Bonds are interest rate instruments which often emit clues as to where the equity market might go. Typically, rises in bond prices (falls in bond yields) will occur during periods where there is an increase in the expectation of economic problems. When bond prices fall, the market is pricing in an interim period of expected growth and subsequent interest rate rises.
The mechanism by which that is achieved is through growth leading to the optimum allocation and increase in demand of scarce resources, leading to inflation and eventual interest rate rises. Although no individual method is infallible, Elliott Wave and ProfitSource illustrate an interesting period upcoming for the Australian bond and potentially equity markets.
The chart below shows the automatic ProfitSource Elliott Wave count in purple and the expected expansion of that count with the Time and Price Projection (TAPP) high-lighted by the dotted lines. This is why ProfitSource is such a powerful tool for every investor and trader looking to manage risk and place orders. To this, I have added my own Elliott Wave count to further show how the TAPP might eventuate (demonstrated by the figures in turquoise). These are not generated automatically, rather are the product of learning!
click to enlarge
First focus, then, is on the manual count. Basic Elliott Theory suggests that any market should move in a series of waves. A five wave motive pattern labelled 1,2,3,4 and 5, followed by a 3 wave corrective pattern labelled ABC. The red dashed lines represent the Elliott Wave’s expected extension – which can be found very simply using the wave extension tool in ProfitSource.
A run of the market between the start of the count in June to the top of wave 3 becomes the guide range (the first red dashed line), which can then be used to forecast the wave five target. Following the retracement to wave 4 the market then pushes out towards the Fibonacci projection of 61.8% (the second red dashed line) which indeed confirms Wave 5 in line with both the market and the theory.
Ensuing to this, Elliott Theory predicts a three wave corrective pattern known as an ABC pattern. At the time of writing, A and B are close to confirming with just the C remaining. A ‘C’ in this context would see a fall in bond prices, coinciding with an equity market rally and a decrease in the likelihood of future rate cuts.
Should we see the ‘C’ confirm and then a return to trend, i.e. the retracement is complete, the larger wave 4 target given by the TAPP comes into play. ProfitSource clearly calls for a longer term resumption of a bullish bond market which is effectively the expectation of lower rates. Lower rates will only come about with a decrease in economic conditions and is likely to coincide with a fall in the equity market.
Of course, the theory and highest probability count may need adjusting as time progresses; however it is well worth noting that, despite many pundits have already called the share market bottom, the prospect for a rapid turn around and shift to bullish conditions may still be some time away.