing concern about the rate of economic progress.

Could it be that the stock market’s rise in 2017 was in part due to individual investors, who previously avoided the stock market for political reasons, finally entering the market again? If so, is this a sign of a bullish bubble forming, that would signal a top in the near future?

I would be highly cautious about making claims that the current state of public sentiment signifies the late stages of a bull market. If the economy were to accelerate over the next couple years, there would be room for more investors who previously stayed out of the stock market due to financial difficulties to reenter the market as their financial situation improves. Furthermore, while sentiment among political conservatives has started to turn, sentiment among progressives is extremely negative.

However, it is hard to tell how much of the negative sentiment among progressives is directed specifically toward the economy or the stock market. The mainstream news media, which often has a discernible negative bias in its reporting on the Trump administration, seems willing to report economic and market statistics without casting a negative shadow over them. Much of the progressives’ angst over the country’s situation carries heavy social overtones, and they seem to be staying out of the fray when it comes to macroeconomic debate. The key question, which is very difficult to answer, is the extent to which these progressives are willing to invest their money in stocks despite the direction they think the country is headed socially.

With all things considered, I am going to refrain from making any definitive predictions about the stock market’s long term direction until we see how the economic backdrop develops over the next couple months, and whether the market makes any erratic moves to the downside in the near future. Given the precarious cyclical situation of the stock market right now from a technical analysis standpoint, I would probably conclude that the bull market has ended if we were to see a drop with accelerating downside after falling 10% from the highs.

Aside from that scenario, it is likely that the bull market will continue until we get a 7-10% drop followed by a rally to at least a marginal new high.

Employment statistics in this post are from Portal Seven (http://portalseven.com/employment/)

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Tax Reform and the Stock Market’s Relationship to the Media (11-04-2017)

I agree with analysts who say that the recent rally in U.S. stocks has been at least somewhat driven by optimism that tax reform will happen. I find it ironic that the U.S. stock market has performed very well during the Trump administration despite the fact that the mainstream media is portraying his presidency with a decidedly negative slant.

In general, Wall Street-style business conservatives are not thought of as Trump supporters. They are generally thought to be supporters of either Republican or Democratic establishment politicians. Thus, they are not the types of investors who approach the mainstream media with an inherently contrarian attitude.

But at the same time, the stock market is often ahead of the news. Back in 2009, the stock market bottomed out before there was any sign that the recession was shallowing. Furthermore, at that time, the reaction to the Obama administration in financial media had a somewhat negative bias. The actual reporting of financial news was fairly neutral, but doomsayers critical of the administration were getting a disproportional amount of air time. After the market bottom in 2009, there was some sort of drop almost every time Obama announced a new policy proposal, but the trend remained higher.

Sometimes the stock market can cut through the noise of the media to see what is really happening in the economy. In the case of 2009, there obviously was optimism that the end of the recession was on the horizon even though headline numbers didn’t show it early in the year.

At the current time, the stock market’s performance over the past year clearly indicates that long-term investors see signs of an imminent acceleration of economic growth. In October 2015, I wrote that I expected the eventual top of the bull market to occur between 20,000 – 26,000 on the Dow.

If investors did not anticipate an economic acceleration, I would have expected the bull market to top out near 20,000, and it could have happened by the end of 2016, as I described in the post.

However, here we are one year past the more conservative target for a top, and the Dow has gone well above the lower end of my target range (last closing price was 23,539). This, to me, suggests that the market really does anticipate an economic acceleration. And it suggests something bigger than the uptick in GDP over the last couple quarters – similar growth spurts have happened throughout the bull market only to fizzle out within a year, and at market prices as high as what we have now, I don’t think investors would get so excited over it.

If there really is going to be sustained, improved economic growth, tax reform is the only source of it that I can see. That is why I think long-term investors really do expect tax reform to happen amid the current political environment.

But what would that mean for the market over the next few years? Lower corporate and personal income tax rates would be a major boost for the market in the short term. I say short-term for two reasons. The first is that a lot of the economic gains may be priced in already. The second is that stronger economic growth will accelerate the rise in interest rates, which would eventually become bearish for stocks.

