The Absolute Return Market Forecast Blog

Executive Summary

Even as some US stock market indices make new highs, US Equity markets continue to exhibit poor reward to risk based on our proprietary predictive models.  A long-term market inflexion is either imminent, or would be seen later in 2011.  The Dow Jones Industrial Average (DJIA) should be constrained by the 13,300 level if the rally continues into 2011 as part of a sideways market, as attempts by a mature rally grow weaker due to rising global inflationary pressures which we believe the central banks are unable or unwilling to contain.  Both technology stocks and small caps have hit very strong resistance from their respective 2007 orthodox highs, and should underperform generally speaking over a longer term period while simultaneously dragging the broader market down.  Tech and Small Caps are affected the most by dropping consumer discretionary spending that is squeezed out by rising intermediate-term commodity inflation, within a longer-term deflationary context that is limiting income.  We believe that other asset classes and active strategies are offering better reward to risk profiles, which can be taken advantage of in our dynamically managed portfolio family at customizable levels of risk and target return.  We have modified a perpetual 25 basis point discount for asset management fees for new clients investing at least $30,000, and are offering it on days that the Dow is above 12,000 as a win-win incentive.

Up against Another Ceiling

Figure 1:  Actual performance of the Dow Jones Industrial Average (DJIA) against the Feb 16^th forecasts (pink and white dashed lines).  The white forecast is no longer valid, the pink forecast has been replaced with the yellow forecast (yellow cloud for top and yellow dashed lines for the forecast), and a new light blue forecast has been added (light blue cloud for top and light blue dashed lines for forecast).  Both the yellow and light blue forecasts have equal probability as of April 1^st.

The markets continually offer clues as to their intentions.  Being of broadest interest, we have chosen to focus on the US equity markets in this blog even though we pay as much attention to all other major asset classes (International equities, Bonds, Commodities, Precious Metals, and Currencies) for our dynamically managed portfolios.  On February 16^th, we had forecast the following

1. S&P500 Futures peaking between 1340 and 1350 in February or early March – The S&P500 futures peaked on February 18^th at 1343.
2. A decline larger than the November 2010 (4.4%) decline was imminent – The S&P500 dropped by 7.2%.  In fact the market tracked the pink dashed lines (See Figure 1), the primary forecast from mid-February, for almost a month which is a testament to the shorter-term probabilistic accuracy of the underlying models.
3. We had assessed the decline to be 10%+ based on the assessment of the wave structure – That was incorrect.  The S&P500 dropped by 7.2% and since then has risen, with both the Russell 2000 (Small Cap) Index and the Dow Jones Industrials making new highs for the rally from March 2009.
4. 2861 being a critical resistance (a ceiling) for the Nasdaq (see Jan 31^st blog post) for the ending wave of the rally – The Nasdaq Composite Index made a high at 2840, below the critical level of 2861, and dropped 7.4%.  It has been underperforming the NYSE since then.

So where does all this leave us?  The keys are in i) the Russell 2000 Small Cap Index and the Dow going above their respective February 2011 highs, and ii) in another stimulus stimulated, very low volume, 3-wave rally from the March 16^th low as it appears from its as yet incomplete structure (not shown).  However, just like the Nasdaq was in February, the Russell 2000 index is up against its own ceiling, its October 2007, orthodox (wave structure based) high of 852, though, again it could temporarily exceed this high in case of the light blue forecast.  The implications of that are

