Correction Could Begin Any Day Now (2/9/2017)

I have identified three pieces of technical evidence suggesting an imminent top in the U.S. stock market, based on the NASDAQ-100’s chart shown below.

ndx-feb-9-2017

The Three Peaks and a Domed House pattern that I have been tracking is labeled in orange. The rising part of the pattern can be considered complete now as it seems to have fulfilled all necessary points. The only contrast from the idealized pattern is the rather compressed form of Points 15-20. However, looking at that segment closely, it still has the right number of ups and downs.

After the top of the domed house, the market typically returns to the Point 10 low. In the current instance, that would entail a drop of about 11%.

On the chart above, I also have an Elliott Wave pattern labeled in magenta and white. There is a clear five-wave pattern from the February 2016 low to the present. I think these are minor degree waves forming the first intermediate wave of the bull market’s Primary Wave 5.

But aside from specific technical patterns, the overall appearance of the chart above suggests that the current rally is vulnerable. Compare the previous two rallies (Feb – Apr 2016 and Jun – Aug 2016) with the present one that’s been underway since November. The current rally has lasted one month longer than the two previous ones, but falls short on both point and percentage gains. Additionally, the current rally has been much choppier. This sort of broadening upside suggests that the rally’s ability to absorb news shocks is fading.

At this point, any economic news that comes in below expectations, or further escalation of political conflict, could serve as a catalyst for a 10% correction.

 

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Domed House – One More High Coming? (2/1/2017)

ndx-tpdh-jan-31-2017

Right now, it looks as if the recent drop is forming Points 21-22 in the Three Peaks Domed House pattern I’ve been tracking. If that is the case, I would expect the NDX make a slight new high before the correction begins.

That said, the Three Peaks Domed House pattern is famous for deviations from the idealized form. Thus, I would not be hugely surprised if the domed house has already topped out.

Typically, after the domed house tops out, the market falls all the way back to the Point 10 low. In this case, that means the NDX would fall to 4647, constituting a ~10% correction.

This is a very strong prospective instance of TPDH (it fits the pattern’s criteria just as well as the one the Dow completed during 2014-15.).

Top Potentially Imminent

Here is another update to the Three Peaks Domed House pattern I have been tracking on the NASDAQ-100.

ndx-tpdh-jan-14-2017

I am not sure whether the intraday drop on Jan. 12 fulfilled points 21-22. But if it did, then the top of this pattern could be imminent.

Another thing worth noting is that the “five reversals” (Pts 15-20) were rather compressed. That is why the pattern is progressing faster than I previously anticipated. But given the height of the rally from the Dec. 30 low (and the quick reversal of the Jan. 12 decline), I find it most reasonable to say that the five reversals are complete.

Domed House Update (12/11/2016)

Recent activity on the NASDAQ-100 provides further evidence that the index is in a Three Peaks and a Domed House pattern. ndx-tpdh-dec-11-2016

We have now had two successful retests of the pre-election low (Pts 12 and 14 on the chart). It looks like the NDX is on track to hit the top of the pattern in late-February. That top would be followed by a return to the Nov. 2016 low, which would probably involve a drop of at least 10%.

Reconsidering NDX Wave Count / Three Peaks Domed House (11/23/2016)

In my last post on Elliott Wave, I suggested that the Nov. 4 low might have been completed an Intermediate Wave 2 decline within a Primary 5th Wave that began in February. But after staring at the charts some more, that count on the NDX just doesn’t look quite right.

ndx-questionable-wave-count

The drop from Oct 10/25 – Nov 4 just looks too shallow to be an Intermediate Wave 2. Given that the Dow and S&P are in a strong rally to new highs, I find it unlikely that the NDX will reverse downward and break the Nov. 4 low without having made new highs.

