Has the Fed Made a New Bear Market Possible?

Before we discuss the present, we need to lay some groundwork; a look backward to help us look forward.  In 2013, we had a similar -- albeit 180 degrees reversed -- situation, so let's begin there.

On January 14, 2013, I published an article titled A Survival Guide for Bears in a Bulls' World.  I wrote that article because a lot of my readers were bears at heart, but many of the charts I studied pointed the other direction, toward a massive bull market.  The technical charts had set themselves up into what seemed to be a large "bull nest" (a series of first and second waves pointing higher).  Since the third wave is often the longest and strongest, a bull nest is a "launch pad" pattern.  In addition to that, the Fed was beginning to pump unprecedented amounts of liquidity into the market via "QE Infinity" (a term I coined, incidentally, when I was writing for Minyanville -- and which many others have used since).

Over the subsequent weeks of early 2013, I outlined my long-term targets for the S&P 500 (SPX), which pointed to the potential of a strong bull market and substantially higher prices.  And the fundamentals backed up the chart projections. 

Now, when I say "fundamentals," I don't mean irrelevancies such as the actual economy (only professors are naïve enough to believe the stock market is driven by the real economy) -- I mean the only "fundamental" that has actually mattered to the stock market over the past couple decades: 

The Federal Reserve. 

When the Fed (and other Central Banks) are creating unprecedented amounts of money from thin air, as they were doing from 2009 to 2014 (and beyond), then asset prices almost have no choice but to rise.  Asset markets are all driven by the simple laws of supply and demand -- so excess cash (liquidity) equals excess demand.  More demand than supply equals rising asset prices.  When the Fed is printing as much money as they were, then huge pools of cash all end up chasing the same resources -- stocks, bonds, real estate, etc. -- and that drives prices higher, because it must.

Combined with the Elliott Wave patterns, it wasn't hard to see that stocks probably had no choice but to rally in such an environment. 

Thus I tried to warn bears about that pending bull market... but to my surprise, many bears didn't like that.  Many didn't want to hear it at all, in fact -- and the bullish articles I was writing in early 2013 were, at the time, anyway, some of the least popular articles I had ever written (!).  Those articles actually cost me some readers. 

Of course, now everyone looks back and views those bullish predictions in a much different light.  But when I was publishing them in real-time, they were quite unpopular-- to the point that for a while, I had to spend time looking for small turns against my always-bullish big picture outlook, just to give my bearish readers something to do.

I suspect the articles I've been writing more recently will be similarly unpopular with bulls.

Because here's the thing:  Nearly 5 years later, the charts finally began to give signals that the bullish move might be getting close to exhausting itself.  On October 4, 2017, I wrote:

Given the structure of the entire wave, there is a genuine possibility of an extended fifth wave, so bears are going to want to be careful...  We have to be aware of the potential for an extended fifth, which, outside of technical analysis, is also known as a "blow-off top." 

In Elliott Wave, the fifth wave (extended or otherwise) is always the final move before a correction.  As time progressed, while the near-term waves kept pointing us toward higher prices, it became obvious that the extended fifth wave was indeed underway.  On December 18, 2017, I concluded the update with:

A few months ago, I began talking about the possibility of an "extended fifth blow-off top," and it appears that's what we're now unwinding.  These can be very difficult to trade if you're a bear, but they're gobs of fun (for as long as they last, anyway!) if you're a bull.  The thing about extended fifths is that they do tend to retrace rapidly -- so once this ends, it's going to catch a lot of bulls by surprise.  

We continued looking for higher prices virtually every day -- up until January 31, that is. 

The main reason I'm mentioning all this is to provide perspective and lay the groundwork for the remainder of this article, by establishing two points:

1. The Federal Reserve is a force to be reckoned with, and their actions can help point the way toward the market's future -- as we've seen time and again.
2. I am not a "perma-bear."  To the contrary, despite the fact that I've always believed the massive money printing from the Fed would all end badly (and despite a few near-term hiccups along the way, where I sometimes thought additional near-term downside was forthcoming when none was), I've remained long-term bullish pretty consistently for the past 5 years.  So if I say "look out below" now, it's not coming from an unbending bearish bias (truth be told, I've grown rather fond of trading this bull market and would prefer a bear market to wait!  But the market doesn't care one iota about what I want.)

