arket Tee icians

VO:ume 1, Issue 2 May 1978

 MARKETTECHNICIANS ASSEIATION JOURNAL

Volume I, Issue 2

May, 1978

PUBLISHED BY: MARKETTECHNICIANS ASSOCIATION

7OPINESTREET
NEW YORK, NEW YORK 10005

Copyright 1978 by Market Technicians Association

 Thanks to Market Technicians Association members for their part in the

creation of this issue are owed to:

Bernadette Bartels
AbrahamCohen
David Diamond
William DiIanni
William Doane
Robert Farrell
Stan Lipstadt
JohnMcGinley
Arthur Merrill
IanMotley
John Ottman
Robert Prechter

i' Editor's Cormbent:

My special thanks go to Stan Lipstadt for all his help this year in
getting the M T A Journals prepared, printed and distributed on time.
F. R. G.
 INDEX

MARKET TECHNICIANS ASSOCIATION JOURNAL - MAY 1978

Pages

Editor's Note . . . . . . . . . . . . . . . . . . . . . . . . . 4

Letters To and Through the M T A Journal . . . . . . . . . . . 5-7

Third Annual Market Technicians Association Seminar Program 8

Indicator Analysis:

An Analysis of Market Performance Based on

Annual Rate of Change, 1872 - 1978
by Robert R. Prechter, Jr. 6r Robert J. Farrell . . . . . 9 - 15

Speed Resistance Lines in Bull Markets

by David L. Diamond & Richard C. Robinson . . . . . . . . 17 - 22

General:

Elliott Wave (Cycle IV)

byWi.lliamDiIanni . . . . . . . . . . . . . . . . . . . 23 - 31

Forces of Cyclicality (excerpted)

byIanS.Notley . . . . . . . . . . . ..*...... 33 - 50

Lowry Without Tears

by Stan Lipstadt . . . . . . . . . . . . . . . . . . . . 51 - 55

A Technician's View of Indexing

byWilliamS.Doane . . . . . . . . . . . . . . . . . . . 57 - 59

Book Review:

Stock Market Strategy

Reviewed by William DiIanni . . . . . . . . . . . . . . . 60 - 61
 EDITOR’S NcYrFi

Attention: Market Technicians, students/practitioners of technical analysis,

the investment unity, and the world in general. Two points determine a
trendline, A TRENDIS New IN McrrION, defined by the two published issues of
our Market Technicians Association Journal, and the trend is rising since
we've grown. We need to continue to add layers of support to perpetuate
-
this momentumand m&e our Journal what many of us hope it will become.
My only disappointment in the first year of editorship is that nore M T A
members haven't gotten involved in the Journal. Do your share for the
future - sat out existing articles worth republishing, write new articles,
help in production or pranotion - let's see your name angst the credits.

The theme of our Third Annual Market Technicians Seminar, "How to Cope
With Change" is represented in this issue by 1) our first "ad" (for
our m Seminar) and 2) several articles dealing with rate of change,
-
etc. In preparing the issue I'm reminded also that "the more things change,
the nore they remain the same" and that lends particular relevance to the
:
articles related to cycle analysis. Static or dynamic, it sinply ineans
to me there is an enormous anwxlnt of subject matter yet ahead of us.

Editor: F'redR. Gruber

-
c/o Keystone Investment Management Company, Inc.
99 High Street
Boston, Massachusetts 02104
(617) 338-3603
-

-4-
 LEXTERSTOANDTHROUGHTHEMTAJOURNAL

FIRST ISSUE COMMENT

As a subscriber member of the M T A and an individual investor struggling
to be a little better informed, I appreciated more than I can say receiving
theMTAJourna1. It is great and most enlightening.

Areas that interest me most are new trends and changes in what we've been
used to. The Roundtable on changing market indicators due to a change in
the environment was partimlarly enjoyed. It is this sort of subject that
I hope you will look for and have more of in future Journals. Arthur
Merrill's Indicator Accuracy article also stands out in my opinion....
3. Kevin Hughes
Denver, Colorado

Editor:
Readers -1etusknowwhatyou foundworthwhile andwhatyouwouldlike
to find in future issues.
Contributors - keep those articles coming.

THEBEARISHSEETIMENTINDEX (l/78 issue)

. . . . . . I think it would be helpful to my own - and perhaps to others' -

understanding of The Bearish Sentiment Index if there were a full list
of who all the advisory services are. Thus, "contrary thinking" to
“mJoe Zilch's" advisory means one thing, but being contrary to The Bank
Credit Analyst is another ball game.
John B. Ottman, V. P.
Cyrus J. Lawrence, Inc.

Abe Cohen Replies:

I don't like to list the market letter writers since it would consume
too mch valuable space. Each service quotes two dozen or more advisors
with name, address and opinion. Over about a six month period better
than ninety percent of the advisors tracked would be quoted.

-5-
 INDICA'IORACCURACY (l/78 issue)
This ground breaking study, the quantitative testing - as opposed to
'eye balling" - of market indicators, mst certainly be considered
the standard against which others will be judged........
I amtroubledoveronepoint, however: Assume the best Chisquared
for an indicator, say the Odd I& Short Sales on p. 7, is associated
with 5% moves (shorter term). Further assume the indicator is
bearish and merits placing in the Bearish pan of the balance.
Lastly, assume it finds itself in the pan with other shorter-term
indicators together with an equal number of long-term indicators.
What nm is the balance saying (at 22.2%) which is different from
what it would say (at 22.2%) if the pan contained only long-term
indicators?
(Merrill's) system would seem to mix apples with pears; makes good
apple and pear sauce, but some favor one particular blend over
another - or no mixture at all - and cannot here tell what is
being served. Using Arthur's exanp?le on p. 12, could the 22.2%
Bearish balance only be for the, say, short term? How would one
klxw? . . . . . . .
John R. McKinley, Jr.
Van Cleef, Jordan and Wad, Inc.

Arthur Merrill Replies:

. . . . . ..You mentioned that you were disturbed that I mixed long and
short term indicators. It's a good point, but I believe that the
weighting methcd takes care of the problem:
Suppose that the balance is aimed at being useful in 5% swings - the
intermediate swings. Intermediate term indicators will be the most
useful, and will yield the highest significance, and will get the
/ highest weight. Long term indicators will be less useful, and
will show a lower significance, and will consequently get a lower
weight (but some weight, if sufficiently useful!). Similarly, the
short term indicators will be less useful than the intermediate
indicators, they will show lmer significance, and will get
lower weight (but they will get sane weight, if they are sufficiently
useful).
Do you see Ily point? I don't think it's a case of mixing apples and
oranges; it's a case of mixing useful and less useful, and giving
each a weight dependent on usefulness.
OK?

-6-
McKinley Again:
Thanks for your quick response. I think I understand you. Let me see:
If you were intending for the balance to be mst useful with, say, 10%
swings, you y0 Id use the weight attendant with 10% swings - even
if the weightv 9 % swings were higher. For example, odd I& Short Sales:
from p. 7, of the Journal Article, the Odd Lot Short Sales Chi Squared
for 10% swings is 16.6 vs. 31.7 for 5% swings. But since our balance
is intend&i for 10% swings, we use the 16.6 weight. Correct? Makes
sense. Or do you in scma way mix the two weights?

Merrill Again:
Your note abut the weighting of indicators is right on the trade. If
we were aiming the balance at 10% swings I'd use just the Chi Squared
associated with swings of that magnitude.

- 7 -
 .
Thursday, May 11 Saturday, May 13
4X&6:30 pm-Registration
Lopmg 7:M-lO:OOam-Breakfast
6:30-7:30 pm-Reception with 9:00-IO:30
A Technical
am
Approach to
7:30
9330
pm
pm
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-Keynote Speaker
Change fnvesting in Commodities
Introduction:
Peter Vermilye William Jiler
Senior Vice President Mayll-14,1978 President
Chief Investment Officer Commodity Research Bureau, Inc.
Citibank, N.A.
Speaker:
Michael 1. Burke
Friday, May 12 Vice President, Manager
Smith Barney, Harris Upham &Co., Inc.
7:3O-TO:00 am-Breakfast Commodities Asset Management
9:00-lo:30 am 10:30-lo:45 am-Coffee Break
The Relationship of Business Cycles and
10:45-12:OO noon
Monetary Factors to the Stock Market
Measuring the Probabilities of
Panelists: Technical Recommendations
Gary Shilling
Panelists:
Senior Vice President
and Chief Economist Richard S. Brannin
White, Weld&Co. Incorporated President
Associated Consultant Services
Richard Katz
Raman Mehra
Senior Vice President Market Technicians President
The 6oston Company
Association Scientific Systems, Inc.
Moderator:
Moderator:
Ann Fahnestock
Arthur Merrill
Vice President
President
Creeley Securities, Inc.
4:30-1:45 pm-Coffee Break Merrill Analysis
10:3O-lo:45 am-Coffee Break
4:45-6:08 pm 12:oO noon-6:3&Lunch and Free Time
10:4.5-12:OO noon
Short Term Strategy: 6:30-7:30 pm -Cocktails
Computer Techniques
Indicators and Case Studies
7~45 pm -Dinner
Panelists:
Panelists:
Anthony Tabell 9:OO pm
Ralph Block
Partner at What’s Ahead for the Economy
Vice President, investment Strategy
Delafield, Harvey, Tabell Louis Rukeyser
Mosely, Hallgarten & Estabrook Inc.
David Upshaw Host of the TV Show, Wail Street Week
Mike Epstein
Vice President, Research Department
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Newton Zinber
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E. F. Hutton & Co., Inc.
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Applying Modern Portfolio Theory
Michael Metz New Approaches
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Stewart Zobian
79 pm-Dinner Director, Option Sales
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Drexel Burnham Lambert, Incorporated MTA Award Presentation to James Yates
i john Magee President
John W. O’Brien
Bridge Data Company
Vice President Author of “Technical Analysis of
Becker Securities Corporation Stock Trends.” Moderator:
Hugh Lamle
Moderator: Award will be accepted by:
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Keystone Investment Management
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 ANANALySISOFMARKETPEREQRMANCERASED
ON ANNUALRATEOF CHANGE, 1872-1978

by Robert R. Prechter, Jr.

b
Robert J. Farrell

~xcexpted from March 31, 1978 Market Analysis

Report on Annual Rate of Change update:

At this time, the annual rate of change momentumindicator, at minus 13%, has
entered the area between minus 8% and minus 18% from which all but two post-
World War II bull market advances have been launched. The exceptions were
1970 and 1974, when the secular bear market then in progress produced deeper
"oversold" levels. Although the current tierate oversold level does not
guarantee thatthemarkethas reached a low, theoccurrenceof threedeeply
oversold readings in a rcw is rare. In fact, since 1972 three consecutive
deeply oversold readings (below minus 20%) have occurred only ontiring
the 1930's. Therefore, it seems reasonable to expect a low in the index
above the minus 20% level this time.
iConfirmation of a trend reversal is generally indicated when the rate of
chaxqe index again crosses the plus 10% line on the upside. Such mves
have oonfirmd reversals on all but four occasions in this century-in
1911, 1912, 1938, and 1948. The durations of previous amfirmed trend
changes indicate that a favorable market environment could be expected
to last for 12-30 months after such confirmation.

