[Article] Predicting Economic and Monetary Trends

This essay is by Robert R. Prechter, Jr. It was reprinted in: Prechter, Robert R. (2003). Pioneering Studies in Socionomics. Gainesville, Georgia: New Classics Library, pp. 231-255 (Note: The book is also available for purchase as part of a two-volume set.)

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How does one apply socionomic techniques to economic forecasting? A socionomist knows that the stock market is a meter of social mood, which is the engine of social progress and regress. Therefore, the current-time change in the stock market is an immensely useful indicator of upcoming economic change. With a knowledge of the Wave Principle, a socionomist has two further advantages over conventional approaches. First, he can often anticipate and recognize the degree of the trend change and therefore the probable extent and severity of the new trend. Second, he can refine his timing in certain cases with respect to the label of the corrective wave, for example expecting only one recession in and (A)-(B)-(C) correction of Primary degree, as a response either to wave (A) or wave (C), as explained in Chapter 16 (p.262) of The Wave Principle of Human Social Behavior.

There are three supporting elements to socionomic forecasting: the wave patterns in economic data, the momentum of stock market and economic data (involving rates of change and divergences) and the psychological state of the professionals and the public. These factors provide evidence either that an analyst has correctly interpreted the wave patterns or that he has done so incorrectly, forcing a re-examination of his outlook.

Some of what follows in this section may be found in Chapter 17 of The Wave Principle of Human Social Behavior, Chapters 13 and 14 of At the Crest of the Tidal Wave and Chapters 1 and 5 of Conquer the Crash. This seems a good opportunity to chronicle the highlights of the record in one place. It also provides an opportunity to include some recent additions to it. The purpose of this chapter is not to claim a track record for economic forecasting (because I gave it so little thought and effort) but rather to show some ways that a socionomist might approach the task.

Figure 1

Some Success in Forecasting Near-Term Economic Trends
Figure 1 shows that from 1975 through 1979, the U.S. economy was recession-free. Then it underwent two recessions, which lasted from January through August 1980 and from July 1981 through November 1982, respectively.

Figure 2

The following quotations show how The Elliott Wave Theorist navigated the expansions and the recessions from the publications inception in April 1979 through 1983s developing boom.

November 4, 1979

In the September 9 letter, I reproduced from the Wall Street Journal a chart of durable goods orders, which then stood at $72b., under the title, Is the Recession Over? Here is an updated chart, and as you can see, the a-b-c reaction in mid-1979 has already produced a rebound. A headline on the front page of the Journal on October 31 read, Surprising Surge Third Quarter Profits Topped Expectations. Elliott waves appear to be useful even with fundamental data, as Elliott claimed.

In a normal wave pattern, the current rise would constitute wave B upward, to be followed by a downward wave C. If this pattern occurs, a steeper downturn in the economy might be expected between now and early next year.

January 6, 1980

The chart of weekly earnings shows five upward waves separated by corrections, which follow the rule of alternation (wave two is simple, wave four complex). Close scrutiny shows hints of five wave subdivisions within each broad up wave. The wave appears to channel well, also. This chart suggests that, unless an extension is building, the first quarter of 1980 may show an a-b-c downswing of greater proportion than any of the past three years (see durable goods orders chart in November issue). Does that mean stock prices have to come down? Not if the recession is discounted, and if you haven’t discounted this recession in your own portfolio, you haven’t been reading the papers for the last three years….

Figure 3

February 9, 1980

In the past several issues, I have featured charts of fundamental economic data that seem to display an Elliott pattern. So far, I have included charts of durable goods orders and weekly earnings of factory workers, both of which show five waves upward. Now comes another data series, construction spending, which shows exactly the same pattern. Taken together, the charts of the economy suggest a marked slowing of economic activity some time in 1980, unless of course an extension forms. A slowing may indeed mean a recession by the official definition, but even if it occurs, it will take a lot more than that to frighten the stock market, since whatever slowing we do get has been more than discounted over the last three years.

Figure 4

April 6, 1980

Not once since I began these letters have I said anything about the economy except Forget the Recession. Now, as you can see on the front page table, I fully expect one to occur. The reasoning is simple. The market, for the first time since 1973, is predicting a recession. How deep it will be depends upon the severity of the decline in the market..

