One of the big debates taking place this year in financial circles concerned the possible effects the 4-year cycle bottom would have on the markets and economy this year, particularly around September when it was expected to bottom. A rather large contingent of analysts expected a big decline similar to the one that hit the market in 2002 at the previous 4-year cycle bottom as well as the big decline at the 4-year low of September 1998. 

Some analysts were of the opinion that the stock market’s June-July low was the 4-year cycle bottom. The argument behind this interpretation was that the cycle had "migrated" forward for various reasons provided by the proponents of this theory. But the yearly cycles -- including the 4-year cycle -- always bottom in the September-October time frame of any given year which disqualifies this interpretation. A cycle by definition is fixed in time, not dynamic, otherwise it’s not a cycle in the technical sense. 

In their book "Cycles: The Science of Prediction," a classic among cycle theorists, authors Dewey and Dakin propose a 3 1/2-year rhythm. In doing so these famed cycle researchers set in motion a trend toward "cycle averaging" that has been in force ever since and which has done more to set back the science of cycle research than to advance it. Other analysts and cycle watchers claimed that the cycle would bottom when it bottoms, that is, we’ll know it only in retrospect. This theory is similar to the one above that holds that cycles are dynamic in nature and can fluctuate around a given time period, i.e., a 4-year cycle is held to merely average 4 years instead of bottoming at regular 4-year intervals. This interpretation is technically lax as well and must be discarded by any serious student of the cycles.

Another interpretation is one worth discovering and is the one we’ll discuss in this commentary. This theory suggests that there may not even be a 4-year cycle, at least not the one most commonly held to exist by most exponent of financial cycles. 

Those of you who’ve been in the stock market a number of years know that the learning curve in this business is never-ending. Along those lines, I had a conversation with my friend Samuel "Bud" Kress recently following the September 1 cycle bottom. Although the dominant interim weekly cycle bottomed at this time as anticipated, which gave rise to the extended rise in the Dow and S&P 500 indices, the 4-year/8-year cycle was also scheduled to bottom in early September at the same time as the weekly cycle, which should have been accompanied by a conspicuous downward move to mark the bottom (as would normally be the case following a major yearly cycle bottom). This year was obviously an exception since the market low was actually made in June-July. So why no emphatic bottom in early September as would normally be expected? 

Kress’s conclusion, looking back at the long-term data and in view of September 1 this year, is that there actually is no such thing as a 4-year or 8-year cycle, per se, a rather controversial statement to be sure. To support this revised view he points out that in some years the 4-year cycle is hardly seen at all (such as 1994, when it should have bottomed around September if it existed). In other years it can be seen quite emphatically (such as in the weeks leading into Sept. 1, 1998). The main component of this cycle, he points out, is the basic 2-year cycle. But another consideration is the peak of the 6-year cycle (or 3-year cycle bottom if you will). In years when the 2-year cycle bottoms and the 6-year cycle peaks simultaneously the market will have that emphatic downside "whoosh" we’ve all come to associate with so-called "4-year cycle" bottoms. But in years when the 2-year cycle bottoms (such as this year) but the 6-year cycle has already peaked the year previous (in 2005), and more importantly, then you don’t get an emphatic downside move in the stock market to accompany the 2-year cycle bottom.

To test his theory we can look back at the market’s historical performance (using the S&P 500 as the benchmark) and see how the market acted during years that were supposed to be "4-year cycle" bottoms. But instead of looking at just the so-called 4-year cycle we’ll be concentrating on seeing the interaction between the 2-year and 3-year cycles as Kress has proposed. Keep in mind that the 2-year cycle always bottoms around the beginning of September in every other year, and it’s always up in odd numbered years (2005, 2007, 2009) and always down in even numbered years (2004, 2006, 2008). Under this theory, for an emphatic stock market decline to occur two conditions must be met: the 2-year cycle must be down and the 6-year cycle must peak (i.e., 3-year cycle must bottom).

1982: 2-year cycle bottoms but 3-year cycle bottomed the previous year and is up in 1982. Result: Market triple bottoms in March-July-August and is up for remainder of year.

1986: 2-year cycle bottoms while the 3-year cycle bottomed in 1984; however, the 3-year cycle peaked around mid-1986 and was down the rest of the year. Result: Market falls hard down in September.

1990: 2-year cycle bottoms along with 3-year cycle. Result: Market falls hard into September.

1994: 2-year cycle bottoms, but 3-year cycle bottomed the previous year and is up in 1994. Result: Market double-bottomed in April-June and rallied vigorously into early September.

1998: 2-year cycle bottoms while 3-year cycle doesn’t bottom until 1999; however, since 3-year cycle peaked earlier in 1998 and was down rest of the year the effect is still the same. Result: Market is down hard into early September 1998.

2002: 2-year cycle bottoms along with 3-year cycle bottom. The more important 12-year cycle also bottoms at this time adding downward magnitude to the decline. Result: Market is down hard into September/early October.

2006: 2-year cycle bottoms but 3-year cycle bottomed the previous year which means 3-year cycle is currently up. Result: Market double bottoms in June-July and rallies steadily into October. 

2010: 2-year cycle scheduled to bottom in September. The 3-year cycle will have peaked earlier that same year and will be down heading into September. Likely result: Should be a "hard down" decline into September of that year.

As an aside, the 2-year cycle will be up in 2007 and the 3-year cycle won’t peak until spring. This should give rise to a bullish first half of the year in ‘07.

In the overall scheme of things I tend to agree with Kress’s conclusion that there is no 4-year cycle or 8-year, as such, when it comes to the stock market. I do, however, still hold that the 4-year/8-year cycle exists in the realm of money supply and which can be observed by looking at Federal Reserve moneys supply indicators. After all, every 8-year cycle bottom (1974, 1982, 1990, 1998, and even 2006 to some extent) has been accompanied by either an economic recession or a slowing down of the economy or some sectors of the economy. 

This year money supply growth has been severely restricted (when measured on a rate of change basis) so you could even say the 4-year/8-year money supply cycle has bottomed this year right on schedule. The recent bottoming of the cycle should be followed by a gradual loosening of the money supply by the Fed, probably by no later than early 2007. There are already hints the Fed is loosening up MZM growth on a very short-term basis. Indeed, preliminary indications from the bank credit statistics released by the St. Louis Fed as well as recent MZM trends show a loosening of the money supply has already begun and should work its way into the markets and economy between now and year-end.

Clif Droke is the editor of the 3-times weekly Momentum Strategies Report which covers U.S. equities and forecasts individual stocks, short- and intermediate-term, using unique proprietary analytical methods.  He is also the author of numerous books, including most recently "Turnaround Trading & Investing."  For more information visit www.clifdroke.com