Three long-term Elliott Wave scenarios for the S&P 500
With the recent market run up – and with bargain dividend stocks becoming increasingly harder to find – I thought I’d step back for a moment and take a look at the “big picture” – in this case, some possible long-term market scenarios based loosely on Elliott Wave theory. I know I promised in this blog’s introductory post no Elliott Wave theory, but I thought its perspective in this case was interesting enough to make an exception.
Elliott Wave: Pseudoscience?
I should note up front that I’m extremely skeptical (to say the least) of the analysis and predictions made by most Elliott Wave practitioners. For instance, I find that they tend to focus on only one scenario at a time as if the market is somehow predestined to follow a particular script (usually influenced by the particular analyst’s macro views on the economy, investor psychology, cycles etc.), while “alternate counts” receive short shrift until needed, which is often.
I’m also unimpressed by the usually overly precise price target forecasts (usually based on Fibonacci ratios) and densely detailed wave count minutiae that typically accompany such predictions. While these help project an aura of objective, scientific precision, Elliott Wave theory ultimately relies on subjective and very often after-the-fact judgment.
So does this mean that it’s a useless pseudoscience? It’s certainly tempting to dismiss it as such, especially after reading attempts to defend it like “Elliott Wave Principle: Mad Pseudoscience?” where the author – an EW believer – admits to having no problem “rubbing shoulders with UFOlogists and ghost hunters.” (Sounds like he could benefit from spending some time watching Penn & Teller: B.S.!)
Despite this, I do think that EW theory has some merit as a pattern recognition tool. For example, I often find its basic “wave pattern” approach helpful in placing market action in some sort of context. And I appreciate its flexibility in allowing for a variety of possible – sometimes conflicting – scenarios.
With that said, and mostly for my own entertainment, I graphed out three possible longer-term market scenarios as they might unfold as per EW theory. Please note that these don’t represent any attempt to forecast any particular timing or price levels – they’re just rough guesses of how the stock market as represented by the S&P 500 might play out over the coming years.
Elliott Wave scenario #1
The first scenario appears to be the current favorite among most EW practitioners:
It sees the 2007 market peak as having been the top of a major long-term “impulse” up wave that began in the 70s or early 80s. This is then to be followed by an “A-B-C” corrective wave of appropriately similar proportions in time/magnitude.
According to this scenario, wave “A” down of this correction ended in March and we are now currently in wave “B” up, which, when it concludes, will usher in a new down leg that’s expected to take the market to new lows (wave “C”) before bottoming. This scenario seems plausible, but timing is everything – some EW analysts already jumped the gun by incorrectly declaring an end to wave “B” in June.
Elliott Wave scenario #2
The second scenario considers the possibility that the 2007-2009 down move was not in fact a wave “A” – the first wave of a correction – but a large wave “C,” the third and final wave of a major multi-year correction:
In this scenario, the market peak in 2000 represents a long-term top of some sort and the market price swings since then – 2002-03 (down), 2003-07 (up) and 2007-09 (down) – a major sideways “A-B-C” correction of the previous 20+-year bull move. If so, the move off the market lows in March would represent the beginning of a new long-term bull market that would ultimately see new all-time highs.
I’m no “permabull” and am not looking for a reason to favor this particular scenario, but I do feel the 2007-09 market crash has many of the classic characteristics of a “C” (or third) wave. So I’d be inclined to at least weight this possibility equally with others.
Elliott Wave scenario #3
Which leaves the third scenario, which also views the 2007-09 market collapse as a “C” wave:
This scenario envisions the possibility of a massive sideways “expanding triangle” correction to the bull market up wave that ended in 2000. If true, this would suggest a continuing move up from here to marginal new highs (point “D”) at some point in the not-too-distant future, and then another move back down to potentially new lows (such moves often undershoot or overshoot) before beginning a new major upleg. In other words, a real wild ride!
All of the above scenarios seem plausible from a price pattern perspective – and they represent only a few of the many possible variations and wave counts allowed within EW theory. But I find this exercise helpful as a way of potentially anticipating key market developments, while at the same time staying open to the market’s many possibilities.
