Trader’s Narrative

Is it possible to time the market using a system that is so simple, it only requires you to be able to count up to four? Can we invest for the long term using a system that only requires a few minutes of our attention every four years?

Not only is it possible, such a system has beaten the pants off the pros in the long term. Being so amazingly successful, it has garnered a name: the four year stock market cycle.

Many theories have been put forth to try and explain it. Some say it is due to the presidential cycle, some that it is due to the business cycle, some to astrology or other esoteric phenomena. While the reasons are up for grabs the results are quite clear. And they are the sort that makes EMH proponents pull their hair out in frustration. How can something so simple, so replicable, and so consistent exist decade after decade?

While academics debate it, you can use it to boost your long-term investment account. All you need to do is to watch for a low every four years. The start year is important, so I’ll give it to you: 2006. From that year, you can go back and forward in four year increments. Those years will be (in the future) or were (in the past) great times to invest in the stock market. Or to add to an existing investment portfolio.

Take the previous cycle: 2006. That was the last intermediate low. Before that, in 2002 we had the trough of the multi-year bear that resulted from the popping of the internet mania. The one before that? 1998 which was the trough from the Asian currency contagion that shook financial markets. Keep going and you’ll see that the four year cycle marks great buying opportunities in an uncanny way.

Of course, it doesn’t have a perfect track record. But it is a damn good one. Out of the last 27 four year cycles, only 5 of them have not been great buying opportunities. They were 1946 (flat), 1930 (ouch!), 1910, 1906 and 1902. You can keep going back in time but my chart (below) stops there:

Click to enlarge graph

For extra mojo, we can combine the 4 year cycle with the annual cycle. That is, we can take the best month within the year (historically October) that coincides with the four year cycle. But remember, the four year cycle is only a guide. No individual occurence has to follow the script to the letter. All we are interested in is putting the odds in our favour as we have detected them from historical observation.

The following graph shows the decennial performance of the Dow Jones Industrial Average. Think of it as putting the annual performance of every decade into a blender and mashing them together. We get a graph that shows the average performance of each year within a decade:

As you can see, year 4 has an unusual lift that the other years don’t. If you’re sharp, you’ll notice that years 7 and 8 also have some pretty good kick as well. This data is not showing the same thing as the four year cycle but it does present us with further proof that returns from the stock market are not random. If they were, then each year would show fairly similar performance.