Merriman Market Analyst

excerpt from The Ultimate Book on Stock Market Timing Vol I: Cycles and Patterns in the Indexes

The division between investors and traders carries over into "market (or investment) philosophy." Another generalization that depicts the difference between these two camps surrounds the issue of "market timing." To the trader, timing is everything. To the investor, the trend is your friend. To the long-term investor, buy and hold is the only sane approach to profiting in the stock market. The later group places absolutely no value upon trying to time stock market turns, or trend reversals. To them, it is an exercise in futility that will lead to inevitable losses.

But for the investor or trader, knowledge of cycle studies combined with either certain technical studies or fundamental analysis can be invaluable even over the long-term. This individual may start with the 50-week cycle, and identify its phasing within the longer-term 22-24 month cycles, and/or 4-year cycles in order to adjust his strategy from bullish to bearish (or vice-versa) perhaps once a year or longer.

In fact, one of the most disturbing solicitations perpetrated on the public by some security firms, mutual funds, and their fundamental analysts is that market timing is indeed a useless skill, that it is better to buy stocks at any time and just hold them. And yet if the public did just that, these firms would likely go broke for lack of adequate commissions. These firms, funds, and their analysts will frequently use charts and figures that show how much money one would have made if he would have just bought a basket of stocks at anytime - even at the highest prices of the index for any year - and held on for any ten-year period. They rave about how such a strategy would out-perform bonds, gold, cash, real estate or most other forms of investments over a similar period of time.

This argument holds some truth. It is true that since 1932, one could have purchased stocks that reflect any of the major U.S. stock indices during any year, and within ten years that index would be higher in price. It doesn't matter which year one chose, nor does it matter where within that year one chose to purchase (even at the high of the year). Regardless of the year, or the date within the year, it is a fact that ten years later that index would be higher than it was at the time of purchase.

But figures, charts, and resultant claims can be misleading. This particular assertion is misleading for several reasons. First, most investors do not typically buy a basket of stocks containing the companies of the Dow Jones Industrial Averages, or S&P companies, or any "basket" that reflects these major indices. Thus their particular investments do not usually "mirror" the major stock indices. Sometimes they are better, but according to most studies, they usually perform worse than the overall indices. Secondly, investors do not typically hold on to their positions for an average of ten years. True, long-term investors do hold on for ten years or more. But they are a relatively small part of the investment community. And do you think a brokerage house or its brokers are going to advise you not to sell (or transfer to other vehicles) your holdings if the trend of the stock market turns bearish? Most investors of stocks typically do not want to ride out a bear market when their monies could be gaining in value in other investment vehicles. Thirdly, these statistics do not show performances for periods of time that actually reflect cycles in the stock market. Investors typically make investment decisions based upon their perceptions of current or potential bull and bear markets, and usually these are measured by the four-year cycle (or some economic cycle of less than ten years), and not according to arbitrary ten-year periods. It is also interesting to note that the "ten-year" intervals which are used in these solicitations, only show performances since the 1932 depression low, which of course gives a very different result from ten year periods prior to 1932. So for the moment, allow me to present some figures that support the importance of market timing to an investor, at the risk of conveying misleading implications as in the case of the brokerage houses and mutual funds which take the opposite viewpoint.

If one would have invested in a "basket of stocks" (like the Dow stocks) in September, 1929, his investment would have lost nearly 90% over the following three years. Furthermore, it would have taken 25 years to "break even" on the investment of 1929 - assuming the companies did not go out of business, and assuming they recovered equally to the Dow Jones Averages. How much better off would he have been to put his money in U.S. Treasuries at that time? Simple savings compounded at 5% annually would have resulted in a gain of nearly 250% which - though not great - sure sounds a lot better than the zero result of investing in the stock market over that same period.

But let's look at this subject from the simple point of view of the four-year cycle. Let's assume an investor bought into the stock market near the top of every four-year cycle crest. This is not so far-fetched since 1) stock markets top out when the news is very positive, 2) the public tends to buy - not sell - as the stock market is topping out, and 3) the brokerage community does its greatest sales volume when the stock market is making highs.

