Market Analysis without the Wall Street Hope and Hype

Bull & Bear Market Relationships
BY TIM W. WOOD

Originally published in 2003

Updated August 14, 2009

According to Dow theory, each bull and bear market period has three separate phases. This phasing is an important aspect of the Dow theory that is most often over looked. I have spoken in the past about this phasing and today I want to address this topic again. I will show you the three phases of the 1966 to 1974 bear market as well as the rallies that separate each of these phases.

In 1942 the second great bull market was born and concluded in 1966. I call this period a great bull market because in the early days of the averages these Dow theory bull and bear market periods consisted of single 4-year cycles. The bull market being the upside piece of the cycle and the bear market the downside piece of the cycle. This changed in 1921 with the birth of the first great bull market that consisted of two consecutive 4-year cycles that ended in 1929. The second great bull market, again, ran between 1942 and 1966. The third great bull market ran between 1974 and 2007.

But, it is not the bull market that I want to focus on here. No, it is the bear markets that always follow and I specifically want to compare the three phases of the 1966 to 1974 great bear market to today’s ongoing secular bear market. I have included a chart of this period below.

Phase I of the second great bear market began at the top in February 1966. This top was confirmed under Dow theory in May 1966. From this top the market declined into the Phase I low in October 1966. This Phase I decline is marked in blue on the chart above and it carried the market down some 25%. From this Phase I low the typical rally that serves to separate Phase I from Phase II began. This rally carried the market up some 26 months and is marked in green on the chart above. During this 26 month advance you can see that there were a couple of false breakdowns that the market was able to recover from and inevitably pushed higher. In fact, with the advance into 1968 bettering the 1967 secondary high points, a traditional Dow theory trend change even occurred.

But, those who understood Dow theory phasing would have understood that this was a bear market rally separating Phase I from Phase II of a much longer-term bear market and not a new bull market. I can also assure you that the longer this rally lasted the more bullish and more convinced the public became that a new bull market was underway. Also, when the market would recover from these false breaks, I strongly suspect that the bullish sentiment must have been off the chart. I’m also sure that the Dow theorist’s continued to warn, but that few understood or listened to these warnings. Then, with the Dow theory trend change in 1968 I’m sure that the public was convinced that a new bull market was underway. They probably proclaimed that anyone stating anything other than this "obvious" bull market needed to be admitted for a psychiatric evaluation. After all, this was "obvious" and anyone not seeing it was obviously blind.

However, in spite of the false breaks, the bullish sentiment, false recoveries and claims of new bull markets, the Dow theory phasing prevailed and the decline into the Phase II low carried the market down some 36% to new lows over a 17 month period. This Phase II decline is marked in yellow on the chart above.

Then came the rally separating Phase II from Phase III of this ongoing secular bull market. This rally carried the market up 66% over a 32 month period. This advance is also marked in green on the chart above. Once again, the world was convinced that the bear market was over. After all, the market had made a new high. How in the world could we still be in a bear market with the market at new highs? Those Dow theorist’s had to be wrong this time around because this time was different and it was "obvious" with the market at a new all time high.

But, once again, the Dow theory phasing prevailed and Phase III took the market down 45% into the final Phase III low. This low marked the bottom of the second great bear market. This time, those who understood the Dow theory were shouting from the roof tops to buy. I know for a fact that Richard Russell called this bottom as I have read his old newsletters from that time. History tells us that the public was so beaten down by the time the Phase III low had occurred that once again they did not listen to the Dow theorists. Bearish sentiment was sky high and anyone pushing stocks at this point again needed mental counseling. Who in their right mind would buy stocks after suffering through these declines? However, the Dow theory phasing was proven correct and the third great bull market that ran until the 2007 top was born at the 1974 Phase III bear market bottom.

This brings us to our current chart below. From the 2007 top, the Industrials dropped some 53% over a 17 month period into the bear market Phase I low in March 2009. This decline is marked in blue on the chart below. From that low the typical rally separating Phase I from Phase II began. Yes, there may be several false breaks, as was seen in 1967 and 1968 before the top is reached. But, just as with the 1966 to 1968 rally, the longer this rally lasts and the more false breaks we see the more convinced the public will become that this is a "new bull market." Yet again, I must stress that the key is a seasonal cycle advance that tops in 6 months or less and/or a failed seasonal cycle.

For now, this rally lives on and identifying its top will be an ongoing process that I will be covering in great detail at Cycles News & Views in the research letters and short-term updates. In the meantime, the point I want to make clear here is that regardless of how long this rally lasts, it still appears to be a bear market rally that should prove to separate Phase I from Phase II of a much much longer-term secular bear market.

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