Bear Market Phasing
By Tim W Wood CPA, August 14, 2009
It seems that everyone is pretty well convinced that we are now operating within the context of a “new bull market.” Rally, yes, but, “new bull market,” I think not. Let me clarify my position on this advance. I told subscribers in my March research letter, before the March low was made, that price was moving into an intermediate-term low and that once this low was made a more meaningful bear market advance should unfold. I specifically stated that this rally would not be something I would be willing to sit on my shorts through and that the advance out of this expected low would be a meaningful trading event. It was then, the week of March 13th, that my intermediate-term Cycle Turn Indicator triggered an intermediate-term buy signal. That signal remained intact until the week of June 19th. It was then the week of July 17th that another intermediate-term buy was given by the intermediate-term Cycle Turn Indicator. The key now is to follow this indicator until it turns back down and then to monitor the developments surrounding that downturn for clues as to whether the advance is finally over, or if we are merely seeing another buying opportunity within the context of this ongoing bear market rally. The point I want to make clear here is that we did foresee this advance, and that as of this writing it is still intact. But when we back up and look at the bigger picture, I maintain that this is a bear market rally.
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 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 2007.
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 26 months 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 pushed higher. In fact, with the advance into 1968 bettering the 1967 secondary high points, a traditional Dow theory trend change even occurred.
But, those who understood Dow theory phasing would have understood that this was a bear market rally separating Phase I from Phase II of a much longer-term bear market and not a new bull market. I can also assure you that the longer this rally lasted the more bullish and more convinced the public became that a new bull market was underway. Also, 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, but that few understood or listened to these warnings. Then, with the Dow theory trend change in 1968 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 phasing prevailed and the decline into the Phase II low carried the market down some 36% to new lows 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 theorists. 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 2007 top was born at the 1974 Phase III bear market bottom.
This brings us to our current chart below. From the 2007 top, the Industrials dropped some 53% over a 17 month period into the bear market Phase I low in March 2009. 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 may be several false breaks, as was seen in 1967 and 1968 before the top is reached. But, just as with the 1966 to 1968 rally, the longer this rally lasts and the more false breaks we see, the more convinced the public will become that this is a “new bull market.”
For now, this rally lives on and identifying its top will be an ongoing process. In the meantime, the point I want to make clear here is that regardless of how long this rally lasts, it still appears to be a bear market rally that should prove to separate Phase I from Phase II of a much, much longer-term secular bear market.
Tim W. Wood
© 2009 Tim Wood