Vadim Pokhlebkin with Elliott Wave International on Earnings

Earnings: Is That REALLY What's Driving The DJIA Higher? The idea of earnings driving the broad stock market is a myth.
October 22, 2009
By Vadim Pokhlebkin

It's corporate earnings season again, and everywhere you turn, analysts talk about the influence of earnings on the broad stock market:

US Stocks Surge On Data, 3Q Earnings From JPMorgan, Intel (Wall Street Journal)
Stocks Open Down on J&J Earnings (Washington Post)
European Stocks Surge; US Earnings Lift Mood (Wall Street Journal)
With so much emphasis on earnings, this may come as a shock: The idea of earnings driving the broad stock market is a myth.

When making a statement like that, you'd better have proof. Robert Prechter, EWI's founder and CEO, presented some of it in his 1999 Wave Principle of Human Social Behavior (excerpt; italics added):

Are stocks driven by corporate earnings? In June 1991, The Wall Street Journal reported on a study by Goldman Sachs’s Barrie Wigmore, who found that “only 35% of stock price growth [in the 1980s] can be attributed to earnings and interest rates.” Wigmore concludes that all the rest is due simply to changing social attitudes toward holding stocks. Says the Journal, “[This] may have just blown a hole through this most cherished of Wall Street convictions.”

What about simply the trend of earnings vs. the stock market? Well, since 1932, corporate profits have been down in 19 years. The Dow rose in 14 of those years. In 1973-74, the Dow fell 46% while earnings rose 47%. 12-month earnings peaked at the bear market low. Earnings do not drive stocks.

And in 2004, EWI's monthly Elliott Wave Financial Forecast added this chart [shown above] and comment:

Earnings don’t drive stock prices. We’ve said it a thousand times and showed the history that proves the point time and again. But that’s not to say earnings don’t matter. When earnings give investors a rising sense of confidence, they can be a powerful backdrop for a downturn in stock prices. This was certainly true in 2000, as the chart shows. Peak earnings coincided with the stock market’s all-time high and stayed strong right through the third quarter before finally succumbing to the bear market in stock prices. Investors who bought stocks based on strong earnings (and the trend of higher earnings) got killed.

So if earnings don't drive the stock market's broad trend, what does? The Elliott Wave Principle says that what shapes stock market trends is how investors collectively feel about the future. Investors' mood -- or social mood -- changes before "the fundamentals" reflect that change, which is why trying to predict the markets by following the earnings reports and other "fundamentals" will often leave you puzzled. The chart above makes that clear.

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CHART CORRECTION

Please note that I changed the count on the 15min S&P futures chart in the previous post to have the 4th wave as an expanding triangle labeled a-b-c-d-e instead of labeling it i-ii-iii-iv-v like I did before.

All the accompanying analysis and forecasts remain valid. Sorry for the confusion.

Lots of Bearish Implications Occurred Today

Aside from the triangle scenario I listed in the previous post, we have a lot of action today to cover that was very bearish, and puts this immediate bearish count I have above on a slightly higher priority than the triangle scenario.

First, the bears had control all day and NYSE internals proved that by having 3.1 stocks trading down for every 1 trading up; also, down volume was 84% of total volume. In addition, only 45 stocks in the S&P 500 traded to the upside. This was very bearish, especially after having that big reversal rally yesterday. It shows no follow-through or conviction by the bulls and could signal their last effort to inflate this market higher. This up/down churning of the market often occurs at tops because bulls and bears literally battle it out for control of the market. Starting Wednesday, it's bears 2, bulls 1. The bears take control going into next week.

Second, the US dollar, as shown in a previous post today through the USD/CHF chart, may have formed a major bottom and will rally the next several months/years. The short term wave count can be viewed as complete with last nights slight new low. The British pound was destroyed last night by the US dollar which is the type of behavior I'd expect to see when the dollar bottoms and rallies against other currencies, but unfortunately this didn't really happen with others, just the pound. But it's quite possible the pound is just ahead of the game and is going to lead the other major currencies down against the dollar. We should know early next week. The dollar story is truly the key for a stock market top. When the dollar finds a bottom, it will result in a stock market top and lead to the crash I've mentioned (and shown in my long term chart at the right of the blog).

Third, the Dow Jones Transports (DJT) was destroyed today down 3.5%, and down 5.41% for the week while the major indices were only down modestly, less than 1%. Many know that the Transports index can often lead the market up or down, so the Dow Transports severe weakness this week can have very bearish implications for the overall market.