Finally, there is one last piece of groundwork that needs to be laid:  On October 30, 2017, I penned an article that I consciously intended as the final chapter of a book that began with January 2013's bullish "Survival Guide for Bears in a Bulls World."  I was aware that I was writing this bearish "reality-check" article a bit prematurely -- but I did so intentionally, because, as I wrote in the article itself:

I have recently become aware that there seems to be an entire generation of new investors who have absolutely no idea what's been going on. 

They apparently think the 2009-present bull market was driven by... I don't even know what.  Magic fairies or something.

So I don't want everything to come as a complete shock to them when it starts getting real.  The time for education isn't in the midst of a crisis, it's beforehand.  And again, don't get me wrong, I'm not saying that's going to happen tomorrow.  But forewarned is forearmed.

How many of us have read the fresh horror stories of people who were wiped out by the massive recent spike in the VIX (Volatility Index)?  I believe those traders could have lived to fight another day, had they only been forewarned of the danger before things "started getting real."

Anyway, this "bearish bookend" article I'm referencing is titled: The Acrobats:  Why the Central Bank-Driven 'Prosperity' Must Eventually End.  If you're not familiar with it, it discusses the role of Central Bank liquidity in the modern market, why that intervention leads to "unintended consequences" and inevitable problems (including negative impact on businesses) -- and it discusses some of the basic foundations that underpin the rest of this discussion.

Instead of waiting here patiently while everyone runs off and reads it (I'm on a tight schedule!), let me briefly quote one of the key points of understanding from that article:

Bull markets do not come about because of “good economies” (although they can). Ultimately there is only one thing that drives a bull market:

Liquidity.

When there is extra cash floating around (liquidity), then some of that cash finds its way into the market. That means more buyers. More buyers than sellers means a rising market. Sometimes extra liquidity is the sign of a healthy economy (which is what has led to the thinking that "good economies create bull markets").  But in today's world, sometimes the extra liquidity has nothing to do with the fundamentals of the economy.

To better understand this concept, Americans might consider looking around and asking themselves: “Is the real economy significantly better than it was in, say, 1997?”

Most who lived through that time would answer “No, it’s not.”

Yet the S&P 500 is currently trading at roughly double the highest price of 1997 even after being adjusted for inflation.

If the above concept is foreign to you, then I suggest reading the entire article when you have time, because the topics it discusses are necessary in order to truly understand what is going on in the world right now, in the present -- and into the future.  And why.

Let's get back to discussing the market for a moment:

While we were on the right side of the trade for the rally, we were also well aware that when it ended, it was at least possible that this would kick off not merely a "correction," but a cyclical bear market, in the form of a high-degree fourth wave. 

However, that cyclical bear would probably still come in the context of a secular bull market, and would likely not be the final end-all to the bull market that began in 1982 -- though it would almost certainly trim current valuations substantially, amounting to collective trillions of dollars of "paper profits" being destroyed in investors' stock portfolios.

This is what the technicals (the charts) were/are telling us. 

But what are the fundamentals saying?

To learn that, we have to look at what the Federal Reserve is doing now.  Because what they're doing now is very different than anything else they've done since 2009.

Back in September, I briefly discussed (in a very tongue-in-cheek manner) when Janet Yellen announced that the Fed would begin to shrink its balance sheet, a process which the Fed calls "normalization." 

If anyone doesn't already know this, at present, the Fed has a monster balance sheet, unprecedented in history.  The chart below is from the Fed's own website.  It doesn't look so bad at first glance, because they put M next to the dollar amounts, leading you to think these are "millions of dollars" -- however, at the bottom they disclose that these millions of dollars are themselves measured in millions of dollars!  So this scale is "millions of millions" (cue Dr. Evil clip). 

Meaning that the Fed's total assets number in the TRILLIONS of dollars (over $4 trillion currently).

You can see that pre-2008, the Fed was carrying less than a trillion dollars on their balance sheet.  But between then and 2015, their balance sheet more than quadrupled.  This is a large part of what bought us that wonderful "can't go wrong" bull market of the past 9 years.

You can also see that their balance sheet has remained largely flat until very recently. 

However, in October, they finally began rolling off $10 billion per month.  The market initially had no trouble absorbing that drain, in light of the bullishness surrounding the Republican tax cut, foreign capital influxes, and ma and pa investor finally "getting back into stocks" (the market recently saw record levels of mutual fund and ETF inflows -- $58 billion from late December to January 19, for example.  This type of thing often happens near market tops.).