The table below identifies the 4-year cycle crests in the U.S. stock market since 1895, and then the date afterwards when the market recovered to that same level. The number of years and months it took to recover just one's initial principle is next indicated. When looking at these crests, bear in mind that they are not four years apart on average. These are the crests that unfolded between the two troughs that were - on average - four years apart. It is the troughs that define the cycle length. Nevertheless, the general rule still holds: the public (the investor) tends to be optimistic and buys stocks near the crest, when the economy and the general stock market look most promising. Volume is usually very high near the peaks, and very low near the troughs, comparatively speaking.

The asterisks (*) in this table represent those cases where the market may have recovered back to the level of the prior 4-year crest, but just barely. Shortly afterwards, it declined again for several months (even years) before taking out the original crest (entry point) again. If those cases were eliminated, the results would be even more striking - it would have been a much longer interval until "recovery of one's investment" was attained. Nevertheless, in the 26 cases of four year cycles since 1895, the average amount of time it took the market to recover back to the level of a four-year crest was 5 years and 4 months. The actual time of recovery varied from as short as 6 and 10 months (following the crests of 1926 and 1990) to as long as 25 years (following the crest of 1929). However, if we eliminate the two cases prior to the "Great Depression" trough of 1932, which were over 20 years in each case, and the 1926 and 1990 cases which were the shortest recovery times, we still get 22 instances with an average interval of recovery of 49.41 months, or slightly more than four years. In these cases, the time of recovery varied from 1 year and two months to 9 years and eight months.

Table 1: Instances of the crest of the four-year cycle in U.S. stocks, and the length of time it took the stock market to get back to that crest afterwards. The asterisks represent cases in which the market just barely recovered before declining again.

So would there have been any advantage to timing the stock market cycles, particularly the 4-year cycle? Is there any value in market timing over the long-term? The answer should be very evident by now. And it is not what the firms and funds want you to believe.

Thus it is apparent that a buy and hold strategy is not always profitable to most investors. It may be to a long-term investor, providing he can and is willing to wait for as much as four years on average to see a profitable return on his investment, particularly if he chooses to invest in stocks while it is near a four-year cycle crest.

So when is the best time for an investor to enter the stock market? The answer is near the bottom of the four-year cycle. Obviously it is not always easy to know when a four-year cycle trough in stocks is forming. In the chapter on the four-year cycle in U.S. stocks, it was clearly shown how the market declines at least 12% (with an average decline of 36.4%) following the peak of that cycle. It was also shown how long in time it takes to form that four-year cycle. So a very good rule for an investor to apply to the stock market is the following: Purchase stocks (invest, buy and hold) when the stock market declines at least 12% from its previous crest, and when it is within the time band for a four-year cycle trough (which means the decline may be even more than 12%). Even if you are a long-term investor, one who subscribes to the "buy and hold" philosophy, applying this simplest form of market timing can result in a tremendous increase in investment performance over time.

Postscript:

Since this article was written in 1997, the U.S. stock market made a 4-year cycle trough in October 1998. The high that preceded occurred in July 1998. In this instance, it took 6 months (January 1999) before the market recovered the 21.5% loss it encountered between July and October. This tied for the shortest recovery time on record, with the cycle which occurred in 1926.

About Author:

Raymond A. Merriman is a Market Timing Analyst and President of the Merriman Market Analyst, Inc. He is editor of the MMA Cycles Report, a market timing advisory service used by individual traders, investors, and financial institutions around the world since 1981. He is also the author of several books on market timing, including: The Gold Book: Geocosmic Correlations To Gold Price Cycles (1982); The Sun, The Moon, and The Silver Market: Secrets of a Silver Trader (1992); Merriman on Market Cycles: The Basics (1994); and The Ultimate Book on Stock Market Timing Vol 1: Cycles and Patterns in the Indexes (October, 1997). He may be reached at P.O. Box 250012, W. Bloomfield, MI 48325, or 248-626-3034, Fax 248-626-5674, e-mail at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it , or internet at www.mmacycles.com