Fourth, observe my 15min S&P futures chart. You can see that the market can be declining impulsively, which suggests the trend is now down. I would have like the futures to break beneath 1070.25 to eliminate the triangle scenario, but it can do that next week if it wants to. Notice that the previous two selloffs from Wed and today are almost straight line down affairs. Prior to both of them, they are not as straight line up affairs, and the market has really been struggling the past couple weeks to make any net gains at all. In fact, the market is at about the same levels it was trading at October 9th, two weeks ago, and those two weeks of gains were wiped out in 1 1/2 hours essentially on Wednesday, and taken away again today. These are elementary signs of trend identification which suggest the trend has changed to the downside, in line with the EWP wave count. But I would like a break beneath 1070.25 to occur so I can eliminate the triangle scenario and put this bear count on firm footing.

So the bullish triangle scenario remains in play until the S&P 1070.25 futures and 1077 cash is broken, which would put the immediate bearish count (shown in chart above) at the very top of my list of probabilities, which we'd then have to look at the ascending trendline holding the market up since March of 2009 to be broken and closed beneath to confirm the crash is underway.

Possible Triangle Unfolding

The above chart is of the S&P futures at a 1 hour timeframe showing a possible triangle unfolding. The up down up down nature this week without breaking significant new highs or lows puts this count as a top view. It's short term bullish because it means the market will rally Monday (perhaps Sunday night in the futures) in wave D, then drop in wave E (usually on a news event), then "thrust" from the triangle in a very strong and ferocious rally to new highs.

Even though this count is short term bullish, it is longer term bearish, very bearish. Triangles are always in 4th, B or X waves. This would obviously be part of a 4th wave, and therefore the "thrust" from the triangle will be a wave 5 and the end of a multi-week rally that started at the beginning of October. Thrusts are strong and fast affairs but they are also immediately reversed. Seeing as that we are looking for a significant top in the stock market, this "finishing move" resulting from a thrust from a triangle MAY mean that the market will for THE TOP at that time.

If the S&P trades below 1070.25 in the futures and 1077 in the cash market, then it will negate the triangle bullish scenario and put the bearish scenario at the forefront all by itself, implying that the crash may be underway.

Short Term Stock Market Outlook

Well I said yesterday that in order for "The Crash" to possibly be underway, we needed the stock market to head lower immediately Friday morning, and it appears we got that. We also got the dollar to fill minimum requirements for a bottom with a completed wave count. Although none of these events are perfect, i.e. the S&P's decline from Wednesday's high looks a lot like a 3 wave drop which is a correction, and only the british pound against the dollar showed reversal-type action; it's still possible for a dollar bottom and stock market top to be in place right now. If not, the next ceiling for the S&P will be the 1120 level.

I may be trying too hard to shove a square peg into a round hole, but above is the S&P futures chart that shows a better 5 wave decline than the S&P cash does. However, this S&P futures chart has the 5 wave decline starting from a lower low than on Tuesday, so keep in mind the square peg analogy. But regardless, the S&P futures counts best on the chart above. On top of this, NYSE breadth is weak right now suggesting that the bears again have control today and are not happy with yesterday's rally and are intent on reversing it. Decliners are outpacing advancers 2.76 to 1, and down volume is 78% of all volume.

On the flipside, there are many holes in this analysis right now. The market is obviously not declining in clear 5 waves, yet, although it is possible to count the declines as 5's. The US dollar has yet to confirm a bottom, although its action against the british pound was impressive, no other majors exhibited this same action. The XLF is another kink in the armor. The financial ETF has made a new high making the decline a 3 wave affair. This is very problematic because it appears to have been leading the market down. But markets don't unfold perfectly, so we'll wait to let the market play out and confirm where it's at.

Descending Trendline from 2007 Top

As pointed out by blog reader, Adan, the descending trendline from the 2007 market top is near where the S&P is trading now. If a top is not in now and Wednesday's highs are exceeded, this trendline would be a good target. Today it hits about the 1120 level and falls about 3 points per day.

Dollar Satisfying Minimum Expectations for a Bottom

The dollar needed one more push to a new low to complete a possible ending diagonal 5 wave decline within a larger 5 wave decline within a larger wave C. Last night it did that, with a very slight new low and reversal. But the reaction after the new low in the USD/CHF has not been encouraging at all. The dollar rallied significantly against the british pound as you can see on the above 4hr chart on the right side, the GBP/USD dropped dramatically last night. I'd expect to see dollar pairs across the board with similar dollar strength in them. This leads me to beleive there is still some subdivisions of wave structure down needed to complete the dollar decline and form a bottom. But the british pound has probably made a top against the dollar, and 1.6700 should not be exceeded for a long time. But since the wave structure in the US dollar can count complete right now, new lows are not required.

