An Analysis of the Sixth (and Last) Cyclical Bull Market Within the 1929 to 1949 Secular Bear Market
(Guest Commentary by David Korn – July 8, 2007)
Dear Subscribers and Readers,
Before I introduce our guest commentator, David Korn, I want to take some time out and update our readers on the Yen carry trade (a more comprehensive update of the world's financial markets will take place in our mid week commentary this Thursday morning). As I am writing this paragraph, the Euro-Yen cross rate just hit another all-time record high of 168.37, and is now 7.01% above its 200-day moving average. Not only is this hugely overbought on an intermediate term basis, but based on this measurement, the Euro-Yen Cross rate is now at its most overbought level since July 1, 2003 (the Euro Yen cross rate would ultimately decline 4.5% over the next two weeks).
More importantly, given that 1) the surge of foreign investments from Japanese retail investors should dissipate early this week, and 2) commercials are now seriously long the Yen, as shown by the following table courtesy of Softwarenorth.net, there is a good chance that the Yen will experience a significant bounce over the next couple of weeks – not only against the Euro but against virtually all major currencies in the world as well:
Given that the Yen carry trade has been a major supplier of liquidity to many parts of the world over the last few years, I am expecting the market to start its correction over the next couple of weeks.
Moreover, the “correction” argument gets even more compelling when one considers that the Barnes Index not only closed at a level of over 70 last Friday, but actually topped that by a significant margin by closing at 73.60. As discussed in our commentaries over the last few weeks, we will consider initiating a 50% short position in our DJIA Timing System if the right opportunity presents itself – and with the Barnes Index closing at 73.60 last Friday, the probability of us initiating that short position has gotten higher. Should the stock market rise further in the coming days on relatively weak breadth, then don't be surprised if you see a (real-time) email alerting that we have gone short.
Now, onto David's guest commentary! David's newsletter is focused on personal finance, stock market timing, and independent stock market analysis. He also provides a summary and interpretation of the radio show Moneytalk, hosted by Bob Brinker; his newsletter has been published for nearly five years and has a very good investment track record, especially over the last few years. David is also co-author of “The Retirement Advisor” – along with Kirk Lindstrom and myself. This is his fifth commentary for MarketThoughts.com. His very first guest commentary, "The Six-Month Market Timing Strategy" was published on May 8, 2005. His last guest commentary, published on March 18, 2007, was a discussion revolving around the fifth cyclical bull market within the 1929 to 1949 secular bear market. In a way, this following commentary from David is a continuation of his last guest commentary for us.
David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2007
Web site: http://www.BeginInvesting.com
July 7-8, 2007 Newsletter
QUOTE OF THE WEEK
"When you arrive at a fork in the road, take it."
- Yogi Berra
MARKET NUMBERS AS OF FRIDAY, JULY 6, 2007
S&P 500: 1,530.44
10-Yr. Bond: 5.195%
DAVID KORN'S NEWSLETTER EQUITY INVESTMENT PORTFOLIO
This portfolio is based on an asset allocation consistently entirely of equities (when fully invested). It does not include fixed income (i.e. bonds) which would be more appropriate for some investors -- especially those approaching or in retirement.
25% Vipers (Ticker: VTI) Cost Basis: $108.24 (Current Price: $152.52)
25% S&P 500 Index Depository Receipts (Ticker: SPY) Cost Basis: $101.33 (Current Price: $152.98)
10% Spiders Select Technology (Ticker: XLK) Cost Basis $19.44 (Current Price: $26.15)
4% Semiconductor Holders (Ticker: SMH) Cost Basis $36.94 (Current Price: $39.23)
2% Plantronics (NYSE: PLT) Cost Basis: $23.95 (Current Price: $26.60)
2% Time Warner Inc. (NYSE: TWX) Cost Basis: $17.80 (Current Price: $21.02)
5% iShares MSCI Japan Index Fund (Ticker: EWJ) Cost Basis $9.80 (Current Price: $14.63)
4% Sanofi-Aventis (Ticker: SNY) Cost Basis: $39.04 (Current Price: $41.84)
2% Microsoft (Ticker: MSFT) Cost Basis: $27.05 (Current Price: $29.27)
21% Cash Held in Vanguard Prime Money Market Fund (Ticker: VMMXX) (7-Day Yield is 5.13%)
DAVID KORN'S WEEKLY STOCK MARKET COMMENTARY: The U.S. market shrugged off the attempted terrorist attacks in London and put in a decent showing this week. By week's end, the Dow gained 1.5%, the S&P 500 gained 1.8% and the Nasdaq gained 2.4%.
