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-- Posted Friday, 22 December 2006 | Digg This Article

TECHNICAL SCOOP FOR DECEMBER 22, 2006

Charts and technical commentary by David Chapman

 Union Securities Ltd, 33 Yonge Street, Suite 901, Toronto, Ontario, M5E 1G4

fax (416) 604-0533, (416) 604-0557, phone (toll free) 1-888-298-7405

david@davidchapman.com

www.davidchapman.com

Offering an annual forecast has to be one of the biggest mug’s games on both Wall Street and Bay Street. That doesn’t prevent many from trying. At least nobody claims to have a crystal ball or mystic powers. We certainly don’t. But if there is one thing we have learned about technical analysis, it is that patterns repeat themselves. And that forms the essence of our forecasts.

W.D. Gann, the famed technical analyst of the early 20th century, showed that he could accurately determine the points at which stocks or commodities should rise or fall within a given time. We confess we are not experts on W.D. Gann. But we do follow Gann experts such as Michael Jenkins of Stock Cycles Forecast (www.stockcyclesforecast.com). So his thinking does creep into our writings and we certainly appreciate what we have learned from Mr. Jenkins. But we also read a lot of other material and try to maintain a broad perspective. And it is that perspective that we hope forms the basis of our writings.

Market performance in 2006 has exceeded most forecasts. After the rather flat year of 2005, expectations were not high for 2006 being much better, although Abby Joseph Cohen of Goldman Sachs predicted 1,400 for the S&P 500 (and she was pretty close).

In May the market started to fall, raising the spectre that the four-year presidential cycle of market troughs was getting under way. Even after the market rallied back in July, the expectation was that if the four-year trough was indeed commencing, the rally would not last. We cited the 60-year cycle that showed a secondary top in August following a major top in May 1946, and then a sharp collapse into October. It didn’t happen this time.

The Record to Date 2006 – To December 15, 2006

Instead the bulls have continued to follow the 1936 bull market that just kept going up into year end with barely a pause. Last year we noted “So 1936 might be worth a look given the continued flow with the 1930’s cycle (70 years)”. In 1936 the mid-year pause occurred in April/May and after that it was almost straight up into year end. Indeed, after a brief pause in December 1936 the market continued its amazing rise into early March 1937. After that it was lights out for five years as the 1937-38 bear market wiped out over 50 per cent of market values, and despite some rolling around over the next few years the final bottom did not occur until 1942.

Almost forgotten in the market euphoria since last July is that the energy, precious metals, and metals and mining sectors have also had a good year. They too topped in April/May along with the broad market but that has been largely it ever since, except for the metals and mining sector that just kept going up. The TSX Metals & Mining sector was showing a spectacular 72.9 per cent gain at December 15. While the TSX Energy Index lagged at +3.2 per cent on the same date, its bigger US cousin the XOI Index was up a sharp 24.4 per cent despite Natural Gas struggling all year (down 29 per cent). Silver was also a big performer. up 48.3 per cent. The Gold Bugs Index gained 22.5 per cent and the TSX Gold Index 27.5 per cent.

The gains in the commodity sectors overwhelm the gains in the broader market, but since they have been generally down since topping in April/May it has felt as if they were poor performers this past year. Not so. Since 2000 the commodity, energy and precious metals sectors have solidly outperformed the broad market. The S&P 500 is still about eight per cent under its highs of 2000 and the NASDAQ has not recouped even 38.2 per cent of its huge 2000-02 collapse. The Dow Jones Industrials has seen new highs but it has been a lonely walk.

The seventh year of the decade has a decidedly mixed record. The record for the Dow Jones Industrials since inception is a dead heat of six up and six down.

It doesn’t particularly help us if the prior year (ending in 6) was an up year or a down year. When years ending in 6 were up (seven times), the year ending in 7 was down four times and up three times, including the past two. When years ending in 6 were down (five times) the year ending in 7 was up three times and down twice (and down big, both times).

The coming year will be the third year of George W. Bush’s second semester. There were eight other presidents who enjoyed second terms since the inception of the Dow Jones Industrials. Here the record clearly favours the bulls with six up and two down. It is also a pre-election year and the general record for the market shows that the first 6-7 months tend to outperform. Typically the incumbent President is opening up the spending spigots in order to stimulate the economy in the prior year to the election to help increase the odds of re-election.

