In Part I we outlined the very long-term or secular forces that are likely to affect the equity market in 2011 and concluded that sometime in the opening half of the year there is a strong probability that the third down-leg in the secular will get underway. Since the turning points of the component waves of these secular movements are difficult to pin point with precise accuracy Part II addresses the cyclical and seasonal factors that will be in force during 2011. An analysis of the seasonal aspects will give us a better feel for the expected pattern of price behavior as the year unfolds. Since we do not know when the peak will actually materialize we’ll discuss some indicators that should be monitored from the point of view of confirming when they have taken place.  First though, let’s take a closer look at some of the seasonal/cyclical patterns and how they might affect 2011.

The Outlook for 2011 Using Seasonal Analysis: The Presidential Cycle

The presidential cycle extends over four years, starting with the first year of a new presidency and following though to the last year, in which the election is held. Since the foundation of the Federal Reserve in the early part of the twentieth century and its ability to tweak monetary policy, analysts have observed a distinct pattern to the cycle depending on the year in question. This year 2011, will be the third one in the cycle. Cynics argue that authorities pump prime the economy in the third year so that economic conditions will be favorable for the election that will take place in the following year. Whether that is true or not the inescapable fact is the third year, which often begins in the fourth quarter of the second year, has a high statistical probability of experiencing significant gains. We can see that from Chart 1, where the average of all third years since 1900 is displayed.

Various Scenarios: Third Year of Presidential Cycle

Chart 1

It is fairly evident that there is an upward bias, certainly going into August, then a small decline into October. The average gain for the year is 10%, with a stronger 17% profit in secular bullish environments. The trajectory for the secular bear years argues for a temporary peak in July with a decline into November for a more modest overall 7% gain. Under all scenarios though, the mid-August to Mid-October period is the one of greatest weakness and should be watched very closely as it approaches in 2011.

The Decennial Pattern

The Decennial pattern was first noted by Edgar Lawrence Smith who, in 1939, published a book called Tides and the Affairs of Men.³  Smith researched equity prices back to 1880 and came to the conclusion that a 10-year pattern, or cycle, of stock price movements had more or less reproduced itself over that 58-year period. Even though the cycle has been relatively reliable to date there has been no rational explanation as to why it “works.”

Smith used the final digit of each year's date to identify the year in his calculations. He termed the years 1881, 1891, 1901, etc., as the first years; 1882, 1892, etc., are the second; and so forth. Inspired by the research of Dr. Elsworth Huntington and Stanley Jevons, who both emphasized the 9 ­to 10-year periods of recurrence in natural phenomena, Smith experi­mented by cutting a stock market chart into 10-year segments and plac­ing them above each other for comparison.

 Average Decennial Pattern Compared to Secular Bull and Bear Markets

Chart 2

The averages of these decades are displayed sequentially in Chart 2 for three series. The one in the top window represents the average for all the decades since 1900 that developed during a secular bull market, the middle series the average for all decades since 1900 and the bottom panel the average for decades that developed in a secular bear environment. It is interesting to note that the green (secular bull) and the red (secular bear) contain different decades yet their trajectories are mostly quite similar. All three trajectories show year one to be a difficult period, especially in the second half. Note that these decennial pressures do not lift until the mid-part of year two. If you refer to Chart 2 in in our Part I article you will see that the average for the three previous secular US bears since 1900 also calls for a primary bear market low in year twelve of the secular bear, which is what 2012 will be.

The top panel in Chart 3 shows the average of all opening decade years since 1900. It indicates an April peak followed by a decline into year end with an average loss of 5%. Out of the 11-years in question  six were up years and five were down. The actual performance depends a lot on whether the “one” year develops under the context of a secular bull or bear.

Various Scenarios: Opening Years of the Decade

Chart 3

For example four of the up years materialized in a secular bull, whilst the down periods were totally confined to the secular bears. Even when the two secular bear up-years are included the average loss was 13%. Once again the trajectory calls for an April peak with a slow grind to the downside into year end.