1. The Dow and possibly the S&P500 should be making new temporary highs as shown by the yellow cloud in Figure 1 which indicates the probable area of the peak for the current rally from March2011
2. The forecast in White dashed lines is ruled out, i.e. the secondary forecast from our Feb 16^th blog post.
3. The forecast in Pink dashed lines (i.e. a new summer high in the Dow) is accelerated and pulled  into the current rally.  The modified “Pink” forecast is shown in Yellow dashed lines.  The forecast in Yellow dashed lines becomes one of the two highest probability forecasts going forward.  Essentially, the fractal structure of the entire rise from March 2009 is now satisfied and can be completed by this current rally (which should not go much higher).   The pink forecast can now be ignored.  In mathematical terms, the wave structure in Yellow font and the Yellow forecast and Yellow cloud represents a necessary and sufficient condition for the end of the US market rally from March 2009 and a long-term market top.
4. Identifies a new probable fractal path for the US markets for 2011, shown in Light Blue dashed lines.  Essentially this indicates a sideways, range bound market for a lot of 2011, with the upper limit around 13,000 for the Dow and the lower level between 11,000 and 11,500.  The Nasdaq still faces the 2861 ceiling, and the Russell 2000 Small Cap Index faces a ceiling at 852, the levels being their respective highs in October of 2007.  We are giving the Light Blue forecast an equal probability to the Yellow forecast at this time.  The behavior over the next month or so of the Dollar, Precious Metals, and Oil will give us clues on whether this is a higher probability, or the Yellow forecast is.  There are other technical indicators like volume and momentum which will also give us significant clues.

Straw that breaks the Camel’s back?

But what is the rationale behind all this, other than mathematical modeling of a non-linear system?  We had no way of knowing before February 16^th about the revolution in Libya, or the deeply saddening cataclysmic destruction and ongoing nuclear danger in Japan.  Egypt’s Mubarak had already resigned on Feb 11^th and the market had seemingly shown it could make new highs despite $100+ Oil.  What we knew then was that the rally from August 2010 was mature, and it would not take much to knock it down, despite the improving employment picture in the Western world and the continued real economic growth in emerging countries despite significant inflation.

Some in the media have voiced the question of whether the events in Japan are the “straw that breaks the camel’s back”.  We think it could very well be, because Japan has the highest debt among developed countries (started 2011 with over 200% Debt-to-GDP ratio) versus 115% for Greece and 93% for the US in comparison.  Just like sub-prime mortgages were the weakest link in the consumer debt chain, Japan could quickly become one of the weakest links in the sovereign debt chain when global appetite for debt starts to decrease (we believe it is rapidly increasing Sovereign debt that has propped global markets up since the crash in 2008).  What is not clear is the timing of when the markets recognize what we think is the irreversible damage to the Japanese economy and by inference the global economy.  We will have to watch closely, but rising long-term Japanese interest rates, and the Yen changing its long-term trend from rising to falling against major currencies would tell us if this is starting to happen.   Even then it could be a year or more before that rise starts to snowball into being recognized as something that is affecting the global economy.  By then it would be too late.

 In terms of the rationale behind our primary forecasts shown in Figure 1:

-          The Yellow scenario models the thesis that indeed the blows to the global economy from Japan and rising commodity inflation are deep enough to “kill” the rally from March 2009, and signify the long-term Equity market top we have been discussing in this blog.  If this scenario is true, we should see almost a linear co-incident rise in Precious Metals and Oil after a brief correction, coinciding with a dribbling drop in the US Dollar.  This is the end-game of the Quantitative easing (QE1 and QE2) and its reflationary effects on the global economic system we have seen since 2009.  Remember that Precious Metals and Oil kept rising for many months after the US Equity markets peaked in October 2007 after the housing boom fueled rally of 2003-2007.

-          The Light Blue scenario models the thesis that the US economy has more life in it, from the effects of dropping unemployment rate, the published Fed action of QE2, and unpublished propping actions/interventions by central banks, i.e. continuing global stimulus that somehow counteract inflation related revenue and profit drops for a while longer.  We believe such stimulated effects are fake and have resulted in the fake growth signature we see in the equity markets since 2009.  If this is true, we will see the US markets move essentially sideways for most of 2011.  Secondly, we should see a sizable temporary correction in Precious Metals and a sizable rise in the Dollar into the summer.

Either way, we think the risk of remaining in the US equity markets is too high, with the rewards being minimal at current levels.  Other asset classes offer a much better reward-to-risk ratio.  We offer a solution for this through our dynamically managed portfolio family which selects investments and adjusts asset allocations as the market environment changes. Each portfolio is designed to provide absolute performance at pre-determined levels of risk over a reasonable period of time.  Contact us to learn what we think about these other asset classes and our portfolio strategy.