The Nasdaq continues its run of outperforming the other major indices. By the close Friday, the Nasdaq was at its highest level in six years. The strength in technology shares is benefitting several of the holdings in my newsletter portfolio, including the Spiders Select Technology exchange traded fund, the Semiconductor Holders and Plantronics. A rising tide lifts all ships as they say and with the stock market only about 1% from its all time highs, everything looks to be in the black.
Next week we kick off the second quarter earnings season when Dow component Alcoa reports after the close of trading Monday. The Wall Street consensus is that S&P 500 earnings grew 4.3% from April through June according to Thompson Financial. That would be a significant slowdown from the 8% that earnings grew in the first quarter and the double-digit growth 14 consecutive quarters before that. However, analysts were pretty pessimistic about first quarter earnings and they underestimated earnings growth by a significant amount. I think earnings are likely to be around 7%. I base that number on Mike Thompson's view. He is managing director of global research at Thomson Financial. It bears noting that over 45% of S&P 500 company revenues is generated from outside the U.S. and corporate profits are expected to grow at 10.3% outside the U.S. versus 7.3% domestically. I will update the valuation of the U.S. market as earnings season progresses. In the meantime, here is a link to the U.S. earnings calendar:
CBOE Put/Call Ratio: The put/call ratio closed Friday at 0.88. The 10-day moving average is 0.95 and the 21-day moving average is 0.99. Continued fear showing up in the options market as it has throughout most of this bull market.
Investors Intelligence: The number of bullish advisors as measured by Investors Intelligence now stands at 49.4%. The number of bearish advisors now stands at 18.0%. Using the formula [(bulls)/(bulls + bears)], the sentiment ratio comes in at 73.29%. This 4-week moving average moved is 73.12%. The four-week moving average and the weekly data have been running in tandem lately. This indicator is toward the bullish side and in the red zone.
AAII: According to the latest poll conducted by the American Association of Individual Investors, 43.8% of individual investors are bullish and 32.9% are bearish this week. Using the formula [(bulls)/(bulls + bears)], the sentiment ratio is 57.10%. There were more bulls among individual investors this week, but still much more bears compared to the pros.
Money Flow: According to AMG Data, in the week ending July 3, 2007 equity funds (including ETF activity) reported net cash inflows of $5.8 billion with Domestic funds reporting net inflows of -$5.1 billion and non-domestic funds reporting net inflows of $680 million. That is good to see. Usually, its the other way around.
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HISTORICAL CYCLICAL BULL MARKET ANALYSIS
Long term subscribers of mine have seen my analysis of all the cyclical bull markets that occurred during the 1966-1982 secular bear market. (If you are a new subscriber and would like a copy, just let me know). I have turned my attention to analyzing the cyclical bull markets that occurred during the 1929-1949 secular bear market. I have completed the first five cyclical bull markets, and today we take on the last one which is the SIXTH bull market in a 20 year time frame, with alternating bear markets in between. I am also going to include the seventh cyclical bear market in this newsletter to conclude this secular bull market period.
There are two important insights that you can gain from studying the behavior of the stock market's history. Although they are obvious in hindsight, when we live in the present we often disregard the past. Today, we are in a bull market that has gone on for an extremely long time by historical standards. Moreover, this bull market's corrections (i.e. the declines) have generally been contained. During the current bull market, one of the factors that helped keep me invested during the declines was the knowledge that the corrections all fell within the parameters of normal retractions that the market faces. That doesn't mean that a tiny correction won't turn into a bear market. Nor is history something that you should rely on exclusively. What it gives is a perspective, and a reminder that there are patterns that exist in stock trading, just as there are cycles to the economy.
The end participants in the stock market are humans. And since stock markets came into existence, human emotions have not changed. That is another factor in the creation of patterns in stock markets.
