Anyone who has read my articles with any regularity knows that I have found much usefulness in certain cycles that seem to reoccur consistently in the stock market.  I generally use this information as “weight of the evidence” type tools to help define periods when the market is likely to be exceptionally strong or weak. One of those potentially exceptionally strong periods appears to be in the offing. Here’s the skinny:

In my article, If the Year is 5, the Bull Is Alive (2/22/05), I detailed the widely known fact that no calendar year ending in the number 5 (“1905, 1915, etc) has ever witnessed a decline in the stock market.  In fact, the average gain for the Dow Jones Industrial Average (INDU) in all “5” years is +35%.  Another thing that I wrote about in a recent article in Stocks and Commodities magazine is the 40-week cycle.  If we put these two phenomena together we get an interesting outlook for the latter part of 2005.

YEARS ENDING IN “5”

Table 1 shows the annual performance for the Dow Jones Industrial Average during “5” years in the last century.  The average annual performance is an eye-popping +35.0%.  The “worst” year was 1965 when the Dow was up only +10.9%.  

Table 1 – Dow performance during years ending in “5”

Chart 1 shows the typical market performance during each year of the decade going back over the past 120 years.  Note how the stock market typically accelerates to the upside during the fifth year of the decade.

Chart 1 – Dow Decennial Pattern Year-by-Year Tendencies

40-WEEK CYCLE

In a 2002 Stocks and Commodities article, I detailed the fact that (for reasons which I certainly cannot explain), the stock market has been moving in a 40-week cycle since 1967.  Essentially, the first 20 weeks of each cycle are considered to be the bullish phase and the 2^nd 20 weeks are considered to be the bearish phase.

Chart 2 displays the growth of $1,000 invested in the Dow in the following manner: starting on 4/21/67 the Dow was bought and held for 20 weeks at which point it was sold.  20 weeks later the process was repeated.  In other words, Chart 2 displays the growth of equity if one invested only during the “bullish” 20-week portion of each 40-week cycle.

Chart 2 – Growth of $1,000 during Bullish Phases of 40-week Cycle

Chart 3 displays the growth of $1,000 invested in the Dow in the following manner: starting on 9/8/1967 (i.e., 20 weeks after the start of the first 40-week cycle on 4/21/67) the Dow was bought and held for 20 weeks at which point it was sold. Twenty weeks later the process was repeated.  In other words, Chart 3 displays the growth of equity if one invested only during the “bearish” 20-week portion of the 40-week cycle.  

Do you notice any difference between Charts 2 and 3?

Chart 3 – Growth of $1,000 during Bearish Phases of 40-week Cycle

Although it cannot be explained – and in fact many people would simply dismiss it as a fluke – there can be little question that the market has performed much better during the “bullish” phase of the 40-week cycle than during the “bearish” phase.

MID-AUGUST THROUGH EARLY JANUARY

The 40-week cycle is presently in a bearish phase.  The next bullish phase for the 40-week cycle begins at the close of trading on 8/19/05 and extends through the close of 1/6/06, which happens to be the fifth trading day of the new year.  Now let’s take a look at what has happened previously in the market between 8/19 of each year ending in “5”, and the fifth trading day of the year ending in “6”.  Be forewarned, the results are fairly compelling.

Chart 4 displays the growth of $1,000 since 1900, assuming an investor had bought and held the Dow only for about 4 ½ months out of every decade.  In other words, once every decade, he would have bought the Dow on the close of trading on August 19^th of the year ending in “5”, and then sold at the close of trading on the fifth trading day of the next year.  

Do you notice a trend in Chart 4?

Chart 4 – Dow Performance between August 19^th of Year “5” and the 5^th trading day of January the next Year

Table 2 displays the results in tabular form. As you can seem, in all cases, this period witnessed a gain by the Dow, in many cases spectacularly so. The average gain during this time period was +14.4%. This works out to an annualized gain of +37%, far exceeding the typical market gain of 9% per annum.

Table 2 - % gained by Dow between August 19^th of Year “5” and the 5^th trading day of January the next Year

Chart 5 displays the same information as that shown in Chart 4 except that all of the time spent out of the market has been removed from the data.  In other words, this chart shows only the activity during the times when this test was in the market (i.e., between August 19^th of Year 5 and the fifth trading day of Year 6 for each decade since 1900).  This too is a fairly compelling chart as evidenced by the steady growth of equity and the minimal drawdowns.

Chart 5 - Dow Performance between August 19^th of Year “5” and the 5^th trading day of January the next Year (all other periods excluded)

Speaking of drawdowns, Table 3 shows the worst drawdown experienced during each August “5” to January “6” bullish period.  As you can see, the worst case was a drawdown of -10% in 1955.

Table 3 - % gained by Dow between August 19^th of Year “5” and the 5^th trading day of January the next Year

SUMMARY

Does all of this mean that the stock market is destined to rise between 8/19/05 and 1/6/06?  Is this a sure thing that we can take to the bank?  Should we mortgage the house and kids, buy stocks on margin and wait for the huge profits to roll in?  Ah, if only.  In reality what we have is this: Based on prior historical trends, we should be giving the bullish case every benefit of the doubt between 8/19/05 and 1/6/06.  However, if the market starts falling apart and breaks down, triggering sell signals from other models during this time period, we should be prudent and protect our capital rather than holding on and “hoping” that the cyclical forces will bail us out.  

Still, if history proves to be an accurate guide, there is the potential for a strong stock market after 8/19/05.  For what it’s worth, I’ve got that date circled on my calendar.

To search for previous articles written by Jay Kaeppel, please click here.

Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site 

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