ABANDON ALL HOPE,THE CRASH IS COMINGTHE EXPERT’S VIEWElliot Wave...

ABANDON ALL HOPE,
THE CRASH IS COMING
THE EXPERT’S VIEW

Elliot Wave Theory has become one of the
cornerstones of analysis for those who believe
they can predict with some degree of
accuracy where a stock market is going next
Just when you thought it was safe to go back in the water, having ridden out at least some form
of equity market correction that was deemed to be necessary, it would seem you are about to be
swamped by an enormous Elliot wave. At a time of tsunamis and hurricanes, this might prove to be
a wave like no other.
Ralph Nelson Elliot was born in Kansas in 1871 and became an accountant and esteemed expert
in restaurant management. Around 1929 Elliot fell quite ill, and it was during his convalescence that
his attentions turned to the stock market. In 1929 the stock market was big news.
By 1934, Elliot had developed what is now known as Elliot Wave Theory, an observation that the
stock market tended to move in an eight wave pattern (five up, three down) that repeated itself in
both short term and long term time frames. By the time of his death in 1948, he had managed to
attract a small school of investment disciples. He died a pauper.
Since his death, Elliot Wave Theory has become one of the cornerstones of analysis for those who
believe they can predict with some degree of accuracy where a stock market is going next, based
entirely on replicating patterns. To many chartists, he is The Man.
Robert R. Prechter began his professional career in 1975 with the Merrill Lynch Market Analysis
Department in New York. He has been publishing The Elliott Wave Theorist, a monthly forecasting
publication, since 1979. Prechter has won numerous awards for market timing, including the United
States Trading Championship, and in 1989 was awarded the “Guru of the Decade’’ title by Financial
News Network (now CNBC). He has been named “one of the premier timers in stock market history”
by Timer Digest, “the champion market forecaster” by Fortune magazine, “the world leader in Elliott
Wave interpretation” by The Securities Institute, and “the nation’s foremost proponent of the Elliott
Wave method of forecasting” by The New York Times.
In more recent times, Prechter’s star has dimmed somewhat while Elliot Wave Theory has been
out of the limelight. Nevertheless, he is still considered a guru amongst the true believers, and in
publishing his weekly newsletter he gives due consideration to fundamental issues, alongside the
chicken entrails.
In the course of 2005, Prechter has begun to make a rather big call - one that might not even seem
quite possible. The following is a brief summation of where Prechter sees the stock market (specifi cally
the Dow Jones index) heading from here, and why. While reading, consider that this writer once
worked in a respected broking establishment where the firm’s chartist one day proudly declared that
his analysis had become so accurate he could now pick the market with 50% certainty.
In January 2004, Prechter made the case that the stock market since 2000 was tracing out a path
similar to that of 1937, but at a much slower pace. In March, 2005, he noted that a projection of the
pattern put the market top on February 28, and this was significant as it was February 28 that the new bull market commenced in 1978.
March 4, 2005 fell in the same week as February 28, so making acceptable allowances Prechter is
happy that March 4 was a turning point, and that whereas a new bull market commenced in 1978, a
new bear market is commencing in 2005. As yet, the March 4 level of 10,941 for the Dow Jones is
still the high (on a closing price basis – the intraday high of 11,027 occurred on the next trading day,
March 7, but the close was 10,937) in this particular bull run.
Adding weight to Prechter’s analysis is that Fibonacci time durations also indicate a major high
occurring in that same week. Fibonacci is another chartists’ pin-up boy – an eleventh century Italian
mathematician who identifi ed a recurring theme in nature which is now known as the Fibonacci
sequence.
Returning to the 1937 analogy, Prechter notes the wave 2/wave 1 ratio occurring in 1937 is 60.6%,
while the same ratio across the expanded replication of 2003-05 is 62.8%. Not only are these
numbers close, but they are also
close to the magic Fibonacci ratio
of 61.8%. More ominously, the price
retracements over the respective
periods are 82.5% in 1937 and 82.4%
in 2003-05.
On the assumption that this
replication plays out, Prechter
predicts the down-wave pattern will
end after wave 3 (the biggest in the
pattern) completes on March 29-31,
2007. As March 31 is a Saturday, he
has reined it into March 29-30.
The theory suggests that the Dow
Jones will fall by 76.6% over this
period, hitting 2,550.
Yes, I know.
In his newsletter of last fortnight,
Prechter said “The stock market is
behaving nicely. Expect brief, sharp
rallies along the way, but don’t
mistake the major trend. It’s a bear market.”
Prechter has now taken to using the word “crash” and suggests it’s not a word he uses lightly. All
the elements, says Prechter, are there: (1) unprecedented optimism, both in extremity and duration,
despite the major averages being below their all-time highs (2001) for fi ve years; (2) excellent
Fibonacci price and time relationships; (3) completed wave-forms for the 2003-05 rally; (4) a reversal
in the previously strong utilities and secondary indices, which are now leading the market down; and
(5) a recent expansion in downside breadth.
Says Prechter: “It’s a recipe with no missing ingredients”.
And it gets worse. Prechter notes there is a group of strategists in the US dubbed the “super bulls”
who are tipping an upside breakout of the Dow Jones, setting 40,000 as a target. Prechter and
followers are tipping “a hurricane – a fi nancial and economic storm that will dwarf all others in
modern history”, the basis for which is 300 years worth of data. Prechter thinks the super bulls are
out by at least a zero, and “if history allows the Dow to fulfi l its normal Elliot wave destiny”, two zeros.
(Did I mention down-wave number 5?).
Prechter notes fi rst waves under the Wave Principle are “surprises”, but third waves are waves of
“recognition”. Thus wave 1 down in 2000-03 surprised investors, fulfi lling its role. Wave 2 ended
this March, and wave 3 is beginning to gather steam. This, says Prechter, should be the recognition
wave in which investors realise that their old belief in a perpetual boom was wrong.
It is at this point Prechter provides what he considers fundamental reasons why the “crash” theory
is perfectly tenable. If the charts can predict a pattern, then one would presume fundamentals are
irrelevant, or even specious. However, here goes.
The fi nancial and economic worlds have been falling apart while the market has held up, says
Prechter. Manufacturing is collapsing in the US, American companies no longer boast AAA debt, and
government corporate and personal debt is at absurd levels.
Outside of government spending on such things as retirement and health benefi ts, Iraq, the War on
Terror and New Orleans (all of which Prechter sees as beyond “fantasy”), the other powder keg is
US real estate prices, which Prechter notes have begun to turn. So leveraged are US banks to the
property market, Prechter suggests even the slightest of pullbacks will lead to an unprecedented
spiral of evictions, property sales and bank failures.
In fact, says Prechter, the US is already bankrupt and poverty-stricken, it’s just that it hasn’t yet
become a matter of record.
Combining Prechter’s technical and fundamental views, his stance is best summed up by his
exhortation that “Short sellers are set to reap the rewards of a unique opportunity – never has a
recorded stock market had so far down to fall”.
I hope the planets aren’t about to align as well.