One important note about this entire analysis. First, when you are studying "bull" and "bear" markets, the determination of what actually constitutes a bull or bear varies is not universally accepted. In my research, I found that there are two major schools of thought. One holds that to have a bear market, you need a decline of 15%. Another school holds that you must have a decline of 20%. Typically, I have gone by the latter definition, but today's analysis marks an exception.
Depending upon what definition you use can obviously change the length of a bull/bear. There are also different views on whether bull markets should be evaluated differently then bears because they tend to occur over longer periods of time. Also, I think it is a valid question to ask whether you should use closing prices, or intra-day highs and lows for purposes of determining start and end dates. I personally use closing prices.
Finally, another question arises as to what index to use for your analysis. I suppose in an ideal world, you would want to use something like the Wilshire 5000 to capture the entire universe of U.S. stocks. Or, the S&P 500 which is perhaps the most widely followed benchmark index. Unfortunately, we don't have the daily historical data going back as far as the Dow for the S&P 500 or Wilshire 5000 which is why I use the Dow. Of course, using the Dow poses its own problems, the most obvious one being that the Dow has only 30 stocks and the composition of those 30 stocks changes periodically.
As you can see, there are many variables, but just because there are different ways to view this, does not mean the exercise is not worthwhile.
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Before you read further, it is necessary to take a moment and orient yourself. We are stepping back in time to see how the market reacted in the most brutal secular bear market of the 20th century which lasted twenty years. I suggest turning the lights dim, perhaps holding a penny and thinking you are Somewhere in Time.
SECULAR BEAR MARKET (September 1929 - June 1949)
It has been a while since my last analysis, so let's take a minute and reflect on what the stock market was doing about 75 years ago. We were in the roaring 20s and the stock market had gained 497% over an 8-year time frame. The Dow had risen from 63.90 on August 24, 1922, to 381.19 on September 3, 1929. People were as excited about stocks as they were back in the bubblicious days of 1999.
Cyclical Bear Market Number 1
And then along came Mary. A vicious bear market began. It was downright ugly as investors witnessed record one-day losses of 13% on Black Monday, October 28, 1929, and another 12% loss on Black Tuesday, October 29, 1929. About two weeks later, the market bottomed (although not its ultimate bottom for this secular bear market). On November 13, 1929, the Dow closed at 198.69.
Investors were despondent. Their portfolios had been wiped in half in just over two months. Things looked bleak, and investors were running scared. Imagine how it was back in October of 2002, or even March 2003 as investors had suffered through the aftermath of the Internet/stock market bubble. We were headed into war with Iraq, the fear of further terrorist attacks was ever present, and the economy was suspect. Quite simply, the stock market was considered a very unsafe place to be invested, just as it was at the end of 1929.
Cyclical Bull Market Number 1
Ok, we are back in November 1929, and the first cyclical bull market began on November 13, 1929, with the Dow trading at 198.69. This bull market lasted about five months before reaching its cyclical bull market closing high on April 17, 1930, when the Dow closed at 294.07. All in all, the Dow gained 48% during this cyclical bull market. Investors were feeling good again. Consider how investors were feeling in January of 2005. The market had gained just about 50% from its bear market lows. Unfortunately, back in 1930, things took a dramatic turn for the worse.
Cyclical Bear Market Number 2.
After peaking on April 17, 1930 at Dow 294.07, the market took a nosedive. In just over two months, the Dow had declined almost 23% and closed at 211.84 on June 24, 1930. Investors got a head fake over the next few months, as the Dow rose about 15% to 245.09 on September 10, 1930. But the gains were short lived as the Dow crumbled to 121.70 on June 2, 1931. One month later, the Dow went up to 155.26 (a gain of 27%), but it happened in 30 days, and was really just a temporary spike. The market immediately resumed its bear market ways for another year, among what might well be the worse bear market our country will ever see again. The carnage ended at Dow 41.22 on July 8, 1932.
Did you catch that? From April 17, 1930 when the first cyclical bull market ended at Dow 294, to July 8, 1932 the Dow declined 86% over a 3-year and 3 month time frame!