The above text and the following charts are reproduced with the permission
of Merrill Lynch, Pierce, Fenner & Smith, Inc., with editing modifications
by the Market Technicians Associatiou Journal.

-9-
r
--13 -
- 14 -
-’ 15 -
A PAGE FOR NOTES

- 16 -
 Speed Resistance Lines in Bull Markets

David L. Diamond & Richard C. Robinson

The Boston Company InVeStment Research h Technology, Inc.

One of the more interesting new ideas in technical analysis to be

developed over the past few years is the concept of the Speed Resistance Line
(SRL). Ori,ginated by Edson Could, SRL's can pinpoint areas where support
should be met or resistance encountered before more conventional trend lines
can be drawn.

Speed Resistance Lines are based on two concepts: (1) reactions against
__ the primary trend normally retrace one-third to two-thirds of the movement
that has occurred and (2) the extent of retracement will-vary depending on
the length of time the reaction takes to be canpleted. Thus, SRL's indicate
the expected tradeoff between time and price.

Speed Resistance Lines will indicate critical levels for turning points
well in advance of when normal chart trendlines give any warning.
.
SRL's are easy to construct (see example). In an uptrend, draw a line
horizontally fran the low point of the advance. Then, draw a vertical line
from that baseline to the highest subsequent point reached before a
significant correction. Divide this vertical line into thirds, placing marks
at the dividing points. Finally, draw lines from the low point of the advance
through these two marks. The steeper line is the 2/3 SRL; the shallower line
is the l/3 SRL. In a downtrend, the process is the same in reverse.

Examplel Speed Resistance Lines e’.

3"/
2\/
I

.-
 The use of SRL's is quite simple. Following an extended move, a reaction
is 'likely to stop in the area of the 2/3 SRL. However, if this line is
penetrated, the reaction can be expected to continue until the l/3 SRL is
encountered. The area of the l/3 SRL should mark the end of the correction.
If it is broken, the correction can be expected to extend at least to the
point at which the initial move got underway.

To evaluate the reliability of SRL's, we have made a study of the seven

bull markets since 1949. XII each case, the two points used to draw the SRL's
were the bear market trough and the peak before the first ten percent
correction.of the bull market. These two points are circled on each of the
following charts. Specifically, we wished to examine one key rule of SRL use:
when the 2/3 SRL is broken, a turning point has tended to occur in the area of
the l/3 SRL (it should be noted that the peak prior to the first 10% reaction
was always identified many months before the l/3 SRL was approached).

It is clear from the charts which follow that during the past thirty
years, SRL's have been very useful. In most of the post-war bull markets, a
significant primary or intermediate low was reached at the level of the l/3
SRL.

- 18 -
 DOW JONES INDUSTRIAL AVEMGE

1949 BOTTOM

360

320

260

The first 10% reaction following the 1949 trough occurred in mid-1950. *en
the l/3 SRL was finally reached, the market was at its 1953 lows. prom this
point, prices doubled over the next three years.

DOW JONES INDUSTRIAL AVERAGE

1953 BOTTOM

600

The first 10% reaction following the 1953 lows did not occur until 1955. When
the l/3 SRL was reached in 1957, it marked another significant buying
juncture. Within two years, prices were 50% higher.

- 19 -
 DOW JONES INDUSTRIAL AVERAGE

1957 BOTTOM

660

Following the 1957 bottcm, the first 10% reaction did not occur until
mid-1959. Again, when the l/3 SRL was reached in late-1960, it marked an
important low. Rrices advanced by over 25% in little over a year from this
point.

DOW JONES INDUSTRIAL AVERAGE

1960 BOTTOM

680

6UO

600

1960 1961 1962 , 1963

One time when the market failed to find support at the l/3 SRL. Following the
1960 lows, the first 10% reaction occurred around year-end 1961. When the l/3
SRL was broken in mid-1962, it was a sign that the 1960 lows were to be
tested. In fact, the final lows in 1962 occurred just slightly below the 1960
bottom.
- 20 -
 DOWJONES INDUSTRIAL AVERAGE

1962 BOTTOM

900

800

700

600

1962 1963 196’4 1965 1966 1967 1968

Following the 1962 bottom, nearly three years elapsed to the first
intermediate peak in mid-1965. When the l/3 SRL was reached in late-1966, it
again represented a significant.buying juncture. Within a year, the market
was almost 200 points higher.

DOW JONES INDUSTRIAL AVERAGE

1966 BOTTOM

960

920

880

8'40

800

760

I I t 1
1966 1967 1968

The first 10% reaction -following the 1966 lows occurred in late-1967. When
the l/3 SRL was reached, it marked the area of the intermediate lows in 1968.
Within the next nine months, the market had moved up over 150 points.

- 21 -
 DOW JONES INDUSTRIAL AVERAGE

1970 BOTTOM

1000

800

700

1970 1971 1972

The first 10% reaction following the 1970 lows occurred in mid-1971. When the ,
l/3 SRL was reached later in the year, it marked the end of the intermediate
correction. Within a year, the market was up over 200 points.

DOW JONES INDUSTRIAL AVERAGE

1974 BOTTOM

800

600

I I I I
1974 1975 1976 1977

Following the 1974 lows, the first 10% reaction took place in mid-1975. %hen
the l/3 SRL was reached in November 1976, the market turned up for its final
assault on the 1000 level. However, though a bounce did occur off of the l/3
SRL, the move was less than lo%, and the l/3 SRL was broken in early-1977.
This would suggest that the 1974 lows are to be tested, perhaps sometime in
1978.

- 22 - December, 1977
 ELLIOTT WAVE (CYCLE IV)

1978 marks the 40th anniversary of

"The Wave Principle". Its message
in 1978 may have important implica-
tions for the long-term investor.

by William DiIanni, V.P.

Wellington Management Co.

R. N. Elliott wrote two monographs in his lifetime: The Wave Principle (1938)
and Nature's Law (1946). In some respects he was to market analysis what Newton
and Einstein were to..physics, or-what Plato and Aristotle were to philosophy. It
is said that a sign of genius is conceptual content and breadth of creative insight.
This was Elliott. It might even be said, as Whitehead said of Plato, that all
modern market analysis is "a footnote to Elliott".

Market-analysts have had more than their share of trouble with Elliott's
theories. But, as the history of arts and sciences reveals, the difficulty usually
does not lie with original theories, but with the understanding and application of
the principles by the disciples. One of the objections is that it is a great
theory that tells one where the market has been after the fact, not where it is
going. To Elliott, this was heresy. Another is that the theories are not as useful
as they might be because too many people are beginning to be attracted to them.
This is like saying that the laws of the universe will not work because universities
are creating too many physicists.

As with most disenchantments the fault lies, more often than not, in the mis-
interpretation of the data and the relatively short time horizon of the analyst.
Yet, if one really understood the position of the market in Elliott terms, one
could have better control of the gyrations which take place within the longer-term
framework, and a clearer idea of what might lie ahead, both as to direction and
amplitude.
,? Proper perspective is important. Dynamic phenomena, such as Elliott Wave
Principles, which originate from theories of form and waves of time, can be quite
helpful in achieving an eagle's view of the terrain. Much as Bertrand Russell
said of Einstein's relativity theory, Elliott's interpretation of the market-
universe shows that the whole thing was what ought to have been expected, and not
a set of makeshift observations to account for surprising experimental results.

..,;At a time when bearishness is so vehement and deeply ingrained, a fresh and
contrary opinion is challenging and even welcomed. This article is a small effort
to shedsome light and understanding on the current market malaise; and more impor-
tantly, to take a critical look at the whole erratic period encompassing the years
1966 to 1978. It is a theoretical exercise with potentially practical consequences.
At times, Elliott Wave perspective does have a particular message of degree and
kind. The long-term analysis reveals a unifying though complex force. It should
restore a sense of order to the subject. As Elliott said in his introduction to
the Wave Principle: "Gradually the wild senseless and apparently uncontrollable
changes in prices from year to year, from month to month, from day to day, linked
themselves into a law-abiding rhythmic pattern of waves. The pattern seems to
repeat itself over and over again."
- 23 -
 There is a growing possibility that the broad time period in question, as
measured by the Dow Jones Industrial Average from 1966 up to and including 1978,
reflects a long and significant Elliott Wave correction force that should mark the
end of Cycle IV and lay the foundation for a substantial advance in stock market
returns.

The market cycle, in Elliott terms, moves in five waves within an uptrend; and
three corrective waves in a downtrend.

The pattern of the stock market in Cycle degree is shown on the following
graph. The whole pattern from 1966 to 1978 is marked and positioned in the area
shown.

Figurel: StockmarketCycle

Minor degrees (or waves) are intentionally deemphasized in all the graphs in
order to focus on the big picture. Likewise, Cycle and Primary waves of previous
periods are merely mentioned for reference. Moreover, no detailed forecast is
intended beyond the interpretation of the current wave with its potential termi-
nation of the 1966-1978 bear phase.

The following schematic graph reflects our interpretation of this undulating

pattern according to an Elliott fit. As the subsequent model will show, this fit
is the longest practical corrective form under Elliott Wave Principles. "Corrective"
is underscored because the underlying assumption is that the ultimate fifth wave
(Cycle V) has not yet begun; and hence, the condition in question is a "form of
correction" and not a Cycle Bear Market under Elliott definitions.

Since the 1966 Dow high of 1000 was reached (Cycle III), many market analysts
and Elliott practitioners have been continuously frustrated in their efforts to
understand the ensuing market movements. Opinions, ranging from simple corrections

- 24 -
 of the previous secular bull market, to alternating smaller bull and bear market
movements, to expanding triangular consolidations, to the end of capitalism, have
. spilled from the pens of commentators. Interestingly enough, no bull market has
occurred since 1966 under Elliott definitions, but only complex contra-trend re-
covery movements which in turn served to complete primary waves in individual
groups and issues in rotation. Recovery moves within the Bow framework merely
allowed remaining strong groups to finish their moves before their own wave-cor-
rections set in.

