Most of us are so far removed from the reality of Wall Street that even seeing blips of what it's really like in movies doesn't really register. Few investors remember that while Lehman Brothers was flushed down the toilet in 2008, Goldman Sachs (GS) was barely spared the same swirl, as the government reached in to save it.
Something has been amiss in recent days, because the credit default swaps on Goldman Sachs are seeing huge spikes. These derivative instruments, as creatively explained in the movie The Big Short, are insurance policies on a company (or country, etc.) that allow speculators to bet on the probability of the underlying asset's default. The rising cost of credit default swaps for Goldman implies that some folks have a growing belief that "the smartest guys in the room" are not doing well. Looking at the monthly bar chart of Goldman Sachs (below) is an objective way of gaining perspective on what is possibly ahead for this company's stock -- and why some big money is betting on the risk that Goldman Sach's will get into trouble.
Goldman's storied success ended abruptly in October 2007, when its shares ended their post-IPO rally with a high amplitude reversal. The pattern, highlighted in the pink column at left, is labeled as an ABC decline, according to the rules of Elliott Wave and Fibonacci theories. The entire correction off the $227 all-time peak could have ended at the November 2008 low, near $43, but the rise from that low to the June 2015 peak only manifested itself in corrective fashion (labeled as ABC, as well). That means the pattern off the 2007 high appears to be two-thirds of a "flat" corrective pattern, which now mandates that the pink column at the right be the highest-probability outcome for the next 13 to 21 months. The final portion of an ABC "flat" pattern typically manifests in five larger waves, which, when complete, signal the maturity of the entire corrective sequence from the 2007 peak.
As you can see, the pattern is far from mature, which won't be the case until the stock's price probes the lower right-hand corner of the pink column on the right. That points to an eventual visit to the $40 +/-$10 zone, which you're probably telling yourself, and anyone else who will listen, is impossible. If you are rationalizing that Goldman is "too big to fail," and you're using the one time in history that the government arranged to bail it out as your only data point, you are justified in your conclusion -- but you're not necessarily correct. If you were, the credit default swaps on Goldman Sachs would not be rising at the rate they are, on some days experiencing double-digit percentage increases in price.
If we take emotion and ego attachment out of the equation and apply some objectivity and flexibility, we can analyze chart two below, which is the weekly bar chart of Goldman Sachs. It zooms in on the pattern from the June 2015 peak, which failed to break above the 2007 extreme. From the first chart, pattern recognition tells us that a huge decline is coming, and the lows of 2008 should be broken.
From June's peak, last year, there is a textbook, Elliott five-wave decline, with perfect impulsive character, to the October low. This is labeled as purple 1-circled. Then, there's a textbook corrective pattern, called a zig-zag, which is labeled with purple ABC for 2-circled. The rest of the labeling is also following textbook patterns, and there needs to be only one more up/down sequence for the completion of wave 3-circled. To conclude the purple-circled trend, yet one more up/down is needed, along the arrowed path to conclude the initial, large-degree decline from last June's lower peak -- but not the final decline.
Ralph Elliott taught that the news will arrive to justify the wave forecast. These two charts show what the forecast is, and the rising credit default swaps hint that the smart money might have a bead on the story. The question is whether investors can afford to slide down this slippery slope of hope before the news surfaces. In the first pink column in chart one, it took 11 months, until September 2008, before the crowd threw in the towel. In that month, the stock went from $148 to $78 (47% lower in less than 30 days), and didn't put in its ultimate low for two more months. The ultimate low was an additional 43% below the low of September 2008!
So, if you are in the crowd that is calling every stock a buying opportunity simply because it's down a lot from higher prices, remember that there is no limit to the number of times a stock price can fall by 50%, unless it becomes delisted. At one point in 2008, Lehman fell so far, so fast, that none of its brethren would do business with it, out of fear that it would be out of business before the next day was over.
When considering whether to buy or sell, ask the decision support engine question, "If I had no money in Goldman Sachs right now, would buying or selling actions objectively indicated?" If the answer comes back as sell, and you are long, you should exit. If it comes back as sell and you are flat, you should consider selling short the stock. If it comes back as sell and you're already short, you should hold on to that position or add to it. Conversely, if the answer comes back as buy, and you're already long, hold or add to your long exposure. If the answer is buy and you are flat, consider buying to establish long exposure. And if the answer is buy and you're short, you should exit.
We ran Goldman Sachs through this process and found several conclusions. First, if your holding period is hours to days, hold off doing anything right now, because $132 +/-$8 can't be ruled out. Second, if your trading window ranges from days to weeks, consider buying actions into that support zone, as an oversold bounce is due into late February toward the pink box in the second chart: the $155 +/-$5 zone. If you tend to make investment decision for durations of months to quarters, or even years, the chart at the top warns to use stop-loss orders at $139 to exit this stock and avoid a potential tsunami of selling to the eventual $50 +/-$5 zone.
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