“The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come. Thus, his person is not endangered and his States and all their clans are preserved.”
~Confucius (551 BC - 479 BC)
In the Roman calendar, the term “Ides of March” was used to denote March 15, and the term is still used in a colloquial sense to denote the middle of the month. The term is best known because Julius Caesar was assassinated on the Ides of March in 44 BC, and “the ides” has come to be a metaphor for impending doom.
The market has been climbing the wall of worry as well as it has ever done in its history. Now the market is vulnerable. We are entering a period where you could have a stealth correction of magnitude. Please understand, I am not predicting a 1987-style collapse. What I am saying is that the market is now set up for such an experience. In early August of 1987, I was speaking at a monetary conference in San Francisco that had a number of top advisors, money managers, newsletter writers, economists and politicians as fellow speakers. The “feel” of the market at that time was very similar to what it is today: bullish. Regardless of what news popped up, the market was going higher and nothing was going to stop it. Every speaker at that conference was bullish, with only two exceptions. Richard Russell, the publisher of Dow Theory Letters, and me. We were alone in 1987, but I was in good company. The market topped August 25 of that year and proceeded to have a 40% correction.
On July 17, the Dow Jones Industrials crossed 14,000 for the first time in history. I have brought up the four-year cycle on many occasions and have pointed out that there was a four-year cycle low due in 1986 just as there was in 2006. Most cycle analysts are aware that 1986 didn’t have anything resembling a typical four-year cycle correction. They state that the market correction was postponed until 1987, implying the delay was the reason for the severity of the 1987 correction. The implication is that there wasn’t a typical 15%-or-so correction in 2006 either and, therefore, a 1987 style correction is very likely to occur again.
The Dow Jones Industrials correction in the summer of 2006 was 6.6% high to low. No, it wasn’t a typical four-year cycle correction of 15% to 20%, but it was a correction. In my view, I clearly see the point of the comparison with 1986 and believe it to be valid. That, in itself, does not guarantee a 1987 style correction. If we are going to be concerned with 1987 and 2007 potentially having some similarities, we should begin by looking at them. The following chart provides a side-by-side comparison of the two years. There is little question that there is a strong similarity in their chart patterns. Chart patterns are a visual representation of price action and price action is a picture of investor psychology. In general, one can see that the first year of these advances was modest, the second year was more robust and the third year was parabolic. Parabolic price action is merely a ‘picture’ of what an extreme situation looks like. In this case, it represents an extreme in “irrational exuberance” as the prior Federal Reserve Bank chairman may have said. The 1987 chart shows what can happen when irrational exuberance exceeds the boundaries of logical price action. A good argument can be made that we have exceeded these boundaries again in 2007; as such, this is now a time for great caution. The reward/risk ratio at this time leaves a great deal to be desired.
My Work
Every few months or so, I sit down for a few hours and do my longer-term work. This involves trendlines, cycles, channels, retracements, extensions and a few other things. Without getting too deeply into the work, I continue to do it because it has a remarkable record of providing exceptional turn dates when things set up correctly. What I look for is a confluence of these lines, i.e. a number of lines coming together at one place. I call these points “energy points” because over the decades, that is what they have proven to be.
Currently, I didn’t have one point of confluence – I have two. One is this week in roughly the Thursday, July 19 time frame. The other is on the July 28, which is a Saturday implying the 27th or 30th as a potential turning point. I use these dates to signal a potential turning point zone. I look to see if other things are confirming a potential turn. Are we pressing the top of a channel? Are we setting up a divergence? Are we resting on a major trendline? Have we formed a clean technical pattern? My view is that the market is set to turn right away. With the date this Thursday, I am prepared for the market to reverse any time this week. The latter date could be a secondary top. We’ll see.
The Decennial Pattern
We know that the four-year cycle low may be extended as it was in 1986 leading into the 1987 crash.
