Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'?

Elliot Wave Technical Analyst & author @ Elliott Wave Trader
January 18, 2022

Those that read my analysis regularly know that I do not take general market fundamentals or news into account when I analyze the stock market. The main reason is that I view that which drives fundamentals as being the same as that which drives market price. However, the effects of that driver are seen in the stock market much faster than in the market fundamentals. That is why most people have adopted the adage that the stock market is a “leading indicator” for the economy. Yet, they do not understand why that is the case.

While I am not going to discuss why that is the case in this article, I am going to refer you to a previous article I have written, which explains the “why:”

How To Analyze Market Sentiment Along With Market Fundamentals

Interestingly, there are many who take serious umbrage with my perspective, to the point that they are personally insulted. I want to assure you that my perspective has been derived from many years of experience and research. So, it is not meant as a personal affront to any of you who read my articles. I am just trying to open your mind to something that is completely foreign to most investors.

As an extreme example, when the market was dropping strongly in March 2020, I was putting out analysis that suggested we would bottom in the 2200SPX region (even before the Fed acted its 4th time during that decline), and then rally to 4000+, with an ideal target in the 6000 region Not only did many not believe me, but most thought my views to be “unmeaningful,” “absurd,” “insane,” or based upon “chart magic,” claiming that I ignored the “common sense view,” as you can see here.

As an aside, one of my members pointed out that we recently received a really nice shout out for our market call in 2020 from Aaron Task of Seeking Alpha at the 37-minute mark in the latest podcast:

JPMorgan Asset Management's Gabriela Santos joins Alpha Trader (Podcast)

“Amazing shout out and even the guest said he remembered the podcast and it was a helluva call. Grateful to be here for the last 10 years.”

Yet, at the time, many took me to task for my expectation of a massive rally from the March 2020 low we called for, and the following commenter exhibited the general feelings of most investors at the time:

“I really don't understand articles like these. Pure technical analysis in a time period in which we are facing a once-in-a-lifetime event, as if economies literally SHUTTING DOWN is just something the market is fitting into an unavoidable pattern. . . It is simply silly to predict market moves with technicals when we're facing a series of historic developments in the world. . .

Your analysis seems to suggest that this current downturn is temporary and that the bull market won't truly end until we hit around 4000? That's pure technical analysis without any regard for fundamental factors in the real world. The idea is absurd. We are not going to magically get there on the back of EWT.

Will we hit 4000 eventually? Yes, over the very long term, markets will always go up. However, current conditions suggest that the bull market is over. Rates have been cut to 0. Unemployment is going to spike up. EVERYTHING suggests that we're headed for a recession that will take a lot of time to clear up before we start recovering.

Your entire probabilistic supposition that the bull market is not over SOLELY based on technicals and that we are somehow entitled to another wave up to 4000 while ignoring EVERYTHING happening in the world right now is insane.

I don't see any way forward that would lead to the kind of recovery and massive rally that you've predicted here. At the end of the day, stock prices are tied to economic fundamentals, even though they may swing above or below the fair value. So paint me a picture in which what you say will happen happens. And no, "just look at the chart" is not a good enough justification.”

This commenter was certainly right about several things, as the market went on to post record unemployment numbers, and the economists declared that we were in a recession. But, amazingly, both occurred AFTER the market bottomed and after we had already begun this massive rally we have experienced since that time.

 

CNBC

 

And, if you based your stock market buys and sells upon these fundamentals, well, then you were likely left out in the cold.

Again, please recognize that most analysts considered us within a recession during a time when the S&P 500 rallied 1500 points off the low, with the majority of investors believing that we had begun a major bear market. If you do not understand why they got it so wrong, I again suggest you read the article about fundamentals that I linked above.

Yet, many still believe that the market should follow the fundamentals. While one of my members recently commented that “March 2020 should have been the last straw for any FA traders,” I would not be shocked if the commenter above is still following his old fundamental perspective despite being taught a lesson in 2020.

But, I do not think it is likely that this commenter has abandoned his perspective. It has been too engrained in the common perception of the stock market held by investors, so most have not likely learned any lessons. Rather, it is clear that the majority of investors will simply lick their wounds and continue along this same path no matter how many times they get caught on the wrong side of the market.

In fact, this past week, another one of my members posted this quote from someone on Twitter:

“The fact that stocks are up today after that horrible 7% CPI print shows what a farce this "market" is. It's completely disconnected from reality and from the fundamentals. There are no analysts anymore. What is there to analyze? If you're in this market, you are gambling.”

Well, actually, it does not mean you are gambling. It simply means that this person (as well as most market participants) just does not understand what really drives the market. And, if what you are doing is not working, isn’t it time to consider something else that may?

In my view, the market and fundamentals are both driven by investor sentiment, and not economics or news. If you would like to understand a bit more about my perspective as to how the market works, this is the six-part series I wrote about my views on how to track the market.

In fact, I am forthwith issuing a challenge to each and every one of you who truly believe that news or fundamentals are what direct the market moves. If you have a modicum of objectivity and intellectual honesty, and are truly interested in the truth about financial markets, I challenge you to read The Socionomic Theory of Finance. It takes just the first three chapters to turn your perspective on its head, based upon real world examples and facts. Once you begin to realize the truth, you will never look at the financial markets in the same way again.

