By Elliott Wave International's Robert Prechter, Prechter's Market Perspective
Dec 16, 2005
It helps to have a sense of history when studying the behavior of human beings, the economy, and financial markets – particularly since human behavior is what makes markets trend in one direction or another. In last month's Elliott Wave Theorist, Bob Prechter wrote about how current events in our time resemble a time 37 years ago when a war was on and riots were raging, yet the economy and the markets were expanding. Here is his discussion of what kind of market ignores bad news.
The news reflects an increasingly negative social mood, yet the stock market is holding up. Many people claim that the market's failure to "react" to the bad news—or its ability to rally in the face of it—is bullish. This idea is a myth. It is borne of the useful observation that during the early months of a bull market, stocks rise despite continuing bad news. Social mood leads social action, so this is a perfectly normal occurrence.
But there is another time when the market goes up while news is bad: during bear market rallies. An excellent example, as detailed in Pioneering Studies in Socionomics, is the market's rally from September 2001 to March 2002 despite anthrax attacks and the Enron scandal. When those events ended, then the market turned down.
When a bear market is in force, people act in accordance with the long-term deterioration in mood, which continues despite periods of near-term improvement. This "crazy" behavior is nicely coordinated to fool investors, who typically try to make sense of the market in terms of its reaction to news. This is not to say that the stock market can't go up from here; the point is about the validity of analytical techniques.
The last time we had a market environment similar to that of today was 1968. There were riots at the Democratic convention, anti-war protests, fighting in Vietnam, runaway spending and anti-Johnson sentiment, yet the economy was expanding as the market was going up, led by small-cap stocks, which brought the Value Line (geometric) Average to a new all-time high.
This time, there are riots in France, protest marches in South America, a war in Iraq, runaway spending and anti-Bush sentiment, yet the economy is expanding as the Value Line Arithmetic average is not far off an all-time high made two months ago.
This parallel is showing up in the press. According to Richard Maybury, "By the end of his first term, Bush's presidency saw the biggest increase in discretionary spending since Lyndon Johnson's in 1968."11 The riots in France are "the country's worst civil unrest since the student uprisings of 1968."12 Says a headline this week, "America's Attitudes on Iraq Similar to Vietnam."13 Cultural trend followers will be interested to know that the band Cream reunited in 2005, playing together on tour for the first time since November 1968.
Seventeen months after the market peaked in December 1968, the Dow had lost 1/3 of its value, and that was within only a Cycle degree bear market. This one is two degrees larger. When the market turned down in 1968, the news did not improve; it got worse. At the climax of negative mood, just days from the bottom of wave C of that bear market in May 1970 and in the midst of a year-long recession, members of the National Guard shot protesting students at Kent State University.
We cannot consider the idea of the market forming even a temporary bottom until an economic contraction is in force and news is worse. I cannot imagine such a time being less than a year and a half away. In the meantime, if the Dow has finished a triangle and is now in a rally to a new three-year high, the bad news may briefly abate somewhat before worsening.
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