Based on the Elliott counts of economic data (see previous letters), a recession now appears to have its best excuse for occurring since the economists began predicting one three years ago. This chart of durable goods orders looks like its right at the top of the b wave of an a-b-c correction following a five-wave advance. The c wave should carry under the 72 level.

Figure 5

June 10, 1980

From the time I began writing these reports to the March 9, 1980 issue, my front-page conclusion regarding the economy was Forget the Recession. Since last November, however, I have been displaying all sorts of charts of fundamental economic data that were counting out complete fives, from the average weekly pay of factory workers to construction spending to durable goods orders to the number of new incorporations. We knew we were close to that recession, but two pieces were missing. The first was the contrary opinion aspect, which finally fell into place when the WSJ headlined: As the Heralded Slump Still Doesn’t Show Up, Firms Disregard Threat Analysts Explain Mistakes, Now See Mild Recession and Still More Inflation. The other indicator which had yet to click in was the stock market, and the performance in March supplied the missing piece. The Elliott conclusion was then clear as crystal: SEVERE RECESSION 1980-1981.

As the two charts below indicate, the economy, which has been weakening ever so slightly, absolutely collapsed in April and May, and may still be collapsing. The leading indicators dropped 4.8% for the month of April, their largest drop since the series began in 1948. That drop compares to a 3% drop in the worst month (September) of the 1974-75 recession. The incredible slide in short term interest rates indicates that the demand for funds is practically zero. The charts of the fundamental data mentioned above are well into their a-b-c declines as well. O.K., score one for Elliott analysis, which not only saw the turn in the economy developing, but recognized the top as well.

Figures 6 & 7

July 6, 1980

The economy has remained on its downward course as per expectations. These charts of retail sales, new incorporations, durable goods orders and construction spending illustrate the Elliott influence since 1977.

Figures 8, 9, 10, & 11

Since the Elliott guideline for a normal bear market is the low of the previous fourth wave of lesser degree (or the second wave of lesser degree when the first wave is extended), we might expect a bottom in the recession quite soon. Normal targets for these economic indicators are as follows:

Retail Sales: $71b.
Construction Spending: $207b.
Durable Goods Orders: $65b.
New incorporations: 42,000.

August 10, 1980

Elliott Wave analysis caught the top in the economy just weeks before the economic indicators tumbled. Last month I displayed four charts of economic data and commented that based on the normal expectation of wave retracement, we might expect a bottom in the recession quite soon. I also gave downside targets for the four fundamental factors. The only follow-up data yet available is for durable goods orders, for which a normal Elliott guideline projected a bottom at $65b. The chart at right shows the latest data, and the slowing down in the rate of descent could indicate a bottom right on target.

Figure 12

September 9, 1980

In the July 6 letter, I put RECESSION ENDING on the front page table and showed charts of four different measures of economic data, with target points for each. As you can see, durable goods orders bottomed at $66b. (target $65b.), while retail sales (target $71b.), construction spending (target $207b.), and new incorporations (target 42,000) appear to have a bit more to go. Based on these charts, we could have a pullback (as part of a W pattern) in some areas of the economy, with retail sales the most vulnerable area.

Figures 13, 14, 15, & 16

October 3, 1980

July was my first letter marked RECESSION ENDING. Along with many other economic indicators, the chart of industrial production shows a July low, as you can see from the accompanying chart.

 

Figure 17

As for the current recovery, I expect that it will peak out in the first quarter of 1981 and show a second dip into the latter half of the year. This projection is based on the Elliott outlook for the stock market and the bond market, as well as an expected tightening of monetary policy after the election no matter who wins.

January 9, 1981

The economy rebounded right on schedule from the Elliott-based forecast, as the accompanying chart of industrial production illustrates. Last month I indicated that I expected a second dip some time during 1981. That second dip should not be a full-fledged recession, but only a month or two of weak statistics. The most important point I can make is that I think the second dip has been entirely discounted during the corrective wave of the past four months, so its not something to worry about from a stock market standpoint.

Figure 18

April 12, 1981

Starting on the front page of the December 14 issue of The Elliott Wave Theorist, I indicated that the economy should undergo a SECOND DIP EARLY 1981. This second dip was not (and still is not) expected to become a new full-fledged recession. These quotes from the WSJs front page summarizes what has occurred since the robust economic rebound that began last July started slowing down.

