October 29, 2008 at 05:57 AM EDT
Have Investors Panicked and Capitulated?
After watching Bob Precter yesterday evening on Bloomberg is why I'm posting this article today.

Robert Precter correctly forecasted the 1987 stock market crash.

Robert Prechter examines historical stock activity to identify how and when fear and panic is recorded in stock market price. He even provides unique insight for whom you should vote in November.

Ever since mid-September, we have read that the bottom is in because investors have ‘panicked’ and ‘capitulated.’"

So writes EWI's Founder Robert Prechter in his just-published Elliott Wave Theorist, which dives into stock market history (recent and past) to determine whether capitulation has occurred.

The tragedy of history is that societies learn so little from it, despite its being a profoundly accurate indicator for the future. The one exception is technical analysis, which is actually based on this very premise.

No living person is more well-versed in stock market history than Bob Prechter. Consider his impossible-to-ignore case for deflation. Nobody else we know of said stocks will decline along with commodities while the dollar rallied. Yet, here we stand.

You see pictures of U.S. stocks every day; now take a look at how other global stocks and commodities have declined in tandem – just as anticipated by Bob’s “All the Same Market” thesis.

The Russian and Chinese stock markets are now down more than 70 percent. Commodities, most of which made all-time highs this year, have plummeted in unison like never before: platinum is down 63%, copper 52%, oil 53%, silver 56%, wheat 57%, corn 54%, soybeans 49%, cotton 54% and the CRB index of commodities a whopping 42% in three months, after peaking in July. We warned that the government’s ethanol program would be another fiasco, and corn investors are learning that lesson. Even gold, which is real money, is down 28%. Everyone wants cash, and they are selling everything to get it.” ~ Robert Prechter, October 2008 Elliott Wave Theorist.

Click here for your Free Credit Crisis Survival Kit and review more of Robert Precter's financial markets forecasts.

Have Investors Panicked and Capitulated?

Click the DJIA Chart for a larger view.

Chart DJIA

Excerpted from pages 1-4 of Bob Prechter's Oct. 21, 2008 Elliott Wave Theorist.

Ever since mid-September, we have read that the bottom is in because investors have “panicked” and “capitulated.” But market history does not support this widespread view.

A perusal of volume (see Figure 1) shows that investors have not panicked. In a market panic, the number of shares traded increases substantially on down days and bottom days. In October 1929 and in October 1987, daily volume surged to between triple and quadruple the preceding summer’s average as prices plummeted.

Volume recently has been quite steady, aside from two spikes. But it is important to get out the microscope and see on which days they occurred. September 19 sported all-time record volume as the market surged upward. September 18 had the fourth-highest volume of the summer, and September 16 had the fifth-highest, and both were up days in the market. Even though September 17 had high volume on a down day, it was a contraction in volume relative to that on the adjacent up days. October 10, which is so far the low day for prices, saw the second-highest volume ever, and in some contexts would indicate an important reversal. But it happened amid hints that the G7 would meet and propose a global bank bailout, and some averages, such as the NASDAQ Composite and the two Value Line measures, closed up that day. Even the record and near-record volume surges of January 23 and March 20 occurred on huge up days, not down days. So most of the biggest volume days this year have been those that attracted mostly buyers, not sellers. This is not how volume has behaved in past panics. It is more like the way it behaves in the early stages of a bear market, when hope still reigns.

Click the S&P500 Emini Chart for a larger view.

The dominance of hope over fear indicates that investors have not capitulated, either. Capitulation is in evidence when investors finally abandon their hopes based on presumably bullish external factors. During September and October to date, investors have expressed immense faith in purportedly bullish news events. Figure 2 displays market actions to confirm this point. From September 1 through today, no fewer than half of the trading days found investors so excited about buying stocks that they drove closing or overnight futures premiums to record or near-record levels and/or concentrated their buying so intensely as to create large opening upside gaps in the futures market. You need not take my word regarding investors’ temporarily euphoric reaction to each news event; just flip through the news reports. This morning AP reports, “Wall Street surged on a burst of optimism Monday, [on] comments from Federal Reserve Chairman Ben Bernanke.” The Washington Post agrees: “The stock market soared in response to Bernanke’s remarks….” Socionomic theory accommodates brief market reactions to emotional stimuli, but we also know that otherwise the market’s trends are entirely in the grip of social mood, which cares naught for news. That is why we analyze waves of social mood, not news, except as it gives us hints about market psychology. Since every one of these days of excited rally had an excuse for buying based on news, it is clear that investors have yet to abandon their bullish bias or to give up hope that external factors will revive the bull market.

The main reasons that market observers are giving to support the case for a bottom are that momentum indicators are oversold and short term sentiment measures show that most traders are bearish. We know about these readings and show them on the Short Term Update. These indicators are tried and true, to be sure, but one must interpret them in context. Recall how often these same indicators registered an overbought condition or traders’ optimism from 1995 to 2007. If we are correct that Elliott waves identify that period as end of the largest-degree advance in nearly 300 years, setting up the largest-degree bear market since the 1700s, then current short term sentiment and momentum readings do not count for much. While they could support more near term rally, the bear market is likely to bulldoze right over them eventually.

Click here for your Free Credit Crisis Survival Kit and review more of Robert Precter's financial markets forecasts.
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