Has a down-leg commenced?
With the S&P 500 and the Australian all Ordinaries Index possibly stalling in the terms of the most recent rally at 2,870 points and 5,550 points respectively, I have received a few telephone calls from investors asking, “has the Wave C down-leg commenced?”
After peaking around 19/20 February 2020, the initial decline into the latter part of March was severe. Since then markets have recorded a very strong rally, as the cases of Coronavirus continues to decelerate; and a staged opening of many economies has commenced or is about to commence.
While I confess, I have never met a wealthy chartist, and don’t ever expect to, Elliott Wave Theory would like us to believe a classic zig-zag charting pattern is unfolding from the market lows established in the latter part of March 2020, known as a counter trend rally. The technique is used as an aid to set price targets, where the ensuing Wave C down-leg would, for example, typically approximate 61.8 per cent of Wave A, being 740 points for the S&P 500 and 1,750 points for the Australian All Ordinaries Index.
|Market Index||US S&P 500||Australian All Ordinaries Index|
|Peak (February 2020)||3,394||7,290|
|Trough (March 2020)||2,192||4,460|
|Loss by points||1,202||2,830|
|Loss by percentage||35%||39%|
|April 2020 Peak (?)||2,869||5,550|
|Gain from Trough by points||677||1,090|
|Gain from Trough by percentage||+31%||+24%|
|April Peak/ February Peak||-15%||-24%|
If this theory comes to fruition, and it is a big IF (Roger Montgomery thought Elliott Wave was nonsense and dismissed it after the world’s ‘leading’ Elliott Wave proponent called an ‘all-time’, ‘forever’-high for the Dow Jones in…wait for it….1994!), then the S&P 500 could re-test the March lows; whilst the Australian All Ordinaries Index, which has demonstrated a relatively weaker market performance, could test sub 4,000 points.
Pulling numbers out of the air has its limitations, so let us at least try and analyse where things currently stand. We will use the S&P 500 as it seems to lead many of the world share markets. At the current 2,800 points, the S&P 500 is at the same level as 17 January 2018 and 1 March 2019, and the table below illustrates some interesting comparisons:
|S&P 500 at 2,800||17 January 2018||1 March 2019||Now|
|Two year forward EPS||$167||$190||$177|
|Two year forward PE||16.8X||14.7X||15.8X|
|Two year forward EPS growth||25.1%||18.5%||2.5%|
|10 Year Bond Yield||2.6%||2.8%||0.6%|
|High Yield Bonds||6.1%||6.9%||8.6%|
|High Yield Bond Spread||3.5%||4.1%||7.9%|
|ISM Manufacturing Index||59.1||54.1||36.4 (1).|
(1). Bloomberg estimates
Current observations include:
- While US Government Bond yield at 0.6 per cent is lower, credit spreads at 7.9 per cent are higher
- Volatility, as measured by the VIX at 40.1, is 3-4X higher than the 11.9 or 13.6
- The two-year forward EPS (of $177) and PE forecast (of 15.8X) assume a sharp V-shaped recovery, from the economic battering experienced – particularly in the June 2020 Quarter, in earnings.
In summary, it seems to me chartists are more pessimistic than consensus analysts and economists, probably believing there will be a second wave of Coronavirus infections thus stalling any recovery in economic and earnings growth. While forecasts are changing rapidly, and I should add I am not a supporter of charting, I have some sympathy with their more cautious view.