As you know I have been calling for a bull market top by the 1st quarter of 2018. Tax reform could extend the bull market further into the year, but I still see the 2019-2020 timeframe as either flat or bearish. It is also probable that there will be a recession of some magnitude by 2020. Since the Great Depression, there has never been a continuous economic expansion lasting longer than 10 years, and the current expansion will be at 9 years in mid-2018.

That said, it is worth noting that the interest rate cycle associated with the current expansion is still in it’s early phases, and if there is a stimulative change in fiscal policy, the next recession could end up simply being a technical contraction that, despite rattling markets for a while, would not have a major impact on society at large.

But in any case, the economic and political events of the next 3-6 months will be critical to forecasts for the next few years.

Targets (10/14/2017)

ndx 10-14-17

For the first time since June, the NASDAQ-100 (NDX) is making new highs without immediately stumbling. While I don’t rule out the possibility of an imminent short-to-intermediate term top, the recent strength raises the probability of a continuing rally.

Zooming out to a longer-term Elliott Wave perspective, I consider the major correction during Dec 2015 – Feb 2016 to have been Primary Wave IV of the 2009 bull market. Since the Feb 2016 low, we have had two completed waves of intermediate degree (labeled in white). The third intermediate wave began at the Brexit low of June 2016. This third wave appears to be an extended wave, in which its subwaves are comparable to or bigger than the overarching intermediate waves in magnitude. These subwaves are labeled in white parenthesis.

Within this extended wave, it looks like we have four subwaves complete, with the fifth wave taking off from the recent low in July. In Elliott Wave theory, the magnitude if fifth waves is notoriously difficult to predict. Sometimes they top out before even reaching a new high. But if they make new highs, they usually do not exceed the magnitude of Wave I by a large margin.

Wave I, in this case, would be the rally from June 2016 – Aug 2016. If the current rally were to be comparable on a point basis, the projected top would be at 6250 on the NDX. On a percentage basis, the projected top would be 6427 on the NDX. This target range is indicated by the rectangle on the chart above.

But as I said above, the top could occur at any time.

After the top occurs, I expect an Intermediate Wave IV drop of 7-10% to match the Intermediate Wave II drop during April – June 2016. This drop would be followed by a final push to new highs to complete the bull market that began in 2009.

New Rally or H&S (9/1/2017)

ndx 9-1-2017

On Friday, Sept 1, the NASDAQ-100 briefly made a new intraday high. Short-term, I perceive the outlook to be unclear. On one hand, from an Elliott Wave perspective, the current rally that began on 8/21 could be evolving into Subwave 3 of the rally off the 7/2 low. However, before getting confident about that I need to wait and see if a head-and-shoulders is forming, with the left-shoulder on 7/27, and the head imminent.

Update (8-15-2017)

ndx 8-15-17

It is looking like the rally that I anticipated in my July 8 post has completed on the NDX. The market has been going sideways for about three weeks now. Although it is possible that the rally from the July 5 low could evolve into a five wave pattern (with the current sideways period being subwave-2), I find that unlikely given that the overarching five-wave sequence from the June 2016 Brexit low had a very long third wave, and a short fifth-wave would be expected to follow.

Also, the U.S. stock market is due for a major top in the Nov-Dec timeframe based on the Ascending Middle Section that I have been tracking since 2014. Between now and then, to fit the Elliott Wave pattern from the Feb 2016 lows we need a drop of 5-10% to match the Apr-June 2016 decline, followed by a final rally to new highs. To meet the timeline, the correction needs to get going in a meaningful way soon.

Rally about to resume? (6/8/2017)

NDX 7-8-2017

Thus far, the drop from the June 9 high on the NASDAQ-100 has been 5.2%. This is very close to the pre-election drop of 5.4% last year [shown on the chart as (1) – (2)]. Thus, a bottom could form any time now. Even if we get more downside from here, I expect the current drop to end up being milder than the 9% correction in Apr – June 2016.

Once the rally resumes, we should get a push to new highs to complete the extended 3rd wave that began from the Brexit low of June 2016.