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Today's WrapUp by Martin Goldberg 05.05.2005  Mon   Tue   Wed   Thu   Fri   Archive

The Crowd and Its Rightness or Wrongness

With 1st quarter earnings results trends already known, the last week saw the stock market moving up seemingly based on news and its corresponding Wall Street and media spin. With such items to digest as Bush’s press conference on Social Security, the FOMC press release - market action – release addendum - reaction, and Kirk Kirkorian’s $31 dollar per share tender offer for General Motors, the stock market posted a strong week as the S&P 500 produced 4 straight days of higher highs and higher lows. Late last week the stock market was oversold when it was suggested by me that investors, “sell ‘em all!”. So it was no surprise that with a background of apparent good news as a tail wind, the market moved ahead with ease and gusto. As I draft this article on Wednesday evening, the stock market just posted a large high volume white (UP) candlestick and probably has a bit more momentum to push even higher in the days to week timeframe. With the obvious short-term effect the news and public perception has had on the stock market recently, it is timely to discuss a compelling perspective on how to use knowledge of crowd sentiment and sentiment indicators profitably. This is relevant because in recent years it seems as if use of contrary indicators has failed many investors.

In his book, Applying Elliott Wave Theory Profitably, Steven Poser discusses the 5 wave pattern (3 up, 2 down) within an Elliott wave bull move in the stock market (Pages 14 through 17). For ready reference, below is the daily line chart of the 5-wave pattern as had occurred in the S&P 500 index from the Oct 2002 low to March 2005 high. Each wave of the 5-wave is labeled in blue.

Those portions of Poser’s discussion on the 5-wave advancing pattern pertaining to crowd behavior are included in quotations below.

Wave 1 Poser describes Wave 1’s as, “…rarely recognized at their inception. When a first wave starts, the news is just about universally bad. The previous trend is seen (by the crowd) as still being strongly in force. Analysts are revising their estimates for the markets lower, and it is not proper in polite company to discuss such investments.” While the market staged a fairly decisive rally in October 2002, it is probably true that there were few believers that we were in the throws of a bull market.

Wave 2 “This leg will lead all the brilliant analysts to boldly announce that they “told you so.” Victory is at hand for the bears as the trend lower resumes.” In retrospect, this was seemly the case in October 2002. For a brief moment in the fall of 2002, bearish advisors exceeded bullish ones as measured by Investors Intelligence.

Wave 3 “Prices rise rapidly and anybody waiting for a pullback to enter will be sorry, because pullbacks will be short-lived and shallow….It is at this juncture that the Elliot Wave analyst must be careful and remember that it is okay to be on the same side of the crowd some time….Momentum always confirms price highs.” Steven Poser pointed out to me in an e-mail, that there were still a lot of skeptics during Wave 3, until about the time when the S&P 500 broke above the 900 barrier. Both before and following that time however, pullbacks were short-lived and shallow – clearly a characteristic of Wave 3. It was at this time that many skeptics referenced the “contrary indicators” to support the bear case. As described by Poser, the momentum (as indicated by the 14-day RSI) confirmed the price highs in Wave 3.

Wave 4 “It is the first time that some analysts may start warning that prices have gone too far, and the most antsy investors and traders may take profits on their longs here.” As I recall, Poser’s description of Wave 4 is accurate in this case. As an extremely bit player in this drama, I was one of those skeptics that were sounding such a warning in the winter and spring of last year.

Wave 5…It is in Wave 5 that everybody is bullish, all the data suggests that the good times can never end, and bears are scorned and ridiculed.” Bullish sentiment as measured by Investors Intelligence, reached its 5-year high in January of 2005, corresponding to near the top of Wave 5. Also as you can recall, most of the analysts were predicting gains in the stock market in calendar 2005 near the top of Wave 5. Yet at the top of Wave 5, unlike Wave 3, momentum did not confirm the price highs.

