The stock market has been in a bull cycle since the October 2002 low. One of the most reliable cycles of all is the four-year cycle, also known as the presidential cycle. This cycle falls in the middle of a presidential term and gets its name from its close correlation to the economic and political actions of a president in general. Historically, in the first couple years of a presidential term, the president attempts to initiate his policies and in the last two years he pumps money into the economy to make things appear good for the election. The four-year cycle has a history of incredible accuracy, with some very significant bottoms such as 1974, 1982 and the recent bottom in 2002. This cycle is due to bottom in the fourth quarter of this year.
There is another meaningful cycle that should assist in pulling stock market prices down into this period. This was initially pointed out to me by cycle analyst Peter Eliades (www.stockmarketcycles.com). It is the 25-year cycle and has a remarkable history of significant lows. Beginning with the Panic of 1907, and followed 25 years later by the most significant low in U.S. stock market history — the Great Depression low in 1932. This was followed by the low in 1957, a psychological low for the U.S. and the year the Russians launched Sputnik. Next came the low in 1982, which launched the bull market leading to the 2000 top. The next cycle low is due in early 2007 and could easily coincide with the four-year cycle low due in late 2006.
These two cycles are assisted by a number of other indications suggesting a low later in the year (see “Midterm slump”). The cycle patterns at the bottom of the chart show the four year cycle lows. Initially, we have a channel top line that provides resistance. Helping to confirm its validity, we have another top line connecting the tops of early and late 2004 with the tops of the past five months. This produces a rising wedge pattern that has traced out a five-wave (Elliott Wave) advance — which also suggests a decline.
The annual seasonal pattern has the investor buying in October and selling in May; the adage is “Sell in May and go away.” This year that adage is particularly convenient in that the four-year cycle appears to have crested in May and the 25-year cycle crested in 2000. With a double top in the Dow Jones Industrials, with the prior peak in 2000, we would seem to have all the pieces to the puzzle in place. For the anticipated decline to be confirmed, a breaking of the lower blue trend line in the chart would be necessary. Typically, these declines into four-year cycle lows are in the 15% to 20% range. Therefore, it wouldn’t be a surprise to see the Dow Industrials drop to the general vicinity of 9500 or the S&P 500 drop to 1100 or so. If these levels are broken, the respective markets can plunge lower.
The psychology that accompanies a drop into these cycle lows should get decidedly bearish. I have late August through mid September as a time that could be particularly bearish assuming the four-year cycle continues to be consistent. In the event that the cycle maintains its validity, it is a good time for investors to raise cash and move a larger percentage of their investment funds to the sidelines — in other words, don’t fight the trend. In the event there are stocks in a portfolio that cannot be sold for tax or other reasons, it may be a good idea to consider writing calls on such stocks or buying puts to protect the positions. Obviously, aggressive traders would reduce long side exposure dramatically and establish short positions in index funds, index futures, individual stocks or ETFs in weak industries or indexes. This is the time to build up cash positions and work on your buy list for what should be a remarkable buying opportunity sometime in the fall.
Garrett Jones is a partner with Peter Eliades in Stockmarket Cycles Management Inc. He is also affiliated with Hillier Capital Management Inc. Mr. Jones can be reached at garrett111@comcast.net.
