This Aeronautical Engineer Holds the Secret to Today’s Unpredictable Market

I have talked in recent posts about the likely reasons why the market has defied what liquidity analysis suggested should be the onset of a bear market by now. The most important of those appears to be an increase in speculative leverage – margin, that is – which only increases risk over time.

Now it’s time to use the tools of technical analysis to look at two things – one, where the stock market is probably headed, and two, over how long a period. This is an exercise I undertake every week in the Wall Street Examiner Market Update Pro.

J.M.-HurstI use the cycle theories developed by J.M. Hurst in the late 1960s and early 1970s as the basis for that analysis.

Hurst, an aeronautical engineer, analyzed years of price data using Fourier and spectral analysis – all with the help of an IBM mainframe computer, which probably had about .01% the computing power of the phones we carry in our pockets today. But it was enough for him to note certain patterns.

Hurst’s observations resulted in the theory that the market had certain repeating cycles. Shorter cycles are nested within longer ones in a pattern that mathematicians call fractals.

Hurst found that those repeating cycles had tended toward certain durations, which can change over time. These cycles serve as the basis of my work in analyzing short term, intermediate term, and long term price patterns. Hurst called the principle of repeating waves of similar duration, the principle of nominality.

The idea is to look at enough of these nominal wave lengths to see the market’s short term and intermediate term directions in the context of longer term waves.

So instead of calling a trend short term or intermediate term, which are very nebulous, I look at them in terms of certain nominal cycle lengths. The most important of those for purposes of swing trading have nominal durations of 13 weeks, 6 months, and 10-12 months, as measured from the lows of successive waves.

Then for the purposes of analyzing long term trends, I look at cycle lengths of 18 months to 2 years, and then roughly 4 years. Anything longer than that is in the realm of a secular trend.

Today, I think that it’s important to show you how Hurst’s theories work to give you the best view of the current stock market…

Hurst’s Theories Show You that Timing Is Everything in These Markets

Liquidity analysis establishes long term secular trend context. It is on that basis that I have been forecasting at least a 4 year cycle top and bear market, and even a secular top and secular bear market.

But liquidity analysis is not a short term timing tool. There have have been times when liquidity flows have been good intermediate term timing indicators, but liquidity is not a closed system with a finite number of inputs. There are several major conduits and lesser pipelines for liquidity to reach the markets. What had been the most important drivers may recede in importance, and new influences may grow in importance.

The Fed and its cohort major central banks are still pre-eminent, but in the absence of direct QE the Fed’s influence is more indirect. The timing of the impact of its policy of removing liquidity from the system has been less clear than under QE. Back then, between 2009 and 2017, the Fed was actively adding cash to the accounts of Primary Dealers by buying Treasuries and MBS directly from them.

The Fed is no longer doing that. Under its program of balance sheet “normalization” the Fed pulls money out of the banking system indirectly. The impacts are more subtle, diffuse, and at times, delayed. Therefore, in the current environment technical analysis becomes more important in forecasting the market’s short term and intermediate term direction.

I do my technical analysis using tools that I learned from Hurst along with a few wrinkles of my own added over the 48 years since I first read Hurst. Needless to say, the tools of TA have become just a wee bit more sophisticated than they were in Hurst’s time, or when I first started using computers to do TA charting way back in 1982.

But one principle remains immutable. Timing is everything. It’s not the type of indicators that we use that matters. It is the use of correct time periods in those indicators that help us to better understand and forecast current trends. Furthermore, to better understand the big picture, we must look at multiple time frames.

In that context, in this week’s post in the Wall Street Examiner Market Update Pro on Monday, I wrote that “The 13 week cycle up phase is ideally due to last 2 more weeks. There’s a new projection of 2860. The 6 month cycle projection now points to 2840. The 6 month cycle is ideally due to top out on Friday.”

I then looked at the longer term cycles and wrote, “I have updated the 3-4 year cycle projection. It now appears to point to 2865-2965. That allows for the possibility that the top is in for this cycle or that it has another 5% of upside.”

I also looked at classical technical analysis using trendlines and support and resistance. I wrote that, “If 2800 holds, then the next target on the upside would be 2830, with a test of the January high likely if that is cleared.

After Wednesday’s surge toward a test of the January high, we’re just a stone’s throw of hitting that high of 2872.87 in the S&P 500.

As of Wednesday, the market was within the usual margin of error for the 13 week cycle projection of 2860, and it had exceeded the 6 month cycle projection that was derived from the market’s position as of last Friday.

Two Charts Prove that an SPX Breakout Isn’t a “Done Deal”

So what are the indicators telling us now?

This chart holds part of the answer…

VIX

On this chart, the market has broken through one set of trend resistance lines and has immediately run into another set of those lines.

