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Using Psychology to Make Economic Predictions : Commerce: Elliott Wave theorists say cycles of public optimism and pessimism help them forecast market and other trends.

SPECIAL TO THE TIMES

A few predictions for the next century: The tax system will be overhauled, if not abolished altogether. Politicians will be among the most respected members of society. And the United States will enter an era reminiscent of the glory days of England in the 17th Century, complete with castles, grand balls and bejeweled clothing.

And forget cautious speculation about when the Dow Jones industrial average will break 4,000. We’re talking about the stock market breaking through 100,000 by the year 2060.

Those scenarios don’t come from the zodiac or the tabloids but from the Elliott Wave Institute in Laguna Beach, a financial forecasting firm that publishes a weekly newsletter identifying trends and predicting movements in stock markets, international currencies, commodities trading and precious metals.

The firm and its founder, Glenn Neely, base their financial predictions on the once-obscure Elliott Wave Theory. The theory, devised in the 1930s, looks beyond conventional economic indicators. It holds that the ups and downs of the national psyche are key to predicting the fluctuations of the economy.

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While some economists dismiss the theory as a gimmick, Elliott Wave theorists fortify their predictions not only with financial data but with extensive historical and scientific research. They contend that the box office success of the film “The Silence of the Lambs” could be as much a factor in predicting the economy as data on the money supply.

And they have had some success. An Elliott Wave forecaster in Georgia is credited with successfully predicting the stock market crash of 1987.

While they most often try to foretell financial markets, these prognosticators say the economy is so intertwined with other forces that they can also see trends far beyond the business world--even into the next century.

“The more unbelievable it is, the more likely it is going to play out,” said Neely, the 32-year-old founder of the Laguna Beach organization, which teaches Wave theory and conducts over-the-phone classes.

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With help from a world history chart going back to the dawn of civilization, Neely recently came up with a prediction that is most controversial, mainly because it is so optimistic: The Dow Jones industrial average will top 100,000 points by the year 2060 in the biggest bull market of all time.

Where does he get this stuff?

Neely’s work is based on a model created in the 1930s by Ralph N. Elliott, an obscure accountant who lost most of his money in the 1929 stock market crash. Elliott theorized that markets do not react to current events; rather, they follow predictable “waves” linked to human psychology as it alternates between pessimism and optimism.

Over the years, stock traders, analysts and even investment managers have looked to Elliott “technicians” when deciding where and when to invest and what the economy is likely to do. Even some large institutions are taking note.

“The market is really a psychological mechanism,” said Peter Eliades, who has studied cycle and wave theories and publishes the Stockmarket Cycles newsletter in Santa Rosa. Most analysts, Eliades said, “have been trained to think it’s important that interest rates are lowered--the latest headline--when explaining a market action. If that were true, anyone could get up in the morning and read the Wall Street Journal and get ahead of everyone else.”

One of the best known Elliott Wave theorists is Robert Prechter. He has published the Elliott Wave Newsletter from Gainesville, Ga., since 1978. Prechter will not reveal the circulation of his newsletter today. At the height of the bull market in 1987, it had 15,000 subscribers.

Prechter’s views have appeared dozens of times in such publications as the Wall Street Journal, Barron’s and Fortune, which termed him “the champion market forecaster” of the 1980s.

Prechter, a former rock drummer, Yale graduate and Merrill Lynch analyst, noted in 1987 that the market was due for a crash. Several weeks later, it happened.

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Now he is predicting that rough times are ahead, “the biggest bear market since 1932,” mirroring the Depression and possibly lasting until 2003.

“There are still many skeptics,” said Prechter, 43. “But most of them reveal that they really haven’t read much about the Elliott Wave Theory.”

Catching investors’ attention recently have been his statements linking current events, even seemingly trivial trends in pop culture, to the bigger picture.

In June, Prechter pointed to the end of Johnny Carson’s reign on TV’s “Tonight Show” and the end of “The Cosby Show” as evidence of indications that a bear market is ahead.

April’s Los Angeles riots and the choice of “The Silence of the Lambs” as the year’s best movie also signaled a rise of pessimism and a decline in the economy, he said. Indeed, Wall Street has been in a trough ever since.

In his 1989 book “A Turn of the Tidal Wave,” Prechter predicted that George Bush would be defeated this year--by a wide margin. (At that time, the President’s approval rating was high.) And he said that the 1980s heroes, so popular during that decade’s bull market, would fall from favor as Wall Street declined.

“According to DC Comics, Superman is going to die in November,” Prechter said. “Then you have Ronald Reagan, Mike Tyson, all heroes who are being viewed negatively. Even Bryant Gumbel was hit hard in TV Guide last week.”

Not every prediction has come true either. Prechter in 1983 said that the Dow would reach 3,600 in 1988. It has yet to make it that high. And some critics argue that forecasts often can be so broad--such as Neely prediction of a long overdue literary reawakening in the 1990s--that as much evidence can be found to support that it is true as can be used to prove it is false.

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Prechter is more of an Elliott Wave purist than Neely, a former Louisiana roughneck who taught himself the theory in his off-hours. Neely launched the Laguna Beach institute in 1983 and publishes WaveWatch newsletter, which summarizes his predictions. He has appeared on CNN and Financial News Network.

Compared with Prechter, who has a staff of about 50, Neely runs a small operation--only a few employees. Like Prechter, Neely predicted a wild swing in the market before the 1987 crash. And in 1988, he forecast the collapse of communism.

