It's not just surfers who scrutinize wave patterns. Steven Hochberg, chief market analyst at Elliott Wave International, uses the Wave Principle to predict the movements of commodities and the stock market based on a number of factors, including sentiment. In this interview with The Gold Report, he reads the waves and shares their indications that the stock market is headed for a downtrend, while commodities will move up, although not in a direct line.
Steven Hochberg is chief market analyst for Elliott Wave International. He is also the co-editor of The Elliott Wave Financial Forecast, a monthly financial newsletter, as well as editor of The Short Term Update, a three times a week online market forecasting service.
The Gold Report: You have warned that the S&P 500 and NASDAQ are in retreat and that we are entering a bear market that our grandkids will have to live through. What are the signs of that?
Steven Hochberg: The retreat hasn't been very big so far, but we see a couple of signs that its start is imminent.
First, we look at all markets through our model, which is called the Wave Principle. It is based on R.N. Elliott's discovery that waves of social mood, from optimism to pessimism and back to optimism, create specific patterns. We believe the market is at the end of its long rally because that wave pattern is coming to its terminal point. That's the main indicator.
But we also look at other indicators to confirm or refute what we're seeing. Many indicators are confirming that we're in the end stages of the rally that started in 2009. Sentiment is one. Sentiment tends to get very extreme at trend reversal points. It is extremely optimistic at highs and extremely pessimistic at lows. The bears shrink down to almost nothing when you're coming into a rally high. A service called Investors Intelligence tracks the percentage of bulls and bears among advisers. Recently, the bear contingent shrank down to 13.3%, which was the lowest in 27 years.
Another indicator is the percentage of money and money market funds relative to assets. That number is at a historic low. That means managers don't feel that they need to hold anything back in reserve in case of a market decline. They're fully invested with this market. The exact opposite happens at lows. At the lows in 2002 and 2009, managers had a huge percentage of their money in money market funds, the reason being that the market had been going down and they were scared. Now, we're at the opposite end.
Internally, the market is starting to thin. The rally is narrowing. For example, the small-cap sector, as indicated by the Russell 2000 Index, made its closing high in March 2014, and it has not confirmed the Dow's rally to a new high or to the NASDAQ. This narrowing is typical at the end of a stock rally, until finally only a couple of sectors are going up. Then, everything rolls over and goes to the downside. That is where we're arriving at in this cycle. I think the next major move for stocks will be to the downside.
TGR: What does this transition look like? Will small caps and large caps be affected differently during the transition?
SH: Initially, perhaps, but eventually they will go down together.
The small-cap sector, which represents the higher-beta, less-liquid stocks within the overall market, tends to top out a bit sooner.
We look at the ratio of small caps to large caps by dividing the Russell 2000 by the Russell 1000 Index. It has been nine months since the Russell 2000 hit its high. Since then, the ratio is down 11%. During that same time, the blue chips have been making higher highs. That ratio has a succession of lower lows and lower highs. It's in a downtrend. That's a key signal that the market is thinning and ready to go down. When the blue chips roll over, both will be aligned on the downside.
TGR: On Nov. 11, you issued an interim report that said for the first time in three years your charts were indicating that a significant countertrend rally was at hand. What are the Elliott Waves telling you?
SH: That was a countertrend rally specific to gold—a fascinating market that we have followed and will continue to follow closely.
Gold topped out in September 2011 at a $1,921/ounce ($1,921/oz) spot price and has declined pretty persistently until now. It went sideways in late 2013 into early 2014, but the Elliott Wave pattern that we were following suggested gold would go down again, and it has.
We've been forecasting these waves of optimism and pessimism as they've been unfolding to the downside in gold. For the first time in three years, we were able to count a complete declining Elliott Wave pattern from gold's 2011 high. That's why we issued a combined interim report from our two main newsletters, The Elliott Wave Theorist, written by Robert Prechter, and The Elliott Wave Financial Forecast, which I write with my partner, Peter Kendall. This was only the second combined interim report that we've put out in our history. We did it because we saw extremes in sentiment that suggested to us the start of an impending gold rally. I think that rally is in its very infancy right now. Ultimately, it's going to carry gold higher. I think gold has upside potential from here.