But, if the pre-1966 market was a terminal part of a large secular movement,
it follows that post-1966 should see a correction of comparable magnitude . . .
multi-cyclic, and extended in time, so that groups in rotation might finish their
respective corrective moves. A process lasting 12 to 13 years should not be too
surprising. An earlier Cycle IV period (1909-1921) also took 12 years to complete.
And, since major market movements , according to followers of Charles Bow, "cast
their shadow before", this corrective process (at times severe) should understand-
ably pervade many diverse economic areas, both in and out of the stockmarket itself.

In the following discussion the terminology, (Minor, Intermediate, Major,

Primary and Cycle) is used in accordance with Elliott definitions and not other
methodologies except when reference is made to the 4 year cycle.

Figure 2: Cycle IV

l The 1966 high to the 1966 low completes intermediate wave (a). That this
(a) wave was a sub-divided 5-wave correction is an indication of more to
come after the recovery.

- 25 -
 The 1966 low to the 1968 high completed an inverted "abc" intermediate
wave (b) - a correction of a correction, and not a "bull market" per se.
These can be profitable, but they are ill-defined.

The 1968 high to the 1970 low completes the (c) wave of an intermediate
(a) (b) (c) phase. More importantly, the 1970 low also represents the
completion of wave A of a larger degree.
l
The 1970 low to the 1972 high (of 1067) completes the B wave of an ABC
major. This also was a recovery move in the Dow and not a typical primary
bull market under Elliott.

The 1972 high to the 1974 low is again a normal 5 wave corrective pattern
(though devastating) that completes the first leg of a new intermediate (a).
This wave started the correction in the growth stocks, and at its completion
terminated important declines in many other averages , sectors and individual
issues. As Elliott said: "Every average, group, or stock is interpreted
by its own waves." It is important to remember that what may be the first
intermediate leg down for one stock group (within the context of a declining
Dow trend) may be simultaneously ending a major decline in another group
which began its corrective process in an earlier wave. This also applies to
rotating waves in intermediate recovery phases. What is a primary move for
one group is a recovery move for another.

0 The 1974 low to the 1976 high is also a simple recovery move in the Dow
completing leg (b) of the final (a) (b) (c) wave. There was no 5th wave
failure at this high, as some Elliott practitioners believe. In these cases,
5th waves assume a Primary wave, and all these so-called bull markets were
not bull markets (for the Dow Jones Industrial average) within the Elliott -
context. Within the Dow Jones framework, there are other wave movements of
different degree in the sector, group and individual stock level.

0 The 1976 to 1978? wave should complete the Cc) of the (a) (b) (c) pattern,
which subdivides accordingly into a 5-3-5-3-5 pattern. But, more importantly, _
it would also complete the final corrective process of the ABC major. Theo-
retically, this period should complete the long erratic process that began
in 1966. The remaining important question to resolve is the nature of this
i leg, because the form and amplitude of this wave might well imply gathering
I cyclic strength not seen since Cycle III.

The Elliott correction model shows that the market is quickly running out of
significant waves or "thrusts" in this corrective cycle, much as "extensions" run
out of waves in a primary bull phase. Upside terminal points are usually classified
as "end of wave mvement”, or in more general terms as "areas of high cyclic risk".
The inverse applies to the end of corrective movements.
Figure 3: Elliott Corrective Pattern
 All corrective patterns need not follow the protracted downward bias of the
model. If one takes the Elliott form and imposes it on the Dow, but first
"flattens" the process somewhat to remove the downward bias and make it a "side-
wise" bias, it would look like the schematic graph below -- a flattish trading
range lasting 12 to 13 years, alternating with "zig-zags" and "flats" in Elliott
fashion.

All of these co-ordinates are merely a systematic way of cataloguing events.

The impact of the law, or the formula of the model, remains .-unchanged.
Fipre4: HybridModel

(a)
A C

Again, notice the Dow pattern with the'lower lows marked with X's called for
by the correction model. But combine it with the "irregularly" even tops at 1000,
and you have the pattern. The whole pattern is a hybrid of downward and sidewise
biases.

Figure 5: The 1966-1978 Wave

\ I \ I I . \ I ’ \
. I I \
735 I \ I \?
X \
v
627
Y
570

This brings us to the 1976-1978? wave; its analysis and its implications.

- 27 -
 If Elliott Wave analysis has any validity at all, it certainly has an important
long-term message, regardless of the remaining shorter-term stresses. But these
principles are not as simple as they are made to appear. Practitioners have
stumbled many times in attempting to interpret the condition of the market.

Long corrective phases are the most difficult. For Elliott corrections, espe-
cially of a major kind, take Time and are always of intrinsic bearish quality no
matter how impressive and convincing the recovery moves appear on the surface. Any
movement in a bear Cycle is by nature quite volatile and erratic, and noticeably
lacking the controlling horns of the bull. Elliott was quick to recognize this;
hence, his privately published monographs devoted much space and time to diagramming
many examples of simple and complex corrective patterns.

Moreover, Elliott Principles are analogous to "work-in-progress". Or as

Aristotalian philosophers would say, it is "being in potentia". It is only when all
the evidence is in that a final determination can be made with a high level of con-
viction. Then, the pattern is "in actu", or completed. In other words, a process
that was "in potentia" has moved into "being". Or more philosophically accurate,
the process is in actu - but not quite.

The problem currently facing the market is the nature of the completion. Does
the final move stop at 760? 7001 Does it have to go below 650? Or even below the
1974 low of 570? It has been demonstrated that Elliott's pattern does assume an
undercut of 570. Hence, before all the evidence is in from Elliott, cycles and
other traditional technical tools, one is well-advised not to be too quick to antic-
ipate. But as Elliott himself said, the habit of the market is to anticipate, not
to follow. In that spirit we attempt the following. As any Wave IV reaction of
any degree is being completed, it becomes necessary to study the market action more
closely.

Pattern, Time and Ratio are essential to Elliott interpretation. Pattern (the
most important of the three) was described above. But the key question is: Does
the completion of the current intermediate (c) and major C wave require a low below
57O? No, not necessarily. Both theory and evidence allow for a possible "failure"
in this zone which would be as bullish as a "bullish failure" is bearish. And
since the nature of the 1974 wave was abnormally severe, one could say that 1974
borrowed some potential future weakness from 1978. A look at other disciplines and
[many other averages can be helpful in determining the probabilities. The wave
~patterns and counts of other averages are somewhat different , and tend to be stronger.

Time, under Elliott, is not strict cyclic periodicity, but Fibonacci time.
(There is no intention to go into cycles or the Fibonacci Summation Series in :
detail.*) Because of the publicity, it is @enerally known that the 4-Year stock-
market cycle forces should end by mid-1978 or 1Q 1979 at the latest. The market is
also approaching the 13th year since the early 1966 Dow top, an important figure
in the Fibonacci Series. If one considers Cycle III to have begun in 1943 and ended
in late 1965, and one uses the .618 ratio of the difference, the figure is 14.
Close enough? "Time cycles are not always exact." Some analysts have used long
cycle lengths of 125 years (high to low), which also falls in 1978. This would be

*The Fibonacci Summation Series was formulated by mathematician, Leonardo

dePiza in the thirteenth century. The sequence is 1,1,2,3,5,8,13,21,34,
55,89,144 and so on. Each number being the sum of the preceding two.
The ratio of each number to the preceding figure is, except for the first
few, 0.618. The reciprocal is 1.618 or 62%.

- 28 -
equivalent to 3 four-year cycles, and many other figures could also be used.
Hence, it is possible for the arithmetic low to be reached before the orthodox
cycle time has run its course. This would produce a magnitude failure, which
under these circumstances implies underlying long-term strength, not weakness.

Using Ratio for the 1976-1978 wave, one could put the risk of the final move
around Dow 700 ?. 20 points. It is currently 760. The lower figure need not be
achieved. And for the long-term investor, it is becoming virtually negligible.

Whatever the ultimate pivotal low, some other favorable aspects are emerging
at present and certain observations can be made to prepare the long-term investor,
so that he may use any remaining weakness to his advantage.

l The Elliott Wave corrective pattern does justify a low below the 1974
low of 570. But it also allows for an important "failure" in the tra-
ditional Elliott sense. In this case, a "failure" could mean that the
leg stays above the 570 low by some significant margin. This would
also produce a magnitude failure under standard cycle theory. Ratio
(as stated) calls for circa.700 at its extremes. Also, certain point
and figure charts suggest a risk of 680-720. Other data, however,
suggest that an even higher low is not inconceivable, as remaining
shorter,wave-lengths continue to "fail" in magnitude.

l The weekly cumulative advance-decline line currently seems like an

ominous top by conventional standards, and might take its toll nearer
term. But in Elliott parlance, it will probably be a sub-normal "abc"
correction of its early 1975!. i~uly'1977 primary advance. It is highly
unlikely however, that the 1974 low will be either broken or approached
in breadth data. The same can be said for weekly cumulative 20 most
actives, Dow Utilities, Dow Transports, ValueLine, Indicator Digest and
many other weighted and unweighted indexes.

l Bond charts (price and yield) have been reviewed under Elliott. Two
possibilities keep emerging. One is an intermediate and a minor wave
count to complete the final wave of an extension; the other is a I'failure"
possibility which would be equally bullish. The implication is that impor-
tant high yields would not materialize. And ditto for inflation. All of
which could allow for a possible future expansion of multiples.

l Gold bullion is currently diverging negatively from gold-backed curren-

cies by failing to go beyond its 1974 high. Such currencies have risen
versus the dollar. But under Elliott, the current recovery of bullion
represents an inverted correction of the previous decline from 200 to
103. And the moves in currencies have virtually completed Elliott
patterns and ratios.

l Gold-backed currencies are also beginning to give off preliminary sell-

signals in their technical structures in favor of the dollar. And they
also seem to have completed long-term Elliott ratio targets. In other
words, the currency game may well be past the 11th hour, though admittedly,
it's not yet 12 o'clock.

l The bond-stock ratio and the annual rate of change of multiples are
leveling out near 1974 lows.