In January, the Fed doubled their roll-offs and began draining $20 billion per month from the banking system.  And that gave us a 10% drop in the stock market in less than two weeks.  The fourth fastest 10% drop in the entire history of the stock market, I might add.  The pundits who are treating this as if it's a "normal," healthy run of the mill correction either haven't been paying attention, or don't know their own history.  Or both.

And here's the thing:  The Fed plans on accelerating the amount they're draining from the banking system each and every month from here on out, until the amount of this "reverse cash flow" reaches $50 billion per month in October 2018.  In addition, they seem intent on continuing to raise interest rates.

If a $20 billion drain gives us a 10% "correction," then what will a drain of $50 billion per month give us?  A true crash and/or a bear market? 

Well... quite possibly.

This will, after all, represent the most aggressive Fed tightening program in history.

The problem is, as I've argued for years, we are in uncharted waters.  None of this has ever been attempted before -- so we don't really know how this story ends.  The level of Fed intervention from 2009-2014 was unprecedented; so, of course, the drain the Fed is now attempting is likewise unprecedented.

Before I discuss this further, let's look at a chart, because the fundamentals and the technicals seem to be aligning.  The chart below is the long-term count I've been operating from over for the past several years.  So far, it has played out rather well, having reached (and slightly exceeded) October's target -- which then generated a reversal, exactly as the chart suggested it would.

Here's how the chart looked in October:

And here's how it actually played out (basically perfectly -- so far, anyway):

(Note:  Chart below is from Feb. 11, when I originally intended to publish this; we've since reached the beginning of the blue projection line, where the market presumably heads lower again.)

I'm showing that chart because it's relevant to my thesis on how everything fits together.  Below is a basic outline on my Theory of Everything.  My thesis is basically the market equivalent of Unified Field Theory:

1. I have long-argued that, from a technical standpoint, we seemed to need a large fourth and fifth wave to fulfil this wave structure.  On the chart above, that fourth wave is represented by Red 4 and 5. 
2. I have also long-argued that the Central Banks (CB's) would likely cause Red 4 -- probably through some mistake or miscalculation (I actually first developed and presented this theory years ago, while QE was still underway).  We may be witnessing the beginning of Central Bank action directly causing Red 4 now. 
3. I have likewise argued that the CB's would then also cause the Red 5 recovery rally. Once they realize their mistake, they are likely to overcompensate, and flood the market with liquidity once again.  That's how the Fed seems to work, after all:  They seem to realize everything on a delay, as if nobody there has the faintest clue how all these puzzle pieces fit together.  (They tend to be late in recognizing both recessions and recoveries.)
4. The same Fed actions that cause the Red 5 rally to new highs (presumably more "easy money" policies) are going to drive us further into the territory of the unprecedented.
5. Red 5 could even come about via some form of hyperinflation, depending on the Fed's reactions, and the market's reactions to the Fed.
6. When Red 5 finally ends, we are going to experience a bear market of truly epic proportions, as the massive imbalances created in the system will need to be rectified -- likely destructively.  As Friedrich Hayek said: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

Let's examine a few implications of my thesis.  The biggest implication can be boiled down to one simple sentence: 

The Fed is already trapped by the monster they created during 2009-2014. 

They just don't know it yet.

If they unwind the monster, the market will tank.  In fact, several markets will tank -- likely bonds, stocks, and real estate, among others.  If they try to salvage the market, then they will drive us further into "bubble" territory, because the only way to keep a bubble expanding is to add more air.

However, there is one way out of the trap they've laid for themselves... but it's one most of us prefer not to consider:  Rapid inflation.  And/or hyperinflation.  I don't know if they'll choose that route, if the market will choose it for them, or if they will avoid it altogether.  (I hope the latter.)  

But the Federal Reserve and Treasury both love inflation.  In fact, they need inflation.  Because inflation lets you pay back yesterday's debt for much less money, by using today's dollars.  For example, $1 in 1980 currency is equal to about $3 today -- so for every dollar you borrowed then, you'd only need to pay back the equivalent of 33 cents today.  Thus, if the Fed had a $4 trillion balance sheet back in 1980 and had done absolutely nothing since, then that balance sheet would have already shrunk by $2.66 trillion in relative terms.  They would really only need $1.33 trillion-worth of 1980 currency ($4 trillion in today's dollars) to clear it entirely.  ("Only," he says.) 

In other words, they would have basically gained $8 trillion for "free" ($4 trillion spent in 1980 is equal to $12 trillion spent today) -- through The Miracle of Inflation. 

Except it's not free.  It's paid for by the American people.