With the record of years ending in 7 a dead heat, following an up year in 6 slightly favouring the bears, the third year of a second-term president favouring the bulls, and a the pre-election year also favouring the bulls we have to turn to our key cycles to look for a hint of what is to come for 2007.

Michael Jenkins has always emphasized the importance of the 100-year cycle. One hundred years ago we had the San Francisco earthquake (April 1906) and a financial panic known as the “poor man’s panic” in 1907. This time, a few months earlier, we had the New Orleans hurricane disaster in September 2005. The housing market did not begin its collapse until several months later. With housing supply clearly exceeding demand we do not believe the bottom has been seen. The economic fall out is being delayed and 2007 might soon bear the brunt of that collapse.

Thirty years after 1907 came the 1937 collapse that wiped out most of the 1932-33 advance. And 30 years ago, in 1977, the market collapsed on the back of huge (for those days) trade deficits, a sharply falling US dollar and rising interest rates.

Ninety years ago, in 1917, WW1 was raging. The USA entered the war in April 1917. In May the draft started and the market kept falling all year long. Now we are hearing that they are talking about increasing troop numbers in Iraq instead of withdrawing and we read they are preparing plans for a military draft. We are reminded that US warships continue to gather in the Persian Gulf, offshore from Iran. The US has been in a bellicose, off-and-on spitting match for years over Iran’s nuclear program, most recently with its volatile President Mahmoud Ahmadinejad.

One of the bullish cases for the market in 2007 is the master 60-year cycle that saw a small up year in 1947. But that followed a down year in 1946. The 10-year cycle is also encouraging, as 1997 was a very sharp up year. But the 10-year Japanese cycle is very negative as the Tokyo Nikkei Dow collapsed in 1997-98 following an up year in 1996.

The four-year presidential cycle that was due to bottom in 2006 also has an interesting history. On occasions it has not worked, as we have seen in 2006. The last time we stretched out was 1982-87 where the market kept rising into 1987 before the famous stock market crash that October. The 1932-37 market also stretched further than expected. Of course, what followed was a huge collapse in 1937-38. We also found that the market stretched in 1912-17 and the 1917 collapse was quite vicious. The lesson seems to be that while we can get through the fourth year without making our trough, we do not survive the fifth year without paying for it.

We remind everyone that we still have our major long-term cycles in play. The cycles outlined by Ray Merriman of MMA Cycles Report (www.mmacycles.com) include a 90-year cycle and a 72-year cycle that in turn sub-divide into 36-year and 18-year cycles. He believes both the 90-year and 72-year cycles bottomed at the time of the Great Depression in 1932. If so, then the 72-year cycle low is due 2004 +/- 12 years and the 90-year cycle is due 2022 +/- 15 years. The two overlap from roughly 2007 to 2016, so we are just entering that time period now.

The 36-year cycle last bottomed in 1974 and has a range of 30-42 years. The current 36-year cycle low is due during 2004-16. Finally, an 18-year cycle low with a cycle range of 15-21 years last occurred in 1987. It is due to unfold 2002-08, so it is possible that one bottomed in 2002. The next one would be due between 2017 and 2023, which is also the outer range of the 90-year cycle.

Our presidential four-year cycle falls within the context of the 18-year cycle, where Merriman notes there are usually five of them. As we noted, the current one was due in 2006 but the cycle does have an observed range of 36-56 months. The low therefore could occur as late as June 2007.

It is possible that the drop seen into June/July 2006 was the four-year cycle low. If so, it had to have been one of the most shallow on record. The drop on the S&P 500 was only eight per cent. The 1998 four-year cycle low drop, for example, was 21.6 per cent. But the 1994 four-year cycle low fall was only about 10 per cent, so it is possible. Given the low volatility as measured by the VIX indicator and the current high bullish consensus factor, we doubt that the low has occurred. But the thought can not be dismissed and we recognize that the low volatility (as measured by the VIX) can continue for some time.

There is also the well-known Kondratieff Wave that has an observed range of 50-60 years. The consensus last bottom for the previous Kondratieff Wave was 1949, so once again we are in the range for its trough. The Kondratieff Wave has generally approximated to the life span of a man, and with man living longer, it is possible that this one could extend and fit more with the longer 72-year and 90-year year cycles.