What's The Prospect For The "Equity Market" For 2016/2017?
In May 2015 we witnessed a new high in the equity market, as can be seen in the S&P 500 (SPX) chart, below. This high is unlikely to be surpassed in a decade or more. Consequently, I have labeled this high, "The Generational Top" to distinguish it from other highs that occurred in 2000 and 2007.
According to Elliott Wave (EW) principles, a progressive cycle consists of 5 waves. These 5 waves are made up of 3 impulsive waves (in the direction of the trend) and 2 retracements (against the direction of the trend).
The cycle that we will be focusing on in this article, is a major cycle that has been widely accepted as having begun back in 1929. The high we saw in 2000, based on my application of EW principles, appears to be the end of wave 3.
The price action seen between 2000 - August 2011 is a contracting triangle that forms wave 4 (this type of triangle is typical for wave 4). Taking this into account, it follows that "The Generational Top" that occurred in May 2015, exhibited all the characteristics that would be associated with the end of wave 5 of such a major cycle.
The frequent, choppy price action that has followed the end of wave 5, namely moves of over 200 points per day, could be an early development of major bearish cycle. If this is the case then there is a potential for the market to drop, over time, to the low seen in 2009. Should this scenario play out then this could be devastating for the general economy and individual wealth. Having said that, those that are suitably prepared to take advantage of such a cycle, it could offer immense opportunities.
Going back in time a little, the period leading up to the 2000, S&P 500 was lagging the Dow Jones Industrial (DIA). The reason for this is that from the early 1980s, interest rates were very high. This meant that smaller companies (such as those included in the S&P 500) would have struggled more with high borrowing costs than larger corporations.
By the turn of the millennium, interest rates had fallen significantly. This created a positive environment, in which smaller companies could prosper and outperform larger corporations in the rising market. These observations can be noted in the chart below.
In the upper window of the chart, we have a S&P 500 chart with the main wave labels shown. In the lower window is a ratio chart of S&P 500/Dow Jones Industrial (DJI), which is contained within a declining trend channel. The ratio chart shows S&P 500 performance against the DJI.
(Click on image to enlarge)
Due to the higher risk intrinsic to smaller companies, they tend to perform poorly in a falling market. Referring back to the ratio chart (lower window) we can see that we have just tapped the upper trend line of this declining channel, which coincides with the top in the S&P 500 chart (upper window). This means that the ratio could fall towards the lower trendline of the channel suggesting a major weakness in the equity market.
Please feel free to post comments, questions and any alternative views are welcome.
Disclosure: As always, please do your own due diligence and analysis for your requirement. If you wish to learn in details why I have come this conclusion and ...
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Thanks for your article Dan. In regards to your statement; "... the period leading up to 2000, S&P 500 was lagging the Dow Jones Industrial. The reason for this is that from the early 1980s, interest rates were very high." I was wondering if you could explain more fully how and why interest rates had more of an effect on the SPY when compared to the Dow? Is it simply a result of larger companies being better able to borrow money when compared with smaller ones or is there another explanation? My other question is regarding the entire process of predicting market performance. I think one of the first lessons any investor learns or is told to be aware of is that past performance does not guarantee future performance ie we have no clue whatsoever how the SPY, DIA, IWM or any other index will perform tomorrow, next week, and for sure not next year. Any thoughts?
Thank you for your question and my apologies for rather late reply, but hope it will still serve its purpose.
Regarding the high interest rate, it makes it harder for smaller companies being able to borrow for expansions and larger portion of their income is spent servicing the interest payment which becomes a drag. In contrast to larger corporation who are well resourced and have more options to finance borrowing requirement at relatively advantageous terms.
The other point about past performance not necessarily being a guide for future performance – I find this debateable. It is accepted that it is almost impossible to predict exact price path of any instruments into future. So in that respect no one can actually predict where price will go.
Several forms of technical analysis can assist us in anticipating where the particular price cycle might end. For example by applying Fibonacci price projection, extensions or retracement in conjunction with trendlines, trend channels and some indicators such as momentum oscillators a potential zone of reversal or retracement can be identified and price action such as reversal or capitulation candle, continuation or exhaustion gaps etc one can narrow down the possible price zone where price might make a reversal or resume a trend.
So in that respect whilst not being able to forecast exact price path, we could get close to anticipating likely outcome. Application of price patterns and Elliottwave and some fundamental analysis all can help to essentially anticipate future price direction and possible extent of the move (call in predicting) at several degree of time.
Since it is not possible to be 100% accurate and price action evolves so what is anticipated might not develop, one has to use some sort of money management suitable for your trading style and risk tolerance.
Thanks for the informative answer.