Where Are We in the Stock Market Cycle?

Oct. 9.08 | About: SPDR Dow (DIA)

My January 6, 2008 article on the PiedmontHudson Blog pointed out we had just traced out a head and shoulders top pattern. Since the support level discussed in that article has been clearly penetrated, it’s time for an update.

The graph below shows the performance of the Dow Jones Industrial Average (DJIA) for the past 15 years.

Click to enlarge

Support level 1, defined by the market lows of 2004 1nd 2005, has been decisively penetrated. This level, near 10,000 should now be considered a resistance level.

Support level 2, defined by the market lows of 1997 and 2002, is around 7500. That region would produce a drop of 45-50% from the October, 2007 top. We are currently approximately 3/4 of the way there.

The average for all 33 primary bear markets since 1900 has been a loss of 37%. As I write this, the DJIA is 36% below the top. Basically we have reached the average primary bear market loss with no bottom in sight. The average of the five secular bear markets since 1900 has been a loss of 54%. At support level 2 we would be near the average for a secular bull market bottom.

What if we are going to the third super cycle bottom since 1900? Support level 3 (lows of 1993 and 1994) represents a loss of 75% from the top. There are two other support levels from the past 21 years not shown on the graph (around 2300 based on 1990 lows and just below 1800, based on the 1987 bottom). These two support levels would represent losses from the top of 83% and 87%.

The two super cycle lows since 1900 occurred in 1932 (89% below the top) and in 1974 (45% below the top).

These are strictly technical comments. I will not discuss fundamental analysis here, but I have seen little discussion by others to convince me that the fundamentals of a bottom are near. I am referring to PE ratios, visibility of forward earnings, credibility of balance sheets, etc. Overriding all these factors is the very survival of our financial system as it has existed for the past 60 years.

To offer some tidbits for the nimble investor, many severe bear markets are punctuated by violent rallies of short duration. These are difficult to predict but do offer some trading opportunities with proper loss safeguards.