The Dow Report: Bear Market Phasing
By Tim W Wood CPA, June 17, 2005
According to Dow theory, each bull and bear market period has three separate phases. This phasing is an important aspect of the Dow theory that is most often overlooked. I have spoken many times in the past about this phasing and today I want to address this topic again. I will show you the three phases of the 1966 to 1974 bear market, as well as the rallies that separate each of these phases.
In 1942 the second great bull market was born and concluded in 1966. I call this period a great bull market because in the early days of the averages, these Dow theory bull and bear market periods consisted of single 4-year cycles--the bull market being the upside piece of the cycle and the bear market the downside piece of the cycle. This changed in 1921 with the birth of the first great bull market that consisted of two consecutive 4-year cycles that ended in 1929. The second great bull market, again, ran between 1942 and 1966. The third great bull market ran between 1974 and 2000.
But, it is not the bull market that I want to focus on here. No, it is the bear markets that always follow, and I specifically want to compare the three phases of the 1966 to 1974 great bear market to today's ongoing secular bear market.
Phase I of the second great bear market began at the top in February 1966. This top was confirmed under Dow theory in May 1966. From this top the market declined into the Phase I low in October 1966. This Phase I decline is marked in blue on the chart above and it carried the market down some 25%. From this Phase I low, the typical rally that serves to separate Phase I from Phase II began. This rally carried the market up some 32% from its lows over a 26 month period and is marked in green on the chart above. During this 26 month advance you can see that there were a couple of false breakdowns that the market was able to recover from and inevitably push higher.
Now, I was only a kid at the time and had never even heard of the Dow theory. But, the Dow theory has not changed, nor has human nature. I can assure you the Dow theorists of that day understood that this advance was the rally separating Phase I from Phase II. Yes, I can also assure you that this rally likely lasted much longer than they expected, as well. Then, when the market would recover from these false breaks, I strongly suspect that the bullish sentiment must have been off the chart. I'm also sure that the Dow theorist's continued to warn, and the longer the market held up, the more bullish the general public became in spite of these warnings. After the recovery from the second false break I'm sure that the public was convinced that a new bull market was underway. They probably proclaimed that anyone stating anything other than this "obvious" bull market needed to be admitted for a psychiatric evaluation. After all, this was "obvious" and anyone not seeing it was obviously blind.
However, in spite of the false breaks, the bullish sentiment, false recoveries and claims of new bull markets, the Dow theory prevailed and the decline into the Phase II low carried the market down some 36% over a 17 month period. This Phase II decline is marked in yellow on the chart above.
Then came the rally separating Phase II from Phase III of this ongoing secular bull market. This rally carried the market up 66% over a 32 month period. This advance is also marked in green on the chart above. Once again, the world was convinced that the bear market was over. After all, the market had made a new high. How in the world could we still be in a bear market with the market at new highs? Those Dow theorist's had to be wrong this time around because this time was different and it was "obvious" with the market at a new all time high.
But, once again, the Dow theory phasing prevailed and Phase III took the market down 45% into the final Phase III low. This low marked the bottom of the second great bear market. This time, those who understood the Dow theory were shouting from the roof tops to buy. History tells us that the public was so beaten down by the time the Phase III low had occurred that once again they did not listen to the Dow theorist's. Bearish sentiment was sky high and anyone pushing stocks at this point again needed mental counseling. Who in their right mind would buy stocks after suffering through these declines? However, the Dow theory phasing was proven correct and the third great bull market that ran until the 2000 top was born at the 1974 Phase III bear market bottom.
This brings us to our current chart below. From the 2000 top, the market dropped some 38% over a 33 month period into the bear market Phase I low in October 2002. This decline is marked in blue on the chart below. From that low the typical rally separating Phase I from Phase II began. Yes, there have been several false breaks in which it appeared that the decline into Phase II was underway. But, just as with the 1966 to 1968 rally, this rally has taken longer than expected. Just as with the 1966 to 1968 rally, the bullish sentiment is off the chart. Just as with the 1966 to 1968 rally, the public is convinced that a new bull market is underway. Just as with the 1966 to 1968 rally, the Dow theorists must obviously be wrong. After all, they have been crying wolf and nothing has happened.
The problem with this rally, which will separate Phase I from Phase II, is that it has given us a couple of false breaks and then recovered. And yes, it has gone on much longer than expected. But, none of this changes what it is. A leopard is a leopard regardless of the number of spots he has and the rally separating Phase I from Phase II is still a bear market rally. The result of which will conclude the same regardless of what public sentiment is, or what the Fed says or does. The Dow theory will once again prevail. Please, don't make the mistake of not listening to the warnings that the Dow theory is so clearly giving.
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Tim W. Wood
© 2005 Tim Wood