Today's Edition

Excerpt from The State of the Global Markets, Elliott Wave International's 2013 Global Forecast

How to Spot a Market Top

"You'll know gold sentiment is at a high when "Slime" (Time) magazine has a cover showing a golden bull tearing apart the New York Stock Exchange."

–Doug Casey

The Economist, whose editors apparently don't read Doug's work, ran the cover below on May 11.

In this case, the bull, whose smug facial expression appears to be taunting us for ever doubting that Wall Street is the most awesomest place on earth, isn't golden. Rather, his smashing through the wall is a metaphor for stocks smashing through their nominal all-time highs, and an implicit projection that there are more gains to come.

Different magazine, different asset, same idea: by the time the mainstream media adopts a narrative, it's a good bet that whatever trend they're celebrating has just about run its course.

The crowd will likely hail this cover – and those sure to follow soon in more widely distributed publications – as an "all clear" sign to jump back in to stocks if they haven't already. But you're probably better off doing the exact opposite: prepare for tough times by reviewing your stock portfolio and cutting loose all but the best companies.

At the most basic level, Doug's observation is a comment on human psychology. I can think of endless knocks on the mainstream media, but one role it competently fills is to reflect the prevailing psychology of the people. The bull on the cover is no exception.

When making decisions, humans tend to rely on their experiences in the immediate past. Thus, while trying to decide where to invest money today, the majority peer into the rearview mirror and see nothing but gains in stocks for the four preceding years. Our brains are wired to tell us this is a good thing – that stocks are safe once again and represent an exciting opportunity to jump on a rising wave and make some money.

But remember: the bull gracing the cover of The Economist is a reaction to the crowd's bullish attitude, not a precursor to it. The crowd is mostly bullish already.

Such a bullish signal will only serve to draw in the most sluggish and unaware of investors. They're very last to get in. After their money is drawn in from the sidelines, there's no one left to buy. Ignore crowd psychology at your own peril.

Which brings me to this week's feature, courtesy of an organization dedicated to studying the effects of crowd psychology on world events. If you're not familiar with the Elliott Wave Theory (EWT), it's based upon the idea that changes in crowd psychology are the dominant driver of changes in markets – more so than earnings, margins, or other fundamentals. Further, these psychological swings usually occur in measurable patterns. Thus, by studying crowd psychology, one can predict where markets may go next.

There's a strong contrarian element to EWT's methods, such as the position that extremes in investor sentiment usually mark stock market inflection points. EWT's sober take is that when euphoria is running high and everyone is bullish, what's really happening is that anyone who could potentially invest has already invested, meaning there are no buyers left – only sellers, which marks a true market top. I suspect EWT proponents would judge the above bull cover in much the same way Doug Casey does – as a warning, rather than a celebration.

You'll find that the excerpt begins with a story of how the author, Robert Prechter, used his study of crowd psychology to predict that the global-warming hysteria of a few years ago was way overblown and that it would die down, just as all of the contrived emergencies before it did. I asked to include this section for readers who are unfamiliar with Elliott Wave Theory, as an example that it can apply across all realms of human action, not just financial markets.

Following that section, you'll find a small taste of Elliott Wave International's forecast for US stocks. If you like what you see, you can download the entire global forecast – which includes big-picture analysis on US, Asian, and European stocks as well as commodities like gold and oil – for free.

Enjoy, and see you next week!

Dan Steinhart
Managing Editor, The Casey Report

Excerpt from The State of the Global Markets, Elliott Wave International's 2013 Global Forecast

Part I: The Global-Warming Panic Is a Distant Memory

By Robert Prechter, editor of The Elliott Wave Theorist

A non-event that recently had the media buzzing was the dearth of discussion of the global-warming issue during the presidential debates, not to mention nearly everywhere else on earth over the past year.

This is another social change predicted in The Elliott Wave Theorist in the face of vicious opposition. This excerpt highlights the key points:

Sometimes scientists herd as much as investors do, and this study [by NASA] appears to be a case of extreme expression following a long-established trend. I am not a climatologist, but I am a student of manias and herding, and that is what the global-warming craze appears to be about.

My purpose here is not primarily to make a case against man-made global warming. My primary intent is to take a look at the question from the point of view of a social psychologist to decide whether it appears to be the result of hysteria. The points above establish that there are two sides to the global-warming question. Yet only one has captured the public's imagination (and I choose that word consciously). The global-warming scare is highly reminiscent of the Alar scare, in which Congress called upon the expertise of movie stars; the ozone-depletion scare and the acid-rain scare, which have all but vanished; the claim that pesticides were making frogs lame (it turned out to be a virus); the rash of reports of devil worshippers, who were never found; the national child-care molestation hysteria, which turned out to be almost entirely contrived; the panic in Europe over poison in Coca-Cola; and any number of like manias. Hysteria often signals the end of a trend.