New “Good Times” Discount

To emphasize this, we are modifying our 0.25% (25 basis point) discount offer for new clients off our asset management fees, which had expired on March 31^st.  We are now offering the same 25 basis point perpetual discount if a prospective client commits to a minimum $30,000 investment in one or more of our portfolios on a day that the Dow Jones Industrial Average is above 12,000.  The discount was meant to be a “good times” discount, i.e. an incentive for prospective clients to move assets to our dynamically managed portfolios while their traditional buy-and-hold portfolios were still in good shape.  We want to highlight the win-win nature of the new offer.  You win because, in our opinion, you move assets to our portfolios that offer lower risk than many conventional strategies in the current economic climate.  We win because your assets are still high enough in value (if the Dow is above 12,000) so we get higher management fees relative to if you came to us after a major drop in the Dow.

On the surface our call for a rise in the US equity markets in February has been a good one so far.  Figure 1 below shows the Jan 31^st forecast for the Dow (in dashed white) against its actual performance.  However, the structure of the rise was not as we expected for the primary forecast which has some pretty important implications for the market’s trajectory for the remainder of 2011 and also for the line in the sand we drew for the Nasdaq Composite Index at 2861 as a key indicator of our bearish case for 2011.

 Figure 1  Updated Elliott Wave structure for the DJIA (Dow Jones Industrial Average) with the new primary forecast in dashed pink with the projected area of a top shown in the pink oval.  The dashed white lines are the forecast from Jan 31^st, 2011 which is still valid but with a lower probability.

To really explain the change, I need to give you a deeper peek into our fractal model for a bit, so you can either choose to skip the remainder of this update, or roll up your sleeves a bit and dive down with me.  One aspect of the rally from March 2009 which we would expect in a corrective rally is the classic 3-wave corrective pattern called a zig-zag (a-b-c)as shown on the left side of Figure 2a.  Normally it would be possible to recognize these in real time.  However the zig-zag pattern has been distorted to contain an “upward triangle” b as shown in Figure 2b, which has made it almost impossible to detect these in real time, unless one is looking hard for them.  This variant pattern was first detected and cataloged by Elliott Wave International in 2006, but our back-testing using our proprietary model has shown that this pattern showed up in 2003 and has been an integral signature of the low-volume market rallies we have seen since then.  I call these patterns the “signature of the stimulus” because they have been visible only during times of huge global liquidity injections by Central Banks and have been present in almost EVERY rally leg of the equity rally from March 2009.

For the rally in February, I was expecting a 5 wave rise to complete the rally from late November.  Instead of the 5 wave rise I expected which would indicate a new ending structure, we appear to be getting the curious pattern of Figure 2b again.  And that too strung after two more of the same curious pattern, which would make the entire rally from August into a triple-zig-zag (W-X-Y-XX-Z) as shown in Figure 3 below.  This brings back to life (and to the top), a modified version of the forecast I had shared back in the November 2010 blog post, and pushes my January 31^st primary forecast lower in probability (still shown as a secondary forecast in dashed white in Figure 1).

Figure 3  S&P 500 Futures prices from July 2010.  The rally from late August 2010 is structured per a string of 2 zig-zag patterns labeled W and Y, with a 3^rd zig-zag pattern that appears to be forming the Z leg.  A triple Zig-Zag is a terminal pattern which means any subsequent correction would be larger than the X or XX corrections within the triple-zig-zag.

