Tuesday, April 12, 2011

A Blow-off Top

There is a strong reason to believe that we are in the midst of a blow-off top, the final stage of a Primary degree bear market rally that has been unfolding for the last 2 years. It's not just the wave path of the stock market that indicates that a blow-off top is in progress. There are also socionomic indicators that point to a blow-off top as well.

Looking at the larger picture, here is a look at the 1999 - 2000 period, the final stage of a Grand Supercycle degree advance unfolding since 1784.

There is a reason for marking the events on the chart. Grand Supercycle degree bull markets always end in a speculative blow-off top. One of the characteristics of a blow-off top is extreme optimism. The extreme optimism unfolds in many ways such as the stock market getting regular news coverage, people getting extremely bullish on the stock market, and yes, people writing books on why the stock market will keep rising into the stratosphere forever.

Here is a case in point for the expression of extreme optimism:

Dow 100,000: Fact or Fiction by Charles Kadlec, came out in bookstores in late 1999.

Dow 40000 by David Elias, came out in late 1999. The author believed that the DJIA would hit 40,000 by 2016.

Dow 36000 : The new strategy for profiting from the coming rise in the stock market by James Glassman and Kevin Hassett. The title came out in bookstores in early 2000.

Notice that shortly after the titles came out, the stock market peaked and a Grand Supercycle degree bear market got underway.

In spite of the bear market unfolding over the last 11 years, there is still a high level of optimism. As we get to the final stages of the bear market rally, optimism is again reaching stratospheric extremes. When the stock market pulled back from the highs of late Feb 2011, there were a number of bearish people claiming that a top in the bear market rally is in. When the pullback was only a few days old, I predicted that we would get one more new high in the bear market rally. The reason for the prediction has to do with the socionomic part of the equation.

Second waves are seen as a continuation of the previous trend. In a bull market, bearish sentiment builds as the second wave unfolds, and by the time the bottom is in, bearish sentiment is even more extreme than it was at the start of the bull market. We are in a bear market, so we invert the expectations. Second waves in a bear market would be seen as a continuation of the bull market, and by the peak, optimism would be even more extreme than it was at the peak of the bull market.

The "blow-off" aspect of the bear market rally were not yet present in Feb 2011. Since the stock market peaks in 2000 and 2007 were characterized by blow-off tops, there is every reason that the bear market rally would end in a blow-off top as well. The market would make a final push for the peak of the bear market rally in a "blow-off" fashion. During that time, the stock market and the economy would get into the news and the last of the bears would throw in the towel in capitulation mode. Ultimately, Minor wave 5 would be a cunning bull trap. Once the bear market rally peaks, the next leg down, Primary wave [3], would get under way and the stock market, the job market, and the economy would plumb greater depths than before.

Here's a chart of the DJIA in 2010-2011

Minor wave 5, which started to unfold in late March 2011, has indeed turned out to be a blow-off top in every sense of the word. Here is what has unfolded since the start of the final thrust:

1 -- Virtually all the economists and analysts have concluded that the worst is over in the economy, and that hiring will accelerate in the job market.
2 -- People have become even more bullish on stocks than they were in 2000 and 2007.
3 -- On April 1, 2011, after the release of the jobs report, Obama declared that the U.S. economy is "back on the road to utopia".
4 -- On April 4, 2011, there was a report on CNBC that a third of the bears threw in the towel in less than a week. This is indicative of a capitulation peak in progress.
5 -- A title, Super Boom Why the Dow will hit 38820 and how you can profit from it by Jeffrey A. Hirsch, is now out in bookstores nationwide. The title is selling like crazy. People are again believing that the stock market will rise into the stratosphere forever.

This is just like 2000 and 2007. From a socionomic perspective, the market is peaking and the next leg down is just around the corner. The worst part of "The Great Deflation" is ahead of us.

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