The Four Year Market Cycle

             From the past 76 years, from 1930 through 2006, a four-year repeating pattern, or cycle,  is apparent in the movement of stock market indexes. These cycles are defined to begin and end in October of mid-term election years ( i.e., 1930, 1934, .... 1998, 2002, 2006).  Furthermore, each four-year cycle may be characterized as being either a bullish cycle (one in which the indexes experience higher highs and higher lows) or a bearish cycle.  The chart below illustrates the six turning points experienced each cycle, with the average durations and average price differentials shown for each up and down leg Of the S&P 500 Stock Index. Data in black represent the averages for all 19 cycles since 1930. Data in blue show the averages for the 11 bull cycles occurring since 1930 and data in red show the averages for the 8 bear cycles that have occurred since 1930.

             Both charts below are taken from a presentation made by Roy Ashworth at the February 2006 AmiBroker Houston Conference, sponsored by FtMonitor.

              Prices rocket off the bottom of each four-year cycle (i.e., F to A on the above chart), gaining about 45% in an up-leg that lasts longer (about 15 months) in a bull cycle than in a bear cycle (about 8 months). Interestingly, the magnitude of the initial thrust is about the same in bull and bear cycles, so that profits are compiled much more quickly in bear cycles. In 1998, in what turned out to be a bear cycle, the S&P surged 47% off its October bottom in less than ten months. In 2002, in what turned out to be a bull cycle, the index soared 49% above its October bottom within sixteen months.

              The extent to which prices fall into the October four-year cycle bottoms (i.e., E to F on the above chart) is also of interest, and not just because we may be experiencing this downleg at the current time. The average decline for this downleg is 20% for all cycles dating back to 1930. The duration and extent of decline varies considerably, however, from bull cycles (4 months, -17%) to bear cycles (13 months, -25%). In 1998, the S&P plunged 19% in three months into the October bottom in a bull cycle. In 2002, it plummeted 33% in seven months into the October bottom in a bear cycle.

               The chart below shows how the actual S&P index compares to the averages for the respective bear and bull cycles for the past 8 year. Using the October 2002 bottom as the focal point at which the actual and average (or theoretical) indexes coincide, it appears that the averages were an effective predictor throughout the eight-year period with respect to the durations of each up and down leg. While the averages have proven to be good predictors of the magnitude of price changes in the bull cycle from October 2002 to date, they underestimated the extent of the downlegs, especially, that occurred from 2000 to 2002.

               The white lines in the chart show a rising wedge formation, which suggests that the next major market move will be to the downside. The presence of this rising wedge is one of the reasons Mr. Ashworth, who prepared the chart, thinks the 2006 to 2010 cycle will be a bear cycle.

           
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