[NEWS ARTICLE 1]

THE ECONOMY slowed in February on the effects of inflation and high interest rates, and new government figures support economists predictions of sluggish performance this year. Housing starts plunged nearly 25% to an adjusted annual rate of 1,218,000 units, while industrial output fell an adjusted 0.5% after six consecutive gains. Personal income rose an adjusted 0.7%, its smallest gain since June, and the savings rate in January, at 4.4% was the lowest in three decades.

For two years now, Ive had excellent success in calling the turns in the economy, and I don’t mind revealing my secret. But don’t hold your breath; its one thats been known for decades: If you can define what the stock market is doing, then you can anticipate the economy with a precision as yet unmatched by any other method. A Cycle degree decline precedes a severe recession. A Primary degree decline generally precedes a moderate or short recession. An Intermediate degree correction, such as we have undergone since August, should precede a softening in the economy. These forecasts are often possible only with a knowledge of the Wave Principle, since many sideways periods might not be defined as corrective declines under another method of analysis. Furthermore, one must employ a flexible definition of recession, not the economists rigid definition of X number of months of decline in GNP.

August 2, 1981

I don’t comment on the economy very often because it isn’t necessary. In the July 6, 1980 letter the front page comment was RECESSION ENDING. That changed to REBOUND IN PROGRESS until December 1980, when it changed to SECOND DIP EARLY 1981. Following a marked slowdown in economic activity in the first quarter, I changed the heading in the April 12 letter to SECOND DIP OCCURRING. The data for April-May-June are now in and show these results:

[NEWS ARTICLE 2]

THE ECONOMY contracted at an adjusted 1.9% annual rate in the second quarter, and many analysts see continued weakness through the fall. They attributed the decline largely to high interest rates. Price increases in the period slowed to a 6% annual rate, down sharply from the 9.8% pace of the preceding quarter. Durable-goods orders fell 0.8% in June to an adjusted $87.46 billion.

Even though I put very little effort into it, Ive had no trouble forecasting the general trend of the economy in these letters. My methods were explained in the April 12, 1981 letter and can be used by anyone who prefers to avoid digesting reams of statistics in order to reach a conclusion. Since no method of forecasting is perfect, one of these days I’m bound to get a false signal, but I expect that the overall record will continue to be highly successful.

September 8, 1981

As these paragraphs from the WSJ indicate, the economy is still on track with a second dip in progress. The chart of housing starts displays the double dip profile quite clearly. I fully expect to be changing the front page comment on the economy next month from SECOND DIP OCCURRING to SECOND DIP ENDING. [Note: This change was not made.]

[NEWS ARTICLE 3]

CORPORATE PROFITS after taxes fell 11.3% in the second quarter, the Commerce Department said, indicating the economy was weaker than had been thought. Gross national product declined at an adjusted 2.4% annual rate after allowing for inflation. The department has estimated the decline at a 1.9% pace.

* * *

The economy deteriorated in July as production, employment and new orders plummeted, according to a survey of purchasing agents.

Figure 19

January 11, 1982 through October 4, 1982

RECESSION IN PROGRESS.

November 8, 1982

I haven’t said much about the economy lately, being satisfied to leave RECESSION IN PROGRESS on the front page of the letter. Until now, the market had not given an adequate indication that the economy was truly about to turn, so I had no reason to change it. Now its given a powerful signal: the current very deep recession is ending. Economic recovery will begin soon.

The correlation between the stock market and the economy is so consistent that it is by far the finest tool for forecasting the economy, as long as you dont restrict yourself to official definitions of recession. It is extremely instructive to note the precision with which the March-May rally gave an advance indication of the subsequent moderate improvement in some economic indicators. The May-August slide then correctly preceded a mysterious backsliding in the economic figures once again. Ive waited for the stock market to give an unmistakable major turn signal by roaring ahead before placing RECOVERY BEGINNING on the front page of the letter. Now its done it, and the Elliott counts on economic data (see charts) agree. By waiting for the full signals, I haven’t been wrong on the economy since The Elliott Wave Theorist began. Lets see how this one works out.

Figure 20, 21, & 22

March 7, 1983

Even while administration officials were still sending out gloomy messages as recently as January, the economy has been roaring into life. Finally, as this recent report shows, the data can no longer be ignored.