Our updated analysis and forecast is shown in Figure 1 in dashed pink lines, with the target area for the long-term peak arriving this summer shown with a pink oval.  Key elements of this forecast are

1. The rise from August 2010 appears to be tracing out a triple-zig-zag which is a terminal pattern, as shown in Figure 3 above.  The first zigzag was from August 2010 to early November 2010, the 2^nd zigzag from late November 2010 to mid-January 2011, and the 3^rd zig-zag from late January 2011 looking to end in February or early March.
   1. The 2^nd zig-zag ended close to a Fibonacci 0.618 ratio (the “golden mean”) of the 1^st zig-zag in the S&P 500.  Fibonacci ratios are found all over nature from human DNA to flowers to spiral galaxies, and in fractal ratios inside liquid markets and consumer demand data.  If the 3^rd zigzag retains the same elegant symmetry exhibited by the 2^nd zig-zag, we would expect the S&P 500 Futures to top around 1340 to 1350 in February or early March, completing this cumulative pattern.
   2. The 3^rd zigzag would end this pattern and the resulting correction would be larger than either the November 2010 or the January 2011 corrections, and exhibit the character of the correction we saw between April and August of 2010.  I would be looking for a 10% correction on the low-end for the March/April timeframe.
   3. The intermediate-term rally from August 2010 to the top we expect shortly would be wave d of XX (Figure 1).  Hence, we still need to see a wave e of XX down to complete the sideways move XX which started in January 2010.  We would expect this wave to be a downward zig-zag or string of zig-zags.
   4. The primary rally from March 2009 would be completed when the 3^rd, larger, zig-zag (Z) forms and completes sometime this summer, also shown in Figure 1.
   5. In the Jan 31^st blog update, I had shared the 2861 level for the Nasdaq Composite Index as a critical level which would indicate whether the rally from March 2009 was over or was going to continue for longer.  The level is still critical, however only for Wave Z in the Nasdaq.  Thus this current wave d of XX, being an interim (versus a final) wave, is allowed to break above the 2861 level without being consider a fatal violation of the 2007 high.  Given the current trajectory of the Nasdaq, I would not be surprised if this happens.

Our purpose in explaining these details is to give you a better feel for the model and for the fractal nature of markets, hopefully lending validity to our dynamic approach to understanding and harnessing these market trends into absolute investment returns with our market forecasting methodology.  Major asset classes like Precious Metals, Commodities, Bonds, and certain Currencies are also just past or near critical junctures per our trend forecasting models, with forecasted moves in some cases far exceeding, in percentage terms, what we are indicating above for US equities.  You can take advantage of our 25 basis point perpetual discount off our asset management fees if you decide to invest in any of our family of managed absolute return portfolios by March 31^st.

Figure 1: Updated forecast for the Dow Jones Industrial Average. New forecast in white and turquoise dashed lines replace the earlier forecast from November 2010 in yellow and orange dashed lines.

In the preface to his book “Only the Paranoid Survive“, Andy Grove the ex-CEO of Intel Corp., explains a term he coins “Strategic Inflexion Points” as “a time in the life of a business when its fundamentals are about to change … They build up force so insiduously that you may have a hard time even putting a finger on what has changed, yet you know something has.”  He goes on, “let us not mince words:  A strategic inflexion point can be deadly when unattended to.  Companies that begin a decline as a result of its changes rarely recover their previous greatness“.

In the last 10 years, a fundamental shift has occurred in the macro-economy from that of the 80′s and 90′s.  In this period, business performance, strategy, and our investments/home values have been pretty much at the mercy of the rise and ebb of this global macro-economy while normal business cycles have become a less important underlying rythm.  It can be generally agreed that the major strategic inflexion points from an economic standpoint during this period were 2000 (peak of the internet bubble), early 2003 (beginning of the housing/consumption bubble), October 2007 (Dow’s all time high and the beginning of the worst bear market since the 1930′s), and March 2009 (new post 2000 market low from the aftermath of the sub-prime credit debacle).  Each of these points marked a massive shift in the nature of our economic lives, and those (companies and individuals) who recognized and adapted to these shifts the earliest arguably benefited the most, and conversely resulted in a “go-nowhere” decade for most investors portfolios.  Our market forecasting methodology at The Absolute Return, we believe, provides a means to projecting these inflexion points (and more).

