ELLIOTT WAVE ANALYSIS OF S&P500

Premium analysis | 24th February 2020

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The S&P500 has been in an uptrend for over a decade. That uptrend
seems to be approaching its end now. Last week, the market opened at 3369
and fell to 3328 before closing at 3338 on Friday, February 21st, 2020. In order to
put things into proper perspective, we need to take a look at the bigger picture,
so we can see where the recent price action fits into the larger wave count. That
is why we have to see the weekly chart of the S&P500 first. It is given below.

The weekly chart shows the whole uptrend since March 2009, when, at
least according to the stock market, the Great Recession officially ended.
The entire bull market has taken the shape of a five-wave impulse1,
which began from 667 in March, 2009, and seems to have ended at 2941 on 17
September, 2018.

1
https://ewminteractive.com/elliott-wave-patterns/
 Wave (I)’s impulsive structure is clearly visible, followed by a running
flat2 in wave (II). As usual, wave (III) was a wonder to behold, traveling from as
low as 1073 to as high as 2136. Wave (IV), obeying the rule of alternation, is a
W-X-Y double zig-zag.
This leads us to wave (V), which I believe ended at 2941. If this count is
correct, the S&P 500 is in a correction. The selloff to 2346 was too shallow to be
the whole of it, so it should be part of a bigger three-wave correction, which can
be expected to drag the index further down towards 2200-2000 in the longer
term. Given that the index has already reached a new all-time high, I think the
correction is developing as an expanding flat3, whose wave B can be over
already.
Now, let’s go even further into the details and see the internal wave
structure of the rally from the bottom of wave (IV) at 1807 to the end of wave
(V) at 2941 and after.

2
https://ewminteractive.com/mischievous-running-flat-correction/
3
https://ewminteractive.com/expanding-flat-and-how-to-avoid-its-traps
 Wave (V) looks like a complete five-wave impulse, labeled I-II-III-IV-V with
a triangle4 in wave IV. The sub-waves of wave III are also visible.
The plunge from 2941 to 2346 is limited to only three waves and so
should be the current recovery in wave B, if the market is indeed drawing an
expanding flat correction. The 2900-3000 resistance area slowed the bulls down
in wave (a) and caused a triangle in wave (b) of B to form. The current surge
from 2856 must be wave (c) of B, which is either over already or near
completion.
Now, let’s take a closer look at the recovery from 2346 and what we can
expect next.

The rally from 2346 to 2954 can be seen as a complete five-wave impulse
in wave (a) of B. The sub-waves of wave 3 are also clearly visible. Every impulse
is followed by a correction. In S&P’s case, that is wave (b) which seems to have
developed as an a-b-c-d-e triangle. Wave “e” of (b) ended at 2856, meaning the
following rally to 3394 so far must be wave (c). We should soon expect the start

4
https://ewminteractive.com/what-are-triangles-and-what-information-they-give-us
of wave C down that can ultimately drag the index close to ~2000. It is too early
to short, though.
On the other hand, according to the alternative count below, the S&P 500
can keep climbing towards the 4000 mark…

There is a way to see the post-2009 bull market as an incomplete five-

wave impulse, whose wave (V) is still in progress. In that case, the triangle wave
(b) of B we identified on the previous charts would turn out to be a sequence of
first and second waves, labeled I-II-1-2 within wave (V). I don’t like this count
and if the market picks it, I am afraid a huge bubble is going to form.
Now, let’s see the other side of the coin. Technical analysis and
fundamentals do not always reach the same conclusion, but when they do, it
pays to listen.
 Fundamental Measures Support Negative Outlook
Now I want to discuss several fundamental measures, which strongly
support the negative outlook for the S&P 500. The first is the famous yield curve
inversion. (shaded areas indicate recessions)

A yield curve inversion occurs when the yield of the 3-month Treasury
bond exceeds the yield of the 10-year Treasury bond. Such an inversion has
occurred prior to every single of the past seven US recessions.
The yield curve inverted in mid-May and remained that way until October
11th. The initial inversion prompted the mass media to ring the recession bell,
but as the yield curve un-inverted two months ago, many took it is an “all clear”
sign that a recession has been avoided.
Unfortunately, the chart above shows that recessions don’t start while the
yield curve is inverted. They begin after it un-inverts following a period of
prolonged inversion. Therefore, October’s un-inversion doesn’t mean we will not
have a recession. Quite the contrary - it means the recession is even closer now.
And since the stock market peaks before a recession officially begins, the top
usually roughly coincides with yield curve un-inversions.
“But why expect a recession when the job market is so strong?”, some
may ask. Precisely because of that. Take a look at the chart of the
unemployment rate going back to the 1950s.
 This chart reveals that pretty much every time the unemployment rate
falls below the 5% mark, a recession follows soon enough. The last reported US
unemployment rate was 3.6% so in our opinion, a recession is overdue. No
expansion lasts forever and the current one is already the longest on record.
Unless it is “different this time”, it won’t last forever either.
Next up is the Shiller cyclically-adjusted price to earnings ratio.

Robert Shiller received a Nobel Prize in economics for his study of

bubbles. He came up with the CAPE ratio as a better valuation tool than the
simple price to earnings ratio, but the logic is the same: the higher the ratio, the
worse stocks perform in the next decade.
 According to the chart above, the CAPE ratio stands at over 31 – its
second highest reading in history. The only time it was higher was during the
Dot-com bubble of 1999-2000. That is another reason for pessimism as we
head into 2020.
The fourth indicator we’ll take a look at is the so-called Buffett indicator.

The Buffett indicator measures the ratio between the total market cap of
the US stock market and the gross domestic product (GDP). A market cap to
GDP ratio between 80% and 100% suggests the stock market is fairly valued. As
of this writing, the ratio stands at 159%, indicating significant overvaluation, more
extreme than the one at the top of the Dot-com bubble in 2000.
In order for this ratio to come down to more reasonable levels, either the
GDP has to rise quickly, or the market has to fall. Given that US GDP growth
hasn’t exceeded 3% since 2005, a stock market decline seems much more
likely.
 One more thing to measure against GDP is the level of corporate debt. As
with all kinds of debt - the lower the better. Unfortunately, that is not the case as
we head into 2020. Take a look:

The chart above shows that the corporate debt to GDP level has never
been this high. This is a debt-fueled economy. The previous three times we had
a similarly high debt to GDP level, a recession followed.
And last but not least, there is a divergence between the market and
corporate earnings.
 Cumulative corporate earnings stopped growing in 2016, while the
market kept marching upwards. The last time this happened was in the late
1990s and it didn’t end well. The market must roughly track earnings. When it
strays too far from them in either direction, it is a sign of extreme investor
sentiment. Heading into 2020, investors seem too optimistic, which is another
reason for us to be very cautious.
In conclusion, Elliott Wave analysis suggests the S&P 500’s post-2009
uptrend is over and the December 2018 selloff was the beginning of a larger
correction. Downside targets in the 2200-2000 area are plausible in the long-
term. A bearish reversal can be expected any time now.
Several fundamental measures also indicate the top must be near. When
technical and fundamental analyses reach the same conclusion, it pays to
listen.

Alex Vichev
EWM Interactive