|The US Commerce Department came out with its report on August 27 reporting that gross domestic product rose at an annual rate of 3.3% for the April–June 2008 period, leaving investors somewhat optimistic. It marked the economy's best performance since the third quarter of 2007, when GDP rose at a 4.8% pace. GDP is considered the best barometer of the economy's well-being and investors are looking for signs that the economy is starting to grow after being pounded by the credit crunch and the housing hassle. However, investors would do better to look in their own backyard for signals as to how the economy is doing, as the stock market is a leading indicator of the economy. So let's look at the stock market to see if this good news about the GDP has a chance moving the stock market higher.|
|FIGURE 1: DJIA, DAILY. This chart shows the Elliott wave count and a bearish flag.|
|Graphic provided by: StockCharts.com.|
|Figure 1 shows the daily closing price chart of the Dow Jones Industrial Average (DJIA). From this chart, note that the DJIA made a bull market top last October and has traded downward, making a new low price in mid-July of this year. Since that time, the market looks to be turning back upward, and the optimism of investors is that the GDP report could be the fuel to continue to propel the stock market higher, but let's take a closer look at the data by analyzing this market using the Elliott wave principles. |
Note that the market made five waves down — waves 1, 2, 3, 4, and 5. These waves form an impulse wave, and impulse waves move in the direction of the main trend of the next larger impulse, which in this case is down. The next larger impulse wave is made up of waves (1), (2), (3), (4), and (5). From the chart we can see that waves (1) and (2) of the next larger impulse wave is now complete. This also means that wave (3) down is now under way, to be followed by corrective wave (4) and a final wave (5) down. Note that wave (3) down is developing in five subwaves with wave 1 down complete and corrective wave 2 either now complete or still unfolding. Once wave 2 is complete, then waves 3, 4, and 5 will unfold to complete wave (3) down.
|From mid-July to the present, the DJIA has been forming corrective wave 2. From a more traditional technical analysis point of view, a bearish flag has been developing. A bearish flag forecasts that the market will continue its downward trend following a breakdown of the flag formation. Wave 2 has now fulfilled the requirements of a market correction and is signaling that the market correction could be over. However, to confirm that wave 2 is complete, we need to see the DJIA break down out of its trading channel, or flag. However, corrective waves can morph into more complex structures and can retrace most of wave 1 down so I would not count the market correction complete until the market breaks below its trading channel.|
|So can the latest GDP figures continue to move the stock market higher? Since the stock market is a leading indicator of the economy, I might suggest that the stock market predicted the better-than-expected GDP numbers in mid-July and rallied higher. In this case, maybe the stock market has already made its move to account for the GDP numbers. But if wave 2 is not yet complete and is going to morph into a more complex corrective pattern, then the GDP numbers will probably get the credit for moving the market higher. However, over the longer term, the current GDP numbers will have no effect on the main trend of the stock market, which is down.|
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