Trader’s Narrative

Guest post by Robert Folsom, senior writer for Elliott Wave International

The following text is courtesy of Elliott Wave International. Until Nov. 11, EWI is allowing non-subscribers to download their latest market analysis and forecasts for free, including Robert Prechter’s latest Elliott Wave Theorist and Steve Hochberg’s and Pete Kendall’s latest Elliott Wave Financial Forecast.

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As you read and look at this page, please know that the chart is the star of the show. My description will add only a few details.

The chart published less than two weeks ago in Bob Prechter’s Elliott Wave Theorist. The rectangular box is plain to see: It envelopes the huge S&P 500 rally that began last March — a gain of 61.5% and 430 points, as of Oct. 18.

But there’s a two-part truth to the rally — and that is what the box really shows.

Part one shows the “wall of worry” — basically March through August. That’s when the media and experts were overwhelmingly negative about stocks. They were surprised by the rally. Remember?

Part two shows the more recent time of “euphoria” — basically September and October. The media and experts turned positive. The market was all about “green shoots” and “recovery.”

You see when most of the rally unfolded. Six months of serious worry produces a 373-point climb, whereas “two months of euphoria produces only 57 S&P points.”

Now, the two-part truth about this rally is an easy story to tell. It’s literally a few lines and notations on a price chart. Yet have you seen or read ANYTHING like this in the past two weeks? Has anyone else pointed out that over the past two months, the stock market “rally” has in fact slowed to a crawl?

As you looked at the chart, perhaps you noticed that the decline, which began in 2007, and in turn the recent rally, are both on a similarly large scale. The full version of this chart shows how important that “similarity of scale” really is (Elliott labels were excluded in consideration of Theorist subscribers).

Price action in the stock market this week has only strengthened the analysis in Bob Prechter’s October Theorist issue.

What’s more, you can read the very latest forecasts in the just-published November issue of the Elliott Wave Financial Forecast — both publications (plus the tri-weekly Short Term Update) are yours for free — only during FreeWeek (now through Nov. 11).

Learn more about FreeWeek, and download the November Theorist

Robert Folsom is a financial writer and editor for Elliott Wave International. He has covered politics, popular culture, economics and the financial markets for two decades, via print, radio and the Internet. Robert earned his degree in political science from Columbia University in 1985.

Here’s the thing. Earnings have collapsed. Utterly and completely. Like a house of cards. Like never before.

And because equity prices only fell by ~50%, that means the price earnings ratio skyrocketed to the stratosphere and beyond. Just look at the chart of the S&P 500 index’s P/E ratio - it looks like it just fell through a wormhole:

Source: Chart of the Day

Honestly, my initial reaction was to ignore this latest chart. First, because we already went over this months ago when the P/E ratio was 122: How The Price Earnings Ratio Can Fool You. But also because this whole issue is truly meaningless.

But then I realized that this chart is making the rounds on the internet at a torrid pace. It is being forwarded and many other bloggers are featuring it with a bearish slant. So while it really is a distraction, perhaps there’s something of value here. Not the data set graphed but rather the reaction of people and their fixation on this useless little statistic.

If anything, the morbid fascination with the gloomy and shocking picture the above chart depicts tells us about the public mood out there. And from a contrarian point of view, this is the sort of ‘worry’ that bull markets proverbially like to climb.

The market seems to be holding on for dear life at a long term support level. The mid August 2007 low on the S&P 500 Index (SPX) was 1370.60 and in mid March 2007 at 1363.98 - we closed today at 1373.20

But when I say long term, I mean really long term. As in back to the start of this cyclical bull market. Back, all the way to 2003:

Looking at things through this chart, not only are we at a major cross roads, the market looks like it has just printed a triple top or head and shoulder formation (squint if you can’t see it). Need I say that looks ominous?

And to complete the trifecta of bad technical analysis news, reknown chartist Stan Weinstein drew a line in the sand for the Dow, back in September 2007 (thanks Tom). He said this in an interview:

… my new level is 12,800. If at any point the Dow breaks down and closes - at the close below 12,800, that would turn what’s a problem market into a much bigger problem.

So there you have it. Things look bleak. Now is this the doom and gloom before the sun comes out again? is this the “wall of worry” that a bull market climbs? or is it the real deal? should we sell everything, buy gold and move to Montana?