- 29 -
 l Five out of six other rate of change studies on the Dow are at, or
approaching, the deep levels of 1974.

l .Long-term individual stock analysis would suggest that many issues are in
the process of completing their own Elliott corrections of various major
phases. These obviously did not all peak at the same time, but fanned out
during different stages of the particular Dow phases in the schematic
breakdown previously illustrated. In other words, the last unifying wave
of the current process is eliminating much of the long-term RISK that has
existed since the corrective phase began in 1966 -- growth stocks included.

l Another important clue is investor psychology. At this writing it is fair .

to say that the world is bearish. Problems are appearing insurmountable.
Confidence is extremely low. Conservatism is upbeat. Risk-aversion is
the vogue. And cash is extremely high. Furthermore, the "corrective"
gyrations of the past have moved everyone into some aspect of market
timing-- a useful strategy for the last 13 years, but only recently
adopted by the majority. Computers stand at-the-ready to spit out models
and signals for the troops to attack the Floor. All are waiting for their
programmed black-boxes to speak. ~Indeed, the Elliott **corrective process"
has done its job well -- stocks are now more underowned, more undervalued,
more maligned and more misunderstood than at any time since the pre-World
War II period. Cycle IV has mangled stocks, portfolio managers, and the
Exchange itself.

l Technicians have even fretted over possible distortions in some reliable

technical tools, blaming the influence of options, institutional dominance
in trading, and any number of other phantasms. But, if Elliott's message
is correct, it is all quite normal and expectable, because when major
. changes of this magnitude are in the process of:pccurring,-many things. .
should not work as they did in the recent past.

The whole process might be likened to a jetliner landing on a runway . . .

the plane continues its forward motion evenas the engines are thrown in reverse.

A thought from Kierkegaard may be apropos: "In life only sudden leaps, or
,berks can lead to progress. Something decisive occurs always by a jerk, by a
,sudden turn which neither can be predicted from its antecedents nor is dete,rmined
by them."

Under Elliott, the pre-conditions are falling into place, rotationally; and
the process from 1966 is moving towards an important ending. Other data confirm
the process.

l A favorable Dow Theory divergence is appearing between the Industrials and

the Transports: short term, and certainly longer term.

l Valuation data such as P/E, P/D, relative multiples, and others are
already near 1974 low extremes.

l The hedging cycle of gold and related items appears to be ending.

0 The Constant Dollar Dow is already testing its 1974 low area.

- 30 -
 l The decennial pattern of stock prices favors an up market in 1978.
1977 (years ending in 7) was favored as a down year. Expanding this
further, the decade beginning with 7 was for the bear; the decade
beginning with 8 favors the bull.

The evidence in favor of equities is becoming more compelling for the long-
term investor, although conventional technical tools nay be helpful in tying up
loose ends.

This article was written on January 27, 1978. More time may be needed for
completion and unification of the low, domestically and internationally. Never-
theless, this would complete the Cycle IV of a larger degree that many theorists
have been looking for since it began in 1966. Now that the moment may finally be
at hand, attention is strongly focusing on a Kondratieff depression. But the
"plateau" period is yet ahead of us , adherents to the contrary notwithstanding.

This article was not intended as a forecast, but as an effort to identify

and understand an important long-term pattern or framework. One caveat for the
future concerns the lay of the land during the next four year cycle. By our
interpretation, the balance of that cycle could be mild, dull or subnormal, in
an a-sphere of disinflation: in Elliott terms, an A-B base. The progress of
Cycle V will depend on the strength of the shock and the circumstances contributing
to this strength. Flexibility and vigilance, however, should never be abandoned.

In a time of doom and gloom stockmarket operators should remember some further
words from R, N. Elliott (which will not be easy to accept):

"The stockmarket never has a 'depression':& it only corrects a previous advance."

From his vantage point, the "Crash of '79" may have to wait for '89.

‘iEAH?Auo NW IF ALL

RqMntedccaesydNEA. hc 01977 by NEA. Inc TM. Rq U.S. Pat. Off.

January 27, 1978

- 31 -
 A PAGE FOR NOTES

- 32 -
 FORCES OF CYCLICALITY (excerpted)

from Trend and Cycle Analysis

by Ian S. Notley
Dominion Securities Limited

Prepared originally for the Fourth International Investment Conference,

New York, New York - June 1977

Revised as of July 1977 and January 1978

Previous Works:

AN INTRODUCTION TO THE STUDY OF CYCLES, November 1974

MARKET TREND ANALYSIS - THEORY andMARKET TREND ANALYSIS - PRACTICAL

August, 1975

Both works revised and reprinted in March 1976 and August 1976

CYCLE INVESTIGATORS

1801: Sir William Herschel described cycle phenomena in investigations

ofe Nature of the Sun, Philosophical Transactions of the Royal Society,
April 16, 1801.
1847: Englishman Dr. Clarke cited a 50-year+ cycle in economics. The
w was again referred to in Britain by Professor W. S. Jevons in the
latter half of the 19th century and in the 20th was described as "the
Kondratieff Wave."
1860: Frenchman Clemant Juglar published his book, DES CRISES COMMERCIALES
ETURS RETOURS PERIODIQUE EN FRANCE, EN ANGLETERRE, ET AUX ETATS URIS.
Juglar had come to the conclusion that a general economic cycle lasting eight
to ten years existed. That is, he discovered the fundamental mechanism of
alternating prosperities and liquidations, the latter of which he interpreted
- to be a reaction of the economic system to the events of the former. Even-
tually his view was adopted, which discounted completely the "crisis" role
and focussed on the wave. Juglar's findings were calculated on banking figures,
interest rates, stock prices, business failures, patents issued, pig-iron
prices, and a variety of other phenomena. In Wall Street it became known as
the Deciennial Pattern--the Juglar Wave, or a 9.225year cycle in stock prices.

If stock behaviour is an example of. random walk, there can be no cycles except
by chance. The 9.225year cycle has repeated itself 16 times since 1834.
According to the Bartels test of probability, the 9.2-year cycle could not
occur by chance more than once in 5,000 times!

- 33 -
 THE 9.2-YEAR CYCLE IN STOCK PRICES, 1830-1966
(from CYCLES, by Edward R. Dewey)

- :.:
.
::
--.J
?
; \I
t v
I lU0 1860 1000 I900 1920

Tie 93Year Cycle in Stack Prices. 183%1366

1878: William Morton Halbert published in England AN EXPLORATION OF ECONOMIC '

AND FINANCIAL SCIENCE BASED UPON A CYCLE OF THE SEASONS IN EACH DECADE. Halbert
observed that the tendency of economic changes formed a pattern which at each
point in each decade had a similarity to changes occurring at corresponding
points in earlier decades. He noted the same decennial recurrence in weather
phenomena and in changes in public health statistics.
1878 : Professor W. Stanley Jevons, a British economist, applied the same
cycle to England, giving thedates of commercial crises as 1701, 1711, 1721,
1731-2, 1742, 1763, 1772-3, 1783, 1793, 1804-5, 1815, 1825, 1836, 1847, 1857,
1866, and 1878.
We refer readers to the following works by Professor Jevons:
"A Serious Fall in the Value of Gold," address tc the British Associa-
tion for the Advancement of Science, 1863.
i
"The Solar Period and the Price of Corn," Bristol Meeting, British
Association, 1875.
"The Periodicity of Cormnercial Crises and Its Physical Explanation,"
Dublin Meeting, British Association, August 19, 1878.
"The Sun's Heat and Trade Activity," CONTEMPORARYREVIEW, 1909.
Because the 9.2-year cycle is also present in a host of natural phenomena, two
Harvard research works in 1932, Dr. Carlos Garcia-Mata and Dr. Felix Shaffner,
set out to establish the rhythmical relationships between business and natural
phenomena. This work was an attempt to establish on a factual basis Professor
Jevons’ hypothesis concerning business cycles and sunspots. Edgar Lawrence
Smith of New York City and Dr. M. J. Fields of Harvard rendered the research
team assistance. Some of the results of the investigation were published in
the November, 1934, QUARTERLY JOURNAL OF ECONOMICS. On the following page
we show two pictures of their findings tracked to 1932:

- 34 -
 r
E
. .
Sunspot area5
:i\$+
h
(Yearly c&nAe)
I-

I-

i-

l-

I- &&-
ness
i- curve
+ra
i differences smaothed)
cl
.
Imk2 af Prob. af Wufactures,smaathed . -10

ma ma

Calg
Cl
m:

- -.I

./-•
,.
01
ltra-
4 Vi ‘olef
r: ad.
r2 rtkn
- tska
-li 50
- Avcrage

- ‘li :n

a0

- 35 -
 THE STOCK MARKET CYCLE

Stock prices, like other phenomena, fluctuate in cycles. Stock prices act
as if they are influenced by a number of different cyclic forces, all acting
at the same time. Cycles can be distorted by randoms. Occasionally, the
cycles themselves can miss a beat, give us an extra wave or two, aberrate
somewhat, before they get back onto course again.

THE FORTY-ONE-MONTH CYCLE--THE KITCHIN WAVE (Four-Year Cycle)

First thought to have been used by the Rothschilds, who had analysed
British Consols and had broken up the price fluctuations into a series
or repeating curves that had been combinedand used for forecasting.
A New York syndicate in 1912 heard of the approach and hired a
mathematician to discover the secret formula of the Rothschilds,
and working with the Dow-Jones Railroad Averages, he discovered
a forty-one-month cycle, plus three others, which his employers
used to help them invest in the market, Apparently, they were
very successful around World War I.
- E. R. Dewey (with Og Mandino),
CYCLES: THEMYSTERIOUS FORCES
THAT TRIGGER EVENTS, Hawthorn
Books, Inc., New York, 1971.
Ten years later, in 1923, Professor W. L. Crum of Harvard published the
result of an analysis of monthly commercial paper rates in New York from
1866 to 1922. Crum showed in the series the presence of recurring 40-month
periods. The importance of the contribution was that it established, at
least for one series, the existence of a cycle which could be observed with
remarkable regularity. Simultaneously, Professor Joseph Kitchin, also of
Harvard, showed cyclic influences in bank clearings, wholesale prices, and
interest rates in Great Britain and the U.S.A. for the period 1890 to 1922.
The "four-year cycle," although at first none too favourably received, has
as the years have gone by acquired acceptance. The particular cyclic pattern
i has since been termed the "Kitchin Cycle." (See top chart next page.)

In 1946, the cycle stumbled and was squashed for two years, regaining its
rhythm completely out of step with the ideal cadence it had maintained since
1868. The beat has become a little longer, with the troughs and the peaks
upside down. (See lower chart next page.)

E. R. Dewey states in CYCLES:

Score of explanations and reams of paper have been expended to
explain this behavior. We are familiar with most of the possi-
bilities, such as distortion by random behavior, two or more other
cycles of near lengths, and even a general public knowledge of
this particular cycle, which may have had a distorting effect on
its timing. But, in truth, no one can positively explain what
happened in 1946 any more than they can explain the regularity
of the rhythm for all the years that preceded it.

- 36 -
 The 41.Month Rhythm in Stock Prices, 18684945

2 -
375 880 k
Rt KITCHIN
WAVE Ifi

r/ -
‘\
STOCK
PRICES

895

/
L\
-f
191
I

J’

19:

L
- from CYCLES, by
L E. R. Dewey.

