Timing, Bear Markets, Hedging
(This was written July 25, 2002, to answer the question, When will this bear market be over?)
The Long Cycles. Timing is absolutely crucial for traders and speculators, and most investors. By any definition, the current stock market is bear. The critical question is when will it be over?
The correct answer must be within a setting of long cycles at work. These are unarguable. But they are rejected by many while accepted by others, and their phases can be irregular and open to differing interpretations. Nevertheless they demonstrably exist and should be considered to give shading and setting for shorter-term timing analyses.
Look at the 36-year cycle below. The red bars mark major tops of some sort, following which the market declines or goes sideways for protracted periods. Prior to the recent delineated peak in 2001, the previous tops were in 1966 and 1929.
(click here to enlarge)
The blue bars delineate bottoms, following which rising prices occur, usually strongly. Bottoms characteristically occur in pairs spread over several years, unlike the topping phase of the cycle which tends to be more singular and well defined.
The next bottom pair does not commence until early 2004 (or possibly late 2003) followed by a second low event in October 2012. The conclusion is that the current market is now in the first phase of its bear development.
Please look at the next chart. Stock prices are at the top. Ignore the blue curve in the middle. Observe that whenever the magenta curve drops beneath the 'low threshold' level (click to enlarge) and turns up, then a substantial period of rising prices takes place, often over several years.
Note that in 1966 upon entering the bear phase of the c36-year cycle it never got below threshold, which may have been suggesting a long-drawn-out trading-range bear rather than the sharp panic, and deep, deep decline which follows phase top in 1929.
Timing Trading Cycles--How to Identify Them. Next look at a more detailed picture of the current market below. The y axis and 'momentum' and 'vernier' scales on this and the previous chart match exactly (though you don't see the numerical values: it's the levels that count, not the numbers). Prices on both are logarithmic with the current set expanded vertically to fill visual space. (click to enlarge)
Note that, as of last Friday (19 July 2002), 'vernier' is below the threshold from which substantial price rallies can and do occur upon the turn up, or, more safely, when a sharply dropping trend line constructed connecting the two most recent descending nodes is broken. In either event, the chart, which I will continue to post, will clearly depict the turn.
But wait. What about the 1929 crash? (Next chart.) Similarly, the initial panic below the threshold resulted in a profitable trading rally. But the residual great volatility which followed the initial crash required special handling for many years (more on this in a later article). (click here to enlarge the chart.)
Unprecedented woes, actual and potential, uniquely new to our era grow and explode without warning. If, despite a positive upturn in the cyclical data, another major western city suffers a surprise lethal attack or a sudden war erupts overnight in a part of the world which affects the West's vital interests, there will undoubtedly be another panic decline similar to the one that struck the market in September 2001.
It is fashionable in the media to talk about limiting stock losses to some arbitrary number, like -7 or -8% or -10%. That may be impossible due to the suddenness and persistence of such a decline. Therefore an alternative loss-protection method may be wisely considered. Put options on the OEX in appropriate dollar amounts to match current long stock positions held could be desirable while applying the proper ratio of dollar coverage by the one to offset potential loss in the other.
In any event, if you were simply following the guidlines in the Summary section at the bottom of the "How to Use This Site" page, you would still be in cash or money-market funds since February 1st when all the portfolio Money Flows dropped below zero--saving yourself losses of 20% to 40% depending on which index best reflected your stock holdings.
(Future additional parts of this article will be published at later dates addressing selling into manias and tops as well as trading during intervals between threshold bottoms. For the current update on the charts above, click here. For a table of long-term results showing profits and losses to date click here.)
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