Trader’s Narrative

By Nico Isaac

In recent months, Elliott Wave International President Bob Prechter has become something of a household name. In the final two days of August 2009 alone, Bob was mentioned by several news outlets from MarketWatch to the New York Times. The claim to his “fame” –

EWI was one of the only technical analysis firms to anticipate a sharp rally in U.S. stocks as they circled the drain of a 12-year low this spring, a feat made ever more exceptional considering the widespread image of Bob as being the ultimate “Big, Bad Bear.”

The lesson? Believe in the facts, not in the “widespread image.”

Bob Prechter has always said that successful forecasting should look to the current wave count (and various other technical measures) for direction. He has never permanently tied himself to the mast of definition — i.e. “bull” or “bear.”

For this reason, EWI’s team of analysts have been able to stay one step ahead of the biggest turning points in the Dow Jones Industrial Average, from the very start of the index’s historic 2007 reversal.

To wit: This two-year chart of the Dow incorporates several calls from our past publications as they coincided with the market’s most memorable peaks and troughs:

For more analysis from Robert Prechter, download a free 10-page July issue of Prechter’s Elliott Wave Theorist.

The chart above presents the abstract details of our past analysis. Here is the expanded version of those insights as they appeared in real-time:

July 17, 2007 The Elliott Wave Theorist:

“Aggressive speculators should return to a fully leveraged short position now. We may be early by a couple of weeks, but the market has traced out the minimum expected rise, and that’s enough to act on.”

Soon after, as the DJIA neared its own historic Oct. 11, 2007 apex, the Oct. 9 and 10 Short Term Update amped up the urgency of its analysis and wrote:

“Odds have increased that a market high is in place. The structure, coupled with turns in the other markets, suggests a top is in place. The potential, at the least, is four a large selloff… Watch Out! The market faces a stout correction.”

Before landing at its March 10, 2008 bottom, the March 5 Short Term Update afforded respect to a bullish alternate count and wrote: “Prices should carry above the wave a high before it ends.”

At its four-month high, the March 16 2008 Elliott Wave Theorist went on high, bearish alert and wrote: The DJIA is entering “Free Fall territory.”

One week before the U.S. stock market landed at its 12-year low of March 9, our Feb. 27, 2009 Short Term Update utilized a traditional turning pattern to outline a specific time window for the onset of a major upside reversal. In STU’s own words:

“By all indication, this pattern is back on track… the turn will come on or near March 10, 2009. Anywhere in this time period may mark a turn, which will obviously be a market low.”

Once the bullish winds of change had turned, the March 16 Short Term Update wrote:

“When the market speaks, it behooves us to listen. The implications of this are that the… major stock indexes are in the initial stages of a multi-month advance.”

Finally, the April 2009 Elliott Wave Financial Forecast calculated a specific target range for the Dow’s rally: the 9,000-10,000 level.

So, now that the upside objective is met, where are prices set to go next? For more analysis from Robert Prechter, download a free 10-page July issue of Prechter’s Elliott Wave Theorist.

Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter is the founder and CEO of Elliott Wave International, author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.

At the close last week, all major indices: Dow Jones Industrial, Standard & Poor’s 500, the Nasdaq and Russell 2000 - all closed at a new high for the year. And today, they again made new highs for the year (but closed lower).

The longevity of this rally is confounding both the bears and the bulls. That is if you can find a bull in this market.

One well respected market technician who has crossed over to the bull camp is Richard Dickson of Lowry Research who wrote today referring to last week’s market action:

There has been no evidence of deteriorating strength in each of the rally days this week, suggesting a continued healthy condition for the rally from the March low…

For more details on Lowry Research and their latest commentary, check out: Lowry Research’s intermediate trend buy signal.

Now that some time has passed I thought it would be opportune to reminisce about a chart that I brought to your attention as a musing of mine almost three months ago. It was a potential scenario that would have echoed the flag formation that we saw in the 2003 bear market low:

And here is what actually happened:

This is what I wrote when I featured the original chart:

Obviously what I’m showing is hypothetical - no one knows what is in store for us at the hard right edge of the chart. But I can’t help but project this potential formation onto the chart because of all the other similarities which we’ve seen so far between the two market periods. Although I didn’t foresee this rally coming and actually expect lower prices in the short term, I’m trying to keep an open mind because this rally has angered and confounded everyone. Just take a look at the recent comments here from readers!