I I I I I
1960 1965

THE'REVERSED'CYCLE FROM 1946

- 37 -
 Reviewing the New York market from 1950 to 1974 using a constant-width
curve superimposed on the raw data, the following rhythms are discerned
(note that the next top on the chart would be due in January, 1977, and
the next bottom in December, 1978):

from THE PROFIT MAGIC OF STOCK

TRANSACTION TIMING, by James M. Hurst

The average of the last six wave components (Kitchin Wave - combined bull
and bear phases) since 1949 is 50.8 months (trough to trough). The average
of the last six bull phases since 1949 is 28.7 months and the average of
the last six bear phases since 1949 is 22.1 months.

AND IN THE BRITISH MARKET:

In the diagram on the next page and the chart on page 21, we again discern
the periodicity for the British market and the endogenous forces shaping
the cyclical changes in London.

(The following diagram is from THE GILT EDGED MARKET, January, 1973, courtesy -
of Joseph Sebag & Co., Members of the Stock Exchange in London, Bucklersbury
House, 3 Queen Victoria Street, London, England.)

- 38 -
 THE FOUR-YEAR CYCLE

1. At peak of equity boom, credit restriction is enforced as part of official policy.

Equities fall; Gilt Edged fall; interest rates rise; money supply restricted

2. At bottom of Gilt Edged slump. credit relaxation, but industrial investment low.

Equities continue to fall, Gilt Edged rise, interest rates fall, money supply expanded.

3. At bottom of Equity slump. reflation, increased demand, stocks reach low ebb.

Equities* rise, Gilt Edged continue to rise, interest rates still failing as credit expands.

4. At peak of Gilt Edged boom, industrial investment improves, so demand for money.
.
Equities rise, Gilt Edged fall. interest’ rates rise and money becomes tighter.

1 2 3 4 1

. # I .
\
\
\
\
,// \
\\
/ &
// Je
/ /
/I
\
1’
//
/
, ‘
I
1’
/
\

- 39 -
 CONTINUING WITH THE CYCLE INVESTIGATORS

1913: Dutchman J. van Gelderen in his book, SPRINGVLOED: BESCHOUWINGOVER

INDUSTRIELE ONTWIKKELING EN PRIJSBEWEGING, observed that in addition to the
ten-year cycle, a much longer one existed, extending over several decades.

1926: N. D. Kondratieff, in his essay, "Die langen Wellen der Konjunktur,"

described the cycle in detail and thereafter it has been named after him.
It was Kondratieff who brought the phenomenon fully before the scientific
community and who systematically analysed all the material available to him
on the assumption of a Long Wave, characteristic of the capitalist process.
He believed the economy moved to a vaster rhythm. For twenty years, its
basic direction was upwards, then,after an inflationary peak, it started a
300year slide, ending up in a depression. Kondratieff considered that this
long wave is the most important force, reflecting not only major economic
trends of the society, but all facets of national life--from prosperity to
social unrest, war, etc. Moreover, it is the dominant wave, with the other
more regular cycles--Juglar's and Kitchin's--acting as brakes and accelera-
tors to the dominant wave direction.

Simply, Kondratieff's argument was that depression made cheap money and
cheap labour, and helped lay the basis for a period of sustained expansion
that would eventually burn itself out in excessive inflation. From this
point, the economy moved slowly back, with deflation feeding on itself into
a full recession. Each inflationary peak, moreover, coincided with a war
that helped drive prices to intolerable levels and then, when it was over,
ushered in a rather pleasant early period of the downturn. This is where
we are in 1977. Kondratieff dated his first long wave from the 1780's to
1844-51, peaking out with the War of 1812. The second ran from 1844-51 to
1890-96, with its peak around the American Civil War. The third cycle
f reached its peak with the First World War, then slipped down into the
depression of the 1930's. The peak was 1920 and the next peak is the early
1970's. The Second World War was the next trough war, with the next peak
following the Vietnam conflict. Currently, the U.S. is into the first
decade of the slide, which will be pleasant at first as inflation moderates,
but must eventually lead to depression in the early 1980's. Us,ing the
Kondratieff Wave, we now face nearly a decade of more stable prices, with
balanced budgets, slowly rising unemployment, little social tension, and
some reasonable performance from the stock market possible during the next
one or two Kitchin Waves (refer to page 27).

Kondratieff occupied the post of Professor at the Agricultural Academy and

was head of the Business Research Institute of Moscow after the Bolshevik
Revolution in 1917. He analysed the prices in Germany, France and the
U.S.A., trade in England and France, and production of gold, coal, iron,
and other products throughout the world. The theory was published as a
series of articles between 1922 and 1928. Kondratieff was inediately
reprimanded by the Party for unorthodoxy. Marxist theory said that down-
turns in capitalist economies were due to the defects of the system and

- 40 -
 -%
THE KONDRATIEFF WAVE
This chart shows the four Kondratieff Wave long wave cycles superimposed over U.S.
Wholesale Price Indices. A similar experience is discerned using British or French
price series.

U.S. Wholesale Prices Source: The Media General Financial

Idealised Kondratieff Wave- Weekly, August, 1972.
A long price record (1264-1954)
-20
--691 years of consumables in
Southern England (E.H. Phelps CYCLES: THE SCIENCE OF
Brown and Sheila V. Hopkins, ~~~~~~~ Source: PREDICTION, E.R. Dewey
November, 1965, ECONOMICA, Vol. and E.F. Dakin, Henry
XXIII, No. 92)--shows a signifi- Holt and Company, Inc.,
..*
cant cycle that measures an ave- +20 - -*20 New York, 1947.
1 I I I I I 1 I I
rage 55.5 years between ideal 1920 1940 lwa 1990 1900 1920
crests. Cycle corresponds with
QUOTATIONS OF IN~~~~-BEARIN~I SECVRITIES
analysis of W.H. Beveridge cover-
ing 370 years of European wheat. Deviations from wend of French ccntc and ,Englirh consols, smoothed by
mean8 of a pycar moving average (after KondraticlT). The curve has been
inverted and a regular 54.year cycle has been added.
 were certainly not self-correcting as Kondratieff postulated. The Soviet
Russian Encyclopaedia swiftly dismissed Kondratieff's work: "The theory
is wrong and reactionary." In 1930, the Russian secret police arrested
him as the alleged head of an illegal, anti-government Peasant's Labour
Party and, without trial., shipped him off to Siberia. So, N.D. Kondratieff
became one of the few economists in history who have ever been punished for
their theories.

Culmination of the next Kondratieff peak in 2020-2026 would fully confirm

the theory for historians, in that Stalin had the one man at his disposal
who really understood the capitalist process and who could have directed
him in making timely forays when that process was the most vulnerable.

Most Western economists sided with the Marxists (whose very ideology was
now threatened), preferring the more logical Keynesian approach of control
over destiny.
1926-1933: Dr. Simon Kurnets published CYCLICAL FLUCTUATIONS--RETAIL AND
WHOLESALE TRADE, U.S.A.; SECULAR MOVEMENTSIN PRODUCTION AND PRICES, and
SEASONAL VARIATIONS IN INDUSTRY AND TRADE. Kuznets discerned a cycle of
from 150to-25 years' periodicity related to productivity, labour and capital,
etc. The Kuznets cycle is because of its length much less recognisable.
Most people tend to focus on the shorter term rhythms, particularly when
other cycle modes are of sufficient magnitude to mask the Kuznets cycle from
popular awareness. Actually, the Kuznets cycle exists more as a statistical
observation,for many time series in the economy seem to fluctuate with the
periodicity of 15 to 25 years.

1938: R. N. Elliott produced his findings in a monograph entitled, "The

Wave Principle," published by the Financial World. This is a study of
rhythmic recurrence. Eight years later, as a result of further discoveries,
f Elliott updated the original work with another thesis entitled, NATURE'S
I LAW: THE SECRET OF THE UNIVERSE, in which he added many philosophical points,
including reference to the Fibonacci Summation Series, all of which formed
the basic rationale for the Wave Principle. Elliott's work when applied to
stock price motion theory became known later in Wall Street parlance as the
"Elliott Wave Theory."

Elliott died in 1948 and his monographs and "educational letters" are long
since out of print. The late A. Hamilton Bolton (past president of Bolton
Tremblay and Company of Montreal and founder and editor-in-chief of THE BANK
CREDIT ANALYST) authored and published in the 1960's THE ELLIOTT WAVE PRIN-
CIPLE OF STOCK MARKET BEHAVIOUR. Later he published THE WAVE PRINCIPLE,
consisting of a series of 12 articles first produced by Elliott and published
in 1939 by the Financial World.

The most recent and comprehensive work produced on Elliott came out of Eng-
land: THE ELLIOTT WAVE PRINCIPLE AS APPLIED TO THE LONDON STOCK MARKET,
by R. C. Beckman of the Investors Bulletin Limited, published in 1976 by
Tara Books, Winchester, England. .

- 42 -
1939: Austrian-born Harvard economist Joseph A. Schumpeter compiled an
exhaustive two-volume study entitled BUSINESS CYCLES: A THEORETICAL AND
STATISTICAL ANALYSIS OF THE CAPITALIS PROCESS. Schumpeter developed a
complete economic system of regular cyclical growth and contraction using
the three cycles of Kondratieff (50-57 years), Juglar (10 years), and
Kitchin (4 years). Schumpeter argued that cyclical fluctuations were
caused by waves of innovation. In this theory, boom is the expansion
caused by innovation; depression is the inevitable adjustment of values
and cost which must follow. Reduction of costs by innovation is rough
on the less-gifted producers, who must be eliminated or reorganised on a
more economical basis. Innovations come in spurts, and, as long as this
is so, excess and adjustment cannot be avoided.

1940: Edward R. Dewey organised and became chairman of the Foundation

for the Study of Cycles. The Foundation is now affiliated with the Uni-
versity of Pittsburgh, and its headquarters are located at 124 South
Highland Avenue, Pittsburgh, Pennsylvania. The Foundation has from its
very humble beginnings advanced knowledge in many and varied sciences and
has substantiated over 1300 cycles in economics and commerce (commodity
prices, stock prices, agriculture, building and construction, real estate,
manufacturing and production, employment), physical sciences (biology,
medicine: disease and epidemics, geology, astronomy, meteorology, wild-
life studies), and in those cycles which are psychological, social or
political in nature (war). Altogether, from the point of establishment
to the present, the Foundation has dramatically advanced cycle discovery
and knowledge in over thirty different sciences. We recommend that serious
students of fluctuating phenomena join the Foundation and subscribe to its
authoritative magazine, CYCLES. We also refer readers to the publications
and research bulletings produced by the Foundation and, in particular, to
Edward R. Dewey‘s book, CYCLES: SELECTED WRITINGS, which is a publication
covering all cycles analysed by the Foundation over the ZB-year research
period to 1968.