Within that book, the author highlights how many high-profile economists questioned the traditional view of fundamentals and economics after it failed to prepare investors for the 2008 financial crisis. And, many of them noted that much of their failure was due to their inability to take into account factors like human psychology and human behavior. Yet, admittedly, they noted that they needed to have something to replace their theories of efficient markets, but they have yet to find a workable paradigm. And, without a replacement, they were still forced to use their old perspectives on efficient markets despite their recognition of its massive failings.

The author also brilliantly outlines why the old paradigms fail, and explains how to view market sentiment and social mood as a new paradigm and insight into market movements. And, once you learn how to adopt this new perspective, you will not be scratching your head at market movements such as those noted above. So, consider reading this book as Morpheus presenting you the opportunity to choose between the blue pill and the red pill. It’s your choice. But, recognize that your perspective will likely be forever changed.

 

Getty

 

Now, does our belief that we understand the underlying truth and driver of market direction mean that we will always be perfect in our market assessment? Heaven forbid we would ever suggest such a thing, as we are still human and will never be able to be perfect in the market. But, it means we have an objective perspective to tell us if we are right or wrong rather quickly, and be able to adjust our positioning a lot faster than most investors in the market.

Last week was a perfect example of our inability to attain perfection, which is quite apropos considering the title of my missive the prior week.

While my initial assessment last weekend would have viewed a break down of the 4600 region in the futures as opening “the door to a direct move down to the 4400SPX region sooner rather than later,” we did break down below that support, yet did not continue the move to 4400SPX. While the door certainly opened for a continued move down to 4400 as we spiked down 30 points lower than that support, when we came right back up before the market close through the resistance we should have held, it told us that it was likely a false break down.

However, during that break in real-time, I was not viewing that break of support as strongly indicative of a direct break down towards the 4400SPX region. Rather, the structure of the market break down was telling me at that time that it was potentially a false break of support, and the market coming right back up through the 4625 level in the futures before the market close told me that is indeed what occurred.

You see, what sets our analysis apart is that we have objective standards which we apply to the market structure we are tracking in real time which tells us very early on whether we are right or wrong in our assessment. Therefore, it allows us to adjust quite quickly when the market makes it clear that we are wrong. And, we are not swayed by the false narratives which cause most market participants to be looking in the wrong direction right before a major change in direction occurs.

So, when the market broke back up through the 4625 level on the futures, it had me again seeing it as a strong potential that we can still rally to higher highs before we may see that pullback towards the 4400SPX region.

For those that want a bit more detail about the Elliott Wave structure that we are tracking, the S&P500 seems to be forming an ending diagonal off the early December pullback low. Ending diagonals are known for their whipsaw, complexity, and volatility as they complete a topping structure. And, I recognized this potential once the market broke back down below the 4700 region from the recent all-time high.

One of the other hallmarks of an ending diagonal structure is that the market often spikes up in a blow off top in its final move higher, only to reverse just as strongly when it completes. Moreover, that reversal will often see a strong move down towards the region from which the pattern originated. So, this is what I will be tracking over the coming weeks. And, if we do get a higher high over the coming week or two, I think we can see a mini-crash-like event that will take us from the new all-time high back to the 4500’s rather quickly.

But, of course, I need to know where I am wrong in this potential assessment. You see, the market is attempting to transition from one phase to another, as I told you to expect in the first quarter of 2022, in order to prepare us for our next major rally to 5500SPX. And, this one has turned much more complex than I expected. So, if we see a break down below the low struck the other week – 4580SPX – then I have to give in to the near-term bears, and view us as potentially heading down to the 4300-4400 region sooner than I had initially expected.

So, in the bigger picture, I think the market has a cap in the 4882-4960SPX region. And, I still think we should see a pullback down to the 4300-4485SPX region before we begin the next major rally I foresee to 5500SPX over the coming year or so.

Lastly, for those that do not appreciate what I write about my perspective on market fundamentals, or anything else I write, you really do not have to read me anymore, as I will certainly not force you to do so. We have 66,000 followers on Seeking Alpha, almost 8000 members to our services, and almost 1000 money manager clients who do appreciate our perspective. So I will continue to write as I see appropriate until there is no longer any interest.

Keep in mind that I began my career using fundamental analysis for the market just as have most of you. Yet, I made an educated decision to switch to primarily analyzing market sentiment since I viewed it as providing me a much more accurate assessment of market dynamics. So, unless you understand what I understand about both sides of the market, you simply cannot make a qualitative assessment of my decision. In other words, I clearly understand your perspective quite well, but do you understand mine?

“I cannot stress enough how much this site not only changed my entire approach to investing, but my life as well. Game-changer is an understatement.”

As I constantly hear things like this from my members and money manager clients, it tells me that I need to continue in my endeavors no matter how much pushback I attract.

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Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net, a live Trading Room featuring his intraday market analysis (including emini S&P500, metals, oil, USD & VXX), interactive member-analyst forum, and detailed library of Elliott Wave education. You can contact Avi at: [email protected].


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