Robert Prechter : Wave 3 of Bear Stock Market Starting

In an interview with Reuters, Robert Prechter, president of research company Elliott Wave International in Gainesville, Georgia and known for predicting the 1987 stock market crash, said that the next leg of the bear market in stocks has probably begun. Prechter further says that stocks as well as gold and corporate bonds are likely to slide as the U.S. economy suffers long-term weakness.

For investors in stocks this is “the last chance to get out with the Dow in quintuple digits,” Prechter added. Prechter is forecasting a long-term deflationary environment for the US economy which may last until 2014 to 2015. Prechter is a highly regarded financial analyst and is considered a leading authority in the application of Elliott Wave theory.

According to Prechter there is a very good probability that the highs have been seen in the Dow Jones industrial averages and that the rally from the lows from March 2009, even though the rally retraced about 53% of the losses from the all-time high, was merely a rally in a long-term bear market. Prechter compares the advance to one that occurred in 1931 in 1932 that advanced an almost identical 52.9% before the market collapsed to new lows.

Prechter is forecasting that wave three of the bear market has probably started and before the bear market has been completed the March lows of March 2009 will be taken out. Wave three is the wave that travels the furtherest in the shortest amount of time. Many traders will be taken completely off guard as the wave begins and will suffer heavy losses as the wave progresses.

Prechter is forecasting that the likely bear move will be violent and extremely severe. According to Elliott wave theory, as explained by Prechter, the current bear market involves a super bear cycle and will be the most severe for at least the past 200 years. The ensuing wave of deflation will take no prisoners, and will decimate stocks, bonds, commodities, as well as real estate. In fact, the deflation will be so severe that he thinks the only investment that makes sense as an asset class will be cash.

In regard to the US dollar, Prechter forecast that a deflationary period of depression will bring strength to the currency. The reason for this is that in a depression bankruptcies, structured settlements, foreclosures, and debt liquidation, create losses and take dollars out of circulation. For example, if a real estate project worth $100 million goes into foreclosure and eventually sales for $50 million dollars, the difference of $50 million is simply lost.

The money does not appear in anyone else’s account, it has just disappeared into money heaven. The fact that a depression causes dollar destruction means that the remaining dollars have more value. In a depression, cash becomes king. Those who have cash find that their cash becomes more valuable as they can purchase just about everything at lower prices.

While it is far too early to say with certainty that Robert Prechter is once again right with his forecast the price action of the last several days strongly suggest that he must be taken seriously. For the stock market to fall about 555 points on the Dow, only to rally today by 23 lousy points, is extremely bearish price action. Over the past two weeks weakness in the gold market and commodities in general have correlated with renewed strength in the dollar. All of this price action is in line with Prechter’s forecast.

If Robert Prechter is correct about this being wave three in a bear stock market the next few weeks, and indeed all of 2010, will likely be an extremely painful period for stock market bulls. A wave 3 in a bear market typically will have sharp sell-offs followed by weak rallies, each followed by another sharp sell-off, until the wave is eventually completed. The price action of the past four trading days will conform to that pattern if another sharp sell-off takes place.

The price pattern of the next few days will be critical. Any further sharp brutal sell-off would be fair warning that we are in a wave three of a bear market. If Prechter is correct about this being the beginning of a bear super cycle the year 2010 will be one long remembered by stock market traders. Unfortunately, it will only be short sellers that will be able to talk about 2010 with a smile on their faces. Those who are long stocks during such a cycle will probably never want to talk about stocks again.