A Short Primer on Cycles in the Current Market

By: David Chapman | Sat, Feb 14, 2004
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Cycles are a part of life. There are the cycles of the seasons, cycles of the calendar and the cycles of life from birth to death. Cycles are an integral part of nature. We have been asked a number of times to explain cycles especially as they relate to technical analysis. We thought in this short paper that we would center on the Kitchin cycle which fits well with the economic business cycle and is the proper name for the four year cycle in stock market.

Economists are always referring to the business cycle. A normal business cycle usually lasts from 42 to 54 months. We do note that it can of course be shorter or stretch considerably longer depending upon the nature of fiscal and monetary policy of the day but this is considered the normal range. During that period we move from a recession to the peak of business expansion and then of course back again. Like all cycles it is measured from trough to trough. During the life of the business cycle, bonds, stocks and commodities are supposed to follow recognizable phases as follows:

Phase 1 - Early recession. Bull market for bonds. Bear market for stocks and commodities.

Phase 2 - Deepening recession. Bull market for bonds but slowing. Bear market for stocks but bottoming. Commodity prices in a bear market.

Phase 3 - Transition to expansion. Bonds in late stages of bull market. Stocks in first wave up of new bull market. Commodities bottoming, starting a new bull market.

Phase 4 - Business expansion starting to mature. Bonds prices fall, starting a bear market. Stocks accelerating their bull market. Commodities also starting to accelerate their bull market.

Phase 5 - Business expansion peaking. Bonds still in bear market. Stock prices topping and beginning early phase of a new bear. Commodities remain in a bull market and may go into a blow off phase.

Phase 6 - Business moving into a recession. Bonds nearing the end of their bear market. Stocks into their bear market and commodities topping out.

So how does this fit in reality with the current market. Well we have observed the following.

Phase 1 - Bonds bottomed in March 2002 and started a rise. We suspect that was also the bottom of the last three year cycle in bonds. Stocks were gripped in a bear market. Commodities were in a bear market. While commodities as measured by the CRB Index bottomed in October 2001 they were barely off their lows through early 2002.  

Phase 2 - Bonds soared into October 2002 but began to lose steam shortly after. Stocks collapsed into their October 2002 lows. Commodity prices were defying the cycle beginning a strong bull market early.

Phase 3 - Bonds soared into a peak in June 2003. Stocks soared from the October 2002 lows and especially after March 2003 starting a new bull market. Commodity prices paused in early 2003 but began a new up leg in June 2003 continuing their bull market.

Phase 4 - Bond prices have fallen from their peaks and have moved into a sideways pattern well off their highs (low in yields). Stock market soared in its bull market but has now reached very overvalued levels and very high bullish sentiment levels. Commodity prices continued their bull market into early 2004 but have backed off recently.

At this stage we have no evidence that we have entered Phase 5. Phase 5 will be confirmed when we resume the bear market in bonds and the stock market rolls over and begins to fall. We have noted that commodity prices could soar in this phase.

The Kitchin cycle is a primary technical cycle that fundamentally follows the business cycle but whose application is generally applied to the stock market. As with all cycles it is measured from trough to trough. And as with the business cycle it lasts roughly from 42 to 54 months but again could be shorter or longer depending upon the business cycle monetary and fiscal policy conditions.  In a secular bull market the bull phase may last from 2 ½ years to 4 years while the bear phase could last from 6 to 24 months. In a secular bear market these bull and bear phases may reverse.

The Kitchin cycle is subdivided into thirds with each third lasting roughly 12 to 18 months. They are called Kitchin Thirds. These thirds are divided into thirds again with each third lasting roughly 4 to 6 months called Wall Days. Wall Days subdivide by 4 again into Wall Years which last about 30 to 40 days. Wall Years subdivide again by 4 into Wall Seasons of about 8 - 10 days each. These shorter term cycles are of prime interest to short term traders and are excluded from this analysis. There is also a short term cycle of about 20 days hence the heavy use of the 20 day Moving Average by many short term traders.

Our main area of concern is the intermediate cycles of Kitchin Thirds. As our chart of the S&P 500 shows we have thus far identified possibly two Wall Days each of which lasted roughly 5 months. The first Wall lasted from the lows of October 10, 2002 to the lows seen on March 12, 2003. This Wall was 5 months in length. The second Wall lasted from March 12, 2003 to the low that was seen on August 6, 2003 a period of 4.82 months.

Thus far the third Wall of the first Kitchin third has already lasted 6 months, long by most counts. But a Kitchin third can last 12-18 months and 18 months is not up until April 2004. If we now have a drop and make an important low sometime into March or April then we will have our third Wall to complete the first Kitchin Third. Until the market takes out a previous low such as the one seen in January 2004 or more importantly the low in November 2003 we can not confirm that a top is in place. We do believe, however, that an important top is being made at this time.

The previous Kitchin cycle lasted four years from the lows on October 8, 1998 to the lows of October 10, 2002. The first Kitchin Third lasted 16 months from October 1998 to February 2000. The second Kitchin Third was 19 months from February 2000 to September 2001. The third Kitchin Third was 13 months from September 2001 to October 2002. Since the last Kitchin cycle peaked in the first Kitchin third and commenced what we believe to be a secular bear market with the first Kitchin third up and the last two Kitchin thirds down we believe we will see the same thing play itself out again. This suggests to us that the highs we could be seeing now will be the highs for the next few years until this Kitchin cycle bottoms sometime projected in 2005 to 2006.

For that scenario to happen we must see the nature of the low that will be Wall three of this first Kitchin Third. If the low is shallow then new highs are possible in the first Wall of the second Kitchin third. In the previous Kitchin cycle (1998-2002) we did see new highs in some markets but others like the Dow Jones Industrials did not make new highs in the first Wall of the second Kitchin Third, a major divergence. If the low is deep, however, then the likelihood of new highs is diminished and the remainder of the Kitchin cycle will be down as it was in the previous cycle. The bull's dream of course is a shallow low then on to higher highs for the second Kitchin Third. Irrespective sectors that should do well going forward remain the commodity driven sectors of oil & gas, metals and mining and precious metals.

The Kitchin cycle is itself a subset of the Kondratieff cycle a much longer wave cycle that is believed to last roughly 56 years but has a range from 48 years to 64 years. Kondratieff wave analysis subdivides into four phases (a Kondratieff Year) that lasts roughly 14 years with a range from 12 to 20 years. There are 4 Kitchin cycles in a Kondratieff Year and 16 Kitchin cycles in a Kondratieff cycle. The last Kondratieff cycle is generally accepted to have ended in 1949. The four phases of the current Kondratieff cycle are generally accepted to have been Phase 1 (spring) 1949-1966 (17 years), Phase 2 (summer) 1966-1982(16 years), and Phase 3 (autumn) 1982-2000 (18 years). Phase 4 (winter) is believed to have started in 2000 and will not bottom for at least 13 years (2013) and could last as long as 20 years (2020).


David Chapman

Author: David Chapman

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Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
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David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

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