See, inflation is a silent tax on We, the People.  Each time the Fed prints more money, that money gains its value in part by stealing value from all the other money in circulation.  In other words:  Every time inflation ticks upwards, your liquid net worth ticks downwards. Some of your money was just stolen from you, courtesy of the Federal Reserve's printing press. 

But there's no new Boston Tea Party for this silent "taxation without representation," because most people don't realize what's going on. 

So there's the whammy.  And that might be what brings us Wave 5 -- above average levels of inflation, courtesy of some new "emergency, one-time program" the Federal Reserve will create near the bottom of Wave 4, the way they created Quantitative Easing near the bottom of Wave 1 (the bottom was March 2009 at 666 SPX -- which has always struck me as an oddly-coincidental price point).

A scary thought to consider is that an extended fifth wave (should one materialize) at Primary wave degree (as represented by Red 5 on the chart) would cause the market to nearly triple from current prices.  If that were to happen, then it's hard to imagine that coming without large doses of inflation.  Please don't panic too much yet, though, because I can't predict a fifth wave extension from this far out; I can only make such a prediction sometime after the fifth wave actually begins, which it hasn't done yet.  This is not "officially" part of my long-term thesis; I'm mentioning it simply because it's always valuable to be aware of the possibilities.  

But Wave 5, no matter which route it chooses, will only drive us higher into the already-rarefied air -- which means we'll have that much farther to fall when it finally ends.  And it must eventually end, for reasons I discussed in The Acrobats article.

The amazing thing is:  We may be witnessing my long-time thesis unfold, both technically and fundamentally, starting right here and now.


But this is the trickiest part.  Finding the beginning was easy, because the Fed shouted from the rooftops that it was going to print money for however long it took (hence my term "QE Infinity") to reflate the stock market bubble, and they did exactly that.

Finding the end is a little tougher, because there are factors such as foreign capital influx and so forth that could help markets absorb the current liquidity drain, or at least cushion it.

I suspect my thesis is correct (obviously, or I wouldn't have formed it!), but I'm not 100% certain on the "starting right here and now" part.  Perhaps they can kick the can a bit farther down the road.

Hence, now I'm going to play Devil's Advocate against myself, and rain all over the idea that it's already begun -- because one thing I try to avoid is complacency in my own theories.  I learned long ago that getting tunnel vision as a trader is a sure-fire way to go broke.  Confirmation bias is one of worst potential enemies in market analysis, so we must always strive not to merely "see what we want to see" in all the ways that agree with us, but to instead see what's really there.

The first thing we need to be aware of is that, from a technical standpoint, this drop has done nothing more than back-test the prior breakout.  On the chart above, the upper red trend line represents the long-term bull market that (in the Nasdaq, anyway) began in 2002.

All the decline has done so far is drop back down to test that trend line -- and so far, that test has held.  That's all that's "really there" right now.  And it's not even an unusual thing to see.

So we need to be aware that if that trend line continues to hold, then that would actually be a bullish signal, not a bearish signal.

There are similar breakout patterns on other major indices (the Dow Jones, the S&P), and they've all done essentially the same thing (back-test their breakouts -- but not whipsaw their breakouts... yet, anyway). 

In other words, it's a little premature to know yet if Red 4 has actually begun or not.  There is room in the charts for this to be a lesser degree fourth wave, so perhaps Red 4 gets delayed a while longer.  The market often has a way of pushing things out just a little farther than you sometimes think (although, it's already done that to most people, and maybe that's enough -- we happened to be on top of the last rally and turn, so it didn't run farther than we thought... yet.). 

Anyway, I can't entirely rule out the possibility that this back-test will hold, which could lead to a rally back up to new highs.  All the evidence points to the idea that it won't, but market analysis is never 100% clear-cut.

The best we can do in market analysis is try to parse probabilities.  There are no guarantees, ever. 

I am inclined to think that the probabilities favor the idea that Red 4 has indeed begun (or is very close to beginning) -- but I can in no way guarantee that yet.  Despite the huge and fast drop we just experienced, from the perspective of the pattern itself, we are (at best) still in the early stages of a turn, and there's just not much to go off of yet.  If we are instead witnessing a fourth wave at a lesser wave degree, then that could represent what Wall Street calls "a correction" as opposed to "a bear market."

Depending on what the market does next, I should be able to assign additional probability to either scenario.

Thus, if you take away nothing else from this, at least take away this much:  I suspect Red 4 has begun, but I can only assign a probability of maybe 55-60% to that at this early stage in the game.  The red trend line on the chart above is important to the bull case.  If the market sustains a breakdown below that trend line, then that will suggest a whipsaw of the breakout.  And whipsaws can be very bearish. 