1947: Dewey and Dakin published CYCLES: THE SCIENCE OF PREDICTION. This
*pointed out the need for the business community to have a better under-
standing of the major swings of the business cycle. Dewey and Dakin analysed
the various cycle measurements, from the 20-second cycle in the growth of
a crocus through to the decennial recurrences which influence insects,
animals, and man alike and up to the 66-68-year cycles found in the flooding
of the Nile River, plus hosts of other cyclical tendencies apparent in busi-
ness, trade, and investments.

1958: The Society for the Investigation of Recurring Events was organised
-New York.

The goal of cycle analysis is to eliminate from the original data any ir-
regular, noncyclical influence so that a typical cycle curve appears.
Seasonal influences are removed by dividing the original data by an ap-
proximate index of seasonal variation. Similarly, the series is corrected
for growth when the data are divided by the computed values of the trend.
Irregular variations of the cycle component are further reduced by smooth-

- 43 -
 ing the data with a weighted-moving-average technique. Sometimes a
section-moving-average technique is used as a cycle smoother to iron out
seasonality. Unlike the moving average, it does not average consecutive
numbers of a series, but averages two or more sections of each cycle
simultaneously.

In England in 1867, Sir William Thompson developed mathematically the

harmonic method, the principle used directly in the prediction of the ebb
and flow of tides. The constituents are sine and cosine curves and, as
all sine curves are periodic, repeating themselves indefinitely, it has
a direct application to our cycle work. Later, an American professor,
A. A. Michelson, devised a machine acting as a harmonic analyser. Such
machines can accomplish what the mathematician can do by laborious method.
The device can be applied to cycle studies covering many disciplines.

Harmonic analysis is based on the Fourier Theorem developed by Baron

J.B.J. Fourier in 1822, which gives representation of frequency relation-
ships. J. M. Hurst, in PROFIT MAGIC OF STOCK MARKET TRANSACTION TIMING
(Prentice Hall, 1970) successfully analysed applications of Fourier
analysis to the American market to determine amplitude and frequency
relationships to assist timing market transactions.

USING CYCLES TO KNOW THE PROBABILITIES

The principal characteristic to be concerned with in the cycle is whether

the action is repeated in the same length.of time as before, for then it is
both cyclic and periodic. The wholecycle activity is referred tp as a
cycle "component." In our economy, the four. most important such rhythms
are as foliows:
i. Kondratieff: The 54-year rhythm in wholesale prices, securities,
interest rates and industrial innovations.
.Kuznets: The 18-l/3-year rhythm in security prices, real estate
activity, and in related industrial enterprise.

Juglar: The 9.225-year rhythm in security prices, wholesale

prices and industrial activity (known commonly as the
decennial pattern in Wall Street).
Kitchin: The 3+4-year rhythm in security prices, interest rates,
business activity, and wholesale and retail prices.

Summation- _ (or Combination) Principle

of Cyclic Forces in the Market
In the marketplace, cyclicality in price motion expresses itself as a sum of
a number of periodic cyclic force components. This means that the longer
term cycle dominates; the shorter term cycle and the smaller cycle components
are subordinate to all other cyclic forces. Here are the cyclic forces at
work in the 19th and 20th centuries:

- 44 -
SCHUMPETER'S MODEL

THE 19th CENTURY BUSINESS CYCLE

s.,/-.\ KONORATIEFF
/

KITCHINS

.THE 20th CENTURY BUSINESS CYCLE

AND CRISIS POINTS
(calculated path)

Source: T.I. Zimmermann

1. Kondratieff
Ceschichce der fheoretischen
2. lugiar
Volkswirtschalts-lehrs
3. Kitchin
-Or. P.E. Erdman-unpublished paper
4. Composite of 1. 2. 6 3

- 45 -
 SHARE PRICES: DEFINITION

Cycle analysts would define stock price trends as early value-discounting

transactions of the future prospects of the world trade cycle, which in turn
is subject to the external directional forces and pressures of the cyclic
phenomena (Kondratieff, Kuznets, Juglar, and Kitchin rhythms) present in the
capitalist economic pmcess.

Professor Schumpeter wrote of his model:

"No claims are made for our three-cycle scheme except that it is
a useful descriptive or illustrative device. Using it, however,
in that capacity, we in fact got 'ex visu' of 1929, a 'forecast'
of a serious depression embodied in the formula: coincidence of
depression phases of all three cycles."
On the stock market, Schumpeter states:
'It is natural to expect that upward movements on the stock exchange
will, in general and in the absence of unfavorable external factors,
set in earlier and gather force more quickly that the corresponding
upward movements in business, i.e., often come about already in the
later stages of revival when tl%i$ are beginning to look better
every day, with new possibilities showing themselves. Similarly,
it is to be expected that stock prices will turn before other indi-
cators, i.e., when in the later stages of prosperity limitations
and difficulties emerge and it becomes clear that possible achieve-
ments have been fully discounted,"

Looking at the 20th century model on the previous page, 1973-74 appears well
into the danger zone and represents the primary recession after the war.
This will undoubtedly be the biggest stress since the 1920's. The early
i 1980's present a period of acute danger and crisis such as last observed in
i 1929-31. Obviously, the long term business cycle has already peaked.

Today many governments pay attention to compensating for the shorter term
cycles, while tending to ignore completely the longer term cycles. The
"built-in stabilisers" are supposed to prevent all reversal of prosperity.
Unfortunately, stabilisation of the shorter term waves often tends to de-
stabilise the longer term cycles and make the liquidations that much more
violent.

Explanations attempting to account for the unstable nature and rhythms of

the capitalist process have, as each year goes by, become noticeably greater
in number and more subtle in detail, as more members of society seek greater
security away from those fluctuations.

- 46 -
MORE ON THE KONDRATIEFF WAVE

“After the initial postwar recession comes a period with something

for everyone. It is the first decade of the downswing, but it is
a matter of prices not going up any more, a plateau between the
peak of-rapidly rising prices and the canyon of their rapid fall."
- James 8. Shuman and David
Rosenau, THE KONDRATIEFF WAVE,
World Publishing Company,
New York, 1972, and Dell
Publishing Co., Inc.

By 1968, E. R. Dewey had listed 35 different data series in which a 54-year

cycle had been alleged. Originally, we had viewed the possible existence
of the Kondratieff long wave as an interesting phenomenon to be substantia-
ted during a slack period. Inspiration came suddenly. We discovered a
remarkable set of data originally produced by E. H. Phelps Brown and Sheila
V. Hopkins of the London School ofEconomics and Political Science, entitled,
"Seven Centuries of the Prices of Consumables, compared with Builders' Wage
Rates in Southern England, 1271 to 1954." We were able to discern a poss-
ible 50-52-year rhythm with the current crest in the 1974-78 period.
Gertrude Shirk of the Foundation for the Study of Cycles using the same
data series was far more precise in her report in CYCtES, Volume XXVI, Num-
ber 3, 1975. She found a cycle of 53 years over the last 333 years of data
(crest 1978), whereas the entire 684 years of data produced a 55.5.year
cycle (crest 1981.9). The picture below is a model of the ideal cycle line
from that data series.

t I I
% of Trend ’

,“\
/ \
t \
8
120 - : \
I \
I \
8 \
\
t4 $
\
\
1’ \ I
.
\
1oc t a \
I \
r’ \
.---
I
- :
,’
0I
Trend is level
ao-
at 100%

. 1 1 I I
1920 0 i 980

A SYNTHESIS, lgoo-2000, OF FOUR IDEAL CYCLES (55.5. 50.6, 40.3, AND 60.4 YEARS) AS FOUND IN
THE PRICE OF CONSUMABLES IN SOUTHERN ENGLAND

- 47 -
 On the preceding chart, we have added a loose fit of a $-year-plus com-
modity rhythm. The projected idealcycle line moves on a high plateau
until 1982, which implies that the next two commodity cycles (including
the current bull phase of late 1975-early 1978 and the 1981-82 bull phase)
may record significant new highs for some commodities. Such action would
best be described as disinflationary, and from the long term cycle synthesis
work shown on the chart, the trend for consumables leads into a very strong
deflationary period commencing in the early 1980's.

To date (early 1977), the behaviour pattern as shown by the Reuters Index
(European and sterling-quoted commodities), the Moody's Index, and the
C.R.B. Index bears the imprint of the long term cyclic projection. Like-
wise, the review of Retail Price Indices of Britain, U.S. France and Ger-
many, which we often publish in our monthly supplements, continues to
support the disinflationary view.

RECENT ACADEMIC CONFIRMATION

The System Dynamics Group at the Massachusetts Institute of Technology

Sloan School of Management have been developing a system dynamics model for
the U.S. economy. The model covers fifteen industrial sectors, plus allow-
ance for decision making, accumulations, buffers, pressures and restraints, -
with a quantitative computer simulation used to derive the qualitative
behaviour of the system. The aim is to determine economic behaviour arising'
from multiple modes superimposing their patterns of interaction within the
economy. Identification of the differing modes (rhythms) is essential;
otherwise, their symptoms would be most confused and in consequence action
taken.might be inappropriate or counterproductive.

First it was essential to distinguish the modes of behaviour within the

economy. The preliminary report from the group presented at the 17th
2 Annual Meeting of the National Assocation of Business Economists, Boca
Raton, Florida, on October 7, 1975, summarised the following points with
reference to business rhythms:

. Several simultaneous periodicities of economic fluctuation can

exist in the.economy atthe same time.
. Basic industrial structures and managements policies can generate,
not only the business cycle but also the Kutnets cycle of some
eighteen years duration and the Kondratieff cycle of some fifty
years duration.
. The three- to seven-year business cycle seems to be caused pri-
marily by interactions between inventories and employment.
. Capital investment probably has less to do with contributing to
the business cycle than it has in generating the longer Kuznets
and Kondratieff cycles.
. Monetary policy, to the extent that it works through investment
in plant and machinery, may have little influence on the business
cycle. -

- 48 -
. Mild recessions since World War II can be explained by the rising
phase of the Kondratieff long wave rather than as a consequence
of post-war monetary policy and "fine tuning."
. The greater severity of the present recession may indicate the top
of a Kondratieff long wave of capital expansion.
0 Confusion between the business, Kutnets, and Kondratieff cycles may
cause symptoms to be misunderstood and counter-productive national
policies to be adopted.
. Recent increases in unemployment may not come from the business
cycle but from the long-term Kondratieff cycle at the end of the
phase of overinvestment in capital equipment.
. The belief in a tradeoff between inflation and unemployment may
be erroneous with the result that increased money supply fails
to relieve unemployment but does produce inflation.

