Elliott Wave Warning

12/27/2002 12:00 am EST

Focus:

Steven Hochberg

Chief Market Analyst, Elliott Wave International

Robert Prechter and Steve Hochberg are arguably the world's leading practitioners of Elliott Wave analysis. The two have historically used such technical factors as time cycles, Fibonacci numbers, and Elliott Wave patterns to successfully forecast market direction, interest rates, gold, the economy, and even social trends. They had previously called for a market top in November and their forecast came within 1 day and 3 points of the actual high to date. Here's their latest outlook.

"Bullishness is back to the same high levels as at previous rally peaks of the past three years," notes Robert Prechter, editor of The Elliott Wave Theorist. "Portfolio strategists are telling pollsters that the Dow will exceed 10,000 over the next four months. Mutual fund cash percentages are below 5%, not far from where they were at the all-time high in the stock market nearly three years ago. Investors Intelligence reports that there are twice as many bulls as bears among advisory services. And the headline of a major article in Time magazine said, 'Here's why you should borrow against your house and buy stocks.' The articles tells the public, 'The wisest choice...today means buying stocks even if you have to mortgage the house--literally.' Can you imagine such an article at an actual stock market bottom? It has never happened and never will.

"We have read that the stock market is cheap relative to current short-term interest rates. On the contrary, when interest rates were in double digits between 1980 and 1984, these same models said that stocks were expensive relative to rates, so people didn't buy stocks. Of course, that time was one of the greatest buying opportunities ever. Today, rates are low, and it is one of the greatest selling opportunities. The actual level of rates tells you nothing about the future of stock prices. Sometimes rates are low because an economy is entering a deflationary depression, as has been occurring in Japan for the past 12 years.

"Where are we now? In our view, we're still at a top, not a bottom, despite the carnage of the past 16 months. The main components of the 3.3 year cycle are the 40-week and 80-week cycles. The 40-week cycle last bottomed in July. We used that cycle to anticipate the summer rally. Now the 80-week cycle is pointing down and the 40-week cycle has just about run out of time. From here through the entire first quarter of 2003, the 40- and 80-week cycles point down. Because the 3.3 year cycle is also rolling over, it will begin lending its power to the downside until at least mid-2004. Overall, the next major step is going to be down, and it should have dramatic consequences in the first quarter of 2003 for the stock market and the economy. We expect the Dow to break below its long-term upper channel line. When it does that, there will be no trendline support for the market. This latest rally is not just another selling opportunity; it may be the last one."

Adds Steve Hochberg, editor of The Elliott Wave Financial Forecast, "The long sideways consolidation appears to be ending in gold, which will probably result in a final thrust up. The maximum potential for this move remains $360, but gold's three-year countertrend rally is showing signs of exhaustion and may reverse at any moment. The Commitment of Traders report shows that small traders (the public) held 41,517 futures contracts, their fourth largest net long position ever. On the opposite side of the public are the bearish positions held by commercial hedgers, who now hold their third largest net short position of the year. Upside potential is limited, and the real opportunity is for a significant decline. Near term, the bulls may experience one final fling before the bear market reasserts itself. If gold drops under $310, it would increase the odds that the primary wave C is in place, which would suggest that a decline to below $200 (which is our long-standing target for the end of the gold bear market) is underway."

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