Yeah. Yeah. Yeah. If You Listen To The Pundits And Talking Heads, You Would Think We Are On The Verge Of Another Great Depression...Are We?

The S&P has been on a serious roll for the past 10 years pretty much heading more or less straight up and up and up. And during these past 10 years, there has been PLENTY Of times where these so-called “experts” were screaming at one point or another that the party was about to end and the market was going to crash. 

In fact. most recently, just last year in October when the market “crashed” and dropped 600+ points in 2 months! If you were to look back at the headlines and news stories back then, you could probably find many of the same things being said then that are being said now. 

You might think that by what I’m saying that I don’t agree. And frankly, I don’t….just not yet! The headlines may be screaming to SELL! But I am not. Not yet. Read on and find out why and what I am looking for to indicate that it’s time to SELL! 

Signs Of The Apocalypse?

Lately, one of the terms that may or may not be new to you that unless you have been hiding in a closet somewhere is the phrase “Inverted Yield Curve”. Some of you maybe familiar with this term and some of you may not. So let me do a little explaining here if you have not Googled it yourself already.

The simplest explanation is that the return rate for long term bonds is lower than that for the short term bonds. Usually the comparison is between 2 and 10 year bonds. Normally, 10 year bonds have higher yield because there are less investors buying long term bonds vs. short term bonds. They need to offer a higher rate in order to attract investors to buy them. So in an inverted yield curve, what happens is that investors are flocking to buy the longer term bonds seeking long term stability to ride out the short term volatility and in anticipation of a Fed rate cut(s) to come. That is what the Fed’s usual response is to stave off a downturn in the economy and of course, Trump who knows nothing about economics and how the economy really works is demanding the Fed cut rates because he thinks that will juice the economy (Hint: it won’t).  So when you have high demand for the long term bonds, the interest rate yield on them gets lowered. That is the basics of an inverted yield curve. 

Now the question is what does it all mean and how does it affect the economy? And of course, how do we survive it or better yet, take advantage of it?

So What Does The “Inverted Yield Curve” Mean To The Economy?

The short answer? Not sure. There is not any definitive answer to that question. But the general answer is that it foretells an economic downturn. That might sound ominous but the reality is that not all economic downturns are created equal. The bad news is that there are several times in the past that this rare event of an inverted yield curve has been followed by a serious recession and market crashes. 

However, it’s also important to know that whatever economic disaster follows, it usually does not happen right away. The average time before anything serious happens has usually been about 14 months. But that is just an average. Who really knows when it can happen? In the current political climate where Trump can fire off some tweet at any time that could roil the markets, it could happen anytime. 

 

 

Inverted Yield Curve Historical

In the chart above, you can see how following each inverted yield curve event, the markets tanked. But not until sometime later. In Feb, 2000, it wasn’t until 7 months later in September that the markets began to crash. In June, 2006, after the IYC event, it wasn’t until more than a year later in November, 2007 that the markets began to crash. But crash they did. Now the IYC event just happened in December 2018, the yield curve briefly inverted and the result was a small correction to the markets. But what if that IYC event in December was just a warning? 

Because less than 8 months later after that December IYC, it just happened again. Or is it just that the December IYC was the one that is going to send the markets down?

Let’s look at some other factors and see what else we can see that might give us some clues.

The World Is Burning!

There has always been world events that has caused complications. Such as the ongoing Middle East situation between Israel and Palestinians. But ever since Trump got elected and started implementing his misguided policies. Maybe this is just my opinion but he’s basically set a match to the world setting it on fire. 

Here’s just some of the current events that are contributing to the what could be a global recession:

  • The China-USA trade war
  • Iranian threatening to severely hamper trade ships crossing the Straight Of Hormuz
  • The ongoing Brexit saga and the recent election of Boris Johnson – a Trump clone
  • North Korea again firing missiles in defiance of world’s condemnation
  • Trump administration having moved the US Embassy to Jeruselum thereby killing any possibility of Middle East peace
  • Trump administration abandoning the Iran Peace Accords setting in motion current Iranian aggression
  • USA recently agreeing to sale of F-35 fighter jets to Taiwan adding more fuel to the fire in the long simmering China-Taiwan relations
  • The ongoing Hong Kong protests that is challenging China’s authority in the region
  • The reignition of the very volatile conflict between India and Pakistan over Kashmir
  • The continuing wars in Syria, Afghanistan and Yemen. 

and there are just so many more world conflicts happening right now that it is hard to imagine a more volatile and uncertain world we live in now.