Once I can confirm a dollar bottom and reversal, I'll post it here. Right now there are still great risk:reward opportunities for aggressive dollar bulls to get long right now with stops just past last night highs, just in case a dollar bottom is in fact in and just tried to sneak up on us on a lazy Friday.

The US Dollar Picture

Above is the 4hr USD/CHF chart which mirrors the US dollar index quite well. The wave count shows the decline since March of 2009 coming to an end, with the subdivisions of wave v of 5 of C concluding with what could possibly be an "ending diagonal", which is typical at the end of trends before major reversals. If so, there should only be one more shot downward before THE LOW is in. Typical targets for 5th waves are the length of wave 1, or a multiple of fibonacci's 61.8%. Since it's already exceeded wave 1's 61.8% level, I'm looking at the 100% and 161.8% levels which are 1.0012 and 0.9879 respectively. A reversal at these levels would be a huge indicator that this wave count was correct, and that the US dollar has formed a major bottom that will lead to a multi-month, if not a multi-year, monster rally that will move inversely to stocks, which should be crashing during that time.

This count on the dollar coincides with the bearish S&P count I posted earlier which would require the S&P to tank hard immediately Friday morning. The dollar can easily slip to a new low in the Asian or European sessions tonight, form a bottom and rally into the US session's open, causing a heavy stock market selloff.

Of course, this is aggressive speculation on my part, but I thought I'd entertain the idea since the wave count on the dollar can count complete soon, and since the stock market decline from yesterday has yet to be completely retraced.

We'll see.

The Earnings Effect

So the market seems to be buoyed by the US dollar weakness and a handful of stocks reporting good earnings. However despite most companies (about 78% last I heard on CNBC) beating expectations most of them are trading at levels below where they were when they reported their "blow out". So stocks are being fattened up into earnings and right after earnings, and then they're being dumped. This is a sign of a severely weakened uptrend. It's probably the institutions and big shot Wall Streeters pushing up these stocks and then dumping them on the smaller guys and retail folks. This is very bearish of course. Afterall, if a stock can't sustain a rally more than a couple days after blasting away earnings then what's left for them to do to make their stock go up from here?

Observe the 4 stocks above that reported earnings in the timeframes I circled in red. Notice that all these stocks are currently trading beneath where they were when they reported their "blow out" earnings. Again, this short term pop then drop action for earnings seems to be market-wide. When you combine this with a weaker dollar every day, you get a puffed up stock market based on smoke and mirrors. This is not a healthy bull run, this is bear market rally-type action.

So that's a little insight as I see the market internally, as to what's really fueling the rally. It will turn lower; but the part that's proven very difficult the past few weeks is determining when. But there's no doubt in my mind that this major rally is in its last throws, and the more it rallies without a break, the harder and faster it's going to fall when it finally turns down.

Stocks Must Decline First Thing Friday to Remain Short Term Bearish

Today the Dow held the market hope with it's stocks Travelers, AT&T, and McDonalds posting good earnings, and a few other stocks related to earnings. Early this morning, the Dow was the only one charging higher, up about 80 points, but NYSE breadth was flat. So the Dow was moving alone, hoisted by just a small handful of earnings related stocks, and the dollar was stable, so I thought the market could roll over any time. But later in the day the Dow pulled the other indices up for a major afternoon rally, severely weakening the short term bearish call yesterday. In response to the big decline yesterday, I posted yesterday that in order for this decline to have legs and open the door to the crash starting now, "We need to see follow through and weakening NYSE volume, breadth, and overall internals accompanied by constant 5 wave declines." We had none of that today, and the US dollar started to weaken later in the trading day, further fueling the stock rally. All-in-all, not a good day for the bears following yesterday.

But more important is the wave count. Above are two 5min S&P cash charts, one with a bearish count (left) and one with a bullish count (right). The bullish count is the most likely structure from a strictly EWP standpoint because the decline yesterday counts best as a 3 wave decline, which is a correction, and therefore new highs must be achieved. However yesterday's decline was so strong and convincing that it can't just be swept aside. But in order for this to remain in contention, the market needs to sell off immediately Friday morning. Otherwise, the indices will be charging to new highs. If that does happen, I will be watching all indices, and the XLF, looking for failures to make news highs with their counterparts. Since major divergences occur at major tops, I'll be set on watching for that.