There is a 20-year cycle and we note that both 1987 and 2007 end in the digit “7.” There are some interesting decennial patterns that deal with how the market does in years ending in a certain digit, such as “7.” Certain years have very clear tendencies and patterns that would seem to be far more than coincidence. Years ending in “5” for example have an overwhelming tendency, and history, of being bullish. Right now, however, we’re interested in years ending in “7.” It may be of interest to know that years ending in “7,” on average, have had the largest declines of any of the digits. Typically, the first half of the year is OK, and in some years is even fairly strong. The second half, however, is quite a different story, as the following chart will show.
My good friend and partner, Peter Eliades (www.stockmarketcycles.com) put together this chart, which is a compilation of every year ending in “7” since 1897. The picture is compelling. It shows that, on average, the market will top around August 4 and continue its decline into early November.
The Big Picture
The stock market has been remarkably robust from the bottom in June of 2006. My trend-following indicator is still in a buy signal and I believe the market has rallied for the longest time in history without as little as a 10% correction. Money is being made readily available via the Federal Reserve and the “Plunge Protection Team” seems to be alive and well. These are formidable hurdles for a correction, much less a bear market.
A market that has been as strong and relentless as this bull market is likely not to just roll over and die. Granted, it is no challenge whatsoever to name a seemingly never-ending list of negatives for the stock market, the economy and the country in general. However, extreme negatives are heard at market bottoms, not market tops. That’s why ‘climbing a wall of worry’ is bullish for the market – it doesn’t allow the sentiment ever to get positive enough to be a truly negative reading
The Current Picture
Finally, the market is beginning to show signs that the relentless bull market may be ready for a rest. The cracks that are appearing in the market are significant. Consider the following:
On Monday, it was the first time in history that the DJIA made a new all time high with the breadth greater than 2 to 1 on the negative side
The market went to a new all time high with the McClelland Oscillator in negative territory
There has been more down volume than up volume
We are also seeing more new lows than we should if the market is going to advance
The market has also received a Hindenburg Omen signal
For those of you not familiar with the Hindenburg Omen, a Hindenburg Omen signal has five criteria:
That the daily number of NYSE new 52-week highs and the daily number of new 52-week lows must both be greater than 2.2% of total NYSE issues traded that day
That the smaller of these numbers is greater than 79
That the NYSE 10-week moving average is rising
That the McClellan Oscillator is negative on that same day
That new-52 week highs cannot be more than twice the new 52-week lows (however it is fine for new 52-week lows to be more than double new 52-week highs). This condition is absolutely mandatory.
The occurrence of all five criteria on one day is often referred to as an unconfirmed Hindenburg Omen. For a confirmed Hindenburg Omen signal, it takes a second Hindenburg Omen signal to occur during a 36-day period from the first signal. What conclusions can be drawn from such a confirmed signal? Initially, the probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen within the next 41 days after its occurrence is 77%, the probability of a panic sell-off is 41% and the probability of a real big stock market crash is 25%. The occurrence of a confirmed Hindenburg Omen does not necessarily mean that the stock market will go down. On the other hand, there has never been a significant stock market decline in history that was not preceded by a confirmed Hindenburg Omen.
The chart above shows prices pressing against some meaningful trend lines and channel lines. The following chart shows the parabolic nature of the market peak in 2000 and the similarity to the current market action today. It also shows the 1987 low to the 2000 and the 1994 low to the present (both 13 years in duration). I couldn’t help notice that the low in 1974 to the top in 1987 was also 13 years. 13 is a Fibonacci number that seems to have the market’s number with respect to some important low-to-high moves.
The final chart is the S&P 1500. This chart shows the clear breakout above the prior highs in 2000. It also shows a perfectly balanced move in this bull market with the initial price thrust from the March 2003 low, a pause in the middle, and the recent advance matching the initial advance. These advances rose at the identical angle of ascent rallying from a low point on the lower blue channel line to the upper trendline of the brown channel. Oh, by the way, if the market reverses here, both advances will be 13 months long.
Garrett Jones
Garett111@comcast.net
(925) 820-0161
Note: this report represents the views of the author and is intended for educational purposes only. There is risk of loss in all types of trading. Past performance is not indicative of future results
