Opinion: Bull market in stocks will top out in 2018, says investor who studies crowd psychology – MarketWatch

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I’ve heard many people say this is one of the most hated bull markets in history.

As the U.S. stock market had climbed higher, more people (including me) prematurely predicted a severe correction and even a bear market. Even with many warning signs, we were wrong. Many hedge funds that use short-selling strategies (betting on a decline in prices) have been decimated as investors used every pullback as an opportunity to buy more shares. In fact, the one strategy that worked well for the past eight years has been “buy on the dip.”

For the past two years, one analyst, Avi Gilburt, founder of ElliottWaveTrader, has been steadfastly bullish (with a few caveats along the way). Gilburt reached his bullish conclusions by using the controversial and misunderstood market theory, Elliott Wave. According to Elliott Wave, markets move in “waves” based on public sentiment and mass psychology. One of the keys to Elliott Wave is to identify when the “herd,” or most investors, shift direction.

“Most humans stay in the herd,” Gilburt says. “The herd is right until it changes, and most people don’t see the directional change coming. But when you stand in front of the herd when it’s charging, you’ll get trampled. You have to know at what point the herd changes direction.”

In addition to analyzing the market using Elliott Wave, Gilburt also uses traditional technical indicators such as relative strength index (RSI), moving average convergence-divergence (MACD) and other moving-average tactics to validate his analysis.

“We use a host of indicators to tell us if we are right or wrong within the wave count,” he says. “As long as the indicators line up with Elliott Wave analysis, there are no surprises.”

Two years ago, Gilburt was bullish when most traders were cautious or downright bearish. Through Brexit, a bizarre presidential election and waves of terrorism, Gilburt has remained bullish, and predicted the S&P 500 SPX, +0.17%  would hit 2,500. Now we’re within striking distance of his target price.

When will the bull market end?

The million-dollar question is when the bull market in stocks will end. Gilburt says he has the answer.

He believes the market will top out in 2018, have a one- to two-year pullback, and top out fully in the early 2020s around the 3,000 region in the S&P 500. That’s about a 25% gain from today.

“Once we hit a high in 2018,” he says, “I’m looking for a 15% to 20% pullback that takes us to the 2,100 region. That could take a few years. If that pullback breaks below 1,775 in early 2020, that tells me the bull market is over.”

That’s when most investors should step to the sidelines, he says.

“I don’t see any big corrections until we hit a top probably in 2018,” he says. “Once we hit the highs in 2018, I’m looking for a one- to two-year pullback that will take 15% to 20% off the market probably into 2019.”

There are no guarantees, of course, that Gilburt will be right this time.

Watching the crowd slowly get euphoric again, just like in 1999, is exactly what Elliott Wave predicts will happen. Why? Because we’re human, which means we’re predictable. And that’s why Elliott Wave is useful.

Is the stock market topping out?

Gilburt sees little signs of a major market top right now, even though he does see us re-testing the 2,300 region later this year. Using Elliott Wave, he is looking for formerly bearish investors turning bullish (such as Harry Dent, who went from bearish to bullish recently).

“It doesn’t mean that every bear turns bullish,” Gilburt says, “but if we can pull off more than a few bears, it’s a clue we’re topping out.”

Since Elliott Wave is based on crowd psychology, Gilburt looks for investors to pile into the stock market. It’s a pattern that has been repeated throughout market history. When a majority of unbelievers finally throw in the towel, that’s when we reach a market top.

“Markets top on euphoria,” Gilburt says. “If you have a hated rally, like this one, it will be a long rally. The more hated it is, the more likely it will extend, until investors buy into it. Once general sentiment turns bullish, that is usually the time markets hit tops.”

Does he see euphoria now? “I’m seeing the seeds. People who were formally bearish are starting to believe in this bull market. Once we move through the third wave (of Elliott Wave) from 2,400 to 2,500, those who were formerly bearish will start to turn bullish. When that occurs, it will be the time to get worried. For now, I’m not worried about tops or crashes.”

What strategies should you use?

For now, Gilburt believes investors should stay the course. He sees every pullback as a buying opportunity until 2018, when there will be a big decline. That will be a buying opportunity. The final blow-off top, he predicts, will occur in the early 2020s, which will be the final nail in the coffin of this unloved bull market.

Should investors short-sell?

“I’m not a big believer in shorting during a bull market,” Gilburt says. “I look at pullbacks as an opportunity to add to long positions.” In other words, buy on the dip until the bull market finally ends. “Pullbacks are to buy, not to short,” he says.

“It’s not likely this bull market is near completion yet,” Gilburt says.

Until this current uptrend is finished for good (not including short pullbacks along the way), don’t expect a 15% to 20% correction until 2018. That’s when the herd, or masses, will get really get interested in the stock market. Until then, I’m marking my calendar to see if Gilburt is right.

Michael Sincere is the author of “Understanding Options 2E” and “Understanding Stocks 2E.”

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