The U.S. stock market has struggled to regain the highs achieved on May 1st. The selling pressure of June 1st underscored the rout established during the month of May. Much of the blame focused on Greece, their elections, and the potential exit from the Euro. Readers of The Sentinel Financial Report (TSFR) understand that we do not subscribe to that sort of causality. The news does not make the market, people make the market. Many financial news outlets ascribe a market move in any given day to an external event. For example (and we paraphrase here),
“The market rose today on better unemployment numbers.”
“The market fell today on fears of Greek rioting.”
For every negative story that supposedly has a dampening effect on the market, that very same external event can have a buoyant effect on another day. Conversely, positive stories on a given day can exert a downward force in the stock market. Recall that when the President triumphantly declared Bin Laden dead (May 2011), the market fell for weeks. When the Congressional debt ceiling deal was reached in August 2011, the market fell like a rock. Were these events not considered good news?
What is truly important in studying stock market behavior is to identify trends and cycles. There are a variety of methods employed to study trends and cycles. These trends and cycles are integral in anticipating the economic climate as well. TSFR’s hypothesis supports the idea that tops and bottoms in the market presage future economic activity.
Historical highs and lows occurred in the stock market in the 20th and 21st century. The most important highs and lows, forming tops and bottoms, are listed in the attached slide.
The 1929 top ushered in the Great Depression. From 1929 until 1932, the stock market, as measured by the Dow, declined 90%. The 1929 stock market top was actually a harbinger of economic decline ahead. The bottom of the ensuing bear market in 1932 is the second major formational point in the market in the 20th century. At the bottom of a market you have complete psychological destruction. It was not until 1954 that the market achieved the same level as 1929. Psychologically, given the fortunes that were lost in the Great Depression market and how the country’s economy reacted to it, it seems plausible to have an unconfident public for what amounts to an entire generation (25 years).
The next important formation in the market occurred in 1974. The Dow made an important low in December of 1974 coinciding with the strong recession of that period. The 1982 bottom occurred during a recessionary period and ushered in the beginning of the greatest bull market in U.S. history. This bull market also coincided with the greatest credit expansion in financial history.
The Dow next made an important top in January of 2000. Some would call this the “dot com” top. This top was important for two reasons. First, the top preceded a strong recession with the ensuing market bottom occurring in 2003. Perhaps more importantly, this top witnessed a disconnect in the relationship between the Dow and gold. Nominally speaking, the Dow went up from 2003 to the top of 2007. In terms of gold, however, the Dow fell during this period. For bearish technicians, the 2000 top is the final top in what will be a prolonged decline.
Rest assured, we have yet another top that we have gone on record as saying will be the terminal historic formation in what will be a generational bear market. The top in the fall of 2007 was perhaps not as noticeable on a Dow/Gold chart, but in nominal terms, we feel this will be the high in a multigenerational bear market. This top is 25 years from the important bottom of 1982. Twenty-five years is an important cycle from the perspective of Saeculum analysis chronicled in TSFR. Twenty-five years represents a generational cycle. The dominant generation in this cycle was instrumental in promoting the ebullient feelings allowing the great credit expansion to occur.
The tops of 2000 and 2007 were in a sense, the same top. They simply occurred 7 years apart. If a true measure of wealth, such as gold, is used as our “money” to buy the stock market, we quickly discover that the top of the market actually occurred in 2000. Since 2000, the market, priced in terms of gold has been in a precipitous decline. While this appears counterintuitive, it highlights the effect of dollar inflation on common indices like the Dow Jones Industrial Average.
In my next article (part two), I will provide context to recent market action.
Jim is the author of Escaping Oz: Protecting your wealth during the financial crisis.