No doubt the studies will lead to a better understanding of the simultaneous

interaction of the major cycles (modes) of economic activity, which may it-
self lead to more effective government and corporate strategies in respond-
ing to economic and social stresses.

The report also implies that the capitalist process is often impervious to
policy and that difficult times are ahead.

KONDRATIEFF WAVE IN EQUITY PRICES

Using American equity prices back to 1789, we have not yet been able to
observe a clearly defined 50-55 year mode. There are only two-and-a-half
repetitions over that period, and we simply do not have enough data for
this cycle to register statistical significance. The current data reveals
that a cycle is present and that it has peaked and is quite advanced on the
downside. Confusion arises, however, from the fact that price motion in
the 20th century has tended towards a 40- to 46-year rhythm. Similar re-
sults were obtained using the index of Australian mining issues from 1875
and the Standard & Poor's Industrial Index from 1860. This is perhaps the
reason why several of the U.S. commercial investment advisory firms who
have become advocates of the Kondratieff Wave Theory over the last five
years continue to stress a 40- to 46-year period.

Reviewing the trend for the Standard & Poor's Industrial Index pictured on
the next page, it appears that the dominant “secular" trend commenced in
1942 and topped out in 1965, with a slight delay through to 1968. Most
international markets bear the same trend imprint, with a few exceptions,
notably the London market, peaking out in the following "Kitchin Wave" peak
of 1972.

Application of the trend juncture years of 1942 and 1965 from the Standard
& Poor's chart to a long term bar chart of the bellwether, General Motors,
revealed that this time frame captured 89% of the amplitude made by the up-

- 49 -
 STANDARD & PDORS INDEX AT 1977 CLOSE:
INDUSTRIAL INDEX STANDARD & PDORS INDUSTRIAL 104.7
DOW-JONES INDUSTRIAL a31

TomN TREND UP AT END 0F1978:

STANDARD & PDDRS INDUSTRIAL 168
DOW-JONES INDUSTRIAL I214
,*
/
/
,
,
I
I

." TO HAINTAIN AT CURRENT RATE:

'* STANDARD & PDORS 104
DOW-JONES 793

move experienced by General Motors in its last supercycle growth phase. Our
object is to capture at least 75% of the price amplitude of a cycle. During
that 1942-1965 growth phase, general philosophy became: "Buy and hold good
i quality growth stocks; buy value." Bearphaseswere often ignored, because
each successive cycle high and low was higher than the preceding ones. When
mistiming occurred, an investor would ride out the bear phase in the belief
that eventually his judgement would be vindicated. Characteristically,
market timing advocates, trend-and-cycle and technical analysts, fell into
disrepute and in the eyes of the investment community became redundant and
totally disproven. P/E multiples and fundamental growth emphasis became the
idols of the investment trade and the keys to untold fortune. The value of
a member's seat on the New York Stock Exchange during this period soared to
an unprecedented $515,000, but within a decade of the reversal of the long
wave the value of a member's seat had fallen to below $40,000.

Since1965-8 cycles for equities have been in the form of successively descend-
ing highs and lows. Growth and the fundamental yardsticks developed and
relied upon in the post-war period tended to fail. "Buy and hold" meant
fast-diminishing portfolio values and returns. Timing was sought as the
cycle became evident again and was popularised once more by investment peo-
ple. Timing was recognised as a tool to investment success. It was again
fashionable to employ a market technician.

- 50 -
 LOWRYWITHOUT TEARS

Stan Lipstadt
Endowment Management & Research Corporation

Those of us who attended the first Market Technicians Seminar had the
opportunity to see one of the few academic studies of a well-known
technical service. This study from the Wharton School attempted to
discern whether the Lowry service had any "merit"; that is, whether its
use would have provided a rate of return in excess of that produced by
a buy-and-hold strategy.

The Wharton study concluded: "The results of this study show that the
Lowry method of technical analysis, which uses only past price and vol-
ume data, has led to returns significantly in excess of those achieved
by naive buy-and-hold programs. In addition, such performance was
achieved in the face of some very stringent operational limitations,
during a number of different time periods. This, of course, is an ap-
parent contradiction of both the Efficient Markets and Random Walk
Theories-"

As technicians, most of us are well aware of the Lowry service- It is

one of the oldest, continuous technical publications available today.
If nothing else, it has provided a long history of "hard" data from
which we can make any modifications we wish for our own specific ends.

I have used the service for many years, with some minor changes in in-
terpretation from what is traditionally detailed by Lowry, and the
series is one of seven variables that constitute my Portfolio Strategy
Model.

If Lowry's service suffers at all, it is from the degree of complexity

necessary to put his program to work in a manner that allows for a full
following of all the rules. As the Wharton study mentioned: 'Many
different trading programs may be devised from the Lowry analysis be-
cause a number of buying and selling controls have been defined which
vary in sensitivity and strength. This (Wharton) study employed what
is referred to as the Basic Trend Program, which involves the utiliza-
tion of all the standard buying and selling controls available." The
study then went on to describe six of these controls and-mentioned
that there were two additional buy signals and two additional sell sig-
nals also used, although less frequently. And these ten signals consti-
tuted merely the Basic Trend Program! Full utilization of every avail-
able Lowry signal would encompass as much detail as was required of
Walter Heiby's Dynamic Synthesis.

- 53 -
 The purpose of this report is not to condemn complex investment tech-
niques; most of us have been stung often enough by facile decision
rules in what has proven to be a rather complex stock market. And the
success of any investment technique, regardless of its complexity, is
sufficient reward for the effort involved.

However, there are interpretations of Lowry's data which involve a good

deal less effort, yet also produce a successful strategy. The simplest
of these is enumerated below.

Before detailing this strategy, it is necessary to make one change in

the traditional Lowry interpretation of his own data. Back when the
Lowry service first became available in 1937, he provided "back-tested"
information to 1933. At that time both the Buying Power and Selling
Pressure indexes were at approximately the "100" level, presumably set
at that level for convenience.

Over the years these two series have grown in a secular fashion, so
that today each is close to a base of "300." That is, if the Lowry ser-
vice is a crude measure of the clout in the market at any point in time,
that clout has approximately tripled in the 40 odd years of the ser-
vice's availability.

There is no way, a priori, that one should expect that the "point spread"
between the Buying Power and Selling Pressure indexes should remain any-
where near levels that existed when those series were at the "100" level
And indeed they have not! One could make the case that the spread
should have, in fact, tripled in terms of points since the service first
became available, under an assumption of constant volatility over time.

In my opinion, it was this interpretive problem that caused the writer

of the Lowry service to remain excessively negative on the outlook for
the market between September 1974 and January 1975. With each passing
i week, the service made reference to the exceptionally large "point
spread" between the Buying Power and Selling Pressure indexes. It was
pointed out that such large point spreads were usually not indicative
of lasting rises in the stock market. And that may be tz. But what
is important is the fact that the Lowry service had, as of late Septem-
ber 1974, reached levels of a long-term oversold nature of identical
proportions to those seen on May 22, 1970, October 7, 1966, June 1,
1962, September 27, 1957; and September 13, 1946.

-_52 -
 What was needed was a way to make the current readings of the Buying
Power and Selling Pressure indexes comparable with those of the past.

I feel the best way to accomplish this is to "normalize" the data, by

making the point spread a percentage of the combined base of the Buying
Power and Selling Pressures curves. Thus, on September 13, 1974, the
Buying Power curve stood at 207, the Selling Pressure curve was at 340,
and the point spread was therefore -133.

On May 26, 1970, similar numbers were: 212, 338, and -126, respectively.

On October 7, 1966, the numbers were: 189, 286, and -97.

On June 1, 1962, Selling Pressure registered a reading 91 points above

the Buying Power Line. This spread subsequently widened even further.

On September 27, 1957, we find readings of 134, 202, and -68.

And on September 13, 1946, similar statistics show the Buying Power
curve under the Selling Pressure line by 70 points. Every one of these
points in time has one common link: although point spreads varied from
-68 to -133 points, the percentage spread was always in excess of -20%.
Taken in order of their above listing, we find: (207-340)/(247+340)=
-24.31%, (212-338)/(212+338)= -22.91X, (189-286)/(189+286)x -20.42X,
(158-249)/(158+249)= -22-36X, (134-202)/(134+202)= -20.24%, and (125-195)
= -22.88%.

I have spent a great deal of time detailing what I consider to be a

deficiency in interpretation in the Lowry service because the service is
otherwise so useful. It is especially important to be aware of the
secular changes that underlie the basic statistics. Performing the
simple calculations mentioned above places each week's readings on a
P comparable basis with every other week's.

With the foregoing corrections in mind, we can see the effect of the
most naive strategy using the weekly Lowry numbers.

The rules of the test were as follows:

BUY: When the Buying Power line rises above the Selling Pressure line
for two consecutive weeks, with the extent of the crossing larger
after the second week than at the first. Alternatively, whenever
the point spread between the Buying and Selling curves reaches an
extreme of -20.0% or greater, BTJY after the first improvement as
of Friday following such a registration.

- 53.-
 SELL: When the Buying Power line falls below the Selling Pressure line
for two consecutive weeks, with the second week showing a cross-
ing of greater extent than the first.

RESDLTS

From January 1946 through December 1977 there were 47 crossings, approxi-
mately 1.5 per year.

Of these signals, 24 were BUY signals. Of these 24, .14, or 58.3% were
profitable, when held until the next signal.

The average profit per profitable long trade was +20.81%.

The average loss per unprofitable long trade was -4.47%.

The average profit for all long trades was +10.28X.

The total number of weeks under consideration was 1,664.

The number of weeks out of the market was 518, or 31.1%.

The average period out of the market between trades was about 22 weeks.

The results of this naive buy and sell strategy are such that $100,000
used in thfs fashion over the 1946-77 period would have grown to almost
$740,000.

A buy-and-hold strategy using the DJIA, on the other hand, would have
been worth something less than $440,000.

The strategy does not take into account commissions necessary to carry
out the trades, and it ignores all interest received when out of the
market. Similarly, it ignores all dividends for both strategies. It
is assumed that the dividend return on the DJIA would be comparable to
low risk paper when out of the market. This point is of some interest
i since the Lowry strategy would have been out of equities for almost 10
1 of the 32 years in question.

The Market Technicians Association has given Mr. Lowry its important
annual award. It is nice to think that the award was not merely for
longevity, but for pioneering a useful technical tool that is every bit
as meaningful today as was true forty years ago.

