Stocks: Why This "Trend Following" Indicator is Worth Watching

This "is compatible with a stock market that has further to decline"

By Elliott Wave International

Large Speculators are a sector of traders monitored by the Commodity Futures Trading Commission and are comprised mainly of hedge fund managers and trend followers.

History shows that this group of traders is usually wrong at key market turns.

The Commercials, which you might call the "smart money," is another sector of traders monitored by the CFTC. They usually take positions opposite that of Large Speculators and are usually right.

This indicator is especially useful when the positions that Large Speculators and Commercials have established reach extremes at the same time a market's Elliott wave pattern suggests a trend turn is nigh.

With that in mind, let's review a chart and commentary from our Feb. 14 U.S. Short Term Update, a thrice weekly Elliott Wave International publication which provides near-term forecasts for key U.S. financial markets:

Friday afternoon's release of the most recent Commitment of Traders Report shows that Large Speculators in E-mini S&P 500 futures are net long 7.20% of total open interest, nearly reaching the record 8.12% registered during the last week of January... The willingness of the trend-following Large Specs to maintain a near-record commitment to bullish bets even though the E-mini S&P is still down nearly 9% from its January high is compatible with a stock market that has further to decline.

As you probably know, the downtrend in the stock market has persisted since this analysis published on Feb. 14.

Indeed, on Feb. 17, the S&P 500 slid 2.1% and the Dow Industrials suffered its then worst single-day 2022 decline, closing more than 600 points lower.

The S&P continued to decline on Feb. 18, with the Dow down by triple digits, making it two weeks in a row that the senior index closed in the red.

And, as of this writing intraday on Feb. 22, the stock market is once again in the red.

Keep in mind that no indicator or service can guarantee that a particular forecast will work out.

In this case, our analyst's confidence level was high as the Elliott wave model also suggested further decline.

Dig into the details of how to use the Wave Principle in your analysis of financial markets by reading the definitive text on the subject: Elliott Wave Principle: Key to Market Behavior, by Frost & Prechter.

Here's a quote from the book:

Although it is the best forecasting tool in existence, the Wave Principle is not primarily a forecasting tool; it is a detailed description of how markets behave. Nevertheless, that description does impart an immense amount of knowledge about the market’s position within the behavioral continuum and therefore about its probable ensuing path. The primary value of the Wave Principle is that it provides a context for market analysis. This context provides both a basis for disciplined thinking and a perspective on the market’s general position and outlook. At times, its accuracy in identifying, and even anticipating, changes in direction is almost unbelievable.

Get more insights into the Wave Principle by reading the entire online version of this Wall Street classic for free.

The only requirement for free access is a Club EWI membership. Club EWI is the world's largest Elliott wave educational community and members enjoy free access to a wealth of Elliott wave resources on investing and trading.

You can join Club EWI for free without any obligations.

Just follow this link: Elliott Wave Principle: Key to Market Behavior -- free and unlimited access.

This article was syndicated by Elliott Wave International and was originally published under the headline Stocks: Why This "Trend Following" Indicator is Worth Watching. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

This Suggests That Stock Prices Are Headed Even Lower

History shows that investors become "long term buyers" at precisely the wrong time

By Elliott Wave International

It's been mentioned before in these pages that the stock market is filled with paradox.

Examples include the observation that widespread denials of the existence of a bubble is an excellent indicator that one exists. Another is that bear markets tend to start when the news is good, and bull markets kick off when the news is bad.

Here's another paradox -- one to keep in mind during the next bear market:

Numerous lows will be touted as the low, which will not occur until people stop calling for it.

That's a quote from the February Elliott Wave Financial Forecast, a monthly publication which provides analysis of major U.S. financial markets.

So, put another way, a sign that stock prices are likely headed even lower during a bear market is when market observers are still touting lows.

Now, let's shift a little and look at typical behavior when downturns are just getting started. That's when many investors believe that the drop in prices is merely a correction -- which, as you know, is often mentioned as the classic "buying opportunity."

Indeed, this is a headline from Feb. 7 (Business Insider):

Investors should prepare to buy the dip in stocks after the Fed's first interest rate hike in March, BofA says (emphasis added)

The very next day (Feb. 8), the same news source had a somewhat similar headline (just a different financial institution and reason for "buying the dip"):

UBS tells investors to buy the dip in US stocks on the back of strong earnings, and predicts the S&P 500 will rally 8% this year (emphasis added)

"Buy the dip" they did -- as this Feb. 9 headline attests (CNBC):

... [I]nvestors continue to buy the January tech dip ... (emphasis added)

Then, on Feb. 11, after the S&P 500 shed 3.7% in just two days, another well-known financial website sported this headline (Marketwatch):

Five reasons why you need to buy the dip in stocks [emphasis added]

And, let's make room for yet one more (CNBC, Feb. 13):

Buy the dip on these global stocks with strong returns, Goldman says

"Buying the dip" is not just "modern day" investor behavior -- it's been around a long time.