Cyclical Bull Market Number 2
The Dow began the second cyclical bull market of the 1929-1949 secular bear market at a price level of 41.22. Hard to imagine now with the Dow above 10,000. Investors were totally beaten down from the last bear market. Investing in the stock market was probably the last thing on many investors' minds. Of course, hindsight is 20/20, but when nobody wants stocks, that has often been the time to buy them. Investors who could stomach the action in July 1932 were quickly rewarded, The Dow began its bull journey with a hefty 68.3% gain in just over a month! The volatility, however, was extreme and it was commonplace to see corrections during this particular cyclical bull market in the magnitude of 15%, 17%, even 20% over a relatively brief period of time. Contrast that with what we have seen in terms of corrections since 2003. The corrections we have been modest, most of them coming in around the 5-8% range. Trust me, sitting through a double-digit correction is enough to make even the boldest bull sweat bullets. This bull market lasted until February 5, 1934, when the Dow closed at 110.74, reaching its cyclical bull market closing high. All in all, this cyclical bull market lasted 19 months. During that time frame, the Dow gained 168.6%!
Cyclical Bear Market Number 3
Some market historians suggest that the prior cyclical bull market continued for another three years until February, 1937. However, this ignores the 5 month period between February-July, 1932. The Dow started that bear at 110.74 on February 5, 1934 and declined to 85.51 by July 26, 1934. That marked a decline of 22.79%. I count that as cyclical bear market #3, although obviously these labels are open to interpretation.
Cyclical Bull Market Number 3
The third cyclical bull market began on July 26, 1934 with the Dow trading at 85.51. The bull market lasted until the Dow topped out at 194.40 on March 10, 1937. All in all this cyclical bull market lasted about two years and 8 months. During that time frame, the Dow gained 127.36%! This bull market had enormous gains. During that time, the market had one correction of over 10%, with seven other corrections in the range of 3.11% to 9.7%.
Cyclical Bear Market Number 4
Following the Dow's rise to 194.40 on March 10, 1937, a very tough cyclical bear market ensued. The Dow fell to 98.95 in just over a year when the bear market ended on March 31, 1938. This marked a decline of 49.1% -- similar to the bear market we had from 2000-2002 in terms of the percentage decline.
Cyclical Bull Market Number 4
The fourth cyclical bull market began on March 31, 1938 with the Dow trading at 98.95. This bull market lasted about a year and a half and brought the Dow up to 155.92 on September 12, 1939. This came about 8 months after the bull market had reached its prior peak of 158.08.
Cyclical Bear Market Number 5
The fifth cyclical bull market was a brutal one. A seriously brutal one. The Dow was at 155.92 on September 12, 1939. Flash forward about 2-1/2 years and on April 28, 1942 and the Dow had fallen to 92.92. That means the Dow was actually trading lower than where it had been four years earlier! Would you have wanted to stay in stocks? If you hadn't sold out at the bottom, you were in for a very long and very profitable cyclical bull market, similar in some respects to the one we are in today.
Cyclical Bull Market Number 5
The fifth cyclical bull market began on April 28, 1942. For you history buffs, this was just 10 days after the U.S. launched an air attack on Japan from the aircraft carrier Hornet, and probably the most daring operation by the U.S. in the beginning of the Pacific war led by Lieutenant Colonel James Doolittle. April 28, 1942 was also the day that Franklin D. Roosevelt gave his "A Call for Sacrifice" speech which came one day after Roosevelt submitted to the U.S. congress a seven point program which was his national economic policy. You can read that speech online here if you are interested:
I bring up this point, not because I like trivia (although I secretly watch Jeopardy just like the next person), but because historical events impact the stock market. Moreover, the act of war, the cessation of war, and major events associated with war are often catalysts for the stock market.
Anyhow, the fifth cyclical bull market lasted just over four years. (1492 days to be exact). It ended on May 29, 1946. During that time, the Dow gained 128.69%. This bull had your typical corrections which parallel what we have seen thus far in our current bull market. In a few respects, that bull market resembles the current one we are in. Both are exceptionally long cyclical bull markets. Both bulls had relatively minor corrections in terms of percentage declines, and both produced very substantial gains.