- 54 -
 LOWRY TEST, 1946-1977

Cumulative
Dow Jones Percentage Percentage
Date‘ Action Industrials .Change _ Change _ Buy/Hold

1/ S/46 BUY 191 --- 100.00

7/26/46 SELL 198 +3.662 103.66
g/20/46 BUY 169
4/19/47 SELL 168 -0.59 103.05
7/u/47 BUY 185
21 7/48 SELL 170 -8.11 94.69
4/10/48 BUY 179
lO/ 2/48 SFZLL 181 +1-12 95-75
ll/ l/48 BUY 189
2/26/49 SELL 172 -9.00 87.13
8J 5J49 BUY 179
6/12/53 SELL 266 +48.60 129.48
11J 6/53 BUY 279
lo/ 5J56 SELL 482 +72.76 223.69
5J 3J57 BUY 498
8J 9J57 SELL 497 -0.21 223.22
1lJ l/57 BUY 435
g/18/59 SELL 626 +43.91 321.23
12/24/59 BUY 671
l/29 J60 SELL 623 -7.15 298.26
8/19/60 BUY 631
9 J23J60 SELL 585 -7.29 276.52
1J 6J61 BUY 622
l/26/62 SELL 692 +11.25 307.63
6/ 8/62 BUY 602
12J 6/63 SELL 760 +26.25 388.37
2J 7/64 BUY 792
6/18/65 SELL 879 +10.98 431.01
; 9JlOJ65 BUY 919
4/22/66 SELL 950 +3.37 445.53
10/14/66 BUY 772
llJlOJ67 SELL 863 +11.79 498.05
5 JlOJ68 BUY 913
3J 7J69 SELL 911 -0.22 496.95
5/29/70 BUY 700
7/16/71 SELL 889 +27.00 631.13
lj14;72 BUY 907
5/12/72 SELL 942 +3.86 655.49
12J l/72 BUY 1023
2J 2/73 SELL 981 -4.11 628.55
9 J2OJ74 BUY 671
8/15/75 SELL 826 +23.10 773.75
l/16/76 BUY 930
6/ 4/76 SELL 964 +3.66 802.06
7/23/76 BUY 991
lo/15 J76 SELL 937 -5.45 758.35
121 3/76 BUY 951
41 lj77 SELL 927 -2.52 739.2 1
12/31/77 CLOSE 835 437.17
 A PAGE FOR NOTES

- 56 -
 A TECHNICIAN’S ViEW OF INDEXING

William S. Doane
Coordinator of Technical Research
Fidelity Group of Funds

After the devastating bear market of 1929-32 Fundamental Analysts threw their
hands up in disgust as their time-tested techniques failed to work. Similarly,
Market Technicians, proud of their timing expertise, tossed in the towel
(charts) and had a big bonfire. Portfolio Managers, shell-shocked at the
experience, grappled for a crutch to judgment. It was then that Formula Timing
and Dollar Cost Averaging Plans came into being.

The stage was set for a repeat in the 1970's. From the euphoric peaks of
1966-68 the Value Line and Indicator Digest Averages declined an amount that
just about equalled the decline of 1929-32. Fundamentalists, failing to take
into account the inflation-ballooned earnings, performed miserably. Technicians,
although a bit more cognizant of the vulnerability, underestimated the degree of
weakness as well'as its duration. And, even for those gifted few who had the
situation well in hand, their advice was seldom heeded or acted upon. As a
result, by December, 1974, some of the best managed pools of assets were off 50X.

Not only was the performance of the conventional conxnon stock funds dismal in
absolute terms, academicians were quick to point out that the relative perform-
ance was equally poor and had been for over a decade. The beleaguered Fund
Manager's ability to beat the averages was again seriously questioned. Index
Matching was a natural outgrowth.

EUPHORIC

CONOITIONS

RISK AVERSION
QUEST FOR VALUE
LOW EXPECTATUNS
To be sure, Indexing is a fad; a fashion. Although it will eventually prove to
be transitory in nature it will, undoubtedly, be with us for some time to come.
As all of us live the investment business from day to day, it is often difficult
to see the forest for the trees. Major shifts in sentiment take time to evolve.
As with Formula Timing in the 30's, only higher prices will restore confidence
and only through increased confidence in one's ability will such mechanical means
of attaining the norm be laid to rest.

Explanations of the "institutional shortfall" (term coined by Charley Ellis)

abound, but seldom has Breadth of the Market been considered. Breadth, or the
cumulative difference between Advances and Declines, is a measurement tool com-
monly employed by Market Technicians. Several insights can be gleaned from the
chart below:

First, although this measurement tool possesses certain mathematical

imperfections, it does give an indication of the severity of the
decline that ended in December, 1974. Looked at in this manner, stocks
were at the same level in December, 1974, as they were in the 1930's and
early '40's.

I 631.10
D-J INDUStRlAL
laLYI-AINUAL
AVERAGE
“AYoE*l I 577.80

1920 1925 1930 1935 1940 194s 1950 1955 1960 1965 1970 1975 1980
 Second, it appears as though there are secular periods of strength
or weakness vis-ayvis the narrowly defined averages. The 1960's
and early 70's were characterized by Breadth (or the great bulk of
stocks) being weaker than the DJIA (or S&P for that matter). The
DJIA has, of course, been misleading for it is quite obvious that
few stocks (especially those bought by the public in 1968 and still
held) are anywhere near their highs as the Dow would have one be-
lieve. Viewed in terms of Breadth (or the unweighted averages such
as Value Line or Indicator Digest Averages) is it not a credit to
conventionally managed funds that their performance is as good as it
has been? Viewed in this manner, is it not ironic that Indexing is
such a hot item today--ten years too late?

Third, there is increasing evidence to suggest that 1974 may have

terminated the secular downtrend (both absolute and relative) in
Breadth. If this assumption proves to be correct, then, without
question, institutions will find it easier to outperform the narrowly
defined averages, Indexers will lag and, in time, the fascination will
wane.

As the pendulum swings from one extreme to another, it is quite likely that
recent experiences will be reversed and emphasis will shift, and is in the
process of shifting, from the Top Tier to the Lower Tier:

Primary Secondary
Top Tier Lower Tier
Larger Capitalized Issues Smaller Capitalized Issues

Over-Owned Under-Owned
Over-Researched Under-Researched
Efficiently Priced Inefficiently Priced

In fact, evidence for the first six months of 1977 substantiates this:

Indicator Digest Average + 3.8%

Value Line Composite + 1.5%

Average Mutual Fund - 1.1%

(Computer Directions Advisors)

S&P 500 - 6.5%

DJIA - 8.8%

In summary, it appears as though efficiency varies directly with capitalization

and therefore future performance may well vary inversely with efficiency. In
other words, strong Breadth may well be the demise of Indexing as the Indexers
index to the wrong index at the wrong time.

First Published in
"Pensions & Investments"
August 15, 1977
- 59 -
 STOCK MARKET STRATEGY

by Richard A. Crowell

Published by: McGraw-Hill, Inc. 1977

Reviewed by William DiIanni, V.P.

Wellington Management Co.

It was a cool autumn day when I casually entered the Lauriat Bookshop across
the plaza from 28 State Street. I wasn't looking for any book in particular. But
it wasn't long before my eye became fixed on the bright red jacket with the free-
scale drawing of a line-chart that covered "Stock Market Strategy".

I picked it up with a curious and unusual sense of anticipation. Flipped the

pages quickly as one is wont to do with any book - as if the rapid running of the
pages under one's thumb could somehow release its massage quickly and effortlessly
through some form of osmosis. Charts and graphs flew by. Words like market-analy-
sis, technical, stock-selection, uptrends - downtrends, odd-lot statistics, a time
to buy and a time to sell, market-timing popped from the pages - confusing vision
and meaning. "Oh no", I thought, "not another book panning market-analysis!"

But this was not the case. In fact, much to my surprise, Richard Crowell has
done a superb job in incorporating many facets of market-analysis into a complete
approach to stock market strategy and portfolio building. Market-timing becomes
the keystone to his analysis, almost to the point of being heliocentric. One quick-
ly realizes that this is no ordinary book.

Over the years, the futile quarterly performance race has clouded many more
important issues in the minds of professional investors. This book goes a long
way in helping one get reoriented and reorganized.

Sometimes the critical question is not which of several stocks should be

bought, but whether any issues should be bought at all under the circumstances of
a particular market phase.

The author stresses three major steps in investment decision making:

1. Establishing how much risk you can take. How much can you afford
to be exposed to the absolute volatility of the stock market?

2. Forecasting the investment environment. Clues involve discipline

investigation, judgment, and insight. The fortunes of the overall
market determine, by and large, our success or failure in the
stockmarket.

3. Security selection. Once the first two hurdles are passed,

stock picking is relatively easy.

Mr. Crowell reassures
up, as it always has been.
knowledge and self-understanding
succeed at making it profitable.
us that the long-term trend of the stockmarket will be
And the book goes a long way in giving sufficient
to help one join the small minority who regularly
- 60 -
 He shows one that while the rules of the game keep changing somewhat, there
are ways to perceive the true patterns underlying market trends regardless of the
distortions of randomness and noise.

The guts of the book liberally treat random walk, risk and diversification,
market risk, and many other elements and nuances of modem portfolio theory.

Market-analysts, however, will feel more comfortable with the section on the
"importance of market timing". The meaning-is broadly used, since Mr. Crowell employs
leading indicators, the business cycle, trend of corporate profits, monetary policy,
interest rates, and movements of diverse market participants as well as many more
conventional technical tools. All of which are neatly packaged into a “Buy and
Sell Checklist" with some twenty items under each column.

Further, the author goes into an analysis of various methods of determining

value and selecting stocks. Graphs and charts are ample to demonstrate his theories.
There is also a separate section on the evaluation and proper selection of growth
stocks. Unfortunately, the book was not written pre-1972.

For those with a speculative flair, there are "theme" stocks. Theme stocks
(or vogue stocks) are part of every significant market uptrend. They are the
"leadership" for that cycle. Chapter 8 runs through the many varieties-of themes as
the storage theme, the one-decision theme, small growth stocks, and so on. Vogue
stocks come and go, but proper recognition and timely purchase can add spice to a
portfolio and improve performance. This is .the exciting area of a particular market
phase. But they alw5ys.-endi. -- - - ' ,_ - .

To quote from the book itself: "The astute investor must maintain a degree
of cynicism that will enable him to play the current game, to take advantage of
the current theme. But he must know from the beginning that it will not last.
The time will come when the theme is over, a new game has begun, and investments
must be adjusted accordingly."

The last chapter asks the important question: How do we put it all together
into a sound stock market strategy?

g Easy.

Bead the book.

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