Why do I point this out? When it times of extreme uncertainty like the times we now live in, investors tend to remove their money from high risk investments like stocks and move them into “safe haven” investments like Gold and Bonds. And there are TRILLIONS of dollars flowing out of stocks and moving into those “safe investment” vehicles. When this happens, that accelerates the global economic slowdown as there is now much less liquidity in the markets and far less people willing to risk their money in them. When money dries up, so does the economic engines.

Let's Get Down To The Nitty-Gritty, Shall We?

If you have come to my site to read about my thoughts on the markets, then I must assume you are not here to read regurgitated news stories from the “fundamental” pundits, right? For you do know that first and foremost, I rely on Technical Analysis to do my charting. You aren’t here to hear me chat on and on about the news, right? 

Well, the reason I at least wanted to touch base on the news that is out there now is to ENHANCE the techinical analysis side of things and not contradict it. Analysis does not need to be either Fundamental or Technical but can involve a little of both. But of course, me being a TA trader, I use a heavy dose of TA. So that is what you are expecting, right? OK! So here we go….

Take a look at this historical chart of the S&P 500. This shows prices as far back as they have been tracking them. First thing you will notice is that prices ever since the stock market has been tracked have more or less just gone straight up with dips coming along the way. This is what should be expected as the price of things always rises. This is also why investment advisors always say to not panic and just leave your money in the markets (as long as you are well diversified) because no matter the dip, the market over time always comes back and goes higher. Well, at least that is the theory anyway. No one knows for sure if that will always be the case. 

But that isn’t why I’m showing you this chart. Take a closer look at the 2 points that I have highlighted. What do you notice about them? I have drawn long term trend lines under prices that define the 2 clear trends that the S&P has had and is in. What you will see is that in the years just before the Great Depression in 1929-1933, prices pulled away from the trend line and accelerated upwards right before that MAJOR crash. 

If you are familiar with price action analysis, this kind of price movement is typical. In a long trend (bear or bull), you will see at some point that prices will accelerate and pull away from the major trend line just before a MAJOR correction or market reversal. 

S&P Historical Chart - 2 Important Points
S&P Historical Chart showing 2 important points where prices pull away from the Trend Line

In a long trend (bear or bull), you will see at some point that prices will accelerate and pull away from the major trend line just before a MAJOR correction or market reversal. 

Without any indicators or anything, when you see this happen, that is a clear indication that the market is becoming overheated. In price action analytics, this kind of price action defines a clear overenthusiastic public. In this case a overenthusiastic BUYING public. That acceleration peak leading up to the 1929 Crash was a break out from a very long sideways market movement and something triggered a buying frenzy. It peaked in 1928-29 and the bottom just fell out from under leading into the Great Depression. 

I’m not here to give a history lesson although without learning from history, we cannot profit from it.

The point I’m trying to make here is that if you follow the logic, you will see in the more recent history that prices are again doing the same thing….pulling away from the main trend line and accelerating up away from it. If history is to repeat itself, then at some point, we are going to see another MAJOR CRASH! And soon! But the big question is…how soon is soon? That no one can say for sure. 

All we can say for sure is that the circumstances for that to happen are present again. 

Wave Analysis

It is quite easy to say that this entire historical trend from the very beginning is one big impulse wave. In fact, it’s quite easy to markup this wave based on that theory. And yes, its only theoretical as we can only base wave counts on what we can see. The complication comes in when you take into account that we do not ever expect that in the stock market at least and historically speaking, it will ever reverse itself and come down but instead always go up with only corrections along the way. Well, that isn’t how wave counting works, is it? In wave analysis, you cannot only ever have one long impulse wave. But at this point in time, there isn’t anyway for us to know if it will ever just continue higher or will there be some kind of MAJOR market reversal and not just a correction along the way of this impulse wave. 