If it doesn't -- well, we just discussed that.

Thus, a sustained breakdown of the upper red trend line is the first signal we'd like to see, to help confirm the intermediate-term bear case.

In early favor of the bear case is an apparent impulsive decline from the all-time highs.  That impulse suggests the market needs at least one more impulse to new lows, ideally to break the min-crash's low.  Typically that second impulse is at least equal in length to the first impulse, which (if we peak near current levels) would send the SPX down toward 2400.

A standard Fibonacci extension of 1.618 would send it down to the low 2200's -- and all that can still happen within the context of a lesser degree fourth wave (although at that point, Wall Street would call it a "bear market").

A true new bear market by my definition (an intermediate or long-term downtrend) could see the market ultimately trim most (or all) of the gains we've had over the past two years, and possibly more.

So, all that said, we always need to know our exit.  In the event the market sustains a breakout over the all-time highs from here, then we would have to rethink the timing of all of this.  I'm favoring the idea that it won't do that, and, as discussed, believe there will be at least one more "mini-crash" type wave down of at least equal or greater length to the first drop.

Incidentally, I didn't use as much Fed data as I initially thought I would when I began this article -- had I done so, I would have drawn heavily from the work of a friend of mine named Lee Adler.  (Prior to beginning this article, I emailed Lee to ask his permission to reprint some of his data -- which I never did -- but I feel obligated to give him a shout-out anyway!)  If you're looking for detailed data on what the Federal Reserve is doing week in and week out, then no one tracks that better than Lee.  I would recommend checking out his site (The Wall Street Examiner) if you're interested in learning more.

In conclusion, we may be witnessing the early stages of a decent bear move, and the fundamentals support the charts in this regard.  If we're not, then we have a fairly clear line in the sand to watch -- a brief break of the all-time highs would be okay, but a sustained breakout would suggest bears need to move back into "watch and wait" mode.  I am currently favoring the idea that this decline has farther to run -- but I'm far from infallible, and this market has behaved as an oulier both on the way up and on the way down, so there are no easy calls here.  Thus I will continue watching for any signals that could prove my preferred outlook to be wrong.  Trade safe.

INDU Update: Ah, the Irony

The oft-mentioned article about how certain other forces may be impacting this current market (alluded to earlier this week) will be published later (I know I originally said "Friday" but it might be tomorrow) as a separate standalone, so be sure and check back this weekend for that article.

In the meantime, we're going to stick to our lone chart of the Dow Jones Industrial Average (INDU), because multiple charts probably won't add much to the outlook during a wave such as this one.

Here's the thing:  I am presuming that the current rally is a b-wave at some wave degree.  B-wave are supposed to be unpredictable and confusing.  I've been trying to get ahead of this one by attempting to figure out in what way it would be unpredictable and confusing.  The market has responded by being rather straightforward.

So I keep expecting the market to begin to behave in a way that is less predictable, which it isn't doing -- which is ironic. 

Perhaps things will "get weirder" soon.

In conclusion, there really isn't much to add at this juncture, because I continue to remain less than confident about the market's near-term path.  The market isn't predictable every minute of every day, only at certain times.  And at those times when it isn't terribly predictable, there really isn't much else to do besides await more clarity.  Trade safe.

INDU Update -- Fed Chair Powell to Market: You're on Your Own

I'm going to hold off on the "long, detailed, and educational" article until Friday, but here's a little teaser:  Folks who aren't aware of the strength of the tie between the Federal Reserve and the equities markets will likely find Friday's article enlightening.

In the interim, though, I did feel it worth mentioning that yesterday, new Fed Chairman Jerome "Powell to the People" Powell (I'm still working on a nickname for him, this is a work in progress.  Bernanke was "The Beard."  Yellen was "Gellin' Like Janet Yellen."  Powell's current nickname is tentative, and may need revision...) stated something I found very interesting. 

He said that the Fed would "remain alert" to market instability.

This is probably best-translated as a message to the market, saying:   "You're on your own unless things get much worse."  

Which is where I figured we were at this stage.  I don't believe the Fed is eager to save investors from themselves at this juncture, and likely views the current decline as a "healthy" correction.  In other words, bulls who are hoping for a stick-save from the Federal Reserve will probably find that one is not forthcoming at current price levels.