In November’s post I provided a long-term perspective from these models and a specific forecast (in yellow and orange dashed lines) for the Dow Jones Industrial Average leading to the next major inflexion point.  This forecast has been updated with current market prices in Figure 1 above.  As you can see, the market did not drop as deeply as I had projected in early November, and has risen almost steadily from late November.  From a fractal model perspective however, the market drop in November satisfies the requirement for ending the sideways move from January 2010, mirroring the structure and truncated end of a similar sideways move in 2007 (not shown).  The subsequent market rise, from late November 2010, structurally matches the rise I was expecting to start later in December 2010.  Hence, it looks like we are about a month early heading into what we see as the next major market top, one which we expect to hold for many years, if not the rest of this decade.  We expect this top to be the start of a downward price move that takes the Dow below its March 2009 lows over the next 3 or so years.  Our primary projection has been updated in white dashed lines in Figure 1, with a secondary and lower probability shown in turquoise.  We are looking for a top to the US equity rally from March 2009 in February 2011, between 12,000 to 12,500 for the Dow.  It is possible we have already made this high, but history (and our fractal model) tells us that the Dow is likely to close firmly above 12,000 before this major rally ends.

Figure 2:  Nasdaq Composite Index from 2000 to date showing the critical level of the 2007 index high

But what is the risk to this forecast?  To answer this question quantitatively let us look at the Nasdaq Composite Index shown in Figure 2 above, which also brings us to the topic of this post.  The Nasdaq Composite Index is the best proxy we have for the Technology industry.  The internet and tech crash of 2000 is where we believe this secular bear market began, and tech is one of the few sectors that has seen higher revenues compared to 2007 so we need to take a close look at this index to measure if the market values this growth higher than it did in 2007, or not.  So far, the market has risen to within 3.3% of the 2007 peak before dropping last week, but has not broken across this level.  Another reason why the Nasdaq is important is that structurally (i.e. from the standpoint of our proprietary fractal models) the major US indices have moved in lock-step at least since 2000.  Hence if the Nasdaq’s advance from March 2009 is stopped by the 2861 level, we expect the Dow, the S&P, and Russell 2000 to do the same.

The US equity rally from March 2009 is hence at a moment of truth.  It will remain suspect using this simple test unless the Nasdaq makes its way over the crucial 2861 level.  If it does, then the rally can continue higher, albeit with good sized corrections along the way, and deflation gets to remain at bay for a while longer.  We will update our forecast if that happens.  If not, we may be right up against another one of Andy’s strategic inflexion points.

Fractal models aside, what could cause such a market peak?  It feels like the economy is getting better every day, as Jeffery Immelt, CEO of GE recently said.  Bob and I will answer this question in our annual 2011 newsletter in the context of explaining the cause, progression, the series of global reflationary responses, and the signature of these reflationary responses to the secular deflationary trend which we believe began in 2000.  For now, we can look back to October 2007 for clues.  At that time, even though the housing market had peaked, and many were aware of the issues with sub-prime loans, both Wall Street and the Fed/Treasury assured us that all would be well and that the problem would be contained.  It was not until Lehman went bankrupt in September 2008, ~11 months after the market peak, that people started to realize that something was really wrong.  Today, we have among other issues, a major sovereign debt crisis in Europe which is being swept under the rug/postponed and has been understimated significantly.  We have many states and cities in the US that are essentially bankrupt.  We have countries like China, that are littered with malinvestment and some serious inflation at the altar of “growth at all costs”, things that become apparent during deflationary times.  And we have developed nations like Japan with debt-to-GDP ratios over 200%, hanging on the fine thread of 1% ish interest rates that have so far been funded largely by an aging local population with a dwindling savings base.  If Greece alone can strike fear into the hearts of investors, dropping the S&P 500 by 15% between April and June 2010, it is not unreasonable to assume that one or more of these factors mentioned could start and accelerate a new downtrend.  Then again, it is also true that markets can remain irrational for the longest periods, but that is where our proprietary market forecasting methodologies come in with an objective, probablistic assessment of the maturity of trends and sub-trends.