But it’s not a done deal that the SPX will make a breakout or even a run at a full test of the January high.

The chart also shows 2 different momentum indicators measuring the speed of the move over periods of 17 trading sessions and 29 sessions. Those time frames are important because they are half the length of the nominal 6-7 week cycle (short term trend) and the nominal 13 week cycle (call that short term or intermediate). These half span indicators are best at showing when cycles are topping or bottoming.

The shorter indicator has reached a level where it has repeatedly peaked, leading to at least a short-term market pullback in each case.

The 29 day rate of change is ambiguous, but it shows that the market is not as strong over that time frame as it was in the initial stage of this rally. It’s not definitive, but I’ll take it as a yellow flag in the context of a market hitting trend resistance around 2850-60.

We also see the VIX, aka the “Fear Index,” plotted on an inverted scale to mirror the direction of the market, showing sentiment ready for a short term rollover.

Based on this chart, a breakout to new highs is far from a done deal. In the short run at least, a pullback is due.

For a longer term view let’s look at a cycle wave chart with a couple of long term cycle and momentum indicators. The perspective there is of a bull market that is topping out, but that may have a bit more to run.

Long Term Trend

First let’s get the two year cycle out of the way. It hasn’t been a factor in recent years. A shorter cycle, nominally 10-12 months from low to low, has been the dominant cycle for trading trends of 3-6 months. The indicators at the bottom of the chart show clearly that it is turning up.

Here’s what’s scary for bears. The last high for this cycle was at the end of January. Therefore, ideally the next high isn’t due until the end of November, and possibly as late as next January. That’s plenty of time to blow the roof off. It doesn’t guarantee that that will happen, but it suggests that time won’t be a constraint.

On the other hand, if the technical indicators for that cycle start to signal a rollover earlier than that it would suggest that the 4 year cycle is out of gas and in the process of rolling over.

The 4 year cycle is where the bears have a foothold. Its projected price channel (teal color, dashed line) is still trending higher. But the cycle indicators, including momentum, suggest that the cycle is in the process of topping out. The bad news for bears and good news for those who have ignored my warnings to get out of the market, is that those periods take many months, during which prices often continue to rise.

There are 3 Possible Scenarios. One Could Put Bears in Charge

The market is now challenging several long term upside channel projection lines.

In this context, there are 3 scenarios to watch for…

First scenario: The market could top out here, putting the bears in charge. A sharp drop in price accompanied by a quick drop in the 10-12 month cycle momentum indicator would be needed for that to be the case.

Second scenario: The market makes a minor new high but runs out of gas finally in the 2900-3000 range when it again hits trend resistance. We would look for signs of a top to develop there, possibly in October-November.

Third scenario: Although it’s least likely, the market could see a strong breakout through the January high, supported by surging 10-12 month cycle momentum and a resurgence in 4 year cycle indicators. A 4 year cycle high would then ideally be due in May of next year, and could be even later. This is the case that long term bulls are banking on and I’m betting against.

However, if I’m wrong about that and price and momentum do break out, then the way to play it would to be to buy calls on the SPY or calls on a basket of stocks when the setup presents itself. We’re not there, and I don’t think that we’ll get there, but I would keep this thought in my back pocket for future reference.

Meanwhile, if you are looking for other trading ideas, long, short, or market neutral, check out my special collapse to profit/collapse to protection report, or check out why Shah Gilani is “DONE WITH STOCKS” and how he’s making money anyways.

Sincerely,


Lee Adler

4 Responses to “This Aeronautical Engineer Holds the Secret to Today’s Unpredictable Market”

  1. This analysis is extremely well written and researched – but just absolutely worthless, in terms of making money. Jim Curry is so much better with cycles, he called the June 28th low to the day and has been bullish with his cycle work ever since. I don’t know what the difference is between the cycles these guys follow, I only know what makes me money :-)….I do think liquidity will work in the long run, just not now.

  2. Mr. Lee Alder, while I agree with your original ideas and point fully and, what may evolve into different outlooks, it seems, so far, many were on one side of the boat. You and as well as others have the right idea in my opinion but there came a time when too many others started voicing the same…Besides some others that probably had the same idea, it became more and more voiced, at least in terms of a down turn ahead…When I was doing simple chores around the house, I heard David Stockman voicing your main idea of the unwind/liquidity issue on the Bloomberg channel and shortly after, it was on the internet. Could this be the reasoning for a potential issue w/everyone running to one side of the boat and why you/we/others w/the same conclusion are usually late or other?

  3. Cara Lembo, MBA

    Mr. Adler: I began reading this to “freshen up ” for tutoring Finance and have been consumed by your SPX breakout charts…thank you for the analysis and informative article for ALL! Investors, Students of Econ or Finance, Retirees, currently employed investors. Best, Cara l

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