At this point, I feel it warranted to change RECOVERY BEGINNING to ECONOMIC BOOM on the front page table. This is somewhat of a change in my thinking regarding the environment for the 1980s. The monetary environment should be one of stability, but the economy itself, if my outlook for stocks is correct, really should enter a full-blown boom, similar in many ways to the 1920s. The rise in stocks, the drop in the price of oil and overall monetary stability for the first time in ten years should provide the fuel. By the way, if someone (as Time magazine did recently) is still telling you to worry about an imminent banking collapse, you should ask them why bank stocks have just begun to take off on the upside.

 

[NEWS ARTICLE 4]

THE INDEX of leading economic indicators rose 3.6% in January, the largest one-month gain since July 1950. The increase confirms that the recession has ended. But Commerce Secretary Baldrige warned that the index’s strength shouldn’t be perceived as a sign of a coming economic boom. We checked in with the World Bank the other day and discovered some good news: The banks earnings are running several hundred million dollars ahead of last year, thanks in large measure to handsome gains in its bond portfolio. In addition, loan requests from the poor countries that the bank is in business to help have fallen off sharply.

August 9, 1983

On the front page of the March 7 issue, I changed the comment on Economic Conditions from RECOVERY UNDERWAY to ECONOMIC BOOM based entirely on the performance by the single best indicator of economic trends, the stock market. 4 1/2 months later, the news is out. The accompanying comments appeared under the headline, Economy Surges to 2-Year High:

[NEWS ARTICLE 5]

JULY 22, 1983 USA TODAY

The economy’s growth has hit a two-year high, the government said Thursday, setting a stunning 8.7 percent pace that President Reagan called the surest route to more jobs.

Gross national product the total output of goods and services soared by an inflation-adjusted $31.3 billion in the April-June quarter. Consumer spending increased by $23.8 billion.

The surge is much higher than the governments early estimate of 6.6 percent, and higher than virtually all private forecasts.

 

From that point forward, my interests shifted, and I ceased analyzing economic statistics. Unfortunately, my lack of rigor in this area from that time forward eventually led to numerous premature warnings about the depression that was expected to follow wave V. For an explanation of why I was so early in my concerns, please see Section Two of View From the Top of the Grand Supercycle.

Getting It from the Point of View of Macroeconomic Causality
Having studied the typical results of Primary degree corrections (see The Wave Principle of Human Social Behavior, Chapter 16, p. 262), I was able to make this statement on August 4, 1986:

Primary wave 4 will precede an outright recession in economic activity, much as Primary wave 4 in 1926 led to the 1926-1927 recession.

This exposition anticipated what did happen, as the final months of the 1987-1990 (1991) wave 4 produced a recession, as you can see in Figure 2.

 

Figure 23

For the record, I did not recognize wave 4 for what it was, and when the time came to announce a new phase of boom, I instead issued this erroneous commentary from July 26, 1991:

There is a lot of talk about the shape of the recession. Is it a V? Will it be a W? A U? An L? While W and L shapes are proposed as the worst possibilities, they are too optimistic. The Wave Principle suggests more of a crippled M, as in the illustration shown here.

Figure 24

I did gain some equilibrium and occasionally reminded readers that as long as the stock market was rising, the economy would do well, but my continual concerns for an imminent downturn in wave V produced a way-too-bearish near term outlook through most of the 1990s. While the Japanese economy followed the script relentlessly, the U.S. economy sailed through the 1990s unscathed.

Some Success in Forecasting Long-Term Economic Trends
Economic Expansions

Chapter 13 of At the Crest of the Tidal Wave tells this story of forecasting a major upturn in the economy based upon socionomics:

The first three years of the 1980s contained the most months of officially recognized economic contraction since the Great Depression bottomed out in March 1933. On November 8, 1982, right at the end of this period, The Elliott Wave Theorist announced on its front page, RECOVERY BEGINNING, commenting, The stock market has given a powerful signal: the current very deep recession is ending. The January 10, 1983 issue announced RECOVERY UNDERWAY, which was amended to ECONOMIC BOOM on March 7. This forecast was based on one thing: an understanding of the degree of the upturn in the stock market. The start of a bull market of Cycle degree implied a long period of economic expansion. What indeed began the very next month was the longest uninterrupted economic expansion since 1961-1969.

