Authored by Avi Gilburt via MarketWatch.com,
I recently interviewed Prechter, who released a ground-breaking book, “The Socionomic Theory of Finance,” at the end of December. In the 813-page book, which took 13 years to write, he proposes a cohesive model that takes into account trends in sociology, psychology, politics, economics and finance. I highly recommend the book.
As I’ve explained here, Elliott Wave theory says public sentiment and mass psychology move in five waves within a primary trend, and three waves in a counter-trend. Once a five, or V, wave move (the waves are sometimes described in Roman numerals) in public sentiment is completed, it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of “news.”
As one reviewer on Amazon wrote about Prechter’s new book: “This [cohesive] approach allows a measure of prediction on the basis that social mood fluctuates in fractal waves, and knowledge of them allows one ‘to achieve some measure of success in forecasting the direction, extremity and character of financial, social, political, cultural and economic trends.’ ”
Here’s an edited version of the interview, in which Prechter gives his outlook for the U.S. stock market, the general theory of Elliott Wave analysis and his new projects.
Avi Gilburt: You’ve said that, once the stock market tops, you expect a major bear market and economic contraction to take hold. What is your general timing for this to occur?
Robert Prechter: The true top for stocks in terms of real money (gold) occurred way back in 1999. Overall prosperity has waned subtly since then. Primary wave five in nominal terms started in March 2009, and wave B up in the Dow/gold ratio started in 2011. Their tops should be nearly coincident.
Gilburt: What do you foresee will set off this event?
Prechter: Triggers are a popular notion, borrowed from the physical sciences. But I don’t think there are any such things in financial markets. Waves of social mood create trends in the stock market, and economic and political events lag behind them. Because people do not perceive their moods, tops and bottoms in markets sneak right past them. At the top, people will love the market, and events and conditions will provide them with ample bases for rationalizing being heavily invested.
Gilburt: You’ve said we will be mired in a “depression-type” event. How long could that last?
Prechter: I don’t know. All I can say for sure is that the degree of the corrective wave will be larger than that which created the malaise of the 1930s and 1940s.
Gilburt: How are conditions going to change from what we have now?
Prechter: The increasingly positive trend in social mood over the past eight years has been manifesting in rising stock and property prices, expanding credit, buoyant pop music, lots of animated fairy tales and adventure movies, suppression of scandals, an improving economy and — despite much opinion — fairly moderate politics. This trend isn’t quite over yet.
In the next wave of negative mood, we should see the opposite: declining stock and property prices, contracting debt, angry and somber music, more intense horror movies, eruption of scandals, a contracting economy and political upheaval. That’s been the pattern of history.
It’s all relative, though, and it’s never a permanent condition. Just as people give up on the future, its brightness will return. The financial contraction during the negative mood trend of 2006-2011 was the second worst in 150 years. Yet, thanks to the return of positive mood, many people have already forgotten about it. Investors again embrace stocks, ETFs, real estate, mortgage debt, auto-loan debt and all kinds of risky investments that they swore off just a few years ago.
Safe havens
Gilburt: Where do you suggest people “hide” during this event for financial safety, and why?
Prechter: Short-term notes of the least unstable governments, held in the safest manner possible. The plan is to trade those investments for stocks, property and precious metals near the bottom. You can be calm and avoid suffering financially if you’re prepared. The trick to maintaining personal prosperity is to avoid popular investments at the turns. It’s not easy to do, but at a minimum, you need a fractal perspective on social trends as opposed to a linear one.
Algorithmic trading
Gilburt: With the advent and proliferation of computer-executed trading, what effect have they had on Elliott Wave analysis, other than the speed at which trading is done?
Prechter: Virtually none. People build their errors of thinking into their programs.
Stock market changes
Gilburt: How have markets changed, if at all, in the decades you have been analyzing Elliott waves.
Prechter: Markets have changed in superficial ways but not in any essential way. They still trace out Elliott waves. But that doesn’t mean it has been easy. Wave V from 1974 has been unusually large in both price and time relative to waves I and III. The closest thing to it in the record is the 1932-1937 rise, in which wave five lasted 15 times as long as wave one. Also, from 1987 to 2007, pullbacks were shallow and skewed upward in the Dow and S&P 500 which threw me off.
Some analysts credit the Fed’s inflating for these market attributes. But even as the Fed was expanding the money supply at a record rate, the 2007-2009 drop in the Dow was deeper than one would have expected for wave C of a Primary-degree flat. So, that causal argument is spurious. Here in 2017, even the Dow/PPI is at an all-time high. I chalk it all up to Grand-Supercycle-degree optimism. That’s why we have record credit expansion, too, along with cooperation among members of the Federal Reserve Board and political support for the Fed. All that will change when mood turns negative.
Modifying the original theory
Gilburt: I have seen many analysts attempt to modify Ralph Nelson Elliott’s original structure, but none with any degree of success. If there were any aspect of Elliott’s structure to be its weakest link, where would you see the potential for such modification to find success in the future?
Prechter: You’re right. I have seen two attempts by others to change Elliott’s fundamental observations, and I have not adopted either of them, because I don’t see them dominating prices.
