Sunday Edition: What Does EWT Portend For The S&P 500?

November 6, 2016

Sunday Edition: What Does EWT Portend For The S&P 500?

This Sunday Edition will conclude our series on the Elliott Wave Theory (EWT). I hope you have enjoyed reading them as a different perspective on the markets, and hope I haven’t confused you too much.

To wrap things up we are going to analyze the S&P 500 and see what the future holds for the major stock market indices – that is, according to EWT.

In past posts we have analyzed oil, grains, and gold, which all appear to be completing a long term A-B-C bear market correction.

The S&P 500, however, has been rising in a very strong fashion over the last 7 years in what appears to be a near perfect motive or impulse wave. It is this impulse wave that we will analyze in an attempt to determine when it might top out and start a long term A-B-C bear market correction.

As I have said before, picking a top is a losing game, much more so than picking a bottom, at least in my opinion. The best thing to do is to using trailing stops, tighten those stops further and further as the market makes new all-time highs and reduce positions sizes to increase cash balances. Then just let the tailwind of central bank easing and or tightening do the rest.

Even dismissing the Elliott Wave Theory, tightening stops and raising cash is just prudent investing behaviour after a 228% seven year bull market run.

In the chart below I first want to point out the near perfect A-B-C flat correction that began in 2000 with the dot com bust which forms the A leg, and the 2008 subprime panic which forms the C leg. The period in between constitutes the B leg. This entire correction forms a 9 year bear market that comprises a textbook A-B-C flat wave 4.

Since that wave 4 low, the S&P 500 has risen in a pretty clear 5 wave motive or impulse wave which I have labeled 1-5.


The big question is how high does this final wave 5 of a larger wave 5 go? Of course, no one knows the answer, and as I have said before, it is in trying to get too intricate and count every little wave that I think too many market technicians get hung up on and spend a bunch of fruitless effort.

However, for the record, I do not believe this wave 5 is near completion just yet, and will continue making new highs in the months that lie ahead. Maybe even rising to 2,400 – 2,500. But the upside is limited when compared to the downside risk.

When we step back and look at the big picture, what is clear is that we are nearing a top and we should be much more defensive since lower valuations and better buying days lie in the not too distant future.

The time to buy aggressively was back in March – September 2009 at the point of maximum pessimism and what appeared then to be, and is now confirmed, the end of a 9 year A-B-C bear market low, much like the lows we have pointed out over the last several weeks in oil, grains, and gold.

The next question you might be asking is, how far does the market fall before it finds its final low to the coming A-B-C correction, and how long might that correction take?

In an attempt to answer this last question, I will introduce you to two additional nuances of the Elliott Wave Theory.

  1. The larger the impulse wave, the larger the corresponding A-B-C correction and the longer it takes to complete. Since the top in the S&P 500 in 2000 appears to be a wave 3 top, with the 2000 – 2009 flat ABC correction being a wave 4 bottom, and the rise from that 2009 low a final wave 5, then the A-B-C correction which unfolds to correct this entire wave will be longer in duration than the 2000-2009 bear market (think Japan).
  2. As far as a maximum downside target for the final low of the coming correction, EWT posits that the A-B-C corrective low will not exceed the wave 4 low of one degree lower. I know this gets a little complicated, and I hope that makes sense, but I will spare getting into too much detail to try and clarify if it doesn’t. Suffice it to say that a wave 4 low of one degree lower would be the 2009 S&P 500 low of 667.75. I know that’s drastic, but that’s what the theory posits as the maximum low. However, the market doesn’t have to fall that low.

And remember, before that final low is reached, there will have been an A leg low followed by a very strong B wave bounce, stronger and longer in duration than the market rise between 2003 and 2007.

So there will be plenty of opportunities in the tough market days that lie ahead to create wealth. But it will require a much more active investing approach and keen stock picking, two things which have completely fallen out of vogue in favor of passive low fee investing, which seems to be all the rage right now. Just remember when an idea or belief becomes so ingrained in the mass psychology, it’s typically time for that particular idea or belief to be turned on its head.

Based on my market views and interpretation of the long term Elliott Wave pattern in the various markets we have covered, this would be my advice for investors:

  1. Look for solid low cost independent oil producers with lower debt levels that are profitable on a crude price per barrel of $45 and under. They must also pay a strong dividend with low risk of being cut. And you need to know that the capital appreciation on these companies may be slower over the next few years. But I think owning this sector offers some defensive protection against an otherwise very overvalued stock market.
  2. Look to put some capital to work in sectors that will benefit from rising grain and food prices such as fertilizers and other agricultural related companies. I believe the inflation trade has already begun and will build slowly before really accelerating. The agricultural sector is also defensive in nature with sizable capital appreciation opportunities over a 1-3 year time period and beyond.
  3. I believe you should be long high quality gold and silver mining companies, and the current pull back is offering investors who missed the January 2016 low and subsequent huge rise, a second chance. Again try and identify those companies that have all in sustaining costs (AISC) at $1,000 or lower or have taken measures that will reduce their AISC to less than $1,000 per ounce in the very near future. Also, make sure their balance sheet and or liquidity position is strong.
  4. And finally, on your core portfolio which is invested in the general stock market, know that whether viewed using technicals, fundamentals, or both, the stock market is very overvalued and the bull market is long in the tooth. Raise some cash, tighten your stops and hope for a blowoff top :).

Be Defensive,

Shane Rawlings
Co-Founder, Investiv