The Dow Report: Could it be different this time?
By Tim W Wood CPA, November 14, 2003
I decided to take one of the e-mails that I received last week and answer it through this week's commentary. Below is the e-mail as well as my commentary on this topic.
How does Dow Theory factor in the liquidity from 401K payroll deductions? This is almost an involuntary stimulus to the market not seen before. You have never had this much unsophisticated money being supervised by jackals. I can't believe the investment trusts of '29 had a DREAM like the present. If the Fed keeps printing money and workers are given only equities as their retirement bet, couldn't this be a NEW ABERRATION of DOW THEORY?
This is an excellent question that I'm sure many of you have pondered. To me this question goes hand in hand with another question. Could it be different this time? The answer, in my opinion, is both yes and no. Unfortunately, there are no quick answers, so please allow me to elaborate a bit. In order to answer the question, I want to draw from some of my historical market observations. Most of this material I have talked about before so many of you may have seen this. However, this is a good way to apply some of my historical observations to real questions. So let's walk through it.
As I studied the Bull and Bear markets of the late 1800s and early 1900s, it became apparent that the Bull markets Mr. Dow and Mr. Hamilton wrote about were the upward movements of the 4-year cycle. It is also apparent that the Bear markets were the downward movements of the 4-year cycle.
As our country became more and more sophisticated, more people started investing and thus more money poured into the markets and the Bull and Bear periods became longer. This new influx of money into the markets had never been seen before. This was no different than the influx of 401(k) money seen today. It was simply a new influx of money. In any event, it is my belief that it was because of this new influx of money that the Bull and Bear markets evolved into a series of multiple 4-year cycles rather than a single cyclical event. To say this another way, the Bull and Bear markets had grown in duration because of the new money that was coming into the market.
The First Great Bull Market: 1921 - 1929
For example, the first great Bull market that was affected by this ran from 1921 to 1929. This was the first time in American history that a Bull market had lasted this long. This great Bull market had evolved into a period of two 4-year cycles, an unprecedented occurrence at the time. The American economy had entered a new paradigm, a new economic plateau that would last forever. In July 1928 Herbert Hoover said, "The outlook of the world today is for the greatest era of commercial expansion in history." The 1921 to 1929 Bull market advanced a total of 568% from the 1921 low to the 1929 high at 381 on the DJIA. The Bear market that followed concluded as the next 4-year cycle low occurred in 1932. This bear market was 37% of the duration of the preceding bull market.
The Second Great Bull Market 1942 - 1966
The next new paradigm came with our nation's second great Bull market. This time the extension was even greater. The second great Bull market began with the 4-year cycle low in 1942 and ran to the 4-year cycle top in 1966. This time the "Primary" Bull market comprised a series of six 4-year cycles and the market advanced a total of 1,076% from the 1942 low to the 1966 top at 1,001 on the DJIA. Notice how this Bull market doubled the percentage advancement of the preceding Bull market.
The bear market that followed ran from the 1966 high to the 1974 4-year cycle low of 570 on the DJIA. This time around, the bull market had grown to the extent that one 4-year cycle down could not correct the preceding Bull market advance.
No, this time around it took two full 4-year cycles to correct the preceding Bull market. This was also a first in American financial history. In spite of the fact that the Bear market correction required two complete 4-year cycles, the Bear was still true to his nature in that this Bear market's duration was 331/3% of the duration of the preceding Bull market. I attribute the expansion of this Bull and Bear market period to once again, more money coming into the market. However in spite of that fact, the natural market forces prevailed and the Bear did correct the second greatest Bull market advance seen in American financial history.
The Third Great (Greatest) Bull Market 1974 - 2000
Now, let's take a look at our most recent new paradigm. This time the new paradigm began with our nation's third and greatest ever Bull market. From a cyclical perspective, the greatest Bull market of all time began with the 1974 4-year cycle low and ran to the 4-year cycle top in January 2000. This "Primary" Bull market comprised a series of seven 4-year cycles and the market advanced a total of 2,061% from the 1974 low of 570 on the DJIA to the January 2000 high of 11,750 on the DJIA. Notice how once again this Bull market doubled the percentage advancement of the preceding Bull market. Also, notice how the duration was stretched by an additional 4-year cycle. Each of these great Bull market periods has been fueled by more money.
Yes and No, Greg
My point to all of this is that yes, this time is different in that we have seen more money flow into the market than ever before. This has in turn created the greatest Bull market ever. This time will not be different in that we will see the Bear market correct the preceding Bull market. This process began in 2000 and I can assure you that it is not over.
If you observe the brief history lesson above, you should see that the greater the Bull market, the greater the Bear market that follows. So, I would argue that this time will be different in one respect. That being that this bear market will very likely be the longest and nastiest of our nation's history. We are still only in phase one of this great Bear market.
It does not matter that we have 401(k) money pouring into the market this time. It does not matter if the Fed cuts rates or prints more money, or buys back Bonds. It does not matter if the markets are being manipulated. It does not matter if the government's financial statistics are being spun to look good. It does not matter what the "analysts" on TV say. None of this matters.
All this does is prolong the inevitable. The natural forces of the markets are at play and this is all that matters. Historically, the Bear markets of the past run about one third the duration of the preceding Bull market. I can almost assure you that the current Bear market will do the same. This means that we should not look for this Bear market to end until sometime around 2010.
Phase One Bear Market 2000 - 2002
It is my opinion that the more these natural market forces are fought, the worse the decline is going to be. There is simply no way that a bull market advance of 2,061% that took some 26 years to complete was corrected in 3 short years. NO WAY! The decline from 2000 into 2002 was just phase one.
Robert Rhea described the three phases of the bear market, which I have also talked about in the past. More importantly, Rhea went on to state: "Each of theses phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market." Does this sound familiar or what? Rhea also states: "Such secondary movements seldom prove perplexing to those who understand the Dow theory."
It is my belief that what Rhea meant here was that Dow theorists are also market historians and if you can understand and use this market knowledge and history as a guide, you will not be fooled by these bear market rallies.
Phase Two Bear Market?
Phase two is the longest and the ugliest of all. This bear market rally is dying a slow death. There is no doubt about that. However, it will wear itself out and when it does, I believe that we will most likely then move into phase two. Once phase two gets in gear, there will be little doubt that the Bear is alive and well.
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Tim W. Wood
© 2003 Tim Wood