But having said that, let’s take a look at a possible wave count and see what it might tell us about the near future and what MIGHT happen soon….

This chart below was given out on January 6th of this year where I was predicting that prices were still rising in the wave 5 of (3) and that for the next few months at least, we would still see higher prices.

Here’s what I had to say about it back then:

This update on the SPX is showing that I don't believe that the MAJOR wave (3) this has been in for decades is over yet. Which means that whatever is happening at the current time is all still part of the overall wave (3). In fact, it should be part of the wave 5 of that (3). So any correction is within the wave 5.

- January 6th, 2019
S&P Impulsive Wave Count Historical Chart

From the time I posted that chart 8 months ago till now, prices have indeed gone higher and reached 3000. In fact, even briefly surpassing 3000. That would be a net gain of +500 points if you had bought at the beginning of the year! 

A Closer Look

History lessons are great but they are of no use unless we can apply what we’ve learned to help us in the here and now. So let’s start taking a closer look at what history might tell us about the now.

Below you will see the most recent monthly chart of the S&P 500. In this chart, I’ve marked up what I believe could be the operative wave count that also is based from my wave count on the historical chart above.

The above chart focuses in on what is probably the ending of a wave (3). From the chart above, you can see as in the historical chart where I have the waves (blue) 3 and 4 marked and ended. And that currently, the S&P is in the wave 5 of the MAJOR wave (3)(highlighted) and that wave (3) has not yet ended. Since this is a monthly long term chart, that would mean this wave (3) has still got more years to go before it does end. 

But if we focus in even more to where prices currently are, you can see where I have the smaller (blue) wave 3 marked at the current highs and that by my wave count, it is very near to ending. But even that wave 3 is only part of the larger (red) wave (3) which is still not ended. 

So to summarize simply, prices are STILL in the wave red (3) of the MAJOR wave (yellow highlight) (3). So no. in the long term, the S&P is still VERY, VERY BULLISH! 

If we accept that that is the right wave counts, then we should NOT be expecting any MAJOR downturn anytime soon. Sure, we may get a pull back but it should only be a minor pull back before it heads even higher. But keep in mind that what I am referring to here is the MONTHLY LONG TERM outlook. So any short term pull back could still be hundreds of points and could last some months/years.

Wave 3's - A Wonder To Behold!

Any student of Elliott Wave Theory will know Robert Prechter’s statement:

"Third waves are wonders to behold. They are strong and broad, and the trend at this point is unmistakable. Increasingly favorable fundamentals enter the picture as confidence returns... AND: "It follows, of course, that the third wave of a third wave and so on will be the most volatile point of strength in any wave sequence. Such points invariably produce breakouts... and runaway price movement."

- Robert Prechter

The following chart is a closer up look at the smaller wave 3 of the (red) wave (3). Look at it and behold its wonder! And unless you were invested for the LONG TERM, you are probably thinking “Damn! I wish I had gotten in from the start of that!” Trust me, you are not the alone in that wish! 

I think when Mr. Prechter made that statement, this is what he was referring to! But wait….the way I see this, this “wave 3” was or is only the wave 3 of a larger (3) and that larger (3) is the wave (3) of the MAJOR wave (3)! If that is right, then this up trend still has a LONG WAY to go! 

But if you go back up above and look at that historical chart that I posted on January 6th and read what I wrote about it then, you’ll also see where I said that any “correction would be within the wave 5”. The correction that I was referring to would be the wave 4 that follows the wave 3 completion.

But let’s not get ahead of ourselves. First, let’s see what reasons there are to believe that this wave 3 is coming to an end.

Why We May See The Wave 3 End Sooner Than Later

If you have been trading for any length of time, then you would’ve heard the phrase “Catching a falling knife”. Or more like “DON’T catch a falling knife!”. If you don’t know or forgot, then let me remind you because this is just SO important to being successful in trading its worth repeating. 

