"Sign of The Bear" Flashing Red

During the last few years, unyielding bears have squandered much of their credibility vainly trying to explain why the finale of the most spectacular bull market in U.S. history was supposedly just around the corner.

Now comes yet another sign that the good times might end, but skeptics should pay heed, since this indicator has never been wrong. It is called "The Sign of the Bear," and in each of the six instances that it has flashed red since 1929, the Dow Jones Industrial Average has subsequently declined an average 41.6%.

The statistical basis for The Sign of the Bear was discovered in 1992 by Peter Eliades, a Santa Rosa-based forecaster who was ranked by Hulbert's Financial Digest as the top market timer in America for the period January 1985 through August 1990.

His bear market indicator is designed to identify exceptional and prolonged instances of "churning," when broad share averages can trade up a storm for periods of weeks without going anywhere. This they have done recently to a rare extreme, leading Eliades to conclude that investors will be bucking powerful headwinds in the years ahead.

"We believe the next five to ten years will be as difficult a market atmosphere for stock investing as has been seen in the history of our country," he warned recently in his newsletter, Stockmarket Cycles.

Eliades was last featured in this column in March, 1998, when the Dow Industrial Average hit 10,000 for the first time. Hi prediction back then that the bull market would be stopped cold by "five-digit phobia" was demolished on short order when the blue chip bellwether shredded its way to 11,000 just six weeks later, enroute to an all-time high of 11750 recorded in January.

Eliades was understandably humbled when the market rocketed past the 10,000 barrier, but he has remained steadfastly bearish ever since -- a fact that may explain why his once-frequent guest appearances on the financial talks shows have tapered off.

However, while bearish instincts may have dimmed his celebrity, Eliades' short-term forecasts have remained impressive, and among his peers he is still one of the most respected market technicians in the business.

And not without good reason, for he was not only America's top timer for the five years up to 1990; his mutual fund portfolio led the pack by a wide margin in the ten-year period ended June 1996, according to rankings published by the American Association of Individual Investors.

With The Sign of the Bear now in force, Eliades cautions that the odds have tipped ominously against shareholders. Here is how the Dow Industrial Average fared following each of the six signals generated during the last 70 years:

1929: -89%
1961: -29%
1966: -26.5%
1968: -36.9%
1972: -46.5%
1998: -21.0%

With the arguable exception of April 1998, every signal has preceded what most investors would refer to as a "bear market." And even if the 1998 bear was relatively mild, the presence of two signals within the last 29 months can hardly be comforting.

The calculations underlying The Sign of the Bear are fairly simple. Using market breadth data for the New York Stoc Exchange, one need only look for intervals of 21 to 27 days during which advances and declines stayed fairly even, implying unusually low volatility. Specifically, the ratio of advances over declines must fall between 1.95 and 0.65 for the entire period. Finally, the streak must end with a reading below 0.65 and a two- or three-day average immediately thereafter of less than 0.75.

Eliades first back-tested these parameters in November 1992 after noticing an unusually long string of relatively dull days. The results, he says, were stunning. "Amazingly, each [qualifying period] came no more than 27 trading days before each of the three most important tops of the past four decades: February 1966, December 1968, and January 1973."

What precautions can investors take now? For starters, they should decide exactly how much pain they are willing to abide if the market should turn sharply lower. While a decline of 10 to 15 percent should not alarm true long-term investors, they must always be on their guard against the 40-80 percent declines that tend to occur every few generations, says Eliades.

A stop-loss can ensure that one exits safely ahead of the Big One. "Decide now where you would sell a stock or mutual fund and still not be badly hurt," advises Eliades. "This should usually be about 12 to 15 percent below current levels or recent portfolio highs."

Stick to your plan, he admonishes, and monitor your portfolio closely so that you can raise your bail-out price as the market advances. "The risk is that you might sell out at lows just before stocks go up again," he says, "but the insurance is well worth it, since you will be protected against catastrophic declines."

Eliades says he is bearish on the stock market and the economy for reasons that go beyond The Sign of The Bear. "I personally believe we are slated for one of the worst bear markets in history," he says, and it will be accompanied by "some very negative surprises" in the economy.

Eliades avers that economic forecasting lies beyond his expertise, but he nonetheless sees disquieting signs that point toward recession. "The retail stocks have been warning of that for quite a while, and I would expect that we will be in an official recession within a year, and perhaps well within a year."

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