Waterfall Decline Ahead

We are very close to the end of Minor wave 2 up, with the top around a week in the future. Expectations for a three month long reprieve period were fulfilled as markets made a rapid bounce off the early October 2011 lows and then stayed elevated for the rest of the year. It was a chance for people to enjoy the holidays while the economic and financial fault lines in the western world were temporarily stabilized.

As we approach the end of the three month reprieve period, the mainstream media has become extremely bullish. Expectations for economists, market analysts, and journalists in the mainstream media to become very bullish on the economy, job market, and stock market by the end of the year have been fulfilled. Since the last write-up in early December 2011 as the last part of Minor wave 2 up started unfolding, people have become even more bullish on the economy, stock market, and job market.

Here are some recent examples of extreme bullishness that has shown up in the mainstream media in the last few days:

1 -- Yahoo news uses the rising consumer confidence as a reason to be bullish on the economy in 2012, even though the long term trend of lower highs and lower lows in consumer confidence since the peak in 2000 is still intact.

2 -- Journalists working for MSNBC are extremely bullish on the US economy, making calls for the economy and job market to grow faster in 2012. This bullishness is also shared by virtually all the mainstream economists as well, who are all calling for increased economic growth.

3 -- Douglas Kass (well known investor) is extremely bullish on the stock market, making bold calls for new all time highs by the end of 2012. The video of the interview on CNBC can be seen here.

4 -- On the Kudlow Report yesterday on CNBC, there was abundant talk about stocks being "ridiculously cheap", which indicates extreme bullishness. Video of the news segment is here.

From a socionomic perspective, extremes in social mood signal a reversal of the current trend. Combined with our current position of being near the end of Minor wave 2 up, there is a strong reason to anticipate an imminent reversal in the stock market.

The DJIA continues to follow the 1930s parallel with the third phase of "The Great Deflation" being a parallel of the Great Depression. Here are some updated charts of the DJIA underscoring the parallel:

DJIA in 1929 - 1930:

DJIA in 2009 - 2012:

Notice that both of the bear market rallies put in a head and shoulders top. In both cases, the head and shoulders top formed with fibonacci relationships in terms of time with a fibonacci convergence at the right shoulder.

In the bear market rally that unfolded in 1930:

1 -- The right shoulder peak formed 1.5 months (3 time units) after the peak of the head.
2 -- The peak of the head formed 2.5 months (5 time units) after the peak of the left shoulder.
3 -- The left shoulder and the right shoulder are 4 months (8 time units) apart.
4 -- The right shoulder peak formed 6.5 months (13 time units) after the start of the bear market rally in November 1929.

Notice the fibonacci sequence  numbers 3 - 5 - 8 - 13 in the head and shoulders top.

In the bear market rally that unfolded in 2009 - 2012:

1 -- The right shoulder peaked 8 months after the head peaked.
2 -- The head peaked 13 months after the left shoulder peaked.
3 -- The left shoulder and the right shoulder are 21 months apart.
4 -- The right shoulder peaked 34 months after the start of the bear market rally.

Notice the fibonacci sequence numbers 8 - 13 - 21 - 34 in the head and shoulders top.

The sentiment in both of the bear market rallies is also identical as well. In both cases, economists, politicians, and the mainstream media were extremely bullish on the economy by the end of the bear market rally, with assurances from politicians and the mainstream media that the worst was over.

Here is a chart of the 1930 bear market rally with our current equivalent position arrowed on the chart:

We are currently at the equivalent of late May 1930. We are close to the end of Minor wave 2 up. After the reprieve period ends, Minor wave 3 down will start and is expected to take the form of a waterfall decline in the stock market with a duration of 4 months. The start of Minor wave 3 down is when the economy and stock market enters the heart of the abyss with "The Great Deflation" unfolding in full force, in the same way that the economy, stock market, and job market entered the heart of the abyss in early June 1930 during the Great Depression.

The downside target for the end of Minor wave 3 down is 7200 on the DJIA and 775 on the S&P 500, both to be reached in May 2012.