Here's a quote from the 1917 book One-Way Pockets, written by a stock broker who went by the pseudonym Don Guyon:

"The public's memory for former high prices usually proves to be more of a liability than an asset. The expectation that these high prices will again be reached causes them to buy many a dead speculative dog."

In case you're unfamiliar with One-Way Pockets, Elliott Wave International President Robert Prechter summarized the book in one of his Elliott Wave Theorists:

A stock broker wondered why his clients lost money over a full cycle in the stock market. After all, he reasoned, if stocks were back near the same level they started, shouldn't his clients have broken even? The pseudonymous Guyon studied his clients' activity statements and found a consistent psychological change among them that explained the losses: At bottoms, they were short term buyers, whereas at tops, they were long term buyers. (emphasis added)

Understanding Elliott wave analysis can help keep investors from falling into this trap.

You see, the Elliott wave model anticipates trend changes.

Here's what Elliott Wave Principle: Key to Market Behavior, by Frost & Prechter, says:

It is our practice to try to determine in advance where the next move will likely take the market. One advantage of setting a target is that it gives a sort of backdrop against which to monitor the market's actual path. This way, you are alerted quickly when something is wrong and can shift your interpretation to a more appropriate one if the market does not do what you expect. The second advantage of choosing a target well in advance is that it prepares you psychologically for buying when others are selling out in despair, and selling when others are buying confidently in a euphoric environment.

Educate yourself about the Wave Principle by reading the entire online version of the book for free.

The only requirement for free access is a Club EWI membership. Club EWI is the world's largest Elliott wave educational community and is free to join. Moreover, members enjoy complimentary access to a wealth of Elliott wave resources on investing and trading.

Follow this link to get started right away: Elliott Wave Principle: Key to Market Behavior -- free and unlimited access.

This article was syndicated by Elliott Wave International and was originally published under the headline This Suggests That Stock Prices Are Headed Even Lower. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Why the "60 / 40 Balance" May Be Hazardous to Your Portfolio

Notice the similar pattern between these two bond charts

By Elliott Wave International

Financial advisors have long advocated a mix of 60% stocks / 40% bonds to cushion portfolios from downturns in the stock market.

The thinking is that stocks go up in the long-term, hence, that's where investors should allocate the most. At the same time, advisors acknowledge that stock prices can sometimes go down so "less risky" bonds will provide at least some protection.

The problem with this investment strategy is that bonds can go into bear markets too. Moreover, they can do so at the same time as stocks.

Let's review what happened during the Great Depression of the early 1930s. Here's a chart and commentary from Robert Prechter's 2021 Last Chance to Conquer the Crash:

The chart shows what happened to the Dow Jones 40-bond average, which lost 30% of its value in four years. Observe that the collapse of the early 1930s brought these bonds' prices below -- and their interest rates above -- where they were in 1920 near the peak in the intense inflation of the 'Teens.

Now, let's review more recent history. Here's another chart and commentary from the book:

This chart shows a comparable data series (the Bond Buyer 20-Bond average) in recent decades. Notice how similar the pattern is to that of 1915-1929. If bonds follow the path that they did in the 1930s, their prices will fall below the 1981 low, and their interest rates will exceed that year's peak of 16%.

Conventional analysts who expect bonds to move contracyclically to stocks in the months ahead may be in for a very unpleasant surprise.

Indeed, the financial pages are all abuzz about the prospects of higher interest rates or bond yields.

As this Feb. 10 CNBC news item notes:

The yield on the 10-year Treasury note jumped 8 basis points to hit a session high of 2.01%, the first time that the benchmark rate reached the threshold since August 2019.

Elliott Wave International has been preparing subscribers for higher yields for quite some time.

For instance, back in early March 2020, when the yield on the 10-year Treasury note was at a then record low 0.91%, the March 2020 Elliott Wave Financial Forecast, a monthly publication which provides analysis of major U.S. financial markets, said:

This is the first time that 10-year Treasury note yields have dropped below 1%. ... Investor ebullience is the only thing that allows for an embrace of no-yield debt. The tidal wave of risk assumption, however, may be turning.

In other words, prepare for higher yields.

Just a few months later, yields hit a bottom and have been trending upward ever since. Mind you, yields had been in a downtrend for some 40 years! Of course, higher yields mean lower bond prices.

All the while, the stock market has been trending lower as well.