The bottom window of Chart 3 reflects a compendium of all three conditions that will be present this year, the third year of the presidential cycle, the opening year of the decade and a secular bear environment. This brings our sample down to an average of three years 1911, 1931 and 1971 and calls for a decline of 18%. The results indicate a trajectory in which prices rise into the first quarter and then slowly decline for the balance of the year. The worst period appears to be between mid-August and mid-October when the decline is steepest. If we are looking for potential time frames in which the market might peak based on this analysis we would have to say at the beginning of the second quarter, give or take a couple of weeks, mid-August or, if we take the average year one secular bears (Center series Chart 3) a less likely January peak, followed by a trading range.

The possibility of a cyclical peak and therefore the resumption of the secular bear sometime towards the end of the first quarter and the start of the second is not implausible and is our best guess (and that’s all it is). In terms of average counter-secular bull market duration this time frame also fits. If we exclude the “big three” cyclical bull markets under a secular bear i.e. 1932-7, 1942-6 and 2002-2007, the average primary trend has lasted roughly 2-years. The current bull dating from March 2009 will be exactly 24-months old in the first quarter. That’s clearly not a basis from which we can make a prediction. It’s merely a statement saying that based on previous cycles two years, give or take a couple of months on either side  is a realistic time frame to expect a turn in the tide. The reason why we exclude the “big three” is that markets often repeat patterns but they rarely repeat the same phenomenon consecutively and are more likely to alternate. Thus, the two previous “big three’s” were followed by relatively small rallies in 1939 and 1948. The good news is that the actual inflation price low in the S&P developed in 1982 right at the end, whereas that for the previous bear developed in 1932, seventeen years prior to the start of the 1949-66 secular bull. The principle of alternation would therefore suggest that the rest of the current secular bear will take the form of a trading range rather than a zig-zag down to significant new post 2009 lows. 

The early part of 2011 may represent a reasonable time frame to anticipate the start of a cyclical bear market and resumption of the secular downtrend. However, it would be irresponsible to make such a forecast since we cannot know what the composition of the technical position will be at that time. For that we need to take a look at the technical state of the primary trend at year-end 2010 and see where we might go from here.

The Primary (Cyclical) Trend

By pretty well all of the technical measures the cyclical trend i.e. the one associated with the business cycle is currently positive. For instance, the S&P and the major stock averages remain above their respective 12-month MA's and 65-week EMA's. Momentum, such as the long-term KST is also bullish. In addition both our monetary/economic and market driven models remain in positive territory. In this respect Chart 4 (next page) features our Stock Barometer, which enters the year with a comfortably bullish 83% reading.

Having said that, a couple of indicators that have consistently flagged primary bear markets in the last 100-years or so, while not outright bearish, have begun to roll over in a negative way and are therefore throwing up some yellow flags.

S&P Composite versus the Stock Barometer

Chart 4

S&P Composite versus Inverted Dividend Yield Momentum 1894-1954

Chart 5

Charts 5 and 6, for instance, show the KST for the S&P dividend yield. The data have been plotted inversely to correspond with movements in the S&P. The solid arrows indicate that when the KST peaks out this has usually been followed by a bear market. The dashed arrows flag the exceptions. The small red arrows against the price plot demonstrate that KST reversals are occasionally early. Despite the exceptions and the early bird signals, it is fairly evident that KST peaks have historically proven to be a warning that is ignored at one's peril. At the present time this momentum indicator is bullish but is fairly overstretched, which hints that it would not take much in the form of market weakness to result in an actual sell signal.

S&P Composite versus Inverted Dividend Yield Momentum 1951-2010

Chart 6

S&P Composite versus Shiller P/E Momentum 1880-2010

Chart 7

That type of outcome is also suggested by the 18-month rate-of-change (ROC) of the Shiller P/E, shown in Chart 7. You can see that whenever it reverses from above or close to the +50% level the odds of a bear market are quite high. The dashed arrows show the exceptions. Occasionally, some of these market peaks are preceded by ROC trading ranges, as was the case in 1929 and 2000. The indicator has enjoyed a good rise since the beginning of 2009 and looks as though it might be in the process of peaking. It's another reminder that the market needs to move forward from here if it is to avoid some major sell signals.

