Beyond the world of the fundamental analysts at brokerages and the technical analysts at boutique research shops lies the strange and largely unexplored world of cycle analysts. While the first two groups are well-represented in major investment media, the latter are generally relegated to obscure newsletters. Yet they are far more influential on the opinions of leading investors than many people realize. And a few have posted decent forecasting records. In contrast to the fundies and technicians, whose large body of work has generated a list of widely accepted methods, there are few established norms among cycle researchers. This leaves them each to ply their trade in separate but parallel universes. When pressed on their methodologies, most either descend into jargon about harmonics, planets, 20-year loops or waves, or just clam up -- practices that satisfy their faithful but leave newcomers adrift. As you might expect, after three down weeks to start the year, some cycle watchers are flashing buy signals while others laugh off the recent softness as a mere taste of horrors to come. The current level of confusion among veteran investors who consider January a reliable month for making money makes this a most interesting time to ponder the topic of market-timing from a different perspective. In a moment, you'll briefly meet three cycle-thought leaders -- Tom McClellan, Phil Erlanger and a European astrologer I'll call ZM. But first, a few notes about their world.
Patterns EverywhereCycle analysts think their work is no more outrageous than using a calendar to gauge which months will be warm and which will be cold. If we were in a primitive society that didn't understand the seasonality of weather, a forecaster in midwinter who predicted sunny skies in six months might be considered a prodigy. To the cycle crowd, the world of stocks and commodities is underpinned by mathematical patterns invisible to the naked eye. Many major cycle observers grew bearish in December as their macroeconomic, astrological, Gann and monthly timing models forecast a decline in investor confidence and a rise in energy prices. Some relied on a long-circulated version of a timeline developed by cycle-watchers' favorite dead Russian economist, Nikolai Dmitrijewitsch Kondratieff, that called for an end to a 2002-2004 bull market on Jan. 2, 2005. If you lump all of their views together, you can assemble a consensus view that the middle of 2005 will witness a market top that will rival the 2000 top in significance and usher in a 1973-1975 style bear market. More specifically, a popular scenario foresees the equity market rallying this week and maybe next, then spiraling into a selloff that climaxes in March. That would be followed by a rally that crests in June or July a smidge above the December 2004 highs. Stocks would then begin a sickening slide into October. Another rally would materialize there into November, to be followed with another plunge into 2007-2008 that would mark the end of the "secular" bear market that began in 2000.
What Does It Mean to the Rest of Us?Should we care about this soothsaying? Yes, to an extent. Even if you do not believe in cycle work, it's important to recognize that many others do. If the views are strong enough -- and acted upon with strong buying or selling -- they can become self-fulfilling prophecies. It's the George Soros theory of reflexivity at work. Many major hedge funds use cycle work to help them plan their year. It tells them what might happen, on the basis of a variety of tested theories. They don't use individual cycles derived from Elliott waves, Gann patterns, seasonality, presidential cycles, 20-year cycles and 40-month cycles in isolation. Rather, they overlay numerous successful cycles from a variety of sources to see where reversal points line up. Then they study a calendar and try to determine what news events would spark downswings or upswings and, most importantly, those reversals. They tend to trust their cycle work without knowing exactly what will lead to inflection points. They always seem to feel safer, intellectually, if they can find a good story to support the math.
Two Fundamentals That CountTom McClellan, the Lakewood, Wash.-based editor of the McClellan Market Report, is one cycle guy with a long-term record that satisfies partisans. His mother and father invented the McClellan Oscillator, widely used to study market breadth, in 1969. Since then, the senior McClellans and their son have invented another 100 methods to measure market cyclicality. In an interview Friday, he said only two fundamentals matter in the market: how much money is out there and how interested people are in investing it. Cycles thus depict millions of individuals' on-again, off-again desire to commit hard-earned dollars to paper assets. McClellan says that not all of the cycles he follows work all of the time, so he depends on his own experience and intuition to determine which ones are working best. Among his most reliable are 40-week and 20-week cycles developed by a technician named J.M. Hurst in the 1960s. He admits they're sometimes off by a few weeks, but he said they most recently accurately forecast the August 2004 low and December 2004 top, adjusted for slippage. Using them, he has forecast a strong rally this week or next, followed by another decline into a nine-month cycle low in June, then a top in August or September, ugliness in October, and then a rally into 2006 that sets up a horrid market for the second year of President Bush's second term. "The market isn't doing anything but what it's supposed to, the way it normally does it," he said. "A 40-week cycle is a historically observed phenomenon."
Cycle Effects of a Second TermPhil Erlanger, who has studied prices for ages at major investment houses such as Advest and Fidelity, says that investors are confused today because a couple of well-worn cycles are simply not working this year so far: One calls for years ending in 5 to be up, and another calls for Januaries to be up. The market, he notes, has a nasty habit of breaking its own rules once too many people discover them. Erlanger, who now runs a research service called ErlangerChartRoom.com, says both his proprietary 20-year cycle and the presidential-term cycle suggest that this year should offer sideways to negative action punctuated by a weak first quarter, a strong second quarter and weak third and fourth quarters. "In the first year of his term, a president does what he wants to do, no matter how painful, and crams it down people's throats -- and investors generally don't take it bullishly," he says. Erlanger is generally pessimistic about the next couple of years and expects a bottom in 2006-2007. He warns that if the market were currently in a true secular bull cycle, the broad indices would have already headed to new highs. Instead, they labored to a very modest rally in 2004, much of which has already been erased. Erlanger notes that the Dow Jones Transportation Average, which was one of the strongest measures last year, has already broken down badly below its 1998 and 1999 highs, and that many technology sectors, such as semiconductors, are clearly in an ongoing bear market despite occasional rallies. "The nature of these things is that when they're done, they're done," he said. "Secondary upthrusts, like we should have in the second quarter, only serve to persuade more people to come in to get slaughtered." If you'd like to plan early for the apocalypse, note that Erlanger sees the potential for many of last year's highfliers, like Google ( GOOG), to get cut in half. He also foresees the potential for crude oil to peak at $60 before retreating back toward $40 and potentially back to the mid-$20s. For that rally he prefers the oil services stocks such as Halliburton ( HAL) and Transocean ( RIG) to oil drillers such as Anadarko Petroleum ( APC) and Apache ( APA).
Written in the StarsI know you've been waiting patiently for me to get to the astrologer, so here is his view. I'm calling him ZM for privacy. He points out that every 72 years brings a key U.S. president who will make a lasting impact:
- 1788: George Washington
- 1860: Abraham Lincoln
- 1932: Franklin Roosevelt
- 2005: George W. Bush (His charts for Bush's second inauguration call for mounting national difficulties and ongoing war.)