STOCKMARKET CYCLES
Prepared by Peter Eliades
Several times over the past few decades, we have mentioned a 20-year cycle that is scheduled to bottom once again in 2002. The last two resolutions of that cycle have been amazingly consistent. From the very major cycle bottom registered on April 28th, 1942 below 100 on the Dow Jones Industrial Average to the very major cycle bottom registered on June 25th, 1962 was a distance of 7363 calendar days. From that major 1962 bottom on June 25th to the final closing low on August 12th, 1982 was a distance of 7353 calendar days. If that cycle is to repeat itself, there would be an important bottom due between September 29th, 2002 (7353 calendar days from August 12th, 1982) and October 9th, 2002 (7363 calendar days from August 12th, 1982). The repetition of this cycle has obviously not occurred often enough to be statistically significant, but it does give us a reason to be looking for a low. Notice also that no significant decline over the past 36 years ended before the ratio reached a reading of at least 10/1. There have been two periods on the chart where the ratio moved relatively quickly from very low readings below 5% to relatively high readings above 10%, but those two periods required at least a one-year period of time to accommodate such a move. This is one of the major reasons we do not expect to see a long-lasting bottom achieved over the next four-six weeks. There could, of course, be an intermediate-term market low which might last for several months or more, but the potential market bottom over the next month or so.
Source--Investment Company Institute.
© Copyright 2001 Ned Davis Research, Inc. All rights reserved.
Refer to vendor(s) statement at www.ndr.com/vendorinfo/
There are a myriad of reasons we would find it difficult to believe that a market bottom of great significance could be formed in only one month from the current time period, but the chart speaks as eloquently as any of them. The chart is courtesy of the talented chart makers at Ned Davis Research and is constructed from data provided by the Investment Company Institute. The upper box in the chart is a monthly chart of the S&P 500 index. The lower box in the chart is a ratio of stock mutual funds cash divided by their assets. The categories used by Ned Davis Research to compute the cash/assets ratio are the following types of mutual funds: Aggressive Growth, Growth, Growth and Income, Sector, and Income-Equity.
The data on the chart go back to 1966. It is imperative that we call to the attention of anyone who even remotely believes we are seeing the beginnings of a new bull market that the current cash/assets ratio is a minuscule 4.4%. Notice that over the past 36 years there have been only three or four other time periods where the ratio was this mechanics of prior mutual-fund money flows suggest we are a good distance away from a mutual fund cash/assets ratio reading that might support a lasting bottom.
One of the most liberating aspects of writing your own newsletter is that you need answer to no muse but your own. Analysts who work for brokerage firms, as the great majority of analysts do, have little flexibility and no real freedom of expression. It's one of the reasons why CNBC has fallen by the wayside in financial reporting and why the old FNN was so good at what it did. With very few exceptions, the creative and talented analysts in this business work independently with no other authority to answer to. One of the best examples of the independent doughty mavericks in this business is the dean of all newsletter writers, Richard Russell. Although we seldom discuss fundamentals in this newsletter, we often find ourselves nodding heartily in agreement at some of the musings of Dick Russell. We are taking the liberty of quoting at length one of the recent updates issued by Dick on a daily basis at his website. They are simple facts that you would never hear from a brokerage analyst or, for that matter, from anyone whose livelihood depends on a rising stock market.
"Many of the 'new economists' are using relative relationships to demonstrate their thesis that stocks are really not overpriced. The favored device is the so-called Fed method where you match the yield on the 10 year T-note to the projected earnings yield on the S&P. If the projected earnings yield on the S&P is above the yield on the10 year T-note then stocks are on the undervalued side.
"Great--but the only trouble is the little matter of the projected earnings yield for the S&P. Who knows what the earnings yield on the S&P will be? For instance--the profits for the quarter ending in September are now expected to be only 11.4% above that of a year ago. But back in July prior to the rally, analysts' expectations were that S&P earnings would be up
16.6%. Wait, back in April analysts were talking about a 21% increase in earnings in the third quarter. And how about this-going back to January, analysts were talking about a 30% surge in earnings for the S&P.
"The bear market has forced analysts to 'adjust' their projections of S&P earnings to the downside. Of course the analysts
had a ready excuse--'it wasn't my fault, 9/11 did it.'
"So I stick with the time-honored method of determining when stocks are on the 'bear market bottom bargain table.' And it's not a relative method, it's a fixed method based on actual case histories. Following are statistics for the S&P seen at three post-World War Two bear market bottoms-and these were true bear market bottoms.
- 1949--The S&P sold at 5.4 times earnings while yielding (dividends) 7.6%
- 1974--The S&P sold at 7.5 times earnings while yielding 5.1%
- 1980--The S&P sold at 6.8 times earnings while yielding 5.7%
"So you can see that if this bear market ends with values that are anything like the values we've seen at the three most recent bear market bottoms, we've got a long way to go on the downside.