Contact us to find out how we dynamically track with and leverage these trends to pursue absolute returns for our clients while simultaneously lowering portfolio volatility, in any market.  You can take advantage of a perpetual 0.25% discount off our normal asset management fee, if you invest in any of our family of managed portfolios by March 31st.

The first 3 days of December have seen a sharp 3.7% rise in the S&P500.  The initial Euro-zone bailout of Ireland was not received well by currency traders with the Euro continuing its decline to almost 9% from where it topped in early November as yield spreads for Irish (and Portuguese and Spanish) debt continued to rise.  Then suddenly, after a morning of a (subsequently denied) rumor that the US was participating in an IMF bailout that would effectively monetize some of Ireland’s (and Portugal’s and Spain’s) bad debts, the market (and the Euro) rocketed upwards, not to be stopped by an abysmal unemployment report last Friday that should have thrown “cold water” on the rally.  So does this mean that the market is shrugging off all kinds of bad news and is off to the races again?  Is the short-term forecast we made in my last blog post early November of a deeper and longer decline in the Dow invalid?  Possibly, but we do not think so as yet.  In fact, our investment convictions (and positions) in our Dynamic Macro series of portfolios have not budged as of the time of this post based on our continuing comprehensive analysis (get a glimpse of the technical side of this in Bob Palmerton’s latest Market Tour Blog post) .  We are watching volume very closely, among other indicators, and do not believe that this rally has any lasting value over the next few weeks unless volume rises substantially.  An update to the published short-term version of the same Dow forecast from the last post is shown below in Figure 1.   The actual Dow is in solid white and the 2 forecasts published on November 12^th are in yellow and brown dashed lines.

Figure 1

At THE ABSOLUTE RETURN, we have observed that the trend is primary and the news either re-inforces this trend or bounces off against it.  In other words the market’s position relative to where it is in the structure of the trend is the key factor to whether any news story is interpreted as a glass half-full or half-empty.  So what is this structure for the Euro?  Is there more downside left whether or not there is more bad news attributed to be causing the downside?  Figure 2 below shows our forecast (yellow dashed lines) for the Euro/US Dollar exchange rate based on our proprietary version of the same Elliott Wave fractal model.   The Australian Dollar/US Dollar exchange rate is superposed on the same graph to illustrate the similarity of the pattern.  Both should drop out of their respective upward trend channels at the same time to resume the downtrend from early November before there is strong support at the 1.25 level.

Figure 2

We are extending our special offer of a 25 basis point (0.25%) perpetual discount to our asset management fee tiers to the end of March 2011.  That should give those who are considering us some more time to understand and appreciate the uniqueness and hopefully effectiveness of our objective, dynamic approach.  Besides, our current primary forecast is that of a very significant equity market high (at least for the Dow) around that timeframe as shown in Figure 1 above.

Summary:  The current rally (from March 2009) is not part of a new long-term bull market.  That is what a structural analysis per the Elliott Wave fractal model of the Dow Jones Industrial Average (DJIA) indicates.  The rally from March 2009 is shown to be “corrective”, and has so far followed the same structure as the rally from 2003 to 2007.  Based on the “corrective” nature of the structure, the Elliott Wave fractal model predicted in 2007 that a decline would ensue that would take the markets below the 2003 lows in the Dow.  The Dow broke below the 2003 lows and bottomed in March 2009.  The same conclusion can be drawn today, i.e. that the Dow should make a new low after (could be a few years after) the current rally is complete.  This post provides a perspective for the current position of the DJIA within the context of this fractal model.  A forecast of a high probability scenario for the DJIA into 2012 based on THE ABSOLUTE RETURN’s proprietary version of this model is also provided.

