Cycles: Where's the Stock Market's 4-Year Cycle?

Investment Conclusion

Evidence is strong but inconclusive that the 4-year stock market cycle bottomed in July. If it has bottomed, then stocks can rally for most of next year. If it has not bottomed, then the window of opportunity for the cycle low will quickly close during the next few weeks. Following this cycle low, stocks should embark on a very strong rally for the remainder of this year and most of 2003.

Investment Review And Analysis

Our May cycles report concluded that the phasing of the 40-, 20- and 10-week cycles pointed to weakness and a bottom in mid-July. A rally off that low would be short-lived as we hypothesized that the 4-year cycle would not bottom until September or October.

In early July we followed up with a report stating the 40-, 20- and 10-week cycles had bottomed and that a strong rally would unfold into Labor Day. This proved to be a couple weeks early as another bout of heavy selling carried the market to new bear market lows. But, from the July 24th low a strong rally did indeed unfold to the August 22nd high.

The purpose of this review is not to pat ourselves on the back for being right, or chastise ourselves for being wrong, but to set up the analysis for where we think the market is now and more importantly where it is going.

Our primary thought is that because the selling in July got more out of control than we anticipated it could mean a cycle larger than the 40-, 20- and 10-week cycles bottomed, namely the 4-year cycle. Remember from the May report the 4-year cycle low was due to bottom sometime in the 3rd or 4th quarter. The assumption of a 4th-quarter low was made when we considered the market's historical tendency for autumn bottoms.

What is the evidence that the 4-year cycle bottomed?

With the July low, the volatility index rose above 50, which historically has marked important bottoms.

Investor sentiment finally turned bearish. Investor's Intelligence survey of market letter writers showed more bears than bulls for 4 of the past 6 weeks leading up to and following the July low. The last time there was this many weeks of more bears than bulls was in September/October 1998 when the 4-year cycle last bottomed. Even the September 2001 low only generated 2 weeks of more bears than bulls.

The market has now had time to discount multiple doses of bad news--corporate malfeasance, disappointing earnings, a tenuous economic recovery, potential war in Iraq, and suicide bombings in the Middle East. All of these fears still exist.

Lots of "heroes" out there are now comfortably stating that stocks are very overvalued, so the market can't rally. We certainly agree that they remain historically overvalued, (See Futures magazine article November 2001) but this is not news. Where were these concerns during the past several years (arguably since 1995) when stocks were overvalued? When used as a market-timing tool, stock valuations have a poor record.

We prefer cycles. The 40-, 20- and 10-week cycles are already phasing higher, leaving the market positioned for a rally over the next several weeks. Specifically, the next 40-week cycle bottom is due the week of April 28, 2003 and the 20- and 10-week cycles the week of December 2nd. Was the low seen in the week of July 22nd in fact the 4-year cycle bottom? This question still is open to debate. If that was the 4-year cycle bottom, a multi-month rally is possible, with the next 40-, 20-, and 10-week cycle bottoms serving as smaller corrections of a larger up trend.

A retest of the July low occurred along with bottoming of the 10-week cycle (the week of September 23rd). The strong rally on October 1 could be confirming that a low is in place and could set the stage for several more weeks of gains during which we look for at minimum a return to the August S&P high of 965.

This analysis is applicable to all the equity indices, but the bullish potential of the NASDAQ stands above the rest. The NASDAQ is/has potentially completed a 5-wave decline (on weekly chart) from the March 2000 high at 5135. Wave 1 was the decline to 3042.6 on 22 May 2000, wave 2 and ABC correction to the 4059.8 high on 28 August 2000, wave 3 the crash to 1619.5 on 2 April 2001, wave 4 an expanded triangle to 1946.2 on 11 March 2002 with the ensuing decline being wave 5. Within wave 5, 4 waves have formed with the decline from 1426.7 high on 22 August 2002 being the fifth wave of wave 5. Accordingly, an important low is or is nearly in place. Short-term, until resistance at 1251 is exceeded, risk is for a decline towards 1075/50, which is both a channel projection and a Fibonacci objective within the wave 5 from the 11 March 2002 high. If this analysis is correct, then following this low, the NASDAQ could embark on a large rally. An easy objective is the 38% retracement and prior 4th wave in the 1946.2/2052 area. From current levels or 1075/50, this is a huge gain. With the 4-year cycle turning up, most of these gains are expected to occur later this year and during 2003.