Economic Contraction

The same book, published in 1995, then went on to anticipate the next major signal:

This book is being published at what I believe is a juncture opposite that of mid-1982. At that time, the long term stock market pattern indicated RECOVERY AHEAD, but the actual start of the recovery was not signaled until stocks advanced on powerful upside momentum in August-October of that year. Today, the long term pattern in the stock market emphatically indicates DEPRESSION AHEAD. When will it arrive? The signal will be the same as that of thirteen years ago: a change in the trend of the stock market, this time in the opposite direction. The Elliott Wave Theorist commented on this approach a decade ago, in December 1985:

We should keep the ultimate probability of an economic crash and financial calamity in mind, but it is still too early to prepare for it. Legions of super bears have warned of impending monetary collapse, imminent full-scale banking crises, and so forth for years. Although they continue to warn that such events could occur out of the blue, at any time, and without warning, history shows that a substantial decline in the stock market has always provided an early warning to such conditions. As long as the stock market is trending upward, there is no reason to harbor such fears.

So years ago, the Wave Principle answered concerns about the economy by saying, Not yet, allowing us to prosper from the very start of the expansion. This approach is in direct contrast to those of the two main groups: the perennial doomsayers, who have for decades predicted another depression just around the corner, and the far larger contingent of perennial optimists, who have neither the means nor the desire to identify signs of impending trouble.

As the above quotation indicates, the signal for the Grand Supercycle downturn will be given when the stock market begins falling in earnest. Then you will know that a new label will be added to our front page forecast: DEPRESSION BEGINNING.

Wave V took far longer than I thought it would, so in retrospect, it would have been better to refrain from warning of an upcoming turn toward depression for another few years. Because I was so concerned about the implications of the approaching Grand Supercycle degree downturn, I prematurely anticipated economic contraction, leaving PREPARE FOR DEPRESSION on the front page of my publication for much of the 1990s. I should not have made that mistake, because, as indicated in the final paragraph quoted above, socionomics allows plenty of time for the market to change direction before we are called upon to make a strong case for economic change. Today, I (and you) now know enough about socionomics never to repeat that mistake. Nevertheless, I believe these words of caution will have saved many individuals and businesses from financial ruin as they positioned themselves for an economic contraction of Grand Supercycle degree.

Since stocks turned down in early 2000, and because I am of the opinion that the turn was of Grand Supercycle degree, I continue to forecast depression. The front page label in The Elliott Wave Financial Forecast changed to DEPRESSION UNDERWAY in 2001. In March 2002, I completed a pop book on how to protect yourself against bear markets, economic contraction and deflation entitled, Conquer the Crash You Can Survive and Prosper in a Deflationary Depression. The outcome of this forecast remains to be seen.

Forecasting the Relative Strength of an Economic Expansion
Fifth waves are weaker than third waves, both in terms of their breadth of stock participation and their economic results. This simple truth has immense value in macroeconomic forecasting.

The idea that there is a difference in quality between the macroeconomic trends that manifest from a third wave and those that manifest from a fifth wave has been a part of the Wave Principle for over twenty years. Elliott Wave Principle describes third waves as wonders to behold as they deliver on the promise of rising stocks with increasingly favorable fundamentals. In contrast, the fifth of the fifth [wave] will lack the dynamism that preceded it. This description is useful because contrasting periods of economic performance can confirm or contradict a wave interpretation. However, it can also provide a basis for forecasting the quality of economic trends. For example, by labeling the March 1942 to February 1966 bull market wave III, Frost and I in 1978 established the extramarket vitality of the 1950s and early 1960s as a standard that the forecasted wave V bull market would not surpass. The Elliott Wave Theorist reiterated the expected relationship between the two periods with this description in the August 1983 report (reprinted in the Appendix to Elliott Wave Principle) on the upcoming superbull market:

This fifth wave will be built more on unfounded hopes than on soundly improving fundamentals such as the U.S.experienced in the 1950s and early 1960s. And since this fifth wave, wave V, is a fifth within a larger fifth, wave (V) from 1789, the phenomenon should be magnified by the time the peak is reached.

This is an unusually specific forecast. The very idea of commenting on the relative strength of a projected multi-year recovery is so unusual that no economist has ever attempted anything of the kind. Once you understand that economic trends fit the overall Elliott wave structure, you can understand how I could presume to do it. How has this prediction fared?

