On the 27 August I posted a XJO monthly chart with an analysis...

On the 27 August I posted a XJO monthly chart with an analysis that concluded we are heading into a bear phase. I struggled with this conclusion as my interpretation of the chart patterns (bearish) was different to what I intuitively felt about the long term outlook (bullish). I’ve been thinking about this a lot and the answer for me comes from looking at the even bigger picture, the Yearly Chart.

3 charts below you might find of interest.

The first chart is the XJO Yearly, that is, one bar equals one year. I’ve deliberately left of any markings. Just look at the clean chart.

Chart patterns recur at all timescales, whether daily, weekly, monthly or yearly. Imagine this was a weekly or a daily chart of some stock. After 6.5 bars up to the current outside bar (blue) I’d expect the next one to three bars to be down in a correction. It’s certainly possible the current blue outside bar could finish half way up and then go green next bar, but it’s not the most likely. I thought it was instructive to just look at the chart this way as it seems at least one (if not more) red bar is due, being 2016.



I’ve then marked up the XJO Yearly chart with some analysis. I won’t go over the same analysis I put on my XJO Monthly chart on 27/8 as you can refer back to that. However, the bigger yearly picture below becomes really interesting.

Elliott Wave works better the bigger and more liquid the security and for index charts on yearly timescales its king. It’s also a fractal pattern. So what looks on the monthly chart to be a Wave B heading into a bearish Wave C, on the yearly that same pattern just becomes a Wave 1 -2 within a larger scale long-term bull move. This makes entire sense to me and reconciles the chart pattern with my fundamental perspective on the economic outlook and cycle.

What the Yearly chart is saying, with my assumptions as marked, is that we had a 6 year recovery phase to date from the GFC lows driven by central banks pumping liquidity into the world’s economic system. I think everyone intuitively knows that markets are quite artificially elevated and distorted the last few years with record low interest rates and assets prices inflated. This liquidity has to come out of the system before normal economic growth resumes once the GFC and its reactions and consequences are consigned to history. We are on the cusp of interest rate rises in coming months, that although slow and gradual, will ultimately return rates to normal levels over a number of years.

If we were to look in history from a future date, it would make perfect sense to me that the story of the GFC is the 2 year collapse to 2009 low, a 6 year pump priming driving assets prices including shares to artificial highs, then a couple of years or more of deflating that liquidity, before the normal economic growth cycle resumes with a new long term bull phase over the subsequent decades.

Wave 2 normally retraces to 61.8% of the Wave 1 rise, although can go to 75% or more in some cases. 61.8% happens to be 4200 on the XJO and is quite a logical level given other support there. So that’s quite plausible. Whether it goes further we’ll have to see.

How long it takes to unwind I don’t know either, but with 6 years up, 1 or 2 years down in a bear phase would be quite quick. Even a three year bear market would be reasonable technically.

For those who follow Volume, note that volume has been declining through the recovery phase, being more evidence that the current Wave 1 is weakening.



The last chart below is a yearly chart of the Dow Jones after 1929. Equity markets have a 40 year and 80 year cycle occurring and so the 1929 crash and recovery is quite instructive for the present recovery phase.

After 1929, you can see it took 3 years down to the 1932 low, then a 4.5 year recovery phase. They didn’t have the central bank pumping liquidity in then which was the lesson Bernake learnt and applied to the GFC, but they did stall the recovery by notoriously lifting interest rates in 1937, thereby withdrawing liquidity. This knowledge is what Yellen is grappling with now and influencing current decisions. But it took 5 years down in a bear phase to work of the initial recovery phase.

If you notice on the chart, the DJI fell to 61.8% in a classic Wave 2 pattern, which is exactly what I think will happen now, before entering a multi decade bull phase. Wave 3 is the longest and strongest of the Elliott Waves.

We are following exactly the same pattern of recovery to date from the GFC that occurred to the DJI after the 1929 crash. Spooky huh. I expect the same pattern to continue to play out. Note that this refers to direction and pattern, actual number of years and final depth needs to be further considered as it unfolds.



Conclusion:

The big picture road map is that the current 6.5 year GFC recovery phase is likely a larger scale Wave 1. I expect we are soon to fall into a Wave 2 retracement as liquidity is gradually withdraw by the central banks, possibly over multiple years, with a 61.8% retracement to XJO 4200 or lower. Subsequently, we'll move into a multi-decade bullish market once the economy has finally seen off the GFC effects and the normal underlying economic cycle resumes.

I'll post another update in about 2025 and see how it's gone!!