With all the craziness going on in the world, the stock market is still rallying. It just does not make sense to most, states Avi Gilburt of ElliotWaveTrader.net.
The Russian-Ukrainian war still rages, oil is still very high, inflation is supposedly ravaging the country, we are facing potential food shortages, the Fed is raising rates, and there does not seem to be an end to the bad news. Yet, the stock market continues to rally on. But, as I have said in the past, this is no different when the market rallied strongly during April and May of 2020 when the highest Covid death rates were being reported, unemployment was hitting massive record levels, economic lockdowns were taking hold all over the country, and economists were declaring us to be in recession.
I know it sounds so counter-intuitive, and many still fight accepting this, but the market does not pay as much attention to these factors as so many believe. In fact, all these factors only lend themselves to extreme negative sentiment, which often marks major market bottoms. In other words, these issues really just don't matter to Mr. Market.
All the market really cares about is where we are in the sentiment trend. And, if you know how to track it, your investing life becomes so much easier, as my members tell me all the time: "Before my subscription, I was a participant in the sentiment action. Now, with your help, I am student/observer of sentiment and am financially rewarded for it."
What I find truly fascinating is that there are individuals who will provide you with really timely postings of their market views, which are often the best contrarian indications you may find. One such individual called me out exactly at the bottom in March of 2020 for my expectation for a rally from 2200 to 4000+.
In fact, as we were bottoming, he proclaimed that "Avi doesn't believe the economy ever means anything to stocks and has told me so several times last year... So, you have that common sense view, or you can believe Avi's chart magic will get you through all of that and is right about a big bounce off of 2200 all the way back up to 4,000."
Well, as we were recently bottoming, he decided to chime in again, outlining his strong bearish views of the market as we were hitting the recent lows. I am going to leave out most of his long-winded diatribe, and post the meat of his view: "So, keep up the chart magic...I'll just sit back quietly for the rest of the journey and watch you keep bumping your way down during the year ahead as 5500 becomes a faint view faraway in the clouds...I know I'm enjoying watching you bounce down...in your dogged beliefs."
Well, thus far, it would seem that my "chart magic" is performing quite well.
Sadly, many in the market maintain similar views as this person above. When they see the market declining, they believe that it will simply continue in linear fashion. And, that goes for perma-bears like the person quoted above, as well as non-perma-bears. But, that is not how markets work, as they are not linear. And, this person is a perfect example of how market participants allow market sentiment to drive their views without even realizing it. That is what drives him to post exactly as the market sentiment reaches its extreme in negativity, and makes him feel extremely confident in his bearish perspective right before the market turn occurs.
But, for those of who are interested in a more mature understanding of how markets work, we need to look towards recent market studies that provide us greater insight into the psychological drivers of market direction.
In a paper entitled Large Financial Crashes, published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation for the overall herding phenomena within financial markets: "Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an "emergent" behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness."
And, as Ralph Nelson Elliott stated many years ago: "The causes of these cyclical changes seem clearly to have their origin in the immutable natural law that governs all things, including the various moods of human behavior. Causes, therefore, tend to become relatively unimportant in the long term progress of the cycle. This fundamental law cannot be subverted or set aside by statutes or restrictions. Current news and political developments are of only incidental importance, soon forgotten; their presumed influence on market trends is not as weighty as is commonly believed."
In fact, the presumed influence is so wrongly assumed that it keeps most market participants looking the wrong way at the major trend changes, like our "friend" above.
In a 1988 study conducted by Cutler, Poterba, and Summers entitled What Moves Stock Prices, they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.
However, the study concluded that "[m]acroeconomic news bearing on fundamental values explains only about one fifth of the movement in stock market prices." In fact, they even noted that "many of the largest market movements in recent years have occurred on days when there were no major news events." They also concluded that "[t]here is surprisingly small effect [from] big news [of] political developments...and international events."
In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years' worth of "surprise" news events and the stock market's corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.
In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were NOT linked to any news items: "Most such jumps weren't directly associated with any news at all, and most news items didn't cause any jumps."
Just consider what occurred last month. As the market was dropping in this current pullback, most market participants don't even realize that the market bottomed and began a 10% rally the exact day that Russia invaded Ukraine. Yet, if you ask most market participants, they would tell you that the decline was caused by the Russian/Ukrainian war. It is truly a shame that most market participants are not burdened by the facts, but would rather buy into a story because it sounded good. Yet, those stories are what keep you on the wrong side of trend changes.
This brings me to my upcoming expectations. And, as I say to my members all the time, I am but a simple market analyst and not a prophet. So, my analysis is only based upon probabilities, as outlined by our mathematically derived perspective. Therefore, I have to approach the non-linear environment of the stock market with a non-linear perspective, as presented by if/then logical progressions.
So, as long as the market remains over 4350 S&P 500 (SPX) (our prior resistance) on any further pullbacks, the bulls remain strongly in charge. And, at this time, I am looking for an initial 5 waves off the recent lows to confirm that we have begun the rally to 5500SPX in earnest. The ideal target region for that 5-waves is the 4750SPX region.
Thereafter, I would expect a bigger pullback before we break out to new highs and progress towards our next major target of 5500SPX. But, due to the amount of time it will likely take to complete this pattern, it may not be until late in the summer—or possibly even early fall—that we see new all-time market highs. Moreover, should the market continue higher in the coming week or two, I will be raising my support level until we complete all 5 waves off the recent low.
Avi Gilburt is a widely followed Elliott Wave analyst and founder of ElliottWaveTrader.net, a live trading room featuring his analysis on the S&P 500, precious metals, oil, & USD, plus a team of analysts covering a range of other markets.