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Today I am going to teach you a little
about cycles.
First a little background information. I'm going to be discussing almost
exclusively the intermediate degree cycle. Now to start let me correct some
misconceptions. Cycles are virtually worthless for timing tops. Cycles are
measured from trough to trough. All we can really do with cycle theory is develop timing bands for bottoms, tops can occur at any
time.
Next I want to go over the concept of left and right translated cycles as it
is pertinent to what is happening in the stock market.
Now in order to understand how a cycle is translated you first have to
determine the average duration of the cycle. In our case we are going to
focus on the intermediate degree cycle in the stock market. That cycle
averages 20 to 25 weeks trough to trough. The median being 22 weeks. If we
divide 22 weeks by 2 we come up with 11 weeks. That is an important number.
It is the dividing line between a left translated cycle and a right
translated cycle.
Any cycle that tops on week 12 or later constitutes a right translated cycle.
Right translated cycles are the hallmark of bull markets. Let me explain.
In a healthy bull market an intermediate degree correction is a profit-taking
event, and that's all it is. The media will find some scary reason for why
the market is correcting but the real truth is that the market has just
rallied long enough and far enough and is due a corrective move to
consolidate the gains. There is one exception, which I will go over in a
minute. Healthy bull markets are composed of multiple right translated
intermediate cycles.
Left translated cycles, on the other hand, are the hallmark of markets that are
in trouble. A left translated cycle is a sign that the fundamentals of the
market are broken, or in the process of breaking. A left translated cycle is
not a profit-taking event. A left translated cycle is a sign that
institutional money is selling into the rally.
Next I'm going to show you the 2002 to 2007 bull market. The intermediate
cycle troughs are marked with blue arrows.
In the chart below you can clearly see that every intermediate cycle, with
one exception, rallied more than 12 weeks. This is a sign of a healthy bull
market. The rallies are moving to new highs. When the intermediate rallies
mature they top late in the cycle followed by a profit-taking event that
holds well above the prior intermediate trough.
The one exception, and I have marked it with the blue box, is that sometimes
an intermediate cycle will top in a left translated manner and make a lower
low after the second leg up in a new bull market. This is just a sign of a
market that needs to consolidate a huge move out of a bear market bottom.
 
Next, let's move into the latter stages of the 2002-2007 bull market.
Again we see the familiar pattern of higher highs and higher lows, and
intermediate cycles that are topping deep into their intermediate cycles.
However, in the summer of 07 something happened that was a glaring warning
sign that the cyclical bull market was in trouble. And that sign; the summer
intermediate cycle dropped all the way down to test the prior cycle low in
February. In a healthy bull market that should not happen. As you recall this
was right about the time that subprime mortgages began imploding. Smart money
could read the writing on the wall, and they began exiting the market.
The deathblow came when the next intermediate cycle topped in an extreme left
translated manner on week eight. That was the warning sign that institutional
buyers had left the market. At that point the bull had officially died.
Now let's take a look at the current bull market.
Up until last summer this was a healthy bull market. The intermediate
cycles were all right translated, and we were making higher highs and higher
lows.
Last summer that started to change. To begin with the intermediate cycle
topped on week 12, right on the dividing line of right and left translation.
The market had managed to rally 16%, so even though time wise it was a
bit early for an intermediate decline, in magnitude a 16% rally is enough to
trigger a profit-taking event. However, this did not turn into just a normal
profit-taking event. The decline moved below the February intermediate cycle
low. Alarm bells started to ring and Bernanke he heard it. Thus began QE2 and
the markets were pulled back from the brink... temporarily.
I don't think anyone is under any delusions about what has powered this bull
market and propped up a deeply flawed economy. Trillions and trillions of
freshly printed dollars that's what. But that is now coming to an end. Does
anyone really believe that the economy or the stock market can continue to
levitate without a constant flood of liquidity? If you do I have some
beachfront property I want to sell you here in Las Vegas.
The market doesn't believe either! We now have an extreme left translated
intermediate cycle in progress that topped on week eight. Notice how the
rally out of the March bottom was only able to make marginal new highs with
absolutely no follow-through. That is a sign that institutional traders sold
into the breakout. And now we have a market that is on the verge of
penetrating a prior intermediate cycle low.
If the March low gets breached we will have the first confirmation that a new
bear market has begun. The second confirmation will come if both the
industrials and transports close below the March lows. That would constitute
a Dow theory sell signal. The last confirmation will come when the 50 day moving average moves below the 200 day moving average
and the 200 day moving average turns down.
Next I want to look at the dollar. In a deflationary environment the value of
currency rises. As many of you know I have been predicting a major three-year
cycle low for the dollar to occur in the spring or early summer of this year.
It came during the first week of May.
These major cycle bottoms tend to produce very powerful rallies, often
lasting up to a year. Now if we were just coming out of recession and
productivity was increasing, or we had a new industry that was creating
massive job growth then yes I would expect the market to be able to resist a
rising dollar. Actually in that scenario a rising dollar is signaling a
healthy economy.
In our current environment however a rising dollar signals deflation!
You can see that during the rally out of the `08 three year cycle low the
stock market came under severe pressure. I think it's safe to say that the
same thing is going to happen this time as the dollar rallies. Unfortunately,
we don't have a new industry to drive job growth, power a sustainable
economy, and allow the markets to resist a rising dollar. All we have is
commodity inflation created by the Fed in a vain attempt to print prosperity.
I've been warning for months that once the dollar bottomed and started
to rally it would signal the end of the bull market and the start of the
third leg down in the secular bear market.
At this point I think the only hope the Bulls have is for Bernanke to turn
the dollar back down into an extreme left translated three-year cycle.
Unfortunately, he has decided to turn off the money spigot (don't worry he
will be turning it back on soon, although by then it will be too late).
Let us all hope that Bernanke has at least some modicum of common sense left.
To turn the dollar back down into a left translated three-year cycle this
early will almost certainly destroy the currency by 2014. Not to mention the
dollar will lose reserve currency status. Actually, that is my next big macro
prediction. By 2014, the dollar's next three year cycle low, Bernanke will
have wrecked the currency, and the dollar will no longer be the world's
reserve currency.
So far this bear market is progressing as expected. It started with the tech
bubble bursting that transformed into a financial crisis. It has now infected
sovereign debt. And will ultimately end in a massive currency crisis.
Toby Connor
Gold Scents
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