In any case, in terms of charts, I feel reasonably confident that the decline is not over yet in the bigger picture.  But over the short-term... I feel less confident about this market's short-term intentions than I've literally felt in months.

Accordingly, we're just going to stick with the single "all roads lead to Rome" chart.  Last update expected the market to rally up to the (b)/ii label and stall, and so far it's done exactly that, which has resolved nothing, left all options still on the table, and even created an additional option.  (In other words:  I expected this much (a rally to (b)/ii and a turn) -- so hurrah for being right about the very short term -- but my real question was "what next AFTER this?") :

In conclusion, the market is keeping all its options open at the moment... well, except maybe the option for new all-time highs immediately.  That still seems quite unlikely.  Hopefully things will clarify more over the next few sessions.  Trade safe.

INDU and Nasdaq Updates

Over the weekend, I prepared a rather lengthy and detailed update, which discusses the Federal Reserve and their role in all this... but then I decided I'm not happy with it yet, so I'm going to save it for Wednesday (or possibly Friday -- lengthy updates make good weekend pieces).

Instead, we're going to quickly cover two charts, and will save the educational discussions for next time.

First is the Dow Jones Industrial Average's "spec" count, which has so far played out very well.  I've adjusted it slightly, in tune with the recent price action.  If INDU blows through the blue b-wave high with conviction, then we may be unwinding red B immediately.

Next is INDU's big picture trend line chart:

And finally, we do want to continue to keep the Nasdaq Composite in mind, since it turned south right at a HUGE inflection point.

In conclusion, while many markets have bounced at long-term trend lines, I suspect we're still pointed lower over the intermediate term.  That said, it is worth noting that it would be arrogant to simply assume that will be the case -- if markets continue to hold those trend line back-tests, then we may have to give the bulls more credit than we're currently giving them.  Trade safe.

SPX, INDU, COMPQ: A Review of Extended Fifths, and How They Impact Market Behavior

It has recently come to my attention that I may need to share some old educational posts for the benefit of newer readers.  I tend to cover things a few times, then sometimes it simply doesn't cross my mind to cover them again (presuming everyone has gained collective knowledge from the past).

(Incidentally, if everything I'm about to discuss is "Greek to you," it may help to read my brief primer on Understanding Elliott Wave Theory.)

Most recently, for the past few months while we rallied, I warned everyone (repeatedly and often) that the rally had all the hallmarks of an extended fifth wave.  Then when we turned lower, I gave warning that the correction should have legs, and simply presumed that everyone remembered all the things I've said in the past about what happens after an extended fifth wave ends. 

I have recently realized that I probably should have gone into more detail, especially for the benefit of new readers.

So, for educational purposes, here are a few of the many posts I've made in the past about how extended fifth waves work -- and about what happens when they end:

• One thing I've always enjoyed about Elliott Wave Theory is the psychological component which underpins each wave.  Extended fifth waves serve a purpose in mass sentiment, and they function to pull the last of the disbelievers into a move -- just before reversing.  When extended fifths reverse, they often do so quite dramatically, and this serves to trap unwary traders on the wrong side of the trade, which gives the subsequent decline steam.  Extended fifths can be extremely difficult to spot in real-time, because they don't die off slowly, the way a normal rally does.  They die at near-peak readings, which lulls bulls into a complacent sense that there's still more upside left, due to the momentum of the move.  
• The expectations of Elliott Wave Theory are for the "rapid retrace" of an extended fifth wave.

• Extended fifths work like this: Just when you think the fifth wave is about to complete, it launches in a parabolic.  They are completely out-of-whack with the rest of the wave structure -- often fifth wave extensions run a distance equal to 1.618 the length of waves 1-3 combined.  This convinces most Elliotticians that the wave count is something else (normally, they assume it's a third wave).  This then creates a situation where they're looking for fourth and fifth waves to unravel when actually there are none left to unravel.  Further compounding that issue is fifth wave extensions often peak on high momentum, which leads classic technical analysts to continue looking for higher prices.  As a result of these issues, extended fifths often catch people looking the wrong way on the way up, then looking the wrong way again on the way down.
• Calling extended fifths is difficult, because the technical indicators literally don't work -- so it's all about "feel."  
• When an extended fifth wave forms, we know to expect a rapid retrace to wave iv of the extension.  This is usually followed by one or more retests of the wave-v price high/low.  Then, after the retests, the next wave will typically retrace to wave-ii of the extension.