Cyclical Bear Market Number 6
After four years of a bull market run, and the Dow up 128.69% and investors were feeling pretty good about things as you might imagine. (Incidentally, the Dow is up about 86% from its bear market low of 7286.27 on October 7, 2002). The six cyclical bear market began with the Dow trading at 212.50 on May 29, 1946. This bear market lasted just about one year until May 19, 1947. During that time, the Dow declined from 212.50 to 163.55. That marked a decline of 23.2%.
With that as a backdrop, let's tackle cyclical bull market number 6 and cyclical bear market number 7.
CYCLICAL BULL MARKET NUMBER 6 (May 19, 1947-June 15, 1948)
Date: Dow Jones Price (All based on closing numbers)
As the foregoing numbers show, the Dow began the sixth cyclical bull market of the 1929-1949 secular bear market at a price level of 163.55. Bull markets often start off with a bang, an this one was no exception. In just under two months, the Dow had gained 14.2% -- gains that most investors would be thrilled with over a year's time.
Over the next six weeks, stocks declined putting in their first correction with the Dow closing on September 8, 1947 at 175.14. That marked a correction of 6.27%. That is almost a textbook average correction based on my studies of prior cyclical bull markets. Over the next week, the market traded in an extremely narrow range, closing between 175-176 each day as the correction bottom was tested and held.
Another six weeks later, and the Dow had climbed back to 185.29, just a little over one point from its initial rise to 186.85 on July 24, 1947. This clearly marked an area of resistance and traders stepped in to sell again.
The market underwent its second correction, declining 4.96% in about another 6 weeks time frame. If you notice, this correction ended less than one point away from its first correction closing low of 175.14. Almost a perfect test of the low. Also, the correction percentage fell within that 4-7% sweet spot that we have seen so often. However, this test turned out to be a false one, at least temporarily.
The market had a year-end rally to close out 1947 at 181.16. Investors were probably pleased to end the year on a positive note and anticipated that the new year would bring about a rally in stocks. Such was not the case.
By the second week in February, 1948, the Dow had declined 8.57%. Not quite a double-digit correction, but this correction would have been a tough one to handle emotionally. Why? Because it brought the Dow back down within about two points of where this bull market began about 9 months earlier when the Dow had closed at 163.55 on May 19, 1947. To see all your gains go down the drain in 9 months ain't easy. Plus, it probably made even the most bullish of bulls question whether this bull was for real. And you will notice that 5 weeks later the Dow returned to the 165 area. Some technicians refer to this as a double-bottom retest. This time, the 165 level held. This was an important correction bottom because it paved the way for a final run to the bull market peak.
Over the next three months, the market rallied consistently with hardly a blip. If you had the stomach to hold on, you would have seen gains of 16.8% from March 16-June 15. This cyclical bull market ended on June 15, 1948 at 193.16. All in this bull market produced gains of 18.10%. Because it did not produce gains over 20%, some historians argue that it shouldn't be considered a "bull" market, others definitely include this period of time in the bull market category. The fact that this lasted over a year suggests to me it is worth analyzing on its own. This bull had your typical corrections which parallel what we have seen thus far in our current bull market. I also think it is worth looking at in context of the next cyclical bear market that followed -- a very important one because it marked the last cyclical bear during this secular bear trend. Let's take a look.
CYCLICAL BEAR MARKET NUMBER 7 (June 15, 1948-June 13, 1949)
Date: Dow Jones Price (All based on closing numbers)
The Dow started off the last cyclical bear market of the 20-year secular bear at 193.16. A little less than 2 months later, the Dow had declined to 179.27. This marked a decline of 7.2%. Pretty standard stuff. In fact, we had a correction last year of just about that percentage.
The market rallied a bit to 185.36, but than three weeks later had corrected again, this time a correction of 5.06%. Notably, it breached its prior closing low by several points.
A month later, the Dow had rallied a little less than 8%, but over a five day period, it topped out at 189.76. No, you aren't seeing double. This double-top had the exact same closing numbers of 189.76. Then we had a decline of 9.79% to 171.20. Traders stepped into buy just shy of a double-digit correction.
Some see numbers, I see patterns. Look how the Dow got to the 181 area twice, creating a level of resistance. Traders look at that kind of things, as do many proponents of technical analysis. From there, the market corrected to 171.20 -- a correction of 5.7%. Did you notice that this correction bottom came within 0.1 point of the prior correction bottom on 11/30/1948? Coincidence? I think not. The notion that support and resistance levels can be used for timing purposes has some academic research to back it up.