I have suggested three variations on forms: the leading diagonal (in which the odd-numbered waves can subdivide into five), the expanding diagonal and the skewed triangle. I remain skeptical about the legitimacy of all three of these forms. I suspect the patterns I described are more likely artifacts of imperfect mood recording than legitimate formations.
On the other hand, over the years I and my colleagues have made a number of valuable observations about wave forms that Elliott never noticed. Some have become well-known, others not. They are:
1. Wave three is most often the extended wave.
2. Peak acceleration occurs at the structural center of each wave, i.e. in wave 3 of 3 of 3.
3. In the stock market, fifth waves are always weaker than third waves.
4. B waves of contracting triangles often reach a new price extreme.
5. Even so, E waves of triangles in the wave four position always end within the territory of the preceding third wave.
6. Double flats are somewhere between rare and non-existent; I’ve seen flat-X-triangle serve as double three.
7. The barrier triangle is a more useful idea than the idea of independent ascending and descending triangles.
8. Zigzags often adhere to channels.
9. In zigzags, A waves tend to be steeper than C waves.
10. In flats, C waves tend to be steeper than A waves.
Useful indicators
Gilburt: While we use various technical indicators to support or show the weakness in any wave count, my favorite has been the MACD. Do you have any favorites that have been most useful to you over the years?
Prechter: Nearly all momentum indicators provide the same basic information. There are hundreds of them, because they are easy to construct, especially with computers. I don’t chart rates of change anymore because I can tell what they look like just by looking at prices. But momentum analysis is not simple. In the stock market, slowing momentum nearly always precedes reversals, but slowing momentum does not mean a reversal must follow. The 1985 and 1989-1994 periods are classic examples. In each case, the market slowed its rise — looking terminal from a momentum standpoint — and then accelerated. In the first case, I knew wave 3 of 3 was dead ahead, so I was really bullish. The second one threw me off. The most consistently useful momentum indicator is breadth. If I had to rely on only one momentum indicator, that would be it.
Markets as ‘fractals’
Gilburt: Do you have any specific time frames in charts that, in your experience, have provided the most insight into a specific market or commodity?
Prechter: No. Markets are fractals. Nothing quantitative is meaningful or useful.
Gilburt: There is a debate among various schools of thought as to what is more important — price or time. What’s your perspective?
Prechter: What matters most is form. Form involves both price and time, although arguably price is the more definitive component.
Improving accuracy
Gilburt: I am sure you have seen a lot of time-cycle analysis in your career. In my experience, I have not really seen any that have been better than 50/50. I am just wondering why you think we are unable to develop the same accuracy percentages in timing models as we do in pricing models using Elliott Wave?
Prechter: I think the reason for your observation is that cycles are not the essence of markets. They are artifacts of the fractal form. They appear for a while and then disappear. Usually by the time someone recognizes a cycle and bets on it, it is poised to vanish. As you say, the success rate is about 50/50, so I don’t rely on them anymore.
I think Fibonacci ratios between the prices and durations of related waves are meaningful. I wrote a book about Fibonacci relationships called “Beautiful Pictures.”
Reaction to socionomic theory
Gilburt: I have personally noted how I view socionomics as the ground-breaking work that will eventually lead market analysis into the future. But I also understand how old habits are hard to break, and most still desperately cling to the old Newtonian-based exogenous-causation theories of market analysis. What sort of reception has the socionomic theory been receiving from the world of academia?
Prechter: It has had wisps of success. We have had several academic papers published, and another was accepted by a journal [recently]. A ranking member of the Academy of Behavioral Finance and Economics commented to me that the term socionomics was becoming part of the lexicon, which was encouraging to hear. Several professors at mid-level universities are including it in their courses, and several top professors have been kind enough to provide a good word for the book. But most economists don’t know socionomics exists, and most of them would dismiss it if they did. Socionomic theory explains why such a reaction is, generally speaking, imperative: People are built better to participate in waves of social mood than to analyze them. So it’s very hard to get the word out. People like you, who do pure market analysis, have been the quickest to get it.
Education and resources
Gilburt: As new studies into the socionomic aspects of financial markets are performed all the time, are there any other resources for us to follow to gain continuing insight into this perspective?
Prechter: The Socionomics Institute puts out tons of interesting material. The website is full of studies, articles, events and videos. People who like this field should become a member.
Gilburt: What are your top three arguments to present to those who do not believe in socionomics but still hold fast to the old exogenous-causation theories?
Prechter: It took 800 pages in “The Socionomic Theory of Finance” to present arguments. But I can make three brief statements:
1. Events and conditions that are often labeled “fundamentals” have no predictability with respect to the behavior of financial markets, so they cannot be causal. (See chapters 1, 2 and 22.)
2. Financial markets differ in numerous fundamental ways from economic markets, implying that their behaviors spring from different causes. The key difference is that in economic markets the context is one of relative certainty with respect to one’s own personal values, which allows for rational decision-making, whereas in financial markets the context is one of pervasive uncertainty with respect to others’ future actions, which prompts people to herd. (See chapters 12 and 13.)
3. Postulating unconscious waves of social mood as a hidden variable explains a persistently compatible relationship among myriad social actions, from popular musical tastes to changes in the economy to political actions to women’s fashions to trends in the stock market. (See chapters 8 and 10.)