"To refresh your memories, the S&P now sells at 37 times earnings while yielding 1.7%--er, quite a ways from classic bear market bottom valuations."
Exactly how we get from where we are to a market that is historically undervalued is impossible for anyone to say--but we will get there--we will indeed get there. That's what cycles are all about!
In our newsletter dated July 15th, 2002, the front page chart depicted the offset for a nominal four-year cycle projection for the S&P 500 cash index. We will not go into the detailed explanation we gave in that newsletter, but as we explained in that newsletter, prices had already approached or reached their maximum downside projection. We have depicted that offset
chart once again in an updated version. It should be obvious from the chart that prices have exceeded their maximum nominal four year downside projections. If they had done so over just a few days and immediately rallied to never look back, we would have allowed the overshoot of the projections, but that was not the case. Prices remained well below the maximum
downside projection for almost three full weeks and now, six weeks later, have once again exceeded the maximum nominal four year down-side projections. We have never seen this happen in the 25-30 years we have been working with price projections. To us, it means only one thing. There is a longer cycle at work now and it will require a longer half span offset
them the approximate two-year offset we use to generate nominal four year projections. Quite some time ago, we experimented with longer offsets on the Dow Jones Industrial Average to see which ones might give accurate upside and downside projections. We discovered empirically that a 278 week (approximately five years and four months) offset gave excellent projections during the decades of the '70's and '80's. The offset implied there was an approximate 10.66-year cycle (twice the 278-week offset) operating in the market. The other candidate for potentially accurate cycle projections would be a 215-235 week offset to measure an 8.25-9 year cycle. Unfortunately, we will not know which if any of the two new offsets
will be successful in this market cycle. For many reasons, we feel confident the market will ultimately move significantly lower. We would like to have a handle, no matter how tenuous, on how low that move might be. We believe either of the newly theorized group of offsets could provide that answer. As of today, we can tell you that the 215-235 week offsets have all been penetrated to the downside. That penetration gave a very broad range of tentative projections between 308-609 on the S&P 500. We will pursue this topic in more detail as the bear market progresses.
Technical Indicators
There are many fascinating critical technical formations in today's stock market. Let's look at a few of them. The first chart is an arithmetically scaled weekly chart of the NASDAQ Composite going back to 1990. An uptrend line has been drawn from the 1990 through the 1994 lows and that uptrend line remained intact during last year's massacre which ended in September. In July of this year, however, the uptrend line was convincingly penetrated to the downside. Prices remained below the uptrend line for around six weeks at which time a classical technical rebound was seen. Prices rallied back up to the downtrend line that had just been broken and touched it almost exactly before turning down once again. Because that classic
pattern is potentially very bearish and because the close spacing on the weekly chart from 1990 makes it impossible to see clearly, we have enlarged the last 1 + years of market action so you can see it more clearly on the second chart.
In fairness to the bulls and in the interest of presenting the full technical picture, the final chart lends an air of hope for an index which has met with outright catastrophe over the past two and a half years. This chart goes back to 1971 and shows the long-term uptrend line from the 1974 bottom through the 1990 bottom on the NASDAQ Composite. This chart differs from the others because it uses a logarithmic scale which measures percentage moves rather than numerical moves. Your eyes do not deceive you. Prices have come down virtually exactly to the very long-term uptrend line and still remain above it. In the month of September, that trendline is at 1209. A monthly close below that level will destroy an uptrend line that has been in effect for over a quarter of a century. In the meantime, the bulls have at least a glimmer of a technical hope that this long-term
trendline will stem the tide of the NASDAQ massacre which has now seen that Index declined over 76% from the March 2000 high to the July low of this year.
Market Projections
On the daily projection charts, the significantly higher nominal 10-week projections that were given several weeks ago were at least temporarily invalidated this past week. However, the weekly projection charts still show projections to be outstanding. Any sideways to down close next Friday, September 13th, on a week to week basis, would invalidate the upside projections. The most important aspect of the projections is that, because most of the major indexes have surpassed their nominal four-year downside projections, it is quite likely longer nominal cycle projections are now in effect. We discussed this to a limited extent in our section on "The Cycles" and we will discuss it in more detail over the coming months.
Mutual Funds
On August 5th, Rydex switchers bought the Rydex Ursa Fund at 14.04. On August 30th, Fidelity select switchers bought Fidelity Select American Gold at 21.19. Mutual-fund switchers should stay in close touch with the telephone updates. We have two different specific model portfolios--one for Fidelity Select switchers and one for the Rydex group of switchers. How you distribute your own portfolio is up to you as an individual, of course.
September 28, 2002
Peter Eliades
Stockmarket Cycles
P.O. Box 6873, Santa Rosa, California
800-888-4351
www.stockmarketcycles.com
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