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The Second Secular Consolidation:

Unlike the first, the 1937-1950 secular consolidation (Figure V) only contained seven cyclical phases (three bulls, three bears, one consolidation) and lasted just over thirteen years. The first cyclical transformation was one of the shortest, yet most devastating bear markets of all time. It lasted about one year but managed to shed 50% of its value. Conversely, this secular channel also created one of the greatest cyclical bull markets to ever appear in a secular consolidation phase. The 1942-1946 cyclical bull market delivered gains in excess of 130% and lasted just beyond four years. The end of this astonishing cyclical run (Point A) came about eight years into the consolidation when it attempted to break above the 195 SCR level for the first time.


Figure V

The technical action is comparable to the 1916 top (Figure III) in that when the market crossed 195 on Jan. 9, 1946, it failed less than one month later while still continuing to hold the larger cyclical bull trend. It immediately made a second attempt on March 21, 1946 but topped out in May 1946 at 213 (9.2% above the SCR). This changed the secondary – not cyclical – phase from bull to bear. From there only a few technical confirmations were needed to substantiate a change in the secular phase from consolidation to bull. First was a successful re-test of the SCR breakout followed by a break back above the most recent secondary bear.

By July 29, 1946 the market re-tested the SCR and again began to move upward. On Aug. 14, 1946 it hit the secondary bear trend, stopped dead in its preverbial tracks and persisted to decline back below the SCR on Aug. 27, 1946 and signaled a technical failure. The SCR cross correlated to a break of the longest cyclical bull trend within a secular consolidation as of yet. The failure led to a 25% decline over a one year period.

By mid-1949 the market completed a two year cyclical consolidation and began another cyclical bull. Interestingly enough it only took five months to attempt the 195 resistance once more. On Dec. 5, 1949 it took out the SCR level on 1.5 times ADV. On Jan. 13, 1950 the market re-tested the breakout but never changed secondary phase from bull to bear while doing so; somewhat unconventional. The advance peaked at 229.2 (17% above the SCR) on June 12, 1950. This time the market did finally break the smaller secondary bull trend when re-testing the SCR.

Seven months from the original SCR break (July 13, 1950) the market successfully re-tested the SCR. From there it continued its confirmation by surpassing the secondary bear trend and completing a continuation/confirmation break from the last peak. The successful completion changed the secular trend from consolidation to bull which lasted just over 16-years, returning over 400%.


The Third Secular Consolidation:

The third secular consolidation began on Feb. 9, 1966 at 1001 (Figure VI). This was very similar to the first macro channel given it encompassed eleven cyclical trends (five bears, five bulls and one consolidation). Also similar was that it had three separate attempts (Point A, B and C) at crossing the SCR level which the first (Point A) occurred seven years into the consolidation.

Without going through each incidence, suffice it to say they were all similar in their failure patterns as demonstrated in the prior examples (1916 graph and 1946 description). Additionally comparable is that all the failures lead to some of the most devastating cyclical bear markets in history. Accordingly, the final breakout was also technically similar in that it…

• Broke above the SCR on massive volume
• Began a new secondary bear trend
• Successfully re-tested the SCR
• Broke above the secondary bear
• Confirmed again with a follow-through break above the recent secondary bear top

As we all know, these events kicked off the largest secular bull market in U.S. history which lasted over eighteen years and returned more than 1000%.


Figure VI


The Fourth Secular Consolidation:

Just over seven years ago (Jan. 14, 2000), the market topped at 11,750 and entered what I viewed as the fourth secular consolidation phase (Figure VII). Since that point the market has gone through three cyclical phases (one bear, one consolidation and one bull - which it’s still in as of this update). Coincidently this consolidation most resembles the 1937-1949 period because of the length and number of its cyclical cycles. Almost seven years into the channel – Sep. 27, 2006 – the market broke above the SCR on 1.2 times ADV (Point A). Hence the $64,000 question - is the market transitioning into a new macro secular bull phase?


Figure VII

Now that I’ve dissected what occurs during successful and unsuccessful transitions from a secular consolidation, it’s time to apply the analysis to present day. The first step is to reduce the timeframe to a weekly chart and definitely find the cyclical bull market trend (Figure VIII). This was simple considering the market has managed to bounce off of it six times in the last 3 ½ years.


