The following is a summary of our recent interview with Urban Carmel, which can be accessed on our site here or on iTunes here.
The bull market looks set to continue, but where are we in the business cycle, and what can we expect going forward?
This time on FS Insider, we spoke with Urban Carmel, lead writer at The Fat Pitch about his take on where we are according to Elliott Wave Theory and what he sees as the final leg of the bull market.
Final Stages of the Bull
Elliott Wave tells us that markets trade in a five-wave pattern consisting of three expansions and two contractions. We bottomed in 2009 and may now be in the final advance, which began February 2016.
There are three tell-tale signs to know if we are at that stage: macro data peaks and begins to decline, corporate profitability starts to deteriorate, and investor sentiment shows signs of euphoria.
During this phase, most investors go all in, Carmel stated.
“When all those things come together, we typically see the end of the advance, and we get a more significant retrenchment,” he said.
This is not an exact science, he noted, but rather is more of a rubric for thinking about the market.
It’s important to note that we don’t know how long the last wave will run. We could be in for another 2-year advance, Carmel noted.
“You typically see as much as 20 percent of the total bull market take place in the last 12 months of the advance,” Carmel said. “I think we’re in that stage right now. I think we still have more to go. We’ll continue to monitor the data and adjust our point of view based on that.”
Caveats and Macro Data
Part of the reason Carmel argues we’re at the beginning of the final wave (and not at the end) is that we’re not seeing a significant amount of flattening in the macro data.
We’re beginning to see growth in consumption of roughly 2 to 3 percent real per annum.
Retail sales are continuing to hit new highs, as well. This doesn’t add up to deterioration in macro data. The one area we’re seeing a little bit of deceleration is in employment.
“Employment growth obviously has been fantastic,” he said. “But the year-over-year growth is starting to decline.”
This is typical as the cycle matures, he added. We’ve probably already seen the peak rate of employment growth.
But to change his stance, he would need to see consumption growth and housing start to deteriorate, which hasn’t happened yet.
Corporate sales data and corporate profitability data have also rebounded from a year ago, where they were looking weak. Energy was the big trigger in those metrics deteriorating, which is why many were expecting a bear market, Carmel noted.
“Since then, things have rebounded very strongly,” he said. “Sales have already recovered. And margins have recovered as well. They’re not entirely back to prior highs, but they are very close to prior highs.”
What he’s seeing now is a strong reacceleration out of that low from last year.
Investor Sentiment and Valuations
Investors are pretty bullish once again, Carmel noted, with bull-bear ratios turning extreme in favor of bulls.
“Many people will misinterpret this data and say we’re therefore back at the top already, that it can’t get any better than that,” he said. “That’s a very difficult argument to make empirically because bottoms and tops are not the same.”
Sentiment data can be exceptionally helpful in identifying market bottoms, he pointed out, because investors have a human tendency to get very concerned all at once.
These bottoms in sentiment tend to be very strong reversal points in the stock market, he added. But the same rule does not really apply at market tops.
For example, sentiment data started to show signs of froth in the first week of December 2016, yet the market has advanced another 15 percent since then. There are lots of similar past examples, Carmel noted.
“The psychology doesn’t work the same way at the tops as it does at the bottoms,” he said. “At the top, investors get bullish at varying rates. … We’re starting to see that sentiment data begin to get frothy.”
That doesn’t mean the market can’t significantly advance from here, he added, but only that sentiment is no longer behind markets.
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