Why this time is different

The pattern presently exhibited in the U.S. equities market is nothing new to investors—it is quite similar to the bearish pattern traced out in 1987, 1997, 1998, and to a much lesser degree, in 1999. Each time the market has bounced back strongly from oversold conditions to post new highs. Why, then, would anyone question whether this time will be different?

What distinguishes the present market environment from previous autumnal downturns is that a plethora of important market cycles are all converging in either the topping phase or the "hard down" phase (which always equates with the last 8-12% of any cycle of any timeframe). What this means, in layman's terms, is that there is no hope of recovery this time. Just as the unified efforts of the Federal Reserve and a consortium of bankers and corporations failed to support the market in October-November 1929, so too will the system fail to contain the wave of selling pressure these converging cycles will create.

Unfortunately, all too many investors have grown sanguine with the notion that "the Fed will bail the market out" if the extraordinary need for intervention should arise. The events of October 1998 are still fresh in the minds of many, and it appeared—at least to the superficial observer—that the Fed did indeed bail the market successfully at that time. Yet a close examination of the market's internal condition at that time will demonstrate conclusively that it was the cycles—not the Fed—that arrested that precipitous decline into October.

For example, a glance at the chart of the Dow Jones Industrial Average will show that the market had found strong support in the 7600-7900 range as early as September, and the Dow proceeded to test the lower portion of that area of support no less than three times before finally reversing its losses in October and making new highs. The Fed took credit for this reversal since the Dow blasted off from its supporting floor the very day that the Fed announced a major interest rate cut. Undoubtedly, the effect of this announcement provided some impetus for the Dow's resulting action, but the market had already long since been under accumulation and would have been bid up anyway, with or without a Fed announcement.

Another consideration in this case is the fact that several important market cycles had already bottomed by October of that year. This bottoming of the predominant cycles (which included the 1-year cycle, the 2-year cycle, the 3 1/3-year Kitchin Cycle, and most importantly—as we shall see—the 10-to-12-year Juglar cycle) assured that there would be no major financial cataclysm at that time. The great stock market crash we had been predicting all year had failed to materialize and I missed calling the turn simply because of our failure to see that the all-important time cycles had turned and were no longer against the market. In retrospect, it is easy to see this.

Why do we give such preeminence to cycles in our analysis of the market? For the simple reason that time is the least common denominator of human existence and is the single most important variable in all temporal affairs. When you have mastered the science of reading cycles in charts—a method which involves combining price and volume—you at once have at your disposal a most powerful and accurate tool for predicting price movements and forecasting important turning points. Cyclical considerations must take precedence over every other consideration when it comes to analyzing the markets.

So why will this time be different than 1998? For this reason: the global market meltdown, and subsequent recovery, of 1998 was a product of the hard down phase (i.e., final 8-12%) of the 10-to-12-year Juglar cycle, a cycle which exerts its influence principally on commodities. While the causes of financial panics are many and varied, extreme weakness in commodity prices has been known to act as a catalyst to stock market crashes in the past. This was most emphatically the case in 1998, for that was the year that commodity prices began a sharp and sustained slide from early in the year into October. The benchmark CRB commodity index briefly penetrated its critical supporting floor in August of that year, just as the stock markets of the world looked as if they would lead a sustained plunge into the great depths of deflationary depression. It was commodity price weakness which led the Asian markets lower in the spring of that year, followed by the U.S., European and South American markets. But the CRB Index chart clearly shows that commodities posted a major bottom in the fall of 1998, coinciding with the bottom in the equities market. Since that time commodities have trended higher, confirming that a major cycle had indeed bottomed in 1998 and a new one was born at that time. This, and not the Fed, was what saved the stock market from oblivion in 1998.

As we have pointed out in previous articles, the final 10 years of K-Wave deflation (which we are presently in) always represents a time of overall reflation for commodities. This is to be expected since the average K-wave deflationary leg is 30 years and commodities have been falling hard for 20 years—it only makes sense that the over-done decline must be arrested and that a period of recovery must set in before the next inflationary leg can begin. For equities, however, it is quite a different story since they typically undergo their worst losses during this same 10-year period. That is because in the initial stages of K-Wave deflation, falling commodity prices act to bolster corporate profits since raw materials costs are lower, along with interest rates. But this phenomenon also stimulates a tremendous buildup of personal, corporate and governmental debt, which must collapse of its own weight in the final third (i.e., 10-years) of K-Wave deflation. We are precisely in that timeframe, and the great U.S. debt bubble will shortly implode.

Our good friend, colleague and market mentor, Samuel J. Kress, cycle expert and editor of the SineScope newsletter (which has the best track record in the U.S. for timing the S&P 500), provides a cross-section of the market's cyclical position that closely coincides with our own. Kress uses a series of harmonically related cycles to measure the short-term, intermediate-term, long-term and very long-term trends. His work, much like ours, is based on the principle of threeness and fourness, and his basic cycle series encompasses a 6-week, an 8-week, a 10-week and a 30-week cycle. Most of these cycles—along with the longer 1-year, 2-year, 3 1/3-year and 6-year cycles, are set to converge—or are beginning to converge—within the next few weeks. He observes that never before in American history have the 60-year K-Wave and the 120-year Master cycle (a harmonic of the K-Wave) converged in their respective hard down stages (last 8-12%). Beginning this fall, they will do so (if they haven't already). That means, according to Kress' supremely accurate cycle work, the week of Oct. 16 should see the terminal top of the major U.S. equity indexes, followed by possibly a reactive bounce in the final week of October. Then begins the bloodbath during the first week of November, a timeframe which will likely commence a historic and cataclysmic decline into February, at which time the first correction of any significance should occur.

The final three months of 2000 will represent a time of major and, for all too many, earth-shattering change. The third week of October, for all intents and purposes, represents the beginning of a massive financial earthquake, an earthquake that will hit with its full force and magnitude in November and will have pulverized the U.S. financial sector by February. After a brief respite—perhaps lasting the better part of 2001—the shock waves will continue devastating the vestiges of the American Economic Miracle into the Year 2004 and beyond. Get ready for the event of a lifetime, coming to a town near you.

Clif Droke

7 October 2000

Clif Droke is editor of the weekly Leading Indicators newsletter, covering the U.S. equities market outlook from a technical perspective as well as the general economic outlook. He is the author of the recently published book, Technical Analysis Simplified. For a free sample issue of Leading Indicators, send name and mailing address to [email protected] or mail to: Leading Indicators, 816 Easely St., #411, Silver Spring, MD 20910.