In developing a market strategy for 2007, it is important to be aware we are currently in what is arguably the longest economic expansion in U.S. history, which began in 1933 with the Great Depression. The significance is that all long U.S. economic cycles have been followed by either a severe recession at best, or a depression at worst. It may be of interest to note that calendar years ending in “7” and “0” have the highest probability of being down years. The Panic of ’07, the top in 1937 and the 1987 crash are examples.
Through the years, the bears have provided a number of reasons for this market to top: debt, deficits, derivatives explosion, overvaluation, war, terrorism, etc. Currently, the reasons have evolved into high energy prices, interest rate hikes, the housing market correction and the debasement of the U.S. dollar. Rather than succumbing to these influences, the market has climbed the proverbial “wall of worry.”
While the rationale for a bearish outlook can certainly be justified on numerous levels, it doesn’t mean the market is finished just yet. One of the most compelling technical expectations is the four-year cycle low. This is a remarkably consistent cycle that is currently due. In fact, the 25- and 75- year cycles are also due in this general time frame as is a 32-year cycle. These cycles contain years that were impressive, if not historic, lows: 1907 (Panic of ’07), 1932, 1942, 1957 (Sputnik), 1974 and 1982. If you are a student of the market, you know these years are major lows. The question is whether the cycle hit with the July 2006 low or if it is still forthcoming.
It is interesting that the dichotomy is so intense with some extreme reasons to be bearish coupled with some decent reasons to be bullish. Both factions may be happy in 2007.
But the second half of a presidential cycle has a strong tendency to be bullish. We have a new Fed Chairman, Ben Bernanke, who studied the Great Depression and would prefer not to preside during the next one. The great dilemma facing Bernanke is that he must support the U.S. dollar, and he also needs to keep the real estate and stock markets from collapsing. Higher interest rates will assist in supporting the dollar — they also will assist in collapsing the stock and real estate markets — hence, the dilemma. As investors, this is the area we must keep in focus as it is critical and is likely to affect everything else.
“It happens every four years,” shows the four-year cycle lows in the past and the downward sloping channel that was broken out of in September. It is clear that the
prior four, four-year cycle lows arrived as projected. This one has not.
The last one to miss its projected low date was due in September 1986. Although the market did have a low at that time, the 1987 crash low is credited as the low of that cycle. This implies that a much more meaningful low is likely in the not too distant future. But even in a 1987 scenario, you can expect a blow off where the market high may be far off.
In the meantime, we have been in an impressive bull market. The proper strategy for such a market is to: Be aware. Maintain a constant awareness that a severe correction can begin at any moment and keep an eye on “the dilemma.”
Have discipline. Place well thought out stop loss orders and adjust them as the market moves higher.
Use trendlines. Trendlines will serve to give you a visual wake up call if you happen to be lax on your discipline.
Historically, the market will usually provide a clue before something really bad happens. There were numerous warnings prior to the top in 2000. That was followed by an 83.5% peak-to-trough correction in the Nasdaq 100. In 1927, you had the Florida real estate bust. Two years later, you had the beginning of the greatest bear market in U.S. history — one that had the Dow Jones Industrials lose 90% of its value. Florida recently had a real estate boom and bust with the bust beginning in 2005. Could history be repeating itself?
Garrett Jones is a partner with Peter Eliades of Stockmarket Cycles Management Inc., the general partner of The Plutus Fund. He is also affiliated with Hillier Capital Management Inc. Jones can be reached at firstname.lastname@example.org.