Each of the two great post-Depression expansions accompanied a bull market in stocks that lasted a quarter-century, from 1942 to 1966 in the first instance and from 1974 to 2000 in the second. The percentage gain in the DJIA during the latter period was nearly double what it was during the former (1930 percent vs. 971 percent). On that basis alone, one might assume that wave V should have produced a stronger economy than wave III. On the contrary, an objective contrast of the quality of the macroeconomic and fiscal aspects of waves III and V shows that wave V has been a weaker performance in terms of every relevant measure, as shown in Figures 3 and 4. Combining the GDP and Industrial Production figures, we may generalize that the economic power of wave V was two-thirds of that of wave III.

Figure 25 & 26

Figure 27

The forecast included this phrase: The phenomenon should be magnified by the time the peak is reached. In other words, the economic expansion would wane even further as wave 5 of V progressed and further as wave (5) of 5 progressed. True to expectation, the economic expansion slackened further in the latter stages of wave V.

Probably because background conditions in the 1980s and 1990s were so much better than those in the 1970s, conventional observers miss this very important long-term distinction. In contrast, the Wave Principle provides the basis for a profound insight regarding the relative character of the economic environment of the 1980s and 1990s. Whats more, it is available not only as a useful latter-day observation (which even today is utterly lacking in current conventional economic discourse) but as a prediction, published four years into the second quarter-century expansion. (Had you been a practicing socionomist at the time, you could have presented that outlook in 1975 or even earlier.)

Picking Up Where We Left Off
When the stock market turned up in September 2001, my associate Peter Kendall and I anticipated a temporary economic respite within the context of a developing depression. Then, in January 2002, we bucked the mounting euphoria and predicted the end of that respite in an article entitled, The Big Hook: Its Not a Recovery; Its a Developing Depression. We submitted it to Barrons on January 11, 2002 and to The Financial Times ( London ) on January 29, 2002, but it was not published. The article contained this near-term outlook:

Bear-market rallies in the Nikkei have led to brief one-month increases in year-to-year real GDP growth in Japan, to 4.7% or better, in March 1991, March 1997 and March 2000. The San Francisco Chronicle records that during the first such bounce, the entire policy establishment is congratulating itself for being the first regulators in history to deflate an asset bubble without impacting severely on economic activity. Yet after each brief recovery, the market headed for new lows and the economy followed.

If the sentiment behind the rally in U.S. stocks since September has the strength to generate an uptick in some economic indicators in the first quarter of 2002, it will likewise prove to be only a false spring. Any such event, ironically, would coincide with the time when 91% of economists reporting to the January Blue Chip survey say they expect the recession to be over.

The first quarter indeed saw an uptick in some economic indicators, with GDP, according to preliminary reports, growing at a six percent annual rate. As of the second quarter of 2002, economists have celebrated the onset of a new boom, and the consensus outlook is for 2.5 to 6.0 percent growth for the year.

In the August 30, 2002 Elliott Wave Financial Forecast, Mr. Kendall illustrated and updated the graphs we had reviewed for our article (see Figure 5):

These charts of the economic data from the last three years show that the same impulsive form has left its imprint on the fundamentals once again. The big difference is that this time the complete fives are pointing in the opposite direction[, downward, while the counter-trend patterns are on the upside]. These data are particularly relevant now because durable goods orders, consumer sentiment, consumer goods orders and the home building index are set to resume their respective declines. Technically, the corrective patterns can develop into more complicated sideways moves, but with the lagging effect of the stock markets fall through July 24 still in the pipeline, we do not expect it. The economy should enter a more severe contraction in a matter of weeks.

Figure 28

It remains to be seen whether the widely expected long term boom will materialize or whether in fact our anticipated uptick in economic indicators was indeed a false spring.

Some Success in Forecasting Monetary Trends

Socionomics is hardly a perfect tool for forecasting long-term monetary trends, but in its brief history of application, it is already unparalleled in that role. We have records of successful forecasts of inflation, disinflation and deflation.

Inflation

Because I was young and did not publish until 1976, our evidence here is weak but certainly shows some value compared to conventional approaches to market analysis. The first investment I ever made was in gold stocks in 1972. The Wave Principle indicated a bullish gold market. I bought West Rand and Orange Free State Geduld, but only partly for Elliott wave reasons because I was only just learning about the subject. (From 1976 to 1979, I published market-timing gold commentary for Merrill Lynch.) Figure 6-11 in Elliott Wave Principle and the accompanying commentary show that in 1978, despite our bullish outlook for the stock market, Frost and I were open to further gains in gold, particularly given the sizeable expanded flat correction that it traced out from 1974 to 1976. So the Wave Principle was useful in recognizing indications of monetary inflation and staying with the trend or at least accommodating it until very late in the game, as we are about to see.