There is no question the stock rally since March of 2009 is in its last throws, and is severely weakening, being held up by a few select stocks and their earnings reports for a day or two. Soon, the market will run out of gas and top. The further this market goes like this without a real sustained break, the more likely it is that the next top that's confirmed will be "The Crash".

Again, the US dollar seems to be key. It seems that the wave count has to subdivide a few more times to new lows before it bottoms. So we again, we wait.

Dow and S&P Levels to Confirm Collapse

As promised, here are the Dow and S&P charts and levels that mark the ascending trendline that's been holding this market up since March of this year. A convincing break, close, and hold of levels beneath this trendline by BOTH the Dow and the S&P cash indices will confirm the collapse in wave 3 or C is underway.

The S&P cash level is 1040
The Dow cash level is 9422

These levels are only good for tomorrow though as they increase upward every day. I'll keep you posted of the trendline levels as we approach them.

Peter Schiff Explains the Fundamentals of the So-Called "Recovery"

Peter Schiff has been a bear for a long time on the US and nothing has changed recently. He was on CNBC's Fast Money today and I recommend you all view his clip if you get a chance http://www.cnbc.com/id/15840232?video=1303178477&play=1

I've heard his arguement before, along with Bob Prechter, that most of the stock market's rally from March of 2009 was based mostly on inflation due to dollar weakness. Obviously, the weaker the dollar gets, the more dollars it takes to buy stocks, so when the dollar falls, stocks go up in dollar terms.

But as Schiff and Prechter report, the stock market has done very little rallying in gold terms, which is real money, since March of 2009. US dollars are fake money, credit slips, that the government prints at will. As I've stated before, dollar weakness and stock market strength has been the trend as of late and when the dollar bottoms and rallies, it should send stocks tumbling lower. However at the very end Schiff says he worries of a dollar crash, which I don't. I think the dollar is bottoming and will rally for months, if not years, which will put tremendous pressure on the US stock market.

CHART CORRECTION

Please take note that the first post had the wrong chart I erroneously labeled the S&P. I accidently labeld the NYSE chart the S&P. It is currently corrected on the blog.

Sincerely sorry!

Divergences Posted in S&P vs. the Russell 2000 and XLF

Today we had a nice reversal day which was "impressive" to say the least. This is the kind of movement we should come to expect for a long time, many months, when the collapse does in fact begin. We don't have confirmation of that collapse beginning quite yet though so I don't want to get ahead of myself. We must wait for much more to occur than just a 1 1/2 hour decline. I am in the process of developing a reliable trendline for the rally with exact point targets to where if there's a solid close beneath it, we can confirm the collapse is underway. I'll have that shortly.

NYSE breadth was solidly strong throughout the day, unfortunately I didn't get a snapshot of it at the time so I don't have the exact numbers, but I know that at one point advancers were over 2000 and decliners were under 1000, and up volume represented about 60%-65% of total volume. But, in the last 1 1/2 hours of trading this quickly reversed to end the session with NYSE advancers at 995 and decliners at 2031, and total down volume of 71% of total volume, on a pretty strong volume day overall. So the move was not a fluke, done on light volume manipulation, or any of that. THE MOVE DOWN TODAY WAS DONE WITH CONVICTION.

The S&P, Dow, and Nasdaqs all made new highs that confirmed each other today, however the Russell 2000 and the XLF (financial ETF) did not with the XLF not even coming close. The XLF has led this market lower and higher the past couple years, so it may lead us down again. So far it has. I posted the XLF weakness and 5 wave decline count in an earlier post, and as blog reader, Doc Steve, pointed out today, Goldman Sachs was very weak today which was a big warning sign apparently of what was to come later in the session. Goldman ended up closing down over 3% on the day. GS is a big leader in the financial sector, so their weakness lately is a big warning sign for the bulls, and encouraging for the bears.

The coming days will be very important. We need to see follow through and weakening NYSE volume, breadth, and overall internals accompanied by constant 5 wave declines. Without that, it opens the door to this just being another selloff and then bottom and reversal to new highs, again. I'm also waiting for confirmation of a US dollar bottom to confirm the top in the stock market as well. But that has not occurred yet.

So we wait, patiently, for the market to play out and let us know where we're at.

Stock Market Tanking Hard, Watching Closely

Quick post on some exciting action. The stock market is tanking extremely hard in a straight line down right now, characteristic of the collapse we're expecting. The Dow lost almost 150 points in the past 1 1/2 hours with most of those losses coming in the past 20 minutes.

If this holds into the close, it could be very meaningful.

Full update with thorough analysis at the end of the session later this afternoon.