As Elliott Waves Go (a white board)
Last Update: 12/6/2023
We ended a 40-year bond bull market with the start of COVID in March 2020. Since then, long bond (20-TB) rate has been steadily rising (see chart below). The rise steepened (classical wave 3 behavior) with Powell’s consecutive rate hikes in 2022, culminating in the apparent completion of an ending-diagonal wave 5 on Oct 23, 2023. A big contributing factor to that final (ending diagonal) leg up was the BOJ’s move to double YCC upper bound from 50 basis points to 100 basis points, as chronicled here. This drove other sovereign bond yields up on a currency-hedged relative valuation basis, as chronicled here.
Wave 2 correction appears to have started after Oct 23, 2023, with the most likely target being 38% retracement to the previous wave 4. The whole move from the trough was a picture perfect impulsive 5-wave structure meeting all the Fibonacci criteria. And Fibonacci time extension would have Wave 2 correction (red arrow) end either 1/2025 or more likely 1/2026.
The first question to ask is. “Do tradable long bonds follow Elliot wave patterns?” Answer is, “Without the data series going further back than 1965, wave count is unclear”:
Assume Elliott wave patterns apply. Then the upcoming multi-decade bond bear market will take long bond rates much higher then the current 5% level. Since the BoJ is the latest player to enter the game (of effective rate hikes by loosening YCC cap), how high it will go determines how high our long bond rates will go,— but not before the 38% Wave 2 retracement (red arrow) which should accompany the long-awaited for and inevitable recession. I look for the stock/bond relationship to also (temporarily) revert to inverse correlation (see later discussion) in this period.
Because this corrective Wave 2 is enormous, it is only reasonable to assume that starts with a strong impulse. This impulse was confirmed in the daily chart on 11/15/2023 (a day when yields along the entire curve collapsed with a huge equity market rally), starting a vicious lower-level wave 3 to continue in the coming weeks:
The circled area is magnified in the 20 min chart below, with wave counts confirmed:
This vicious downward wave 3 started with panic short covering. Leading up to the first week of November, hedge funds shorted treasury futures to a new high, — figuring the onslaught of large amounts of coupon bonds will overwhelm demand and drive rates up. Yellen’s surprising QRA (Quarterly Refunding Announcement) on 11/10/2023 — of issuing an extraordinarily large amount of bills instead of coupons — was immediately recognized by hedge funds as a stealthy way of “hoovering up” money market funds (household savings) to fund federal deficit spending. This would create demand for bills thus lowering short (e.g. 2TB) rates, at the same time alleviate supply overwhelming demand for long bonds, thus lowering long bond (e.g. 10/20TB) rates.
Hedge funds thus covered shorts in waves on 11/10/2023, causing a huge bond rally:
With downward wave 3 in motion across the entire yield curve (and the long end dropping more than the short end), the “yield curve steepening —popularly measured by 2–10 un-inversion — presaging recession” story (see historical chart below) falls apart:
The 2–10, after a few days’ steepening, is now re-inverting (long end falling signaling recession expectations):
As bond vigilantes expect for 2024–2025:
Long bond yield dropping typically means recession. Maybe this time, recession is not preceded by yield curve normalization, but that only after recession arrives in 2024, bull steepening will kick in with Fed easing.
As recession deepens between 2024 and 2025/2026, 38% Wave 2 retracement will progress per my idealized chart in my Macro Outlook:
It is only after 38% Wave 2 retracement is done in the 2025/2026 timeframe before long bond yields take off in earnest in the next multi-decade “high inflation/high rates” bond bear market. This makes sense because Yellen’s QRA was only a temporary tactic, delaying the longer term inevitable tsunami of coupon bonds to come:
Thus far, USD is dropping in tandem with bond yields in the first 2 weeks of Nov 2023 (boosting gold price accordingly), — breaking a long term uptrend since the GFC bottom. This move looks to be a wave 2 correction, and it makes sense because USD is overvalued by 30% per the Purchase Price Parity (formal form of the “Big Mac Index”). It also makes sense considering sequential downgrade of UST first by Fitch and now by Moody. It is also consistent with increasingly ludicrous deficit funding problems, given all of Biden’s nonsensical programs (to help get himself re-elected). USD dropping means worsening inflation and portends further rise in long bond rates (but only after another round of coordinated central bank printing in response to global recession in 2024-2025).
In the first week of December, gold made all time high, consistent with the fact that every time the Fed pauses on rate hikes gold price rises. Resistance of $2,000/oz became support so we should be off to the races in 2024. Historically, gold price also does well in an equity down market so this is consistent with a down market for stocks in 2024.
Meanwhile, the knee-jerk short-covering induced bond market rally in the first 2 weeks of November eased financial conditions:
and in turn caused a knee-jerk panic-covering of shorts in equities most vulnerable to rising rates (witness small caps and other most-shorted equities rose the most). The long term (monthly) chart of IWM suggests that the Super Grand Cycle Wave 1 concluded with an ending-diagonal terminal wave 5:
Magnified in the weekly chart, it looks like correction of the Super Grand Cycle had already begun with a Leading-Diagonal wave 1 (notice the 50dMA/200dMA “death cross” accompanying this last wave movement):
For the general broad market, we first zoom way the hell out to the longest possible 100 year chart of the DJI, and we see here the wave count is picture perfect:
To answer the “?” in this chart, we go to the monthly chart of DIA which corroborates the reading of Wave 4 by MacD being at 0. What follows looks like an ending diagonal in progress.