Disinflation

Elliott wave analysis has proved useful in forecasting a major trend change from accelerating inflation to disinflation (i.e., decelerating inflation). The story, related in At the Crest of the Tidal Wave and briefly in The Wave Principle of Human Social Behavior, is hereby retold.

The spiraling inflation dating from 1967, after weathering two setbacks, finally culminated in January 1980 in an atmosphere of long term financial panic. The month before, in December 1979, The Elliott Wave Theorist spelled out expectations for the major sea change that was at hand. Commodities (now Futures) magazine published some of EWT’s comments in its January 1980 issue. Here is an excerpt:

The incredible conjunction of fives in different markets [gold, silver, interest rates, bonds, and commodities] all seem to point to the same conclusion: The world is about to begin a phase of general disinflation. As I see it, a pattern of several disinflationary years leading to a deflationary trend later on would be a perfect scenario for the Elliott outlook for stocks. A gradual disinflation would create an optimistic mood in the country and lead to the conclusion that we may have finally licked the inflation problem. This sentiment would support a bull market in stocks for several years until the snowballing forces of deflation began to take over. At that point, a major deflationary crash would be impossible to avert, and the Grand Supercycle correction would be underway.

The inflationary trend that had accelerated for a Fibonacci 13 years ended abruptly, as indicated by gold and silver prices, the very next month. Indeed, the above paragraph spelled out, just weeks before the reversal of trend, the experience of the ensuing two decades.

The onset of the new trend was as exciting as the termination of the old one. The 1980 peak was followed by a brief two-year period of extremely rapid disinflation that shocked the markets. From a peak of $850 per ounce in January 1980, gold collapsed to $296.75 (basis London fix) in June 1982. From its long-time resistance area just above 1000, the Dow fell back to 777 in August 1982, reaching its lowest real value since World War II. The bond market was scraping bottom, having been ravaged by both the inflationary period, which stoked fears of ever-rising interest rates, and the recessions of 1980 to 1982, which kindled default worries. The next monetary event appeared to be anyones guess. The most popular competing opinions were (1) that inflation would accelerate into hyperinflation, and (2) that deflation and economic contraction would bring about financial collapse. These opinions were so popular that they were called The Great Debate at financial conferences, which attracted thousands of people.

In contrast to the two prevailing opinions, the September 13, 1982 issue of The Elliott Wave Theorist offered ten points supporting the forecast for the Dow to quintuple to 3885. (For details, see the Appendix to Elliott Wave Principle.) Two of those points pertained to the expected monetary environment:

Fits the idea that the Kondratieff cycle plateau has just begun, [supporting] a period of economic stability and soaring stock prices. Parallel with late 1921.

Celebrates the end of the inflationary era [and] accompanies a stable reflation.

Specifically, then, The Elliott Wave Theorist forecasted a mild reflation relative to the crunch of 1980-1982 that would occur within the longer term trend of disinflation. Monetary stability was the last thing on most peoples forecast list. Yet, the period of stability and reflation began right then. That the Wave Principle could be applied to recognize the onset of such a period was of immense value to investors, particularly in the stock and bond markets, which began historic advances.

Four months later, in January 1983, The Elliott Wave Theorist added to its case as follows: Quietly behind the scenes, despite all the return-of-inflation rhetoric, the utility stocks have scored a major breakout, providing [another] strong foundation for the continuing disinflation argument. That November, EWT further bolstered the case that the slackening in the rate of inflation was not just a brief respite but was of multi-year significance:

Two years ago, I used the percent change in the PPI to show a massive momentum divergence against new highs in the index in 1980. That lower peak in the rate of change was essentially a sell signal on inflation. Since then, the inflation rate has not only declined substantially, but its rate of change has fallen beneath the long term uptrend line from 1949. That break…does seem to support the claim that there has been a change over the last three years that is larger than just a cyclical disinflation due to recession.

