The Wild Ravings Of An Elliott Wave Heretic, And Why "P3" Is Still On

Hi again, everyone. Papa Boule here.

Here's my heresy, right up front: I depart from the purists when it comes to "the market never lies" dogma. When intervention is going on at this level -- when they are painting the tape through intervention dollars exceeding half the market cap of the entire Wilshire index -- you're doggone right the ticker lies. (In one way -- but not in another, as I will explain.)

If someone loaned you and me 7 trillion (or more) free dollars to play with against a total Wilshire cap of 15 trillion, I guarantee you we can move the ticker, a lot, no matter what the social mood. We can play havoc with the S&P and other indexes. We can target the bellwethers and the weighted stocks. We can extend our impact by moving futures around in the overnights. And if we compressed it and did it all in a single week, we could probably shock the economic world by skyrocketing a couple of major indexes' levels in a mother of all "blow-off moves."

With that much liquidity injected (far, far more than we knew about at the time), intervention worked. It moved the tickers up, the big crash predicted by Elliott Wave theoreticians didn't happen, and the big P2 and P3 counts were blown. (And those who went against the flow and came up with bullish counts and calls got lucky.) And here we are at around 1500 on the S&P again.

So is Elliott Wave theory totally discredited and useless now? No, not really. Not from where I sit. And neither are other forms of technical analysis.

The market ticker is lying. Social mood is not where the market ticker says it is. But Elliott Wave analysis can still provide a clue as to where it really is, or at least the direction it has really been moving.

The tell is in the wave shapes.

In terms of social mood, the wave shapes are still correct, as are their individual directions. Their relative sizes and where they end up are not.

The wave shapes can be seen as vindicating Elliott Wave theory. Even though intervention has concealed the level of social mood (the levels of the waves), it has not concealed its direction (told by the shape of the waves). Actual social mood has been declining the whole time. It's actually much lower than the metric of the markets indicate.

Impulse (five-leg) waves down have been shortened and compressed as they struggled down against the upward influences of intervention. (Think of helium balloons under them pushing back up.) So impulsive fivers down have been overlapping, sometimes taking the form of diagonals.

Corrective (three-leg) waves up, moving with the current of intervention, have expanded and extended. So they exaggerate and stretch, and wind up finishing above the preceding impulse wave. (Think of helium balloons pulling them up.)

(By the way, helium is a non-renewable resource. Did you know that? It's running out. This is bad news for Geddy Lee. I threw that line in there for AlbertaRocks. ;)

This distortion has led to EW theoreticians putting 5-wave counts on what are actually corrective waves, and ABC 3-wave counts on what are actually impulse waves. Since the correctives were finishing higher than the impulse waves, they presumed they had no other choice. They were handcuffed by "the market ticker doesn't lie" dogma.

I illustrated this ticker distortion theory a few days ago by simply rotating a current chart 17 degrees clockwise. Look at the shapes of the waves, and how easily they count as an impulse down and a corrective up, rather than the opposite.

Click image for larger view

You can do that sort of thing all the way back to April of 2010, at least. Downward moves have been impulsive in shape, upward moves corrective. And yet the correctives end up taking the markets higher and higher.

There's a simple explanation. Each move up is built on all the preceding intervention. Prices are bid up atop already inflated prices. So the levels of distortion increase -- the market keeps getting further and further from where it should be in terms of social mood.

So the market ticker says that social mood has been going up. The shapes of the waves, and Papa Boule's wild theory, say it has been going down. And along comes Gallup with some strong evidence supporting Papa Boule's wild claim:

Americans are as negative about the state of the country and its prospects going forward as they have been in more than three decades. Fewer than four in 10 Americans (39%) rate the current status of the U.S. at the positive end of a zero to 10 scale. This is about the same as in 2010, but it is fewer than have said so at any point since 1979. As they usually are, Americans are more upbeat in their predictions of where the U.S. will be in five years (48% positive), but this is also lower than at any time since 1979.

The lowest it's been in over thirty years -- that's some pretty convincing evidence of a decline in social mood. A big decline. The market ticker is lying.

What about that huge triple top we talked about a couple of weeks ago? If the market ticker is lying, does that big resistance line still mean anything?

