Bull market in stocks has years to run, despite the inevitable correction


In the financial markets, it is no secret that rallies give way to corrections, and declines give way to recoveries, often on measurable timetables.

This phenomenon is called a market cycle, and investors are likely familiar with the seasonal cycle dubbed “sell in May and go away.”

Market analyst Peter DeGraaf posted an article a few years ago suggesting that since 1973, a different cycle has been in play. Apparently, the U.S. suffers a financial calamity (his words) of some kind every seven years. The last one occurred in 2015, resulting in the “flash crash.”

If this is a valid cycle, and cycles expert and newsletter publisher Stan Harley pegs it at a more precise 84.3-month cycle over the long term, then we should not expect a major market dislocation until 2022. (Please see chart, below.)

Ralph Vince, author of five books on portfolio management and portfolio/trade optimization, points out that the market follows a liquidity cycle where the most recent manifestation culminated in the aforementioned flash crash on Aug. 24, 2015. “The Crash of 1987 was exactly on this cycle,” he added. the next time this should hit is on, or near, 2022.

And that means the wind is at the bulls’ backs for the next few years.

Of course, that does not mean there won’t be sell-offs or even major corrections.

However, the calls for pending market crashes published by a few pundits recently don’t fit with this scenario and, therefore, seem less likely to occur.

Read: Wall Street bonuses have soared 890% over the past three decades

Keep in mind that all cycles are not hard calls for tops and bottoms. They are tendencies for these changes and, therefore, can extend or contract in length. For example, the four-year presidential cycle saw a low in 1982, suggesting the next low in 1986. That cycle did not bottom until 1987, during the Black Monday debacle, and we can explain it away with economic, sentiment and other factors. The cycle got back on track in 1990 and worked fairly well until 2006 when the Federal Reserve was in the midst of its zero interest-rate policy and bond-buying program.

Here is a short list of the market bottoms, actually starting before 1973:

• 1966 – The great credit crunch

• 1973-74 – Arab oil embargo

• 1980-81 – Fed spikes interest rates to squash inflation, Hunt brothers silver collapse

• 1987 – October crash

• 1994 – Bonds suffer a bear market and interest-rates spike

• 2001 – Internet bubble collapse

• 2008 – Real estate bubble collapse

• 2015 – Flash crash

• 2022 – ?

It is possible to follow the cycle even farther back in time, but it starts to degrade. Also, it does not explain the Asian currency crisis and U.S. stock market correction in 1998, which was arguably more important than the 2015 flash crash. Clearly, this is far from an all-inclusive theory of the market’s ebb and flow.

But the point is not to put the market in a neat pattern but rather to create a framework for the big picture. And that tells us that overall the bull market has years to run.

Also see: Fed rate hikes + low growth = recession, says stock-market strategist

And that brings us to the inevitable correction.

It is no secret the stock market struggled this month after the Dow Jones Industrial Average

DJIA, -0.01%

 closed above 21,000. Indeed, the Dow was fresh off a record-setting pace of consecutive all-time high closes before blowing its last remaining fuel March 1.

But more than just a big round number, 21K represented a technical target. It was the top of a long-term trend channel drawn from the start of the bull market in 2009. And on the S&P 500

SPX, -0.11%

it was the measured upside target for the break of the giant two-decade sideways market that included the peaks of 2000 and 2007.

I won’t get into reasons why the market will or will not begin its correction now, but there are technical reasons why the market can struggle further. But even if this is just a short-term speed bump, there are other cycles at play that suggest 2017 will not end up being a very strong year. The only way that happens after its very strong start is for a correction to set in later this year.

Let’s make some assumptions.

First, as interest rates start to rise, liquidity will dry up, at least a bit. The Fed has already started to raise short-term rates and the Treasury bond market has already broken down, sending its commensurate rates higher.

Second, elections in Europe can lead to big disruptions. While the Netherlands failed to elect the anti-European Union candidate, France will head to the polls soon with a similar candidate. Germany will vote later in the year. Fears are that the EU itself is under extreme pressure to even stay together. At a minimum, currencies are at risk of volatility.

And now the technicals.

The four-year presidential cycle with a first-term new party president tends to be problematic, according to Tom McClellan of the McClellan Market Report.

And the 10-year decennial cycle will take hold. Over time, years ending in “7” tend to be among the worst performers.

Barring a major news event outside the markets, such as war or political upheaval, it would seem that if, and when, the market corrects, it is likely to be relatively modest. A 10% correction is well within the limits of a healthy bull market. For the Dow that could mean a three-quarters give-back of the Trump rally and a return to Dow 18,700. That’s about 10.9% from all-time highs. (Please see chart, below.)

On the charts, that would return the Dow to test its breakout from a two-year range and barely break the 200-day moving average. It should also be an excellent buying opportunity if the correction gets that deep. And even if it does not, with a few more years of gains still ahead, according to the seven-year cycle, it would still be a pretty good opportunity for investors.

Michael Kahn, a chartered market technician (CMT), is a columnist for MarketWatch as well as Barrons.com, where he writes the “Getting Technical” column. He is the author of three books on charting, contributes to several trading and investing websites, and speaks at industry events.

Source link