Magnified in the weekly chart, we see the ending diagonal is in its final wave 5. Again, the reading of the lower level wave 4 is corroborated by MacD being at 0. Wave 5 should terminate within the ending diagonal channel two to three weeks (by the first or second week of January 2024).
Next, we sanity check this with the long term (monthly) chart of the NASDAQ composite. Just like the DIA, the reading of Wave 4 is corroborated by MacD at 0 and what follows looks like an ending diagonal in progress.
Magnified in the weekly chart, we see the ending diagonal also in its final wave 5. Again, the reading of the lower level wave 4 is corroborated by MacD at 0. Here, it looks like wave 5 may take a little longer to terminate. 3–4 weeks will take us to second or third week of January 2024.
Finally we check SPX. We have to keep in mind that just like the Qs, this index is distorted by the Magnificent 7, expressed in “abnormal” wave patterns. Where MacD hits zero would have the larger Wave 4 happen later then DIA and the NASDAQ composite. Nonetheless the final Wave 5 is an ending diagonal in progress, — just like the other indices:
Magnified in the weekly chart, we see the reading of the lower level wave 4 corroborated by MacD at 0. Here, it looks like wave 5 will most likely take 3 weeks to complete, — taking us to the second week of January 2024.
The first thing to note about all these indices (except for small caps) is that the final wave 5 of Wave 5 of the Super Grand Cycle — which pretty much takes up the entire year of 2023 — is an Ending-Diagonal, — by definition a very weak wave form running out of steam. This is completely consistent with the fact that at current levels, the S&P500 will have closed out 2023 with a whopping 18% gain (all because of the magnificent 7), yet equal weighted SPX will have made nothing for the year!
The second thing to note is that the jaw-dropping rally in the first two weeks of November 2023 (whose nature was detailed in my Macro View for 2024–2025) started this final wave 5 of Wave 5. Timing-wise, this wave plays right into seasonality factors. The two week rally was so sharp that the market is due for a sell off the last week of November (after the Thanksgiving lull week) and first 2 weeks of December (in preparation fund distributions of capital gains, dividends etc.). This sell off (a minor wave 4 of wave 5) will relieve the overbought situation and fill the many gaps on the way up. Then the final minor wave 5 of 5 of Wave 5 will commence in the form of “Santa Claus rally” between Christmas and the first five days of January 2024, whereby fund managers buy winning stocks just for optics before they close out their books for the year. In other words, the Super Grand Cycle that started in the 80s will conclude with 2023!
The third thing to pay attention to is 2024's “January Effect”. Is my wave count thus far is accurate, the big correction to the Super Grand Cycle starts in January 2024. This would be consistent with Bob Farrell’s mean reversion rule, considering market performance in 2023. The most likely downside target for this correction is 38% retracement which is slightly below previous Wave 4 (DIA ~ 30,000 in the 100 year DIA chart). Why such a modest retracement for such a huge (4 decade long) cycle? Because the exponential age (as described in the Next 1st Turning) will have kicked off!
Fourth, let's consult the fundamentals as they currently stand. At 20 times earnings multiple (which translates to 5% yield), equities are significantly overpriced right now. Why would professional money managers hold equities when they can get the same yield from risk free T-bills or 10% yield from junk bonds (i.e. holding bank loans)? It is extremely timely professional money to recognize the “long and variable” lag effect of “higher for longer” in 2024 and reprice equities.
Finally, let's double check the timing of recession much discussed detailed in my Macro View for 2024–2025. Stock declines typically lead recessions (by approximately 6–9 months). So if we expect recession to start Q3 2024, it is entirely reasonable to expect stock market decline to started in Jan, 2024:
This brings us back to the special subject of small caps. In past recessions, small caps declined throughout each entire recession (see chart below). So I can be comfortable that despite significant decline in 2023, small caps have more to fall in 2024. But I also note the rise of small caps (enterprises most sensitive to interest rates) is swift and sharp exiting each past recession. This means I must exit SRTY expeditiously (using Elliott wave counts as my guide) in late 2024/early 2025.
As described in the Next 1st Turning, exponential growth of the magnificent 7 — fueled by increased global liquidity —may stealthily take place while the general economy goes into recession in 2024 . The divergence between the Qs and smallcaps started March 2023 and has significantly widened since and bears tracking all through 2024:
This means if the Qs break out to all time highs, I may have to hedge SRTY with TQQQ. But I doubt this will happen because all but three of the magnificent 7 (AMZN, MSFT and NVDA) are now experiencing revenue decline, margin compression, and diminishing pricing power to pass on higher input (including elevated wage) costs. I believe the Magnificent 7 will crash in 2024 just like they did in 2022.