As this bear market wound down, the Dow had rallied to 178.45, but then declined to 161.60 -- a correction of 9.45%. Once again, buyers stepped in before the correction reached a double-digit percentage.
June 13, 1949 marked the end of this cyclical bear market. All in all, the Dow had declined 16.34%. Again, by some definitions this might not constitute a bear since we didn't have a decline of 20%, but the declines occured over a period of almost exactly a year. Also, it bears noting that the final closing level of the Dow of 161.60, marked a retest of the closing low of the prior cyclical bear market (number 6) when the Dow closed at 163.55 on May 19, 1947. Thus, we basically ended the day where we started. It was the same for investors back them. Over two years passed and the Dow was back right where it started.
Studying past market cycles, can give you the ability to gain a perspective on how the market moves. Too often, we are unable to see the forest through the trees; or, we follow so closely, that we only see the trees without being conscious of the forest. Studying these cycles also helps give us a feel for the types of corrections we can expect during bull markets, and that has proved invaluable during the bull market we have been in since October 2002. The bull market we are in still looks like it has legs in my opinion, but we do know that a bear market is inevitable.
I hope you enjoyed this analysis. As always, feel free to e-mail me with any questions, thoughts or comments.
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BOB BRINKER FIX
This isn't a weekend I am doing an Interpretation of Moneytalk. Bob published his newsletter earlier in the week, and the shows that follow that usually are relatively bland as these were. Bob did show up, and here the highlights in bullet form:
1. Bob discussed the recent jobs report saying that the number of new jobs reported of 132,000 fell right in the "sweet spot." As for the stock market, it is now only about 1% from its all time highs.
2. Bob noted that the FOMC left interest rates alone, and predicted that they will remain unchanged at the August meeting.
3. Bob mentioned an auction of the Treasury Inflation Protected Securities next week. Here is a link to the TreasuryDirect auction web site: http://tinyurl.com/n4ytz.
4. Bob said he still likes GNMAs and expects them to trade in a range of $9.50-$10.50. If you can't handle the volatility, Bob suggested creating a laddered portfolio of CDs.
Finally of note, Bob got a mention by Mark Hulbert this week in an article where Mark analyzed the top market timers. Mark quoted from Bob's June Marketimer where Bob had wrote that he believes there is "no risk" of a bear market occurring this year. I referenced that quote in my June 9-10, 2007 newsletter. It bears noting that none of the other market timers are bearish right now and their average stock market exposure is 79% --- exactly the same as mine. Read Mark Hulbert's article entitled, "Top market-timing newsletters are still bullish" at this url:
Lots of Treasury auctions next week. As for economic data, not too much. We get International Trade on Thursday, Import and Export Prices on Friday and Retail Sales onFriday. This link brings you to a calendar of the upcoming economic data:
FINAL THOUGHTS FROM DAVID KORN: Have a great week! David
GLOBEX FUTURES PRICES: Check out this link to try and gauge how the United States' stock market will open tomorrow morning. Remember though, the market sometimes opens very differently than the futures indicate:
DISCLAIMER: This e-mail is neither sanctioned by, nor written under the auspices of ABC Radio Networks, Moneytalk or Bob Brinker. This e-mail is not a substitute for listening to Moneytalk, it is only my interpretation and commentary of some of what is discussed on Moneytalk, along with additional educational information that I include, editorial comments about the market and helpful financial links. I also provide my own stock market commentary to subscribers as part of my service and give them access to my web site, www.BeginInvesting.com. If you want to know what was said verbatim on Moneytalk, listen to the show live or subscribe to "Moneytalk on Demand" which allows you to listen to the show in case you missed it live. The web site, bobbrinker.com has all the links to the ABC Radio Network stations that broadcast the show live. The information contained in this newsletter is not intended to constitute financial advice and is not a recommendation or solicitation to buy, sell or hold any security. This newsletter is strictly informational and educational and is not to be construed as any kind of financial advice, investment advice or legal advice. Copyright David Korn, L.L.C. 2007.