Tuesday, March 31, 2009

Correction Not Over & Thoughts On Cycles

Today's poor close and the afterhours drop in the futures points the way to a continuation of the pullback that started last Friday. Today's action probably was wave b of the correction. If wave c lasts as long as wave a, then we have at least two more days to complete the pullback, which neatly coincides with the (Un)Employment Report on Friday.

One thing that I do when evaluating market action is to view the action in the context of the cycles. I admit that there is so little agreement on stock market cycles, that it is hard for many to take it seriously. However, what I have learned about stock market cycles is that they differ from other natural cycles. For one, the end of a cycle does not have to occur at the absolute price extreme of a movement, and two, cycles do not have a constant periodicity, and lastly cycle periods can measure from top to top, bottom to bottom, bottom to top or top to bottom depending on a number of factors.

In addition, it is useful to know the following fundamental cycle periods (there is little agreement on these among analysts, but my research supports these as the correct ones):

84 year with 42 year, 21 year and 7 year harmonics
45 year with 22.5 year, 11.3 year and 3.75 year harmonics
30 year with 15 year, 7.5 year and 5 year harmonics
20 year with 10 year, 5 year and 20 month harmonics
14 year with 7 year, 3.5 year and 14 month harmonics

As you can see from the above, there is no true 4 year cycle, but rather the 4 year cycle is the result of the interplay between the 3.5 year, 3.75 year and 5 year harmonics of the fundamental cycles. The average of the 3 being 3.92 years.

It is no coincidence that the SP500 bottomed on 10/10/02 and topped on 10/11/07 exactly 5 years plus one day from bottom to top, and we can most likely expect some kind of bottom around October 2012. Similarly, the SP500 topped on 3/24/00 and 10/11/07 which is just over 7.5 years and so we may expect some kind of top (or bottom) around March 2015.

These larger cycles can be mapped out, but it requires a great deal of work and for the intermediate term trader, it is enough to concern oneself with the 20 month cycle and its half-cycle, the 10 month, against the backdrop of the larger cycles.

So, where are we in the big picture? I will make the following statements without proof and leave it to the reader to investigate further:

The 84, 42 and 21 year cycles are due to bottom in 2026+-, and will not coincide with the nominal low in the indexes. The last 84 year cycle low occured in 1942, which was not the nominal low. The 42 year cycle bottomed in 1982 (40 years). The 21 year cycle bottomed in March 2003. The twin peaks of 2000 and 2007 on either side of the March 2003 bottom is the double top of the 42 year cycle. Thus we are in the declining phases of the 84 year cycle and its 42 year and 21 year harmonics, and the greater trend will be down until 2012+- to 2014+- when the nominal lows are expected.

In 2010, we can expect a low in the 7 year cycle, March 2003 plus 7 years, and the "4" year cycle. This low should coincide with the wave 3 or a of C, depending on the count, low of the elliott wave count that plays out.

So where does that leave us at the moment? Currently, there is little doubt that the 10 month cycle bottomed on November 21, 2008 and the next bottom is due in September 2009. The 10 month cycle typically subdivides into 4 movements of 12 to 18 weeks up, 4 to 10 weeks down, 4 to 10 weeks up, and 12 to 18 weeks down. In bear markets the up phases tend to be weaker and shorter, and the down phases stronger and longer. We are now in the 4 to 10 weeks up phase of the 10 month cycle. If that was all we had to go on, we might conclude that the current rally was over and we are at the beginning of a new downtrend.

But we do have other tools that can mesh with the cycles to help give a clearer picture of what lies ahead. One of those tools is elliott wave analysis. Now, here too, there is a great deal of disagreement as to the wave count. But three facts stand out that give the greatest weight to a particular wave count. First, two measures of sentiment hit historic extremes at the March 2009 low: the AAII sentiment poll, and the DSI trader's sentiment poll. Second, the number of stocks making new lows was significantly less in March than in November giving a positive divergence. Third, the major indexes broke out above the upper channel line of waves 2 and 4 of primary wave 1 on March 18, if properly drawn on a logarithmic scale. These facts support the March 9 low as being the end of primary wave 1.

Since this wave lasted over 16 months, a normal second wave retracement should last a few months whatever form it takes. Therefore, we should expect that the current up phase in the 10 month cycle will last at least 10 weeks if not longer with a move in the Dow to around the 10000 level.

The recent positive crossing of the moving averages should be viewed in this context as another supporting piece of evidence that wave A of primary wave 2 is underway and far from complete.

Of course, all of the above conclusions could turn out to be completely wrong, which is why prudent speculators don't bet their whole account on such analysis, but rather they spread the risk over multiple markets and trades, enter trades in steps, use price levels and pivots to confirm entries, and use appropriate stops and risk management. Prudent speculators enter every trade with confidence knowing all the while they could be dead wrong.

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