There is powerful evidence of herding at the social level on the global-warming issue. Commentary on the subject is even selling theater tickets. And like all past social trends that were ending, there is a rush to extrapolate. The temperature data from which modelers at NASA derive their extrapolations are scant, the projection is extreme, and their tone is strident. When any writers, including scientists, extrapolate 29 years' worth of temperature data to predict an imminent apocalypse of biblical proportions in an environment of waxing social focus, rising panic, and calls for government obstruction, one must acknowledge the likelihood of social-psychological forces behind such a report and investigate whether the data support the prediction.

The crowd fearing global warming rejects as heretics professors and scientists who challenge all these methods and conclusions, whether they be at MIT or Stanford. Such rejection is akin to what happens near the end of a financial mania, such as the peak of the real estate mania [in 2005], when bears were dismissed as delusional.

GW advocates told me that doubting man-made global warming is akin to denying evolution, but the GW movement has not a little taste of old-time religion in its accompanying admonition of humanity: Man is evil; he is destroying the earth; he is "fouling his own nest," as one scientist on the Web says. Scientists are usually good at their fields but not necessarily at recognizing their own political, moral, and philosophical biases.

One thoughtful scientist took issue with the term "hysteria." But the term applies here to social activity, not the overt behavior of any particular individual. In 2005, when I was speaking about real estate hysteria and warning people against investing in property, people sporting a rather bemused expression would coolly respond, as if instructing an alien who lacked understanding of the way things worked on Earth, "They are not making any more land" and "It's all about location." They would say this with utmost calm. They had thought about it and sifted through the evidence. They were not hysterical but rational and thoughtful. At least, this was the appearance of behavior at the individual level. At the collective level, something else was going on. The number of people participating in the real estate market was unprecedented, and their borrowing, building, and bidding activities, collectively, were extreme.

Advocates of man-made global warming may appear sober as judges individually, but they are participating in a mass movement, complete with press releases, student rallies, pop concerts, movie documentaries, and an underlying tone of moral crusade.

I think the current frenzy over the subject is probably a symptom of peaking cycles in both climatic temperature and social psychology. But unfortunately 70 years from now most of us won't be around to know the answer. What I expect, based upon observing mass movements, is that this fear, too, will go away.

–The Elliott Wave Theorist, June and July 2007

That was six years ago. Recently it has come to light – from globally collected data reported by some of the very institutions that had passionately promoted the case for man-made global warming in 2007 – that the earth in fact hasn't warmed at all since 1997. One would think the case for man-made global warming would be virtually closed from such contrary evidence and that those who feared global warming would breathe a happy sigh of relief and go home. Some of them have done just that. But proponents remain vocal.

[In November] a professor in a syndicated editorial blamed the recent relative silence on the issue on "a profit-driven economic system that demands and necessitates endless growth, a global US military presence that helps facilitate it, and the ecologically rapacious consumption it entails." Whatever your opinion of these matters, all three of them were in place during the entire period of waxing panic over the global-warming issue, negating the claim to their causing its opposite.

He further charged, "In the wake of extreme drought in much of the United States, widespread wildfires in the western US, and now Hurricane Sandy, Barack Obama's and Mitt Romney's refusal to discuss human-induced climate change will undoubtedly go down as political recklessness of historic proportions." If hurricanes, wildfires, and droughts were evidence of man-made climate change, man must have secretly industrialized the world millions of years ago. Archaeologists are pretty sure that didn't happen. The main thing likely to go down as being of historic proportion is the extent of fear about global warming that held sway in 2007. I doubt it will return in our lifetimes.

Further suggesting that the old trend is dead is that government, always the last institution to join a herd, is taking action. California passed a "cap and trade" law at the height of the panic in 2006 and is now implementing it. Naturally, it involves taxing people:

Under the plan, the California Air Resources Board will auction off pollution permits on Wednesday called "allowances" to more than 350 businesses, including electric companies, food processors, and refineries. The board has estimated that businesses will pay a total of $964 million for allowances in fiscal year 2012-2013. (AP, 11/15)

Extorting a billion dollars annually from industry will ultimately cause more pollution, as it did in communist East Germany, where air became toxic and rivers caught on fire. But California doesn't yet shoot people trying to leave, so the first likely trend here is that businesses will accelerate their exodus out of the state.