Although we remained bullish into the January highs, way back on December 13, 2017, I had warned that the completion of this wave would likely be significant:

The extended fifth would allow a possible "resolution" higher, if it occurs, and could prelude a much larger correction.

Most recently, the following was posted on January 17, 2018.  Note that I mentioned that the textbook target for the rally was 2869-71.  The exact all-time high was 2872.87.

In conclusion, the market appears to be in the midst of yet another extended fifth, this one having begun at 2792 SPX.  The textbook target for this wave would be 2869-71.

Here's another thing about extended fifths:  Because they are fifth waves, they set off everyone (even non-Elliotticians) "topping signals."  But because they extend, they then blow right through those signals and leave everyone who wasn't wise to the potential of an extension scratching their heads.  And missing out -- or worse, losing money being wrong-footed.  

We've been wise to the extended fifth for the past several months (and past several hundred SPX points), and it has saved us countless dollars of loss, and earned us significant profit.  While Elliott Wave is my go-to market tool, I have been doing this long enough to (sometimes, not always) recognize when a wave is extending (as I did in this case), and when that happens, you pretty much have to throw almost every technical system out the window for a time.  Technical systems, just like fundamental systems, are based on the past and the "average" performance of the past.  Extended fifth waves are outliers, though, so they render "averages" pretty useless.

The point I'm getting at is that while I know everyone wants to see wave counts, there's a time for that, and there's a time to simply let the market lead while you just go along for the ride.  We are now in a larger inflection point, as shown by last update's long-term COMPQ chart -- but unless and until the market gives us a signal that it's done extending (in the form of an impulsive decline), we're just going to keep riding along with it. 

Then, the instant the market reversed, I saw it as likely that an impulsive decline was forming (even before it had technically completed as an impulse).  The preferred count was favoring lower prices, and, as I had promised during the past few months, I immediately warned bulls to stay away.

On Wednesday, January 31, I concluded with:

Probably the key point to absorb from all this, though, is that this is the first time in months that we've seen a correction that looks like it may develop some meat to it.

And by Friday, Feb 2, I was doing my version of "screaming from the rooftops," and even titled the article

"Bears' Turn -- Bulls Should Stand Aside for Now"

I'm not certain how much clearer I could possibly have been. 

If that wasn't enough, I followed up on Monday, Feb 5, with the headline:

"Bears Not Done Yet"

Again, the title said it all, and I don't believe I can be any more unequivocal than that.  In each update, I warned that bears had the ball and all-but dismissed the bullish options as highly improbable.  Analysis is all about probabilities, not certainties, so I usually tend to caveat quite a bit, because I'm far from infallible.  But in this case, I felt I conveyed things with more certainty than should ever reasonably be expected in a probabilities game.

I'll admit, this went a bit faster than I was initially envisioning, even despite what I know about extended fifths; I'm not omniscient and don't know exactly what the market's going to do every minute of every day.  But it's worth mentioning that on the morning of Friday, February 2 -- at 9:52 a.m. (before everything got really rolling on the downside) -- I posted in our widely-read private forums that a mini-crash was entirely possible from there.  A little later, I even posted my target of 2759 for that day's low, and (somewhat to even my own surprise, because that target was pure instinct, not math) 2759 ended up being the exact low of the day. 

On Monday I posted my real-time short entry within a few points of the high of that day, and then kept our forum readers looking lower throughout the session, including into the big crash bar.  I exited the last of my shorts within a few ticks of the bottom, then posted my exit on the forum immediately before the market embarked on a massive bounce.

In the most recent update, I posted my "best and worst case scenarios," both of which led to new lows.  And we've already made new lows.

Anyway, I don't hit every move perfectly -- but I can't call a move much better than I've called this one.

Let's take a look at the charts.  First up is INDU's chart with its preferred (but still "speculative") count from last update.  This count worked out very well to this point:  INDU turned at the alt:4/a label, and ran down to the b-label.  Bulls NEED a solid bounce to develop from here (see chart notes):

Next up is the SPX "worst case scenario" chart.  It appears that either I was premature in thinking wave 1/A was complete... or we're in for a monster crash of 25-30%.

Finally, the Nasdaq Composite long-term chart kept us looking higher for the last portion of 2017 and the beginning of 2018.  It is quite possible that a multi-month cyclical bear market has begun, to fulfil the expectations of red wave 4.  Keep in mind that the target for wave 3 was published well in advance, and we turned within 1% of that price point:

In conclusion, we've reached an inflection point on several levels.  Crash waves are always a challenge, especially since we've reached a potential bottom zone -- but we do have some price points and signals to watch heading forward.  Trade safe.