Within the 5-wave advance described above between Wave 4 and 5, there was a smaller 5-wave advance which occurred from August of 2004 to March of 2005. It is notable that within this smaller advance, there was similar Wave 3 sentiment along with Wave 3 behavior (e.g. pullbacks were “short lived and shallow”). At that time the crowd was pretty much in agreement that Bush is good for stocks, and the market would move higher. Although in a larger Wave 5 there was a Wave 3 within it with Wave 3 characteristics with respect to public sentiment and nature of advance.

So to summarize, the crowd and sentiment indicators are sometimes correct and sometimes they are wrong. Yet an understanding of the principles of Elliott Wave can help glean some useful information and perspective from the headlines and sentiment indicators that would otherwise be missed or misused.

Thanks to Steven W. Poser, author of the excellent book,
Applying Elliot Wave Theory Profitably, who helped me with this article.

A Most Unfortunate Word

The S&P debt rating downgrade today of Ford and GM’s debt runs deeper than the effect from these companies having to pay higher interest rates on their considerable amount of debt while competing in a low margin business against Asian-based businesses with relatively clean balance sheets. Since the 1950’s automobile companies have barraged the US public with advertising that expressed both direct messages, as well as subliminal ones to sell their cars and trucks. Just watch any major sporting event on TV and you will notice that perhaps half the ads are for cars (the other half is beer). The subliminal messages in these commercials convey lifestyle ideas that suggest that if you buy their cars or trucks, your life will resemble the positive ones portrayed by the actors on TV. If you see a SUV commercial, there may be a young attractive housewife loading her vehicle with leisure items in front of her new mansion. Or similarly, the guy driving the 4-door sedan through the city is the guy that has coworkers kissing up to him in part, because his car is so nice. This commercial subliminally tells us that if we buy that sedan, we’ll be the envy of our co-workers. Or worse yet, consider the Hummer commercial that portrays the guy who, now middle-aged, dreams of winning the soap box derby as a child in a scooter that resembles a GM Hummer while “Happy Jack” by The Who plays in the background?

Well today’s S&P debt downgrade to “JUNK” will be seen by millions of Americans on the evening news and morning drive time shows tomorrow. They will receive the subliminal message from newscasters uttering “General Motors” and “Ford” in the same breath as the word “JUNK.” Not a good subliminal message! This may, in my view, wipe out the subliminal effects of at least 3 years of expensive Super Bowl ads. This is deserved as these companies seemingly got fat on the short term boost of the SUV fad which they promoted to the detriment of the US’ energy position in the world. If these companies had planned ahead, they would have seen this coming as any person of average intelligence could have. Their focus was instead about one quarter ahead.

This is now occurring in other industries too, and the effects will be similar. If you want some more perspective on the auto sector, see the article, “Nobody Needs a Hummer” which I penned in January of 2004.

Today’s Market

Most major indices were little changed today on heavy trading. Today can be characterized as a day of churning. Oil is back over $50/barrel. Gold and silver were up slightly, and the HUI and XAU were down slightly. Bonds continued their rally as the interest rate in the 10-year note was down again. Below is the long-term technical chart with trendlines suggesting that interest rates may be making a higher low.

The market over the last few days could be characterized as wild, as several stocks are whipping around furiously on relatively little news. Typical of this action is the homebuilders and for profit education companies. Here’s a short term daily chart of Career Education (CECO).

Not being in a wave 3, or so it seems, it makes no sense to chase stocks up or down. It’s choppy out there.

Tomorrow is the much watched monthly unemployment report. If bonds continue to rally as they have in recent weeks, speculators will get skeptical about the so called economic recovery and sell stocks. The bond market could probably take a small (emphasis added on small) hit without doing much damage in the financial or housing markets. A good number will boost consumer confidence and help the stock market as long as the bond market does not swoon too badly in a day. So with this in mind, I’m expecting 202,000 new jobs which will be slightly better than expectations, and an unemployment number that remains the same or goes down by a tenth of a percent. The other possibility is that the unemployment numbers will be released followed by a half-hour of market reaction, followed by a revision of the numbers. Does this sound crazy? Where were you on Tuesday?

Have a great evening.

Martin Goldberg

Copyright © 2005 All rights reserved.

Martin F. Goldberg, MS, P.E.
Market Analyst

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