Unfortunately, there may be more action at the federal level as well. At a press conference on November 14, President Obama declared, "I am a firm believer that climate change is real, that it is impacted by human behavior and carbon emissions. And as a consequence, I think we've got an obligation to future generations to do something about it." (Reuters)

Republican Mayor of New York Michael Bloomberg likes Obama's position on this issue so much that he endorsed the president for reelection. But Obama's waste of billions of taxpayer dollars propping up so-called "clean energy" companies, along with whatever new taxes and regulations the feds dream up, will ultimately contribute to the trend toward national poverty, which will increase pollution, not reduce it. With any luck, the depression will distract various governments from this destructive path. But, then again, destruction is what depressions are about.

Part II: The Stock Market Is Ripe for a Decline of Historic Magnitude

By Steve Hochberg and Pete Kendall, editors of The Elliott Wave Financial Forecast

Incredibly, the DJIA rallied back to a new all-time high, a move that generated a cornucopia of ever-higher projections.

The wide array of optimistic extremes in sentiment measures includes several readings that exceed the extremes of 2007, when the Dow made its previous high. With a finishing structure that Elliott Wave Principle describes as occurring at "the termination points of larger patterns," the market is ripe for a decline of historic magnitude.

The sudden, loud chorus of market bulls, which has grown to a full-blown crescendo, fits perfectly with the terminal stages of a major advance. This chart shows the stunning breadth of optimism extending to every class of investor.

The first indicator (second graph) on the chart shows the percentage commitment to equities in the portfolios of members in the National Association of Active Investment Managers (NAAIM). The latest reading reveals an all-time high equity exposure of 104%, which means managers are in a leveraged long position for the first time in the seven-year history of the survey. The reading far surpasses the 83% level, which occurred at the October 2007 all-time high in the Dow.

A separate BofA Merrill Lynch survey of 254 fund managers confirms that money managers' "appetite for risk in their portfolio" is at its highest in nine years. "An increasing number judge equities as undervalued – particularly in Europe." They soon will become even more "undervalued," as the Euro STOXX 50 Index has traced out five waves down from its January 30 countertrend rally high, indicating that Europe's bear trend has returned. There's more: Even though Spain, Portugal, Greece, and Italy are de facto bankrupt, confidence is suddenly so high in that region that Europe's junk-bond yields relative to investment-grade debt have collapsed to the lowest premium since the start of the global credit crisis. It is an astonishing and historic display of optimism relative to a collapsing economic reality.

The second indicator shows a major upswing in bullishness among options traders via the Credit Suisse Fear Barometer Index (the name is misleading since a rising index means less fear). This index measures trader sentiment by comparing the cost of three-month out-of-the-money calls on the S&P 500 relative to puts of the same duration. The recent extreme of 33.32 on January 25 is the highest in the history of the indicator, which goes all the way back to November 1994. The CBOE Volatility Index (VIX), which tracks the level of fear and complacency using the premium paid for at-the-money S&P options, declined to a low of 12.29 on January 18, its lowest reading – indicating the most complacency – since April 2007, just prior to the major top in the financials.

The third indicator shows a new optimistic extreme among investment advisors. The 15-day average of Market Vane's Bullish Consensus rose to 68.2% in February, its highest reading since June 2007.

The bottom graph plots the total assets in the government money-market funds at Guggenheim (formerly Rydex), showing that the public is likewise complacent about the potential for a market decline. We've inverted the totals to align them with the trend in stocks. When people are highly confident that stock and bond prices will continue to rise, they see little need to hold money aside in money-market funds and instead load up on financial assets. The total holdings in Guggenheim's money-market funds just dropped to their lowest level ever, reflecting a supreme confidence by investors and a full embrace of stocks and bonds.

At the opposite extreme, corporate insiders – investors who are presumably privy to the future potential of their companies – are dumping shares into the market at a furious pace. According to Vickers Weekly Insider Report, among NYSE stocks there were 9.2 insider shares sold for every share bought over the previous week. The last time the ratio of sales-to-buys was higher was in July 2011, just before the Dow declined 18% over the following four months. As we've said previously, there may be many reasons why an insider sells shares, but one of them is not because they think their price is going higher.

Taken together, the breadth of extremes shown on the chart indicates that stocks are not making a short-term top: these measures are all greater than at any time since at least 2007. This is a rare alignment that confirms this is an even more important, and more bearish, juncture than 2007.

You have just read an excerpt from State of the Global Markets – 2013 Edition, a report from Robert Prechter's Elliott Wave International. The full report, including big-picture analysis on US, Asian, and European stocks as well as gold, silver, oil, and more, is available for free for the next week. Follow this link to download the full 39-page report now – it's free.