The Dow Report: Focus on the 4-Year Cycle
By Tim W Wood CPA, September 22, 2006
I have heard it said that the June/July lows were the 4-year cycle low and that the market is now moving up in a new 4-year cycle advance. I have also heard it said that the 4-year cycle low will come in October with what has become the expected fall decline. With the most recent rally, this idea seems to be giving way to the idea that the June/July lows were the 4-year cycle lows. Because of the data surrounding the 4-year cycle, I'm personally not in agreement with either point of view. I have said all along that I thought we would see the gain in the first part of this year and the pain in the latter part of the year. What has been happening since the May high has been the setup for the pain that statistically should still lie ahead. As a rule, the analysis in my newsletter is not made available to non-subscribers. But, in regard to the 4-year cycle I have decided to share some of the statistical data surrounding the 4-year cycle.
The bottom line is that the market can do anything it wants and only a fool would say that he knows for sure what is going to happen. My work with the 4-year cycle is based on probability and the cyclical relationship between the 4-year cycle, the 12-month/annual cycle and the 22-week cycle. So, what my work gives us is probability. This is not to say that the market will unfold in accordance to these probabilities every time, because it won't. But, by using probabilities I will at least know what the most likely outcome is and therefore I know what I should expect based on a given setup. Sure, things may unfold differently than the probabilities suggest, but chances are it will unfold pretty much in accordance with the statistical averages.
At this time, my work does not indicate that the June/July lows were the 4-year cycle low or that it will come in October. In late January I laid out a scenario that outlined the most probable path for the market to follow as it moved from that point into the 4-year cycle top and the low that is to follow. This scenario was based on over 100 years of statistical data, as is related to the 4-year and annual cycles. This scenario also looked at the interrelationship and phasing aspects of the annual and 4-year cycles. Since that scenario was introduced to my subscribers back in late January, the market has unfolded pretty much right in line with these statistical-based probabilities in which our expectations for the current 4-year cycle top and the low that is to follow have been based.
If this scenario continues to unfold, then the decline down into this 4-year cycle low has a few surprises in store. One, the probabilities never have been and are still not supportive of a low in October. It seems that the infinite wisdom has come to expect market lows in October. At present, the phasing of the short-term cycles is suggestive of an October low. But, the phasing of the intermediate-term cycles is not set to make a secondary low until November/December. As the phasing of the intermediate-term cycles currently suggests, that will not mark the 4-year cycle low either. The phasing of the intermediate-term cycles tells me that the 4-year cycle low is not ideally due until after the end of 2006. As a result I think that one of the hooks this time around will be that the cyclical phasing has set the stage for two false bottoms with the final 4-year cycle low coming later than most people are expecting. Let me add that expecting the 4-year cycle low later rather than sooner is right on track with my statistical model that was first introduced to subscribers in late January and remains right on track today.
Now, I want to specifically address the talk surrounding the June/July lows as having marked the 4-year cycle low. In the monthly chart of the Industrials below I have plotted one indicator. This is my monthly Trend Indicator. In going back to 1896 I have found that this indicator has turned down below its trigger line at every 4-year cycle low.
The fact that the down turn into the 4-year cycle low is now due along with the fact that this indicator has not turned down below its trigger line is a hint that the 4-year cycle low has not yet occurred. To bet that it has is simply betting against over 100 years of market history and this indicator. Sure, there is a first time for everything, but to bet against these odds in assuming that this time is different is not something I'm comfortable with, as I always try to align myself with the statistical probabilities. Let me also point out one more thing here. The fact that this indicator has not turned down is also telling us that we cannot yet confirm the 4-year cycle top and yes, this does leave the door open for higher prices. But, a 4-year cycle low? I think not.
Next, I have plotted a monthly chart of the Transports below.
Here too, I find that since 1896 there has been a down turn and cross over below the trigger line of the monthly Trend Indictor at every 4-year cycle top. This indicator is just now rolling over, but has not crossed below its trigger line. Therefore, we have yet to see the behavior that has been associated with every 4-year cycle low in the past. As a result, this should only be the beginning of the decline and probability suggests that the low should still lie ahead.