That phrase refers to trying to catch the tops and/or bottoms of trends. This is an especially a BAD thing to do when it comes to a wave 3. However, there are clues to when a trend is ending or has ended. 

Looking back at that chart above, you will also see that within that wave 3, there are also 5 waves and that prices are now in the wave (V) of 3. And if you look closer, it is also in the wave V of the (V) of that wave 3. At least that is how I have broken down the waves. Am I right? Only time can tell for sure. But look closely at where I have the wave 3 ending and you will notice a formation that is commonly seen when strong trends are coming to an end. It’s called an “Ending Diagonal” or an “ED”.  As is appropriate, they appear in wave 5’s. 

Take a look at this chart below. This is a Daily chart of the S&P 500. In this time frame we can better zoom in on the wave V of the larger (V) of that wave 3. It is that wave V that we must focus on that wave. 

S&P 500: Possible Ending Diagonal Wave V

Keep in mind that what you see in my chart above is only 1 of several possible scenarios. I am showing this one as I believe this is the most likely outcome. 

As I mentioned above, endings to strong impulse waves very often end with a pattern formation like an ending diagonal. Why? Because there is usually a pitched battle between sellers who think that the market is completely oversold and ripe for the picking and buyers who think that the market should continue in the trend and are buying every dip. 

In any case, when you do see an ending diagonal (ED), that is almost a sure sign that the trend is ending. And if that is what we get here in the possible wave 3 ending of the S&P 500’s long year’s long bull run, then expect that there will be a market correction soon.

Alternative (ALT) Scenarios

If you are serious about your trading, you should always have “alternative” scenarios prepared just in case you are wrong about what is to happen. You don’t want to be caught with your pants down. Another benefit of having ALT scenarios prepared is that you won’t get too “married” to your main scenario and can be prepared to change on a dime in the case that prices DO NOT go with your main scenario. The difference between success and failure is preparation. Only the prepared get “lucky”. 

NEVER sell yourself on your main scenario. Always be prepared to admit you are wrong and to go with the ALT scenario. With that being said, here are some of my ALT scenarios that I have developed.

ALT Bearish Scenario – The wave 3 is DONE! 

S&P 500 Alternative Bearish Scenario #1 – Wave 3 has already ended

This was actually my main scenario as late as last week. But upon further re-analysis, I went with the ED scenario and put this one on the back burner. 

Under this scenario, the wave 3 has to have ended and prices are going to drop after a retest of the wave 3 high. Confirmation of this scenario would be prices definitively breaking that minor red tl below prices. But also take note that at this moment, that minor tl is not anchored and could change. Obviously, if the wave 3 high is broken, then this scenario is no longer valid.

ALT Bullish Scenario – Wave 3 is NOT DONE and the wave (v) is just beginning.

S&P 500 ALT Bullish Scenario – Wave 3 is NOT DONE. Wave (v) just starting.

In this S&P 500 scenario, the main wave 3 is NOT completed and in fact, the ending wave (v) of the V of the larger wave (V) is just beginning. That would mean that prices are actually heading even higher and will be making several new highs along the way.  A possible target would be the 1.618 wave (iii) fib extension around the 3388 level.

A break of the current highs would trigger this scenario although it would still be an ALT scenario to the main ED scenario that I am currently following.

Summary

From fundamental reasons to the technical charting reasons, I do expect that there will be a market correction coming. But this market correction in the larger scheme of things would be just a “minor recession” and not a full-blown market crash…if dropping 500-600 points in the S&P 500 index would be considered “minor”.

That inverted yield curve that happened in December cannot be ignored or written off as an anomaly. History tells us that. It is a rare phenomenon that is a warning that “something” is going to happen. What and when are not clear. 

My main wave count shows that the years long impulse wave is coming to an end. How it ends and when it ends is also not clear. But it is. And we should prepare for that.

1 Comment
  1. Aley Ali 3 months ago

    Astonishing explained to the bits.. Really thankful to you.. Pls keep up the good work.. Always stay blessed.. Thanks again..

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