In June 1984, as stock prices slipped to an intermediate-term low, The Wall Street Journal published a five-page special report on the financial outlook, which included interviews with many distinguished economists and statesmen. The consensus was overwhelming that the country’s economic and monetary problems were insurmountable and about to get worse. (Page 128 of The Wave Principle of Human Social Behavior provides some details of this report.) Yet the benign disinflationary trend was already underway, supporting the bull markets in stocks and bonds that continued for another decade and a half.

Deflation

As you have read, the forecast for disinflation issued in late 1979 spelled out the expected sequence of events, calling for several disinflationary years leading to a deflationary trend later, which would resolve with a major deflationary crash. In 1995, At the Crest of the Tidal Wave argued that outright deflation was imminent, worldwide. Japan had been experiencing deflation for five years. Countries in Southeast Asia underwent deflationary crashes in 1997 and 1998. Argentina s deflation hit bottom in 2001. Hints of deflationary pressures have continued to build in the United States and Europe , particularly after early 2000. For more on my outlook for deflation, see Conquer the Crash. The outcome of this forecast remains to be seen, but I believe that signs of accelerating, developing or approaching (depending on your locale) deflation are now more legion than ever.

A Basis of Value for Macroeconomic Prediction
There are two ways to look at the performance of conventional economists vs. what socionomists can do. One is to assess how right they both are in terms of a percentage of the time that they make predictions. On that basis, conventional economists do pretty well, being right about whether the economy will expand or contract in the next quarter as much as 70 percent of the time. Their opinions, demonstrably in the aggregate and (based on my observations) in almost every individual case as well, simply lag the actual economy. Thus, after they finally recognize a new trend that has been in force, their extrapolated predictions can be correct for awhile thereafter when the economy trends that way for a long period of time. In terms of time, socionomists would probably do about as well. The second way to assess performance gives a far different result. If one presumes that economists job is to anticipate change, then they are virtually never right. Economists views lag the economy, which lags the stock market. Socionomists anticipate the stock market, which anticipates the economy, so they are often way ahead of coming changes. Even when they fail to anticipate the stock market, they can observe the stock market in real time and forecast economic change quite reliably thereby. Most conventional economists get something close to a zero for performance, a lower score than one would get flipping a coin annually to call economic expansions and contractions. Socionomists, on the other hand, can be trained to read the indicators of approaching or concurrent trend reversal, so they can anticipate change correctly fairly often (although there are as yet no data addressing the rate of success). To be sure, sometimes they anticipate changes that do not occur, and sometimes they miss changes that do. Still, they often do anticipate change, and conventional macroeconomists do not. On this basis, there is no comparison between the two approaches; socionomics wins hands down.■

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The Socionomist is a monthly online magazine designed to help readers see and capitalize on the waves of social mood that contantly occur throughout the world. It is published by the Socionomics Institute, Robert R. Prechter, president; Matt Lampert, editor-in-chief; Alyssa Hayden, editor; Alan Hall and Chuck Thompson, staff writers; Dave Allman and Pete Kendall, editorial direction; Chuck Thompson, production; Ben Hall, proofreader.

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Most economists, historians and sociologists presume that events determine society’s mood. But socionomics hypothesizes the opposite: that social mood regulates the character of social events. The events of history—such as investment booms and busts, political events, macroeconomic trends and even peace and war—are the products of a naturally occurring pattern of social-mood fluctuation. Such events, therefore, are not randomly distributed, as is commonly believed, but are in fact probabilistically predictable. Socionomics also posits that the stock market is the best available meter of a society’s aggregate mood, that news is irrelevant to social mood, and that financial and economic decision-making are fundamentally different in that financial decisions are motivated by the herding impulse while economic choices are guided by supply and demand. For more information about socionomic theory, see (1) the text, The Wave Principle of Human Social Behavior © 1999, by Robert Prechter; (2) the introductory documentary History's Hidden Engine; (3) the video Toward a New Science of Social Prediction, Prechter’s 2004 speech before the London School of Economics in which he presents evidence to support his socionomic hypothesis; and (4) the Socionomics Institute’s website, www.socionomics.net. At no time will the Socionomics Institute make specific recommendations about a course of action for any specific person, and at no time may a reader, caller or viewer be justified in inferring that any such advice is intended.

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Tags Economic Myths Economy Elliott Waves Peter Kendall Robert Prechter Social Behavior Social Mood Stock Market