Thus, I now think a better wave count would be to label the whole period sideways period from August-November as a minor degree 4th Wave, as shown on this chart:

ndx-oct-22-2016

There also appears to be a George Lindsay pattern, Three Peaks and a Domed House, underway on the NDX.

ndx-tpdh-nov-23-2016

This is the strongest prospective TPDH that I have seen since the large-scale instance that took place on the Dow during 2014-15. Typically, the duration between Point 14 and the top of the house is roughly equal to the duration which the three peaks spanned. In the current instance, Points 3-7 spanned about two months, suggesting that the pattern will top out in early-mid January 2017.

A scenario in which the market drifts higher in December and then tops out in January would fit a seasonal pattern which has been rather prominent in recent years.

But now I should address the burning question of whether a January top would mark the end of the bull market. As you may already know, I am tracking another George Lindsay pattern, Counts from the Middle Section, on the Dow Industrials index. I last described it in detail in a post from September, but to summarize, I have two interpretations of the pattern which give different projections for the bull market top. One scenario projects a top in January 2017, and the other projects a top in Nov-Dec 2017.

I still favor the count in which the bull market continues through most or all of 2017. My view is that, in the current environment of low interest rates and bearish/anxious public sentiment, the only thing which could trigger a bear market is an outright economic recession. However, I think that the election outcome has greatly reduced the risk of a recession next year.

For reasons I described in my election commentary, I expect the Trump administration, in conjunction with the GOP-controlled Congress, to implement a fiscal policy that will boost economic growth. Although the growth acceleration could take more than a year to take off, the stock market is forward-looking, and if Trump keeps lower corporate tax rates and a more business-friendly regulatory environment in his agenda discussions, the market is likely to trend higher. It may be a volatile rise though, given the uncertainty regarding how some elements of Trump’s agenda will play out (similar to how, during Obama’s first year, the stock market exhibited sharp short-term reactions to all of his major policy proposals, even though the market trended higher).

 

 

 

 

Elliott Wave Update (11/10/2016, 2:00 AM)

It looks as if the NASDAQ-100 entered an intermediate degree Wave-2 decline in October, a scenario I described in this post. Whether the Nov. 4 low marked the bottom is highly debatable. Precedent from this bull market’s history suggests that the Nov. 4 low will be broken given that thus far, the NDX has only had a peak to trough decline of 5%, and the previous declines since 2009 that I have labeled as intermediate Wave 2’s ranged from 8 – 13% (June-July 2009, Aug 2010, Apr – June 2012, Sept – Oct 2015).

However, if you count the post-election futures plunge, the NDX had a drop of 7% since the October highs, which is close to the target range. So, that could have completed the correction, although it is also possible that the futures low represented a support level that will eventually have to be hit in the actual index.

But regardless of what happens short term, I expect the NDX to rally to at least 5500 by Q3 2017 as a powerful 3rd wave kicks in.

 

My Commentary on the U.S. Presidential Election

From an economic perspective, the last eight years have been rather ambiguous. Although the U.S. economy has been growing overall since 2009, GDP growth has not had sustained movement above 3%, the level which historically represented the long-run growth rate. Unemployment has declined from its recession peak amid moderate job growth; however, there are many signs that the economy has not yet returned to full employment, despite an economic recovery that has lasted a longer-than-average duration of seven years.

A wide range of issues have been cited as contributing to the weak growth rates, including tax rates, government debt, companies moving manufacturing overseas, and computerization of labor that has shifted skills in demand. I think that all of these factors have had a meaningful impact; however, considering the structure of the government, I consider fiscal policy to be the aspect of the economy for which the president has the most influence.

However, I do not see fiscal policy, consisting of tax rates and government spending, to be the primary driver of economic cycles. I see economic cycles as fundamentally driven by monetary policy, through the Federal Reserve’s influence on interest rates. Thus, fiscal policy affects the magnitude of economic activity rather than the direction of economic activity.