 ________________________________________________________________________

Context is everything, or almost everything for those who aim to buy low and sell high as every investor should.  At THE ABSOLUTE RETURN, we believe based on our observations, that the markets are NOT efficient at a macro level (only at a micro level and that too in relative rather than absolute terms), but are actually structured per a self-similar, robust, fractal.   We utilize a proprietary, objectively derived version of the Elliott Wave Fractal Model of the markets as the cornerstone of providing this context.  The fractal model is one of 3 key pieces of our price forecasting methodology for an asset or security.  Figure 1 below is a summary of our very long-term view of market progression for the US equity markets as it relates to a simplistic depiction of the fractal model, which includes our addition of timeframes (in red) to a chart originally published by Elliott Wave International. 

We believe we are at the juncture marked “We are here?” in Figure 1 based on our analysis of historical data, which jives with some of the key proponents of the basic model, including Bob Prechter and Elliott Wave International.  The path shown beyond the marked point, is one of the probable paths forward, again based on our proprietary analysis.  However, it also happens to be the highest probable path forward for the next many years, hence we will use that as the illustration for our analysis rather than muddy the waters with alternative scenarios, which do exist and may actually end up happening.

Figure 1: Elliott Wave fractal model idealization with important market turn dates for the Dow Jones Industrial Average superposed.

I started using this model in 2007 after adding proprietary enhancements to it, and it has correctly projected each of the two subsequent primary market trends and their general form since I started applying it to real money in June of 2007, including predicting the historic market decline of 2008 and the dramatic market rise in 2009, which we still have not yet completed the end of.  I was not in the financial industry until October 2008, hence you will have to take my word for the first claim, ask to look at my brokerage account, or talk to those of my Silicon Valley colleagues whom I told to stay out of the market that year.  My first publication after I moved into the Financial world, in January 2009, contained both the prediction that the market would make new lows with respect to the 2003 lows (which the market had not done at the time the letter was published), and the prediction of the 2^nd primary trend, which was the market rally we have seen from March 2009.  My next newsletter in January 2010 called an end to the rally from March 2009 and painted a picture of the next primary market, which I projected would be a decline that dwarfed the 2008 decline.  The major rising phase of the rally from March 2009 did indeed end in January 2010 (to prove my point, the Dow will need to drop to near or below the high from January 2010 on its next decline which which we expect to happen shortly), but instead of transitioning into the next primary trend (down), the market morphed into a sideways market for 2010 still within the context of the primary rising trend from March 2009.  That’s where I believe we are today.

Now that you know where we are relative to the very-long-term model progression as illustrated in Figure 1, I am going to dive into the last 8 years of the US equity markets, using the Dow Jones Industrial Average (DJIA) shown in Figure 2 below.  These 8 years have consisted of 3 distinct markets, a 97% rise from 2003 to October 2007, a 54% decline from October 2007 to March 2009, and a 77% rise from March 2009 until the last peak as of November 5th, 2010.

Figure 2: Dow Jones Industrial Average (DJIA) – Elliott Wave Analysis and Forecast thru mid-2012.  Note the structure of the counter-trend rallies which is “corrective”, versus the “impulsive” market drop from October 2007 thru March 2009.  The key difference that you can note is that a “corrective” move has its sub-moves in the direction of the move as being in 3 waves, whereas an “impulsive” move the sub-moves in the direction of the move are sub-divided into 5 waves.  It is important to note that it is the structure of the forecast that is pertinent rather than any timeframes indicated.  Timeframes will likely be off even if the forecasted structure plays out.

The first period, from 2003 to 2007, was a corrective rally, i.e. a rally which retraced part (or all in this case) of the market’s decline from the 2000 peak (this 2000 peak is where we believe the secular bear market began, which we are in today).  There are 2 reasons for calling this “corrective”.  First, the fact that the markets made a new low in March 2009, after this rally ended in October 2007.  A second reason is predictive, based on the structure of the rally from 2003 to 2007.  You can learn more about corrective wave structures per the Elliott Wave Principle by calling us or referring to http://www.elliottwave.com/club/EWI-basic-tutorial/default.aspx?code=20301&articleid=0 (you will need to sign up for a free membership to Club EWI and agree to receive marketing materials from Elliott Wave International in order to get this).  This structure, called a triple-zig-zag, is characteristic of a corrective rally within the context of a larger bear market where prices would decline below the point at which this rally begins.  The structure is a 3-3-3-3-3 structure, where each “3” is a chain of 3 trending waves, as shown in Figure 2 and is labeled W-X-Y-XX-Z  Again, I would love to explain over a phone call if you want to understand this better.  Because the structure of the 2003 to 2007 rally was corrective, the model predicted that the market’s decline which started in October 2007, would result in a new low for the stock markets, a low below the 2003 low.