Another important DNA marker, if you will, of 4-year cycle tops is the formation of a quarterly swing high. In the Industrials, all but one 4-year cycle top has occurred in conjunction with the formation of a quarterly swing high. In the Transports all 4-year cycle tops have occurred in conjunction with a quarterly swing high. We now have quarterly swing highs in place on both the Industrials and the Transports, which serves as another piece of long-term evidence that the market is in the process of making an important top and not a bottom. Also, quarterly swing lows always form at 4-year cycle lows. With us now having a swing high in the making rather than a swing low, to argue that we have made the 4-year cycle low is just not sound.
Now I want to share another statistical fact surrounding the 4-year cycle. When going back to 1896 I find that there have been sixteen 4-year cycle tops in which a failed annual cycle advance followed. You can see on the first chart above that the 4-year cycle tops in 1987, 1990, 1994 and 1998 occurred with the very last annual cycle advance up into the 4-year cycle top. The lows of these intermediate-term annual cycles are marked with an "s." In these examples a failed annual cycle advance did not follow the 4-year cycle top. To say this another way, in those years the annual cycle dropped straight down into the 4-year cycle low from the 4-year and seasonal cycle tops. Once the 4-year cycle topped, there was only one leg down into the 4-year cycle low and that leg down occurred in conjunction with a single decline of the annual cycle.
Now, look at the 4-year cycle that topped in 2000. Here we had the annual cycle and 4-year cycle tops in January. From that top the market moved down into an annual cycle low in March 2001. From that low there was an advance up into the May 2001 annual cycle top. The fact that this advance failed to better the 2000 top means that it was a failed annual cycle advance. Then, there was another leg down into the September 2001 annual cycle low. From that low there was another failed annual cycle advance into March 2002 and then the decline into the final low in October 2002. In this case there were two failed annual cycle advances as the market worked lower into the final 4-year cycle low opposed to the straight decline down, in the examples in the paragraph above. I have found that these failed annual cycle advances tend to follow the 4-year cycle tops in true secular bear market environments. Examples of this occurred in the secular bear market between 1899 and 1904, 1909 and 1914, 1930 and 1932, 1937 and 1942, 1966 and 1974. The last time this occurred was in 2000. I want to add here that the average decline from the 4-year cycle top down into the 4-year cycle low is 41.47% when these failed annual cycle advances occur. More specific details on this and how it relates to the current setup are covered in the September issue of Cycle News & Views.
I also want to point out that a failed annual cycle advance, following the 4-year cycle top, is actually the most bearish because it sets the market up for multiple legs down rather than just a single drop. This in turn creates the false bottoms that I spoke of above and it is for this reason that I think many people will perceive false bottoms on the way down into the 4-year cycle low this time around as well. Actually, we are already seeing this in that many are already thinking that the June/July lows marked the 4-year cycle low. If the statistical based scenario that I have been following continues to unfold, then I see a secondary low coming in November with the next intermediate-term cycle low. Then, there should be another advance as that intermediate�term cycle begins to move up. But, that low is currently expected to be another false bottom as another failed advance is expected to follow before the final 4-year cycle low is reached.
Speaking of average declines, I now think that it’s appropriate to bring up another statistic that we have been following and which remains totally applicable. This statistic is related to the current 4-year cycle itself, without taking the annual cycle into account in any way. Yet, this statistic yields similar results as the statistic in the two paragraphs above. For that reason I think it is important to review these numbers. Since 1896 there have been eight failed 4-year cycle advances. When I say failed, I mean 4-year cycles that did not move above their previous 4-year cycle top. Given that the advance out of the 2002 low has yet to better the 2000 high, we now potentially have a ninth failed 4-year cycle advance in the making. The average decline of the previous eight failed 4-year cycles has been 41%. Interestingly enough, this statistic yields the exact same results as the statistic in the two paragraphs above. I think we should perhaps pay attention. When you get multiple targets from two distinctly different angles it’s probably telling you something. If the May high truly marked the 4-year cycle top at 11,670.20, then an average decline of 41% would take the Industrials down to 6,885.30.
Another interesting statistic that I want to throw out is that of the eight 4-year cycles that have failed to move above their previous 4-year cycle high, only three moved below their previous 4-year cycle low once the 4-year cycle turned down. This statistic is a bit more encouraging for the market in that it suggests that there is only a 37.5% chance (3/8) that the decline into the coming 4-year cycle will violate the 2002 4-year cycle low. But, when I dig deeper into these eight failed 4-year cycles I find that the five failed 4-year cycles that held above the previous 4-year cycle low occurred as the market was emerging from bear market lows. The three occurrences in which the previous 4-year cycle low was violated occurred in true secular bear markets. So, if we apply this logic to the current 4-year cycle we find that the coming decline into the 4-year cycle will confirm if the Dow theory phasing is correct in that we are still operating within the context of a secular bear market. If so, the 2002 low should be violated. On the other hand, if we are emerging out of a bear market bottom, then the 2002 low should hold and then we should look for new all time highs with the advance out of the coming 4-year cycle low.