I perceive that this relationship between fiscal policy and monetary policy has been clearer over the past eight years than it has been at any other time in modern history. Because inflation has been very low, the Fed has been able to keep interest rates close to zero. This makes it virtually impossible for the economy to go back into recession. The fed funds rate has been below 1% since 2008. Under normal circumstances, if the rate were kept that low for several years, the economy would grow gangbusters briefly, and then inflation would rise through the roof.

But why has that not happened? I believe it is because the government’s fiscal policy has put a major damper on economic growth. Current tax rates are inhibiting domestic hiring and business expansion, but the continual threat of a crisis from the national debt load has made it difficult to cut taxes without massive cuts to government spending.

I do not think that either Hillary Clinton or Donald Trump has a fiscal plan that would reduce the debt load in the near term.  In fact, regarding the next two to three years, I may even concur with the analysts who say that Trump’s plan would cause a greater debt increase than Clinton’s plan, due to Trump’s unusual proposal of simultaneously cutting taxes and increasing infrastructure spending.

However, I am not averse to increasing the debt short-term as long as economic growth accelerates. The reason I say this is that stronger growth would enable the Federal Reserve to raise interest rates, which would strengthen the U.S. Dollar. A strengthening dollar would keep U.S. bonds attractive on the debt market, helping to prevent a situation in which creditors suddenly demand their money back and the U.S. is forced to default.

Many people are angry at the Fed for keeping interest rates low. They think that the low interest rate policy is a scheme to inflate the stock market and make rich investors even wealthier. Although I think the Fed could have started tightening rates a bit earlier, the bigger picture is that low interest rates are the only reason the economy has stayed afloat in the current fiscal environment. Without the support from loose monetary policy, the current fiscal policy would have put the economy back into a severe recession. Without monetary support, unemployment could have risen to a reported rate of 15-20%, with actual levels even higher. This is what has happened in some Eurozone countries which have high tax rates but no independent central bank to create an accommodative monetary policy.

Thus, I think that some of the frustration with the Fed is misdirected. I understand that there are consequences to keeping interest rates low forever. However, to raise interest rates substantially without detrimental effects, stronger economic growth and job creation need to be generated. That is why I am not opposed to a fiscal policy that cuts taxes even if it causes debt to rise in the short term.

Once the economy accelerates, I would not necessarily be opposed to some of the policies that Democrats are advocating, such as expansion of programs to address socioeconomic inequality, or new environmental regulations. However, bigger government cannot solve problems such as climate change and the shrinking middle class with an economic backdrop of 1% GDP. But if economic growth accelerates, more people will be working, wages will rise, and as a result, the government will bring in more tax revenue, which will enable them to fund programs to address various issues without major tax hikes.

Since this blog is focused on financial markets and economics, I don’t want to detour into subjects that are too far out of scope to address thoroughly. However, I should mention that I do not agree with all the ideas Trump has proposed on immigration and foreign policy. But at the same time, I do not see Trump as promoting the “us vs. them” mentality that progressives are accusing him of. I consider Trump’s worldview to be focused on American competence rather than American dominance. From what I see, he is not an imperialist who believes America has a mandate to impose its influence across the world and purify its culture domestically. Instead, he appears to simply focus on making the U.S. more proactive in its domestic and international affairs.

As everyone knows, there is a lot of controversy surrounding both major candidates involving matters from their pasts. I do not have a firm basis to say that the accusations directed at one candidate are more serious, or more truthful, than those facing the other. Thus, I have decided to vote as a pragmatist rather than an idealist. The question becomes, does one candidate come out substantially better than the other when the potential benefits and risks are weighed out?

I consider that analysis to favor Trump. I see Trump’s fiscal policy as considerably more in line with what the economy needs right now. The risks associated with his proposals on other issues are mitigated by his worldview which I mentioned earlier, as well as the government’s system of checks and balances. Thus, when weighing potential risks and benefits, I consider the balance to be in Trump’s favor sufficiently enough for me to vote for him in this election.