There is no question that we are in a severe bear market. From a record high of more than 14,164.53 on Oct. 9, 2007, the Dow Jones Industrial Average (DJIA) fell to 8,777.67 on Dec. 31, 2008. If any financial indicator in your electrical contracting business fell to 62 percent of what it was, you would expect your investors to demand a clear explanation.
Things are not as simple as they seem, though. Four of the five days showing the largest point gains for the DJIA occurred in the fourth quarter of 2008, but so did four of the five worst days. Oct. 9 was the best day, with a 936.42-point (11 percent) gain, closing at 9,387.61. The worst was September 29, with a loss of 777.68 (nearly 7 percent), closing at 10,365.45.
The highest percentage drop in history was 24.39 percent on Dec. 12, 1914. We can only guess at what caused that massive “adjustment” so long ago. No single factor can accurately predict or define a change in the market. Unfortunately, few analysts can either predict or consistently analyze the reasons for the changes in stock market performance.
Predictions and systems
There is general agreement that the economy lags behind the stock market by up to a year, but most attempts to predict trends are merely extrapolations based on historical data and limited by hindsight. They fail to account for changing conditions.
Charles Dow, who founded The Wall Street Journal with Edward Jones, used a strict “technical analysis” based on tracking price and volume over three simultaneous cycles (day-to-day, 10 days to three months, and up to four years). After Dow’s death, this technique became known as the Dow Theory, and the cycles have been referred to as waves of varying size.
Benjamin Graham, a money manager and Warren Buffett’s mentor, used “fundamental analysis,” based on the strengths and weaknesses of the company, with no concern for trading price or volume. Graham believed that every stock had an intrinsic value based on the company’s ability to generate earnings and that stocks should be bought below that value and held until it was realized— Buffett still uses the “buy and hold” approach.
Buffett built his company and reputation on patience and contrarian timing, exercising the discipline necessary to buy low and sell high. He is famous for this saying, “Be fearful when others are greedy and greedy when others are fearful.”
Flaws in the analysis
All these approaches are successful, but not one attempts to integrate all factors that affect stock market trends or allows for the unpredictability of investors. For example, a rise in consumer confidence is followed by higher stock prices, which result in further increases in consumer confidence and higher stock prices. The upward trend should go on forever, but it doesn’t. And we don’t know what triggers the change in direction.
Should we be fearful or greedy now? Economists predicting a stock market crash tell us that the combination of a bear market and devaluation of real estate is causing a major reduction of our collective national wealth, creating economic conditions more severe than during the Great Depression. Yet, some investors will profit.
Also, statistical analysis is imperfect. Two factors may correlate (occur together or in sequence), but that doesn’t prove one factor causes the other. Add the impossible task of determining how investors will respond, and it seems ludicrous to attempt any prediction of stock market trends or cycles. What people believe is often based on fallacies that circulate almost instantaneously through the Internet, without adequate context or factual verification.
Waves and Fibonacci
Perhaps the most intriguing approach is the “Wave Principle,” developed in the 1930s by accountant Ralph Nelson Elliott. Using the work of 12th-century Italian mathematician Leonardo Fibonacci, Elliott discovered that crowd behavior occurs in recognizable patterns and that the stock market investment cycles can be analyzed using Fibonacci’s Golden Ratio. Tracking stock prices through cycles that ranged from a few minutes to centuries, he asserted that the stock market reflects the pattern of mass human psychology, with human progress taking “three steps forward, two steps back.”
Wave patterns already appear in the Dow Theory, and the Golden Ratio has been found throughout nature (for example, in the proportions of a nautilus shell and the human body) and the universe. Former Merrill Lynch analyst Robert Prechter used Elliott’s system to set a U.S. Trading Championship record, achieving a 440 percent gain over four months. If you are skeptical, review the tutorial at www.elliottwave.com.
As you make investment decisions, keep an open mind. Whether you believe there is a pattern to stock market cycles based on predictable natural harmonies that also reflect human behavior, base your decisions on intuition or a coin toss, remember the universal disclaimer—past performance is no guarantee of future results. So, are you feeling fearful or greedy?
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at email@example.com.