Aside from these statistics that are specific to the setup of the current 4-year cycle, we also know that since 1896 the average decline of ALL 4-year cycles has been 31.52%. The least decline ever into a 4-year cycle low from the intra-day top down into the intra-day low was 12.04% and this occurred with the decline into the 1994 4-year cycle low, which was obviously part of the greatest bull market ever. The second shallowest decline into the 4-year cycle low occurred with the drop into the 1953 4-year cycle low and there the decline was 13.79% on an intra-day basis. I might add that this occurred during the second greatest bull market ever. In the current case, the decline from the May 10th high at 11,670.20 down into the July 18th low at 10,683.30 was a mere 8.46%. Now I have to ask the question, �Is it logical for us to be sitting in the 47th month of a cycle that averages 47 months in duration along with a 4-year cycle advance that has not moved above the previous 4-year cycle top, with my monthly Trend Indicator still positive and with historical statistics for such setups that have seen average declines of 41% that we could have actually made the 4-year cycle low in July with only an 8.46% decline? I think this question answers itself, or at least I hope it does.
I have also been asked if I think the market can hold up into 2007 with a drop straight down into a 4-year cycle low later in 2007. Sure, the market can do anything, but what are the odds? We know that since 1896 the 4-year cycle has averaged 47.04 months and September marks the 47th month of the current cycle. So strictly from a time perspective this cycle is due to be rolling over. Moreover, we know that in true secular bear market environments the 4-year cycle top tends to be followed by a failed annual cycle advance. Therefore, probability tells us that this is what we should see this time around. But, could the market move higher from here? Yes. Could the May highs be exceeded? Yes, and if they were exceeded it would mean that we should then look for a single leg down into the 4-year cycle low. That single leg down would come with the downside piece of the current annual cycle once it rolls over and historically the average decline for such setups has been 24.39%. This would also mean that we are seeing the more bullish setup unfold for the 4-year cycle. Such setups are typical in secular bull markets. As a result, we would then know to expect new market highs with the next 4-year cycle advance.
It is important to understand that this particular work simply looks at the statistics and at present they are telling us that we should be very skeptical of the long side. I don't want to miss a move in the market, but at the same time I certainly don't want to oppose these statistics because that is just completely illogical. If the market does press higher from here, so be it, as I believe any such advance will be limited. Until we get past the coming 4-year cycle low I'm personally just not willing to take the risk of being long, knowing these statistics. Once the Cycle Turn Indicator gives its signal on the intermediate-term basis, my model will be telling me that we have the setup for a high probability turn. Until such time, the topping process continues. If you are afraid of missing something to the upside here, then get long, but please keep these statistics in mind. Personally, I just can’tsee being in front of such risk. Then, once the 4-year cycle low is made and the downside risk has passed, I will gladly get long.
Let me add that once this 4-year cycle tops, regardless of whether it occurs above or below the May high, it will confirm the personality of the longer-term trend and we will know if we are truly in a secular bull or bear market. We will know if we have a setup that has historically averaged 41% or 24%. We will know whether to expect to see the 2002 low violated or for it to hold. We will know whether or not to expect new market highs coming out of this 4-year cycle low, or if we should expect another failed 4-year cycle advance. Yes, a lot will be known as this setup unfolds.
This serves as a sampling of how cycles can be used to form trend quantifications. If you are interested in a statistical and technical based source that also utilizes Dow theory and provides statistical probabilities as to what should occur, then Cycles News & Views may be for you. I also provide web-based updates giving specific short and intermediate-term turn points on the stock market, gold, bonds and the dollar, utilizing my Trend and Cycle turn Indictors. The Trend and Cycle Turn Indicators keep us on track with specific turn points and guides us in regard to our longer-term forecasts. The September issue is now available and in it I give all of the updated statistical probabilities and specific expectations for the stock market for the rest of 2006 and into 2007. A subscription also includes short-term updates three nights a week. Please see www.cyclesman.com.
Tim W. Wood
© 2006 Tim Wood