SPX and INDU: Best and Worst Case Scenarios

Last update warned: "Bears Not Done Yet" and that the decline could develop another fifth wave extension -- and that's exactly what happened.  That fifth wave extension took the form of a mini-crash, as they so often do. As I warned in that update:

...the market seems to have chosen the same route it chose on the way up, which was extended fifths.  Extended fifths tend to offer extension upon extension with very little breaks in the opposite direction, as we saw during the rally of the past few months.  The decline may choose to go that route, so don't get too attached to the potential B-wave I've sketched in on the chart below.

It blows my mind how many people seem to have been taken completely off guard by this recent move -- probably because we've been pretty firmly expecting it to show up one way or another.  We knew to expect this because the rally was part of an extended fifth wave, and as I've written dozens of times, extended fifth waves lead to rapid retraces in the other direction.  This fact is exactly what prompted me to recently (on January 10) ask the question:  "Does 2018 Rhyme with 1987?" -- and conclude that we did indeed share the hallmarks for a "surprise" crash to show up in the not-too-distant future.

There is also some present similarity to 1987 -- a year which saw a crash, but saw that crash come within the context of a larger bull market.  Most interestingly, the blue chips have created the perfect setup for a very similar situation this year. 

And it might not be too far off, relatively speaking.

As I've also written, I do not think this is going to completely end the bull market just yet -- but it could precipitate a much more significant correction (that much remains to be seen).  What does seem fairly likely, however, is that the final bottom isn't in yet.  Add that to the first sentence, and we know that bottom could even, potentially, be a long way off. 

There are several forms the move can take from here.  Let's look at the most complex option first, as that's what I'd prefer to see.  The chart below is highly speculative by sheer necessity of the fact that there's really no other way for me to arrive at a chart this convoluted otherwise -- so we could deviate (substantially or otherwise) from the path shown.

SPX would, of course, be expected to follow a similar path:

If we do continue to crash more directly, then "getting fancy" (as I did above) rarely works out.

Thus, below, I've drawn a "worst case scenario" chart, just in case we don't continue to bounce around as shown above:

[Please note the typo:  2nd target at red 3/C should read "2240-60," not 2440-60]

Obviously, if we sustain an immediate breakdown at the recent low, then we have to consider that the market may opt for the "more direct" route shown in the worst case chart above.

In conclusion, the ideal move now would be for a super-complex correction that confuses pretty much everyone, bulls and bears alike, and grind around in a huge range eating up time premium at a time when volatility premiums are high.  If we instead sustain an immediate breakdown at the recent low, then the potential exists for an ongoing waterfall.   Trade safe.

Bears Not Done Yet

Last update was crystal clear that it was "bears' turn; bulls should stand aside" -- and I probably couldn't have offered better advice for Friday's session, which turned into a waterfall decline and closed near the session lows.

We are in difficult predictive territory because we don't yet have one clear larger fractal, and the market seems to have chosen the same route it chose on the way up, which was extended fifths.  Extended fifths tend to offer extension upon extension with very little breaks in the opposite direction, as we saw during the rally of the past few months.  The decline may choose to go that route, so don't get too attached to the potential B-wave I've sketched in on the chart below. 

Once wave A finds a bottom, we can come up with a more accurate picture -- since the B-wave fractal and the C-wave fractal are both built from the A-wave fractal.  Really, until the A-wave finds a bottom, I can only blindly speculate on the B and C waves.  It's possible that the A-wave will continue to waterfall in an ongoing series of extended fifths, or it's possible that the extended fifth which seems to be nearing completion will mark the bottom of this wave -- we can only watch and wait.  Our first signal of a tradeable bottom will be an impulsive rally.

INDU shows us that there is potentially a lot of room for a correction to run.  Even if we're not dealing with the Minor Fourth wave discussed in the prior update (via the NASDAQ Composite (COMPQ)), there is plenty of room for a smaller fourth to drop substantially, to the tune of a couple thousand points in the Dow.

In conclusion, it's worth noting that the first downside targets I presented in the prior update were both captured.   SPX's second target was 2735-45, which could be captured right at the open.  If SPX keeps dropping through 2724, then the next obvious horizontal support doesn't show up until 2695, then 2673.  It's also worth mentioning that one potential target method suggests that the final target of this move could be as low as 2229 SPX -- and we could get there faster than seems reasonable.  That's not a prediction yet, just a cautionary mention.  Trade safe.