Tuesday, April 27, 2010

The Ten-Year Cycle

¹²Market Trends: The Ten-Year Cycle

By Clare White, CMT, Optionetics.Com | 15 April 2010

Initial discussion of a decennial pattern in the stock market is attributed to Edgar Lawrence Smith in 1939 in the book, Tides and Affairs of Men. His observations focused on ten-year periods for the markets rather than tenth-year findings. Since then the pattern has been broken down and assessed a bit more closely by a variety of other analysts and traders.

Pattern & Cycle Resources

Whether it's a matter of timing in someone's progression as a trader or simply preferred authors, I began to better appreciate the importance of patterns and cycles after reading The Right Stock at the Right Time, from legendary trader Larry Williams. The book has nice depth on the topic from a trader's perspective— inclusive of pitfalls and benefits. Definitely consider it to develop your knowledge of the full pattern while staying grounded in the fact that a 'forecast' is not a stand-alone trading tool.

Martin Pring is another trader-plus-author whose incorporation of economic cycles with intermarket work provides really nice context for different patterns and cycles. His 2010 outlook paper titled, "The Decennial Pattern, the Presidential Cycle, Four Year Lows and How They Affect the Stock Market Outlook for 2010," is available via search on-line. The chart techniques provided here were definitely inspired by some of his work and reviewing this paper will provide better context for different influences at play. Again, the idea that a forecast is not a stand-alone plan is driven home.

As a more timely resource that is readily accessible, take a look at Jay Kaeppel's articles and commentary at the Optionetics site. Even if he is addressing a different pattern or cycle, his trader's-approach— given current market movement— will help you translate knowledge into a potential tool for your own trading. At the end of the day it is really important to stick with a style— including analysis— that is well-suited to you.

Tenth-Year Returns

Since I find I have to get into the data myself to avoid having my expectations for the market override the reality of the market, I exported Dow Jones Industrial Average (INDU) daily close data from the Worden Brothers, Inc. TeleChart© package. I generally need to create a few different types of charts and hopefully have included in my articles those that provide the best view for you. Keep in mind that regardless of how well versed you may be in past price movement, it's managing risk today that matters.

Using daily data from 1920 through the first quarter of 2010, the first 250 trading days of each tenth year were assessed. (Note: 1950 had 249 trading days so an "unchanged" data point was used for day 250.) Figures 1 & 2 combine daily data for the 9 periods and applies average and median returns to a $1,000 initial investment. Keep in mind it does not constitute statistically significant results. However, when broken down into quarters, the increased sample size displays a [decidedly] negative bent for a market that tends to display a positive one over time [[ie, about two-thirds of the time! : normxxx]]

Table 1 provides a breakdown of returns for the tenth year by quarter. Top performance and worst performance are highlighted in green and red, respectively, with mean and median measures also provided.

Table 1: Quarterly Return Data for Decennial Years

Click Here, or on the image, to see a larger, undistorted image.


When aggregating the returns to obtain mean and median data, the impact over the 250 day period to an initial investment of $1,000 is displayed as Figures 1 & 2, respectively. Note there is a substantial difference in year end results compared to the median chart ($923 versus $1,062) suggesting that there are loss outliers skewing the average returns downward. The problem of "fat tails" in market returns which can create a very real problem for investors.

(For a more learned discussion of "fat tails" in probability distributions, see "Fat tail".)

Figure 1: Daily Returns for Aggregated Decennial Years Using Mean Values (1920-2009)

Click Here, or on the image, to see a larger, undistorted image.


Figure 2: Daily Returns for Aggregated Decennial Years Using Median Values (1920-2009)

Click Here, or on the image, to see a larger, undistorted image.


What do the extremes look like? Figure 3 displays the highest daily return with the lowest daily return for the 250 day period. Note the linear regression line drawn through the data is slightly further from the zero-axis on the downside.

Figure 3: Daily Extreme Returns for Decennial Years (1920-2009)

Click Here, or on the image, to see a larger, undistorted image.


Going Forward

I imagine even raging bulls would welcome a moderate pullback of the broad averages to improve the probability of a sustained upward movement over the long-term. While 2010 could certainly have positive returns for all four quarters, it feels like the more time it takes for a retracement to occur, the deeper it could potentially be. It seems even a Gaussian normal (aka, 'average') corrective move would take people by surprise at this point.

Trend and momentum measures still favor bullish positions; however, a recent volume increase may be the start of a blow-off top leading to a correction. Bearish trades remain contrarian in the stock market, but relatively low volatility (for now) may offer a good environment for some proactive risk management with a little bit of time to expiration.

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Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

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