I think it does. And this also supports the underlying theories of Elliott Waves and technical analysis.

The faster a car goes, the more resistance there is. You probably have experienced this. Just stick your hand out of an open car window at 30 mph, then again at 70 mph. You notice immediately that it takes much more effort to move your hand forward against the wind at 70 mph than it does at 30 mph. And the faster the car goes, the stronger the resistance becomes. If it keeps going faster, at some point you won't have enough muscle power to move your hand against it.

The same physics apply to race cars. Getting up to 200 mph takes a certain amount of horsepower, but because of resistance increasing, every mph gained above that takes increasingly more and more horsepower.

So as intervention inflates the markets to higher and stronger resistance levels, the amount of intervention required increases exponentially. Eventually a point is reached where the amount of intervention needed to overcome resistance would wreak havoc in the form of unintended consequences.

That big resistance line has already busted two HUGE bubbles. So it is a tremendously powerful resistance level.

Now that the market levels are at that resistance line again, all those people who would have sold some time ago, but are still in the markets because of intervention, will be digging in their heels and, well, resisting.

I think of big resistance lines like that as "reality check" lines, or "credulity lines," the point where people start saying or thinking things like, "If I keep going along with this and acting any more exuberant, the men with the white coats and butterfly nets are going to come after me." It's a line so far from the moving average centerline of social mood that irrational exuberance starts feeling like full-blown delusional mania. It gets uncomfortable, in other words. And increasingly so, the further away from the centerline it's pushed.

So, getting the market ticker up to resistance like that triple top line is one thing. Getting above it and staying above it is another, requiring a level of intervention that would quickly take the wheels off the economy in other ways.

And in spite of the supposed wild abandon of current intervention operations, there still are practical limits. In a relatively civilized country, actually printing money without any limits is like an economic nuclear option. It's an option of last resort, something that won't be exercised until there is literally no other choice. Objectivists might explain the reluctance to use that option as a function of self-interest. Relatively sane powerful and rich people will not resort to something that, in the long run, actually reduces or threatens their power and wealth. It's only in the most desperate times that such things are resorted to. Those times may come eventually (like, say, after a default-causing, debt-destroying, deflationary crash), but they aren't here yet.

So where is social mood actually? Where would the markets be right now without intervention?

Since the level or amount of intervention isn't constant, but fluctuates (and we don't know how much off-the-record intervention is going on), there's no way to apply a constant curve, or to simply rotate the whole five-year chart a fixed degree. Going by nothing but "feel" based on how things look, I'm going to take a wild guess and say the S&P should be in the 800s right now. And ready to move even lower.

That's right. I'm saying Primary degree wave 3 ("P3"), or a similar sized wave, however you choose to label it, is not only still on, we're already in it. The current rally should have been painting the ticker as a lesser degree correction within it.

So my theory (actually, my belief) is that one of the upcoming impulse moves down will be so powerful that it breaks through the "floor" of the forces of intervention (pops those helium balloons holding things up). And when that moment happens, the market tickers will be in a race (or maybe freefall is a better word) to get back down to where they would be without intervention.

The longer intervention succeeds, the lower that point will be. And there's no way intervention can continue (without consequences) at the levels that would be required, and for the decade or more it would take, to meet the rising wave on the other side of this high-cycle-degree social mood trough.

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Now that all that's off my chest, I'd like to give a shout-out to GregInBaltimore for the great comments he's been making about FOREX -- particularly the Yen. I hope he and all the other FOREX traders who pop in here keep us updated regularly. Currencies are going to be a fascinating and turbulent market in the days and years ahead, and a very profitable one for people on the right side of trades.

And I'd like to once again thank our host, AlbertaRocks, for keeping this place so doggone friendly! Trade safe, everyone.

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I'm adding a chart showing the major triple top resistance line location on the S&P500. The previous chart used the S&P100. This is the resistance line that popped both the Dot Com and the Housing bubbles. The question is -- will it make it all the way there?

Click image for larger view

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I'm also adding this point, which I mentioned in comments: This wild theory also explains the "unfinished" counts at tops we've seen several times over the last few years -- the expected fifth wave move higher that never came. It's because the waves up were corrective, not impulsive. And they were over.