Figure VIII

Now I dive deeper to evaluate the subsequent minor timeframe from a daily graph (Figure IX).


Figure IX

This chart begins with the market’s first attempt at the SCR in May of 2006. The failure to surpass brought about a secondary shift from bull to bear which re-tested the larger cyclical bull twice before starting anew. After the re-test and completing a divergent bottom the market began a secondary bull. On Sep. 27, 2006 the market pushed its way above the SCR on only 1.1 times ADV and climbed in excess of 9% above before topping.

The recent Feb. 27, 2007 drop changed the secondary trend from bull to bear and started the market heading for a SCR retest. Interestingly enough it never actually made it down to the SCR and on March 14, 2007 it put in a divergent reversal day (lower intraday low which closed at the high). Not more than three days later it broke back above the secondary bear trend and changed the short-term back to bull. On Friday April 20th the DJIA surpassed the secondary bear top on 1.2 times ADV bringing forth a continuation/confirmation.

Nonetheless, there are still some lingering issues that fail to provide 100% confirmation that this is a true change of secular trend. Until this point, the update has been exclusively technical in nature and has failed to address one of the most noteworthy facts contained in the original Theory which reads:

Distilling data to increase probabilities [of success] - that’s the name of the game!

Resulting from this work, it is our contention that in all likelihood the market has entered yet a fourth consolidation period whose channel logically ranges from a 7,200 low to a 12,000 high. Also inherent within this contention is the idea that the channel will not end until the P/E multiple again crosses back below the undervalued 10 level. Most likely this will not transpire for many years to come and be aptly related to the length of time of the latest bull run – nearly 18-years.

By simply taking a glimpse at TAM's New Dow Chart containing data through 2006, you can plainly see that not only has the 10-year smoothed P/E multiple not yet crossed the undervalued level of 10, it hasn’t even dropped back below the overvalued level of 22. From a valuation standpoint this is very disconcerting. Under no circumstances throughout history has there ever been an occasion where the market has successfully broken above the SCR and changed phase from consolidation to bull without first reducing the excessive overvaluations inherent within the multiple.

With that being said, there are also a few additional concerns on the technical front which have to be taken into consideration such as:

• All of the other secular channels have had failures before successfully transitioning
  • The fourth has had no failures as of yet
• All previous “first” attempts/failures occurred seven to ten years into the channel
  • This consolidation's first cross of the SCR took roughly seven years
• The market’s failed attempts have surpassed the SCR by as much as 19% before fading
  • At present it is roughly 9% above the SCR
• All previous secular consolidations consisted of seven to eleven smaller cyclical trends
  • The market has experienced only three cyclical trends thus far
• All of the other secular channel breakouts successfully re-tested the SCR
  • A true retest has yet to occur
• The recent SCR cross had the lowest relative volume within all four consolidations
• The SPX has yet to confirm a breakout and won’t happen until it crosses 1,553
• The majority of failures have lead to devastating downturns

Conclusion:

However daunting the contrary conditions may appear, they do not negate the fact the Dow Jones Industrial Average is at new highs and has managed to hold above the secular consolidation resistance and the cyclical bull market trend.

Most professional money managers look at the horizon to ascertain possibilities, weigh risks and evaluate potential scenarios in order to manage the road they are on. The intent of this analysis is to help determine the best course of action depending on one’s investing time horizon and risk tolerance. That perspective is different for everyone and the implications of the Theory pertaining to personal strategies are left in the hands of the individual. Understanding the nuances within the various timeframes ensures a comprehensive awareness of the multiple interpretations for the potential road ahead.

At this juncture, at TAM our view is that it is not critically important to determine if the market has moved into a new secular bull phase or is just a continuation before failure. What will be meaningful is if the market does break the current secondary bull trend followed by a break of the cyclical bull and the secular consolidation resistance level. If this scenario occurs (the key word being “if”) then, and only then, would the latest move become a false-positive and have drastic ramifications on our future outlook for the U.S. equity markets.