Even so, Neely said he takes a new approach to the Elliott Wave Theory. He maintains that he has come up with a more objective way of determining whether we are at the top of a wave, at the bottom or in between.

Past Elliott Wave theorists, Neely said, have had to use a certain amount of guesswork; he has eliminated some of that, he said, by using physics and logic.

For example, Neely said, his prediction of a skyrocketing stock market starting at the turn of the century is reasonable if you put it in context. Two centuries ago, he said, the Dow would have been about 0.30; by 1987, the index was at 2,700. That was a 899,900% increase in value. A rise to 100,000 by 2060 would be just 3,600%.

“That’s highly plausible in comparison to the historical record,” he said.

Some Elliott Wave technicians are less optimistic. They say the stock market crash of 1987 ended the fifth and last major wave of a “super-cycle” that started in 1932. Prechter, whose forecast for the remainder of the century is gloomy, is leery of predicting what the economy will do beyond that.

Neely argues that the economy is merely pausing for the next decade or so on the verge of the largest wave yet in a super-cycle that will lead to “an international boom of unprecedented proportions.”

Other Wave watchers say Neely’s approach has yet to be tested.

“It’s quite a stretch,” said a technician who asked not to be identified.

But Neely won praise from several stock and commodities magazines as well as market analysts for “Mastering Elliott Wave,” a 1989 textbook based on his new approach.

“It’s a good map and guideline, and it has a tremendous amount of examples,” said Tom Hartle, editor of Technical Analysis of Stocks and Commodities Magazine in Seattle. “It’s not an easy issue to take up and understand. . . . And there’s a lot of different angles (in Elliott Wave), so I’m not surprised a wide amount of opinion has come out of it.”

Because the Wave theory can be applied in such different ways, some people are wondering which approach is correct.

“People have had some success with it,” said Doug Fabian, who publishes Fabian’s Telephone Switch Newsletter in Huntington Beach and uses neither waves nor cycles. “But the funny thing about the Elliott Wave Theory is two people can interpret it differently. Only time passing will tell. It’s sort of nebulous.”

Others are much more skeptical.

“Any time any extreme happens to the market, these theories seem to get attention because there is always someone who said it was going to happen,” said Esmael Adibi, professor of economics and director of the Center for Economic Research at Chapman University in Orange.

“But if you look at any long-term empirical evidence, they don’t stand with well-established economic theories. These guys are trying to say that the market has nothing to do with what the Federal Reserve does, or the money supply. That doesn’t hold weight.”

Chief Executive Chet Needelman at the investment advisory company of Palley-Needelman Asset Management Inc. in Newport Beach said that, while he takes into account mass psychology, what a particular company is doing cannot be discounted.

Wave proponents “are using things akin to Halley’s Comet coming every 86 years,” he said. “They do have some basis in fact, but their degree of prediction we don’t feel is as good as looking at an individual security. You can use any investment method, and the sun will shine on it eventually.”

Another Elliott Wave theorist is Daniel Ascani, who publishes the Global Market Strategist in Gainesville, Ga. He maintains that the economy can be affected by a combination of mass psychology and current events.

“The market merely is a barometer of economic events and psychology,” said Ascani, a UCLA economics graduate. “But I certainly for one second would not leave out mass psychology. How do you explain the 1987 crash when the economy was going so well, or a market that is doing so well in a recession?”

Neely, for his part, defends his rosy picture of the next century. He points to “psychological similarities” with other eras, when wave patterns were much the same, as proof that today’s stagnation is temporary.

He looks at the lingering recession, the collapse of banks and thrifts, national fear and pessimism, even the success of the TV series “Roseanne,” about a family struggling to make ends meet, and sees parallels to the 1930s.

This “correction” will last at least until 1996 and maybe through the end of the decade, he said, but is nonetheless a precursor to prosperity.

“We’re now preparing for the next economic boom,” Neely said. “We’re straightening out the government structure.”

He said there are signs of that already in talk of overhauling the tax system and abolishing government entitlement programs. He cites presidential candidate Bill Clinton’s advertisements, one of which said that welfare “should be a second chance, not a way of life.”

“I saw the ad and said, ‘Oh, my God!’ I can’t believe he said that,” Neely said.

Candidate Ross Perot, in his speeches, mentions 1776, Neely noted. “It is almost like reliving the quest for independence in America, a better kind of government, less taxation.”

He sees today’s return of hot rods and a revival of “psychedelic” clothing--remnants of the 1960s, when there was a similar “correction"--as signs of increased social consciousness, self-analysis and a righting of society’s wrongs.

Internationally, he cites the collapse of communism as further evidence that bureaucracy as it exists today is on its way out. (He goes on to predict that Russia will go on the gold standard.)

Skyrocketing stock prices will not be the only upswing in the new century, Neely said. The nation’s psychological outlook will improve, setting the mood for positive economic and social developments. Among Neely’s long-term predictions:

* The budget deficit will be eliminated, taxes will be much lower or will disappear entirely, and Social Security will be abolished.

* The populace will vote electronically from home.

* Because of international competition from Third World countries, Japan will lose its edge in the electronics industry.

And what will the weather be like? Neely leaves that to others.

“Human behavior is far easier to predict than the weather,” he said. “Just ask any weatherman.”


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