Current Technical Analysis and Beyond

Wave Theory and Cyclicality

By Vaughn Woods, CFP, MBA

Government spending is the direct cause of inflation. To offset inflation the Federal Reserve Board has driven the cost of capital sky high to slow the economy. The lag effect of this downward pressure has been a cloud hanging over investor sentiment throughout 2022-2023. Nevertheless, the stock market has held up nicely and advanced throughout a year of exceptionally poor investor sentiment. From a cyclical-trend index perspective, the immediate setting shows the market is flashing overbought.

That doesn’t suggest more upside is not possible through year-end. Any further data suggesting inflation is cooling could rally both stock and bond markets. The U.S. Consumer Price Index, U.S. Retail Sales and U.S. Industrial Production data for November are reported in December.

While investment sentiment is and has been negative, the major indices are still benefiting from a short squeeze, which is being supported by improved U.S. productivity, improving corporate earnings, and the sense that the Federal Reserve has either gone too far or gone far enough to end U.S. inflation fears. Further interest rate moves by the Fed, it is thought, may be to the downside. Note: when rates go down two things benefit investors: (1) bonds rally and (2) price-to-earnings ratios on stocks go up.

The Lag Effect That Eventually Leads to Rate Cuts

The lag effect of higher rates on cars and homes is slowing the economy. This slowing is expected to further erode new home sales, automobile sales, real disposable personal income, and consumer confidence in 2024. Real Gross Domestic Product (GDP) growth slowed to 0.7% in the third quarter, down from 2.0% in the second quarter. Further weakness is expected in the first quarter of next year, which will be reported during the second quarter.

Real U.S. GDP is slowing. The employment cost index is declining. Unemployment is flat. Retail sales relative to last year are somewhat flat. Industrial production is flat. Housing starts are falling.  Consumer confidence is falling. Business confidence is falling. The Manufacturing Purchasing Managers’ Index (PMI) is falling. The Service PMI is falling, and both Europe and China are close to recession. U.S. consumers therefore benefit by inheriting lower product pricing.

Technical Wave Theory Overlay

For your enhanced contextual thinking I now introduce an overlay to the first quarter of 2024 thinking. The cyclical trend index looks at cycles. The cyclical trend index (see below) is watched for its capacity to act in waves. The much-regarded Elliott Wave Theory, introduced in the1930s by Ralph Nelson Elliott, accounts for the market cycle in waves. It has held up over time though the theory was based upon data researched between the 1800s to 1930 and is a powerful tool that can be used to identify potential trading opportunities. Elliott Wave analysts use the theory to identify the direction and magnitude of future market moves.

I bring up Elliott Wave Theory thinking to you to help you expand your capacity to think about your holdings in both a short-term and-long term context.  Put another way, if you haven’t been introduced to wave theory thinking you may want to think about your surfing experience. That is, you know waves come in sets and you can anticipate bigger wave sets though there is no guarantee of accuracy. Then again, wave cycles do exist and never end. You just need to reset your expectations from time to time to reorient yourself to the cycles.

Bottom line: If the cycles are properly aligned longer-term bullish cycles of cycles D and E should be forming within the next 4-7 months or June of 2024. That’s right about the time many analysts are projecting the first Fed rate cut to add support to a weak first quarter; of which much of the data will be reported in the second quarter of 2024.

Artificial Intelligence (AI) is playing a role in this productivity growth. Increased worker productivity can help to mitigate the effects of inflation by increasing the overall supply of goods and services. This can lead to lower prices for consumers and businesses.

In summary, sometimes the fundamental reasons align for the perfect long-term bullish cycle E. If so, here are eight possible reasons:

1. Fed rate cuts by June of 2024 and or into 2025.
2. New U.S. artificial intelligence products facilitate improved work force productivity, reducing inflation.
3. Lower interest rates reduce the crowding out of U.S. government debt over private sector access to capital through bank lending.
4. As China, India, and Brazil experience rising consumption the U.S. will benefit.
5. Spend-happy baby boomers in retirement support the healthcare, housing, and leisure industries.
6. As the next generation witnesses a transfer of wealth by way of inheritance- investment leverage will improve, especially in the housing market.
7. The housing market will benefit from lower rates as pent-up demand is real.
8. The U.S. economy and its’ allies will make further advances in advanced logic, chips manufacturing AI, robotics, data storage, biotechnology, quantum computing and the digital economy. This is wealth creation at the fastest pace in history.

This set of possibilities or any combination of these positive fundamental occurrences suggest the U.S. economy is well-positioned for the long-term growth of wave cycle E. Should you put your hope in wave theory? Well, there is some evidence to suggest that Elliott Wave Theory can be a useful tool for predicting market movements. For example, one study found that Elliott Wave Theory correctly predicted the direction of the stock market in 70% of cases over a period of 20 years. Wave theory is just one more tool we consider when implementing a diversified investment portfolio. There is a vast sum of factors and factor-combinations we use in decision making,

Thank you for your continued faith in all we do daily for you.

Sincerely,

Vaughn L. Woods, CFP, MBA

Vaughn Woods Financial Group, Inc.

2226 Avenida De La Playa

La Jolla, CA 92037

858-454-6900

www.vaughnwoods.com

Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal.  Past performance is not a guarantee of future results.  Asset allocation cannot assure a profit nor protect against loss.  Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed.  Views expressed in this newsletter are those of Vaughn Woods and Vaughn Woods Financial Group and may not reflect the views of Bolton Global Capital or Bolton Global Asset Management.  The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.  VW1/VWA0294.