Now is the time to know the Elliott wave chart patterns of both bonds and stocks.

If you're unfamiliar with Elliott wave chart patterns, you are encouraged to read Frost & Prechter's Wall Street classic, Elliott Wave Principle: Key to Market Behavior.

Here's a quote from the book:

The Wave Principle is governed by man's social nature, and since he has such a nature, its expression generates forms. As the forms are repetitive, they have predictive value.

Get detailed insights into these repetitive forms by reading the entire online version of the book for free!

All that's required for free access is a Club EWI membership, which is also free. If you're unfamiliar with Club EWI, it's the world's largest Elliott wave educational community and offers members free access to a wealth of Elliott wave resources on investing and trading without any obligations.

Become a Club EWI member now by following this link: Elliott Wave Principle: Key to Market Behavior -- free and unlimited access.

This article was syndicated by Elliott Wave International and was originally published under the headline Why the "60 / 40 Balance" May Be Hazardous to Your Portfolio. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Does the Fed Really Determine the Trend of Interest Rates?

Here's what "leads" the effective federal funds rate

By Elliott Wave International

Forbes magazine summed up the Fed's January statement this way (Jan. 26):

The federal funds rate remains on hold at zero to 0.25% for now, bond purchases should end in March -- and then it's time to raise rates.

The speculation on Wall Street is that the U.S. central bank will raise its federal funds rate by 25 basis points at least twice in 2022. Some Fed watchers expect a bump up as many as four times.

The federal funds rate is the interest rate that banks charge each other to borrow or lend excess reserves overnight and, yes, the central bank sets that rate.

However, what many investors may not realize is that the market leads and the Fed follows. In other words, it's really the market which determines the trend of interest rates.

The evidence is easily provided. Here's a chart and commentary from Robert Prechter's landmark book, The Socionomic Theory of Finance:

No one monitoring the Fed's decisions can predict when T-bill rates will change, but anyone monitoring the T-bill rate can predict with fair accuracy when the Fed's rates will change. We demonstrated this ability in August 2007 by predicting that the Fed was about to lower its federal funds rate dramatically.

As you can see, the chart shows when the prediction was made and the aftermath.

Financial history shows other times when the market led, and the Fed followed.

Yet, many Fed watchers point to the early 1980s, when interest rates and inflation had reached historically high levels. The conventional narrative is that then Fed Chairman Paul Volcker decided to strangle the 20% inflation by raising interest rates. In this interpretation, it was the Fed who was proactive. It was the Fed who brought down inflation.

But, the evidence shows that the market was leading and the Fed was following -- the whole time.

Here's another chart, along with commentary, from The Socionomic Theory of Finance:

The chart plots T-bill rates and the effective federal funds rate from 1978 to 1984. T-bill rates peaked four times in 1980-1982. Each of those peaks occurred a month or more before subsequent and reactive peaks in the federal funds rate. The Fed's rate also lags at bottoms, as depicted on the chart at the lows of 1980, 1981 and 1982-3.

The Socionomic Theory of Finance goes on to say:

That interest rates were in a relentless upward trend during the entire decade of the 1970s and that they have been stuck at zero since 2008 -- in both cases despite the Federal Reserve's contrary desires -- is powerful evidence reinforcing the point that the Fed is not in control of interest rates.

So, it's a myth that the Fed leads the way on the direction of interest rates (and bond yields).

Interest rates (and bond yields) are set by the market and in turn, the market is governed by the repetitive -- hence, predictable -- patterns of the Elliott Wave Principle.

Get insights into how the Elliott wave model can help you analyze financial markets by reading Frost & Prechter's Wall Street classic, Elliott Wave Principle: Key to Market Behavior.

Here's a quote from the book:

Although it is the best forecasting tool in existence, the Wave Principle is not primarily a forecasting tool; it is a detailed description of how markets behave. Nevertheless, that description does impart an immense amount of knowledge about the market's position within the behavioral continuum and therefore about its probable ensuing path. The primary value of the Wave Principle is that it provides a context for market analysis. This context provides both a basis for disciplined thinking and a perspective on the market's general position and outlook. At times, its accuracy in identifying, and even anticipating, changes in direction is almost unbelievable.

Here's the good news: You can read the entire online version for free once you become a Club EWI member.

Club EWI is the world's largest Elliott wave educational community and is free to join. As a Club EWI member, you'll enjoy free access to a wealth of Elliott wave resources on investing and trading without any obligations.

Follow this link for free and unlimited access to Elliott Wave Principle: Key to Market Behavior.

This article was syndicated by Elliott Wave International and was originally published under the headline Does the Fed Really Determine the Trend of Interest Rates?. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.