Pretty well all equity bull markets are brought to a close after a period of accelerating interest rate hikes caused by commodity price inflation. As 2010 comes to an end long rates have started to rise but money market yields have been held down by the Fed. Chart 8 offers some economic support to the idea of higher rates as our Growth Indicator, a composite series constructed from the momentum of several economic indicators, remains at an elevated level at 23%. The green highlights indicate that when it has been above +20% in the past this has usually indicated that the economy is strong enough support a trend of higher short-term rates.  Note that the KST for the Commercial Paper Yield is also consistent with higher rates as flagged by the green arrows.

The 3-month Commercial paper Yield and Two Indicators 1955-2010

Chart 8

Since the economy is consistent with higher rates and the Fed is holding them at artificially low levels the inescapable conclusion is that monetary policy is unnecessarily inflationary and that means that rates will rise faster and further if that were not the case.

Conclusion

Trend analysis work tells us that the primary trend is still positive. The S&P is above its 12-month moving average and our inter-market and trend driven Stock Barometer remains in a positive mode. However, as we move into 2011 sentiment and internal breadth measurements are at bearish levels and some key sectors (e.g. financials) and markets, such as China have failed to confirm the recovery highs in the S&P. These non-confirmations could be extended or even cleared up, but as long as they exist they serve as a sober reminder that the secular bear still stalks. Our best guess is for a spring peak, but we will be looking for several events for confirmation should it develop sooner or later. They are listed in the accompanying box.

Checklist for End of Cyclic Bull Market

Indicator	Trigger Point	Source
S&P Composite	Negative 12-MA Crossover	Yahoo Symbol ^GSPC
3-month       Commercial Paper Yield	Positive 12-month MA Crossover by 4-week MA	http://www.federalreserve.gov/releases/h15/update/
Stock Barometer	Bear Signal	Monthly Intermarket Review
Shiller P/E	18-month ROC below +25%	http://www.econ.yale.edu/~shiller/data/ie_data.xls

 

 

Final Note

So far in this secular equity bear market it has been relatively easy for equity averse investors to hide in bonds. However, if, as we expect bond prices have also begun a secular decline the investment horizon will become more difficult to navigate as both equities and bonds are likely to be under pressure. However, as in all secular bear markets there will be limited windows of opportunity. Essentially, an investor needs two games plans, one for defense, to protect assets in difficult periods and one for offense, to grow wealth during favorable conditions.  A prudent and profitable investment strategy should be flexible enough to actively adjust portfolio asset allocations, depending on where we are in the business cycle and the direction of the secular trend.  With knowledge of business cycles, secular trends, and tactical asset allocation, it is possible to create better returns with less risk and most importantly to experience financial peace of mind.

How is Pring Turner Unique? View our Brochure

About Pring Turner Capital Group

Pring Turner Capital Group is a registered investment advisor, providing highly personalized investment management services on a fee-only basis since 1977. The three managing partners, Martin Pring, Joe Turner, and Tom Kopas combine for over 110 years of professional investment experience. Martin Pring is author of numerous highly acclaimed books regarding market analysis and business cycles, including Technical Analysis Explained, The All-Season Investor, and his most recent The Investor’s Guide to Active Asset Allocation. Please visit our website www.pringturner.com to sign up to receive our latest research.

Pring Turner vs. S&P 500 (January 2000- December 2010)

 

 

*Pursuant to the provisions of Rule 206(4)-1 of the Investment Advisers Act of 1940, we advise all readers that they should not assume that all recommendations made in the future will equal that referred to in this material.  Investing in securities involves risks, including the possibility of loss. Performance numbers include all retirement accounts.  Performance includes total return (capital growth and dividends, after all costs)

Investment decisions formulated by Pring Turner Capital Group, Inc. are based on proprietary research and methods developed since 1977 by the owner/managers of the firm.  None of the material contained herein is intended as a solicitation to purchase or sell a specific investment.  Readers should not assume that all recommendations will be profitable or that future performance will equal that referred to in this material.

 

 

(c) Pring Turner Capital Group

http://www.pringturner.com/