Stock Market Reversion to the Mean and the Risk of Ruin

By: Joseph_Russo

The Silver Bullet Band - Groping in the dark for the golden gun with silver bullets, should they get their hands on it- the Fed, Treasury, and the political bodies at large, may soon discover they have been on their knee's pleading to engage in a willfully ignorant round of Russian roulette with a fully loaded revolver. 

Inevitably, we envision this high-level failure of leadership bringing about an unprecedented opportunity for the US to raise the white flag on its irreparable financial system, and place disciplines from the Austrian school of economics to task in rebuilding its financial markets.  In the interim, it is our hope (or fantasy) that the real (peoples) economy is somehow able to survive with vim and vigor while old school Wall Street deservedly crumbles amid a period of historic restoration. 

Before a grand momentous occasion of this sort can save the street, the financial sphere must first hit the very bottom of the barrel.  Where IS the bottom of such an epic and calamitous event?  History suggests clearly that 80% to 90% declines from peak values are the norm.  The sooner it hits rock bottom the sooner it is able to embark upon restoring prudent and sustainable growth path.  It is scary, but that simple.

There IS no meaningful floor under the market – only the very bottom
Quite honestly, even we did not think the floor would fall out as quickly as it has.  Below is an updated chart we presented nearly a year ago in a piece entitled V-for Vendetta.

Revisiting the Wilshire 5000
If one opens the “Vendetta” link and looks at the March 2008 version of the chart below it will become clear that we got it right, but failed to anticipate the gravity and speed in which the floor under the broadest representation of equity markets would collapse.  As the updated chart graphically expresses, the “risk of ruin” is nearer than one might have conceived previously.  Moreover, should it play out, we have now defined its target zones.

Below are a few of our prescient quotes from a segment within the Vendetta article, which provided briefings on the state of various markets at the time:

On the S&P 500: from March 10, 2008
The S&P is struggling franticly to hang onto its five-year reflationary uptrend from 2003.  Despite a potential breach (and apart from an all-out-crash) this beloved benchmark equity index is likely to get some sort of reprieve from its most recent five-months of bear whipping.

On the NASDAQ-100: from March 10, 2008
The NDX is one of the first widely followed equity indices threatening to post an ominous five-month closing low beneath its five-year uptrend.  The presidents “working group” must now do whatever necessary to insure a March close back above the mandated perpetuity of inflationary growth, or risk watching all of its fiat-managed equity indices stumble and fall.

On Gold: from March 10, 2008
Gold is frantically holding above its upper trend-channel eyeing the $1000 milestone, telegraphing to all of financial civilization the necessity to change its ways.  So far, no one is paying serious attention. 

Prescient Quote Outcomes:
On the S&P- After registering in an interim low of 1256.98 the week of 17-March, the S&P recovered more than 180-pts or 14.5% by mid-May.  This was the rather generous and anticipated reprieve mentioned in our timely status briefing.  The all-out-crash is still unfolding.

On the NDX- After registering in an interim low of 1668.57 the week of 17-March, the NDX recovered more than 380-pts or 23.2% by early-June.  Whether or not this occurred with the aid of the presidents “working group” by September, all were watching in awe as fiat-managed equity indices stumbled and fell.

On Gold- From its 7-March 2008 close of 974.20, Gold went on to surpass the $1000 dollar milestone.  In the week ending 17-March, Gold registered an interim high of $1033.90.  Ironically, since the US Fed and Treasury still hold all the games poker chips gratis the reserve status of its fiat currency, Gold dipped 34% testing the 681 level in October 2008 as a combination of deleveraging and lemmings rushing to dollars reanimated signs of life in the otherwise dead US currency. 

And still scratching our heads
We simply cannot comprehend the logic of leadership.  In fostering an egregious 30-year span of hyper-like inflation, they suddenly stop the game, decree rule changes left and right, and then claim that we are facing a threat of a massive deflation, thereby mitigating any negative effects of their current radical plan, which is to embark on the largest inflationary effort ever attempted in the history of humankind.

Four months after its initial pounding, Gold is knocking on the door of $950, up some 40% from its lows, and is again approaching the $1000 milestone despite the continued surge in an otherwise worthless paper currency.     

A reversion to the mean spells RUIN
The new normal, not yet defined, has potential to be truly incomprehensible.  The old, so-called “normal” growth path that leadership is betting the ranch to salvage was an artificially created erroneous paradigm that is now just beginning to implode.  By default, the US will take down the rest of the Globes financial markets in this extraordinary process of vile but necessary cleansing.  The irreparable financial sphere is now poised to deliver itself a tsunami of forced-cleansing simply because of leadership's failure to exercise the wisdom and discipline to allow the system to cleanse itself. 

And they all fall down
Many if not all Global Equity Indices now sport trendline trajectories, which if breached, portend total collapse.  Contrary to the false paradigm of what we are now bombarded with as an essential kick-start quest to getting things back to the “old normal”, a simple reversion to the mean will equate to a serious breach for many of these “risk of ruin” trendline trajectories.  It is indeed time for truly radical about-face change.  Radical enhancements to what caused the problem in the first place constitute no change whatsoever.

Thus far, all seems eerily calm as the powers that be have yet to find the golden gun laden with silver bullets.  We should become more concerned after a convincing market rally, which gives off the appearance that their convoluted efforts are actually starting to work.  Such a feat would indicate that they finally found their golden gun, and have begun spinning its big shiny barrel frantically, and with hubris of old, awaiting their turn to pull the trigger in the fatal game of fully loaded Russian roulette.  

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By Joseph Russo
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Elliott Wave Technology
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Copyright © 2009 Elliott Wave Technology. All Rights Reserved.
Joseph Russo, presently the Publisher and Chief Market analyst for Elliott Wave Technology, has been studying Elliott Wave Theory, and the Technical Analysis of Financial Markets since 1991 and currently maintains active member status in the "Market Technicians Association." Joe continues to expand his body of knowledge through the MTA's accredited CMT program.

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