Monday, February 13, 2012

Bear Market Rallies and B wave psychology

Bear Markets unfold in 3 waves. Most commonly labeled A-B-C. Whenever a supercycle is completed, a crash unfolds. This is the "A" wave of the bear market. It is usually a very sharp drop in a short amount of time (in this case, 17 months from October 2007-March 2009). Then, a B wave bear market rally unfolds, that serves to unwind the oscillators and relieve oversold conditions. This is often associated with a temporary recovery in economic activity. But perhaps the most important element here is the psychology of B wave bear market rallies. At the "A" wave low in March 2009, pessimism was dominant, with most thinking we were headed into deflation and  economic depression and thoughts about the end of the world. A bear market counter-trend rally then unfolds, called a "B" wave, and serves to correct the decline that just unfolded. By the time a B wave is over, most economists and financial professionals are convinced that the worst is over and good times are back. Then, the final, and most devastating, portion of a supercycle bear market unfolds, the "C wave" that drops significantly below the "A wave" low. I believe we are facing something similar to 1929-1932, and this time period can be compared to April of 1930, at the top of the "B wave" during that bear market. Economists have credited the FED with saving the economy, and most investors are convinced that we are in a new bull market. This is the nature of B waves. They fool everyone into thinking the worst is over. The goal of bear markets is to make the most number of people lose the most amount of money, Bull and Bear alike. I would say that has certainly been true of this bear market, as the bulls took it on the chin in 2008, and the bears have all but given up trying to short as the market has gone higher and higher since March 2009. However, even amidst this tremendous 100%+ rally we have seen, it is still just a wave B bear market rally, with wave C still to come. This deflationary wave should be MUCH worse than 2008. Historical precedent for this type of move can be found in the 1929-1932 bear market, shown below:

 

As can be seen, the B wave bear market rally retraced part of the initial decline from the 1929 top. The C wave then carried the market down to MUCH lower lows, and by the time the bear market was over the market had lost 89% of its value. I believe we are in for a similar decline, and my target remains the same of below 800 on the DOW.  The sentiment currently out there is certainly consistent with the top of a bear market rally, with some sentiment exceeding extremes seen at the all-time high in October 2007. Many who were calling it a bear market rally before have given up and turned bullish. The same thing happened by the top of the B wave in April 1930. The difference this time is that everything is bigger. The bubble is bigger, the upward retracement is bigger, and the lies are bigger. Ultimately, the decline should be bigger as well. This kind of environment is why it is important to NOT listen to the talking heads on CNBC and stay safe in the safest possible cash equivalents. The collapse of our debt-money system is dead ahead, and by the bottom the bear market nobody will even think about buying stocks, but of course that is the time when attractive valuations show up in the market and that is the time to buy. But its IMPERATIVE that people remain safe during this time. The C wave is out there, should be much worse than 2008, and likely worse in percentage terms than 1929-1932. This time everything has been magnified. The debt bubble is bigger, and the central planners have done even more to try to prop the system up. It will not work, and their efforts will only serve to make matters worse. I believe we are very close to the top of this B wave bear market rally. The C wave is next, and its NOT going to be pretty.

6 comments:

  1. Above what level will your count for the B wave be invalid?

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  2. It is hard to say. Technically, B waves can exceed the start of the A wave. In Elliott Wave Analysis, corrections can take on many different forms. This one from the March 2009 low certainly is tricky, but I still view it as a bear market rally. In other words, I expect the low of 6,470 to be taken out before the bear market is over.

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  3. From what i understand, wave B cannot exceed the start of wave A.

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  4. Yes, they can. They are called expanded flats.

    http://www.elliottwave.com/tutorial/Lesson4/4-2.htm

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  5. Dow 800? Not if the Fed and the ECB keep pumping more money into the system. In that case stocks could go much higher regardless of the state of the world economy.

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