Early July brought lower prices (eventually) and another, longer and more beautiful flag formation hugging the long term moving average. For me it wasn’t enough as I was expecting more of a correction. But what struck me most back then, as you can see from the quote above, was the lopsidedness of sentiment from most traders. I could scarcely find anyone who would publicly risk ridicule and criticism to be a bull. To some degree that is still the case today.

Apropos of nothing, if you haven’t listened to Leonard Cohen’s Hallelujah you don’t know what you’re missing.

Here is a recent note from David Rosenberg:

“Two historical factoids underscoring just how overbought this market really is:

Going back to 1950, not once has the S&P 500 managed to surge more than 40% in advance of the recession ending. I think mostly everyone would agree that while the recession may be in its final stages, it is not over just yet.

On average, the S&P 500 rallies 20% from the lows to the end of the recession. I realize that the comeback is that we hit an egregious low, but we always do in bear markets. I am just talking about what the ‘norm’ is, in terms of rallies that typify the late stage of the recession in the real economy. So, it would not be untoward to see a 20% correction just to mean revert this rally from the lows, assuming that this is all about hopes of the recession coming to an end. Yes, that would be 750-plus. As an aside, Sam Stovall from Standard & Poor’s stated in the Sunday NYT that 800 on the S&P index is an inevitable retest point.

Again, back to 1950, by the time the S&P 500 was up 42% from a bear market low (as is now the case), not only was the economy not in recession at that point, but it was typically nine months into recovery mode. So even if the consensus is correct that the recession ends by September, the market right now is trading where it would ordinarily be in May 2010. What are we going to do for an encore?”

If you’re not familiar with who Rosenberg is and why you should listen to him, check out this link (from there you can also sign up to receive his daily commentary for free).

Here’s this week’s walk through the sentimental landscape:

AAII
The retail investors, as measured by the weekly AAII survey are paring their new found bullishness. The bulls are down to 34% while the bears increased to 45% (each going in the opposite direction by 10% points from last week). Although this is an about face, it only takes us to sentiment territories we have occupied since late March.

Investors Intelligence
The newsletter editors on the other hand as sticking to their guns. According to ChartCraft, this week the II bulls are at 40.7% - almost unchanged from last week - while the bears were 29.1% - down slightly from last week.

ISEE Sentiment
Although we closed the week down, and Friday flat, the retail options traders, as measured by the ISE sentiment, were quiet ebullient. They spent the entire week see-sawing up and down then on Friday they bought twice as many calls as puts, putting the ISE sentiment index at an even 200 (equity only).

To get some perspective on this, see last week’s sentiment overview which showed a chart of the ISE index and a short term moving average. All in all, such optimism has easily tripped up the market in the past.

CBOE Put Call Ratio
We see the same nonchalant display from the option traders at the CBOE. The put call ratio (equity only) continues to drip lower, reaching for the uptrending channel that it has occupied for some time:

The 21 day simple moving average has been a good guide for timing the market with this indicator. Whenever it has fallen to similar depths, the market has had either a tough time or fallen precipitously. But, as you’ll notice, the CBOE put call ratio has been behaving rather bizarrely throughout this bear market.

The S&P 500 has managed to sustain an uptrend even as the put call ratio has fallen to levels which previously would have halted it in its tracks. Arguably, the market should have stopped going up sometime in April. Of course I mean that facetiously because I’m not about to tell the market what it should or should not do.

The Grey Beards
I keep track of a few ‘grey beards’ - investors who have lived through several bear and bull markets and have the scars to prove it. The 71 year old Steve Leuthold of Leuthold Weeden is one of them. He called the March bottom almost to the day! Click to watch the Bloomberg video here (from March 4th 2009).

Keep in mind that he runs a short fund aptly named Grizzley Short Fund. But he’s agnostic enough (and brilliant enought) to see opportunity when it presents itself. Since having changed his position, he now is considering adding to his longs - for details see this article (and video) from Bloomberg that I already showed you at news.tradersnarrative.com

Check out the latest Economist cover to your left. Can it be any clearer that we have a washout of negative sentiment and a significant bottom being put in here?

Of course, I’d love to see BusinessWeek do one of their infamous covers or a general magazine like Newsweek or Time but I don’t think what we are experiencing is of a magnitude to deserve such treatment. This is just an intermediate bottom, not a multi-decade or multi-year one.

In any case, it is amusing for me to see the Economist putting this cover out, especially as their recent Goldman Sachs cover was so useful. For contrarians that it.

When that cover was published, GS was trading around $160. It then proceeded to fall to almost $140 (and has just begun to rebound).