The second period, from October 2007 to March 2009, was the 2^nd worst decline in market history.  This took the form of an “impulse”, which is what a real, fundamentally driven market move looks like.  The structure of an impulse is 5-3-5-3-5 and you can see (and call me with questions) on how this decline was an impulse.  An impulse is one of only two kinds of motive trends, i.e. a trend in the direction of the larger move in the fractal structure of the market.  The second kind is a “diagonal” but these only occur in certain specific positions in a trend.  Impulsive trends are a lot easier to forecast in real-time than corrective trends.

The third period, which started in the infamous market bottom of March 2009, continues till today.  This has been a fascinating rally, the 2^nd largest market rally in history in a similar timeframe, and naturally people have looked at this rally as signaling the beginning of a new long-term bull market.  But is it?  There are many ways of trying to answer that question – macroeconomic research, fundamental analysis, other technical analysis approaches, etc.  But sticking with the topic of this post, our fractal model looks at the structure of the rally and sees one that is clearly not “impulsive“ BUT one that is “corrective”, in fact one that is paralleling almost EXACTLY the same structure as the corrective rally of the first period above, i.e. a triple-zig-zag, the 3-3-3-3-3 Structure.  The last leg of the 4^th “3” is not done yet, and the 5^th “3” has not happened yet.  But it has tracked remarkably so far with the first period.  More on that in another post.  The same logic applies to reach the same conclusion that I came to back in 2007, i.e. that the fractal model predicts this rally to be followed by a decline that breaks the March 2009 low, i.e. for the Dow to drop below 6469.  This low could happen in 2011, or could take until 2013 if the forecasted trajectory shown pans out.  There are alternate trajectories which may not end up breaking to new lows until later in the decade.  Nevertheless, the conclusion is still the same.  This is no new bull market.  Did I tell you that our fractal model is frighteningly straightforward in its conclusions?  Now we simply have to wait and see … again.

In the meantime, we have a data-based picture of a probable trajectory for the markets that becomes a useful guide for intelligent money management.  The yellow and brown dashed lines show our primary forecast for the Dow as of the time of this post, thru mid-2012 or so.  We track a set of such probable trajectories and use inter-market analysis, and other technical and macro-economic indicators to determine and rank the probabilities of these trajectories.  We can be wrong with our real-time picture, which is fine since we know relatively quickly when we are wrong and can course correct and re-orient ourselves to an alternate or modified trajectory as new data comes in.  Again, this is ONE of THREE forecast models, albeit the cornerstone, that we utilize in our decision making process for discerning trend changes and aligning investments with them.

At THE ABSOLUTE RETURN, we model each of the major asset classes and sectors/types, i.e. equities, bonds, precious metals, commodities, and currencies using our proprietary version of the Elliott Wave fractal at may degrees of trend.  Each of the pictures has to holistically tie together into a coherent macro framework which is supported by economic indicators.  Contact us to find out how we dynamically track with and leverage this fractal market structure to pursue absolute returns for our clients while simultaneously lowering portfolio volatility, in any market.

We are offering a 25 basis point (0.25%) perpetual discount to our asset management fees if a client opens an account with us in 2010, even with the minimum account size of $30,000.  This perpetual discount will be applicable for all future assets added in any of our managed portfolios by clients who make use of this offer.  Client accounts are liquid and funds can be de-linked from our management or withdrawn at any time without penalty.  Client funds can include regular investment dollars and retirement funds including IRA’s and 401K rollovers.

Come back soon for our first blog!