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2005: Don't Fight the Data

I believe 2005 will go to the bulls. I have heard many of the bearish arguments, and I believe them all, but I just don't think they'll affect the financial markets next year.

The most convincing bearish argument concerns the mountain of debt we are under. I understand that the U.S. national debt is high, each of us currently bears $25,665.63 of a national debt that totals more than $7.5 trillion.

But since 1983, the national debt (adjusted for inflation) has been rising each year, with the exception of 2000 and 2001. So a rising national debt is nothing new. Of course, at some point the national debt will cause a lot of pain. I just can't say the House of Pain will open for business in 2005.

Also, most (nonpartisan) observers who are intellectually honest realize that the $5.6 trillion in surpluses that existed in 2001 were actually projected surpluses. It's not as if we had that money in the bank! Those projections were based on a bubble economy that ultimately burst. That surplus never would have come to fruition unless the Nasdaq Composite hit about 20,000 by now. The "projected surplus" is a fiction. It never really existed.

Simply put, it is in everyone's best interests to let us keep borrowing and spending. If the U.S. goes down, it takes everybody else with it. So while we all focus on the new soap opera As the Dollar Falls, let's not forget that the entire world economy depends on a stable U.S. economy.

The bears may have great arguments for why the financial markets should tumble, but we've been hearing them over and over for years and years. Simply put -- and according to that time-tested "Efficient Market Theory" -- everything I have written is already factored into the market.

Bulls, Technicals and Calendars

Why do I believe 2005 will go to the bulls? Two main reasons, and nothing really novel here. First, the technical picture is positive. Second, the Decennial Pattern favors a strong 2005.

First, here is a monthly chart of the S&P 500.

We can see how the S&P began trending lower in late 2000 and did not bottom for about two years. Over the past couple of years the market has been fighting back. But as we look at the oscillations, we see this inverted head-and-shoulders pattern, which is two lower lows followed by a higher low. This pattern is usually quite reliable, so long as it is completed.

Many chartists tend to anticipate them and assume that a chart that is almost a head-and-shoulders will actually form a completed pattern. The error there is that there is no entitlement in chart-reading. Many patterns fail prior to completion. Also, even fully formed head-and-shoulders patterns can break down. The key to head-and-shoulders patterns is to draw the neckline. I've drawn it on this chart, and current support is around 1175. So long as that support holds, then this uptrend is intact. But if that level breaks down, we could be in for trouble.

I think it will hold. Why? Because of the Decennial Pattern, which has an excellent track record over the past 100 years.

This graph (built from data supplied by Moore Research Center) illustrates a trend in price over the past 100 years, parsed by the number in which the year ends. For example, all years ending in 0 (1920, 1930, etc.) are accounted for in the first column ("0"), all years ending in 1 (1921, 1931, etc.) are in the second column ("1"), etc. You can see that the years ending in 0 were not the greatest time to buy stocks, because it would have taken four years on average before the Dow even got back to your entry level. However, we can see that those who bought in year four were consistently happy campers. Buy in the fourth year, and enjoy the ride in year five.

I recently looked at Yale Hirsch's book Don't Sell Stocks on Monday. He published some compelling statistics that lend additional credence to the validity of the Decennial Pattern. The following table is a very simplified version of the 10-year stock market cycle described in Yale's book. It details the annual percent change in the S&P Composite Index between 1881 and 1990. The data are broken up according to years within each decade.

Hitting for the Cycle
We are entering a sweet spot
0 1 2 3 4 5 6 7 8 9
Up Years 3 7 8 4 6 11 7 3 8 8
Down Years 7 3 2 6 4 0 3 7 2 2
Total % Change (36%) 25% 32% 27% 64% 254% 47% (74%) 164% 41%
Source: INSERT SOURCE

As you can see, the total percentage change in the years ending in 5 during the years 1881 and 1990 was a whopping 254%. I like those numbers.

Climbing the Wall of Worry

Now, I have heard many folks discount the Decennial Pattern as "old hat." Well, of course it is. It's based on more than 100 years of data. It's supposed to be old hat. But just because the pattern is well-known does not negate its credibility. The result speaks for itself.

So while there are plenty of reasons to worry, those reasons will prompt the bears to provide stock for the bulls. So buy early -- you'll be happy you did.

But as always, be careful out there!

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Dan Fitzpatrick is a freelance writer and trading consultant who trades for his own account. His columns focus on quantitative strategies for trading and investing. Fitzpatrick is a member of the Market Technicians Association and manages The Stock Market Mentor, a Web site focusing on the proper use of technical analysis for trading and investing. At time of publication, Fitzpatrick held no position in any stocks mentioned, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Fitzpatrick cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send your comments to dan.fitzpatrick@thestreet.com.

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