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Weekend Stock Market Analysis

(5/11/13)

For those that read my daily reports I mentioned if the Dow ends up with a positive gain in May this would be the 17th Month out of the last 20 that it has ended positive or 85% of the time.  Going back to the Dow's inception in the 1890's there have only been two other occurrences in  which it has seen a positive gain  85% of the time over any 20 Month Period.   These occurred in 1951 (point A) and back in 1936 (point B).   Thus the question is what phase are we currently in and how will things evolve in the future?

The most optimistic outcome is that the Dow will repeat the period from 1950 through 1966 in which it gained around 500% (points C to D).   In 1951 the Shiller PE Ratio was around 11 so the market was rather undervalued at the time leading up to the 17 year Bull Market.  Currently the Shiller PE Rato is around 24 so the market is pretty overvalued as compared to 1951.

In order for the Dow to repeat the period from 1950 through 1966 it would have to rise up to the 40,000 level by 2026 to achieve a 500% gain from the March 2009 low.   This means over the next 13 years it would have to average 13% a year to achieve a target of 40,000.  With the Shiller PE Ratio currently at 24 this scenario doesn't look very likely unless you believe in Birinyi's Ruler, Hockey Sticks or Santa Claus.   

Next if we take a look at 1936 event the Shiller PE Ratio had risen into the lower 20's so the Dow was becoming rather overvalued at the time as it had rallied strongly from the 1932 low (points E to F).   After peaking in early 1937 the Dow went through a 12 year Consolidation Phase that lasted until 1949. 

If the Dow ends up going through a consolidation period in the coming years there is one potential long term scenario to watch for which is an Inverted Head and Shoulders pattern.   This scenario would satisfy both the Bearish and Bullish Analysts in the long term.   In this scenario the Dow's first Shoulder occurred with the 2002 low while the Head was associated with the 2009 low.  Meanwhile the Dow would stall out along the Neckline (black line) connecting the 1999 and 2007 peaks.  This would then be followed by a multi year pullback for the 2nd Shoulder with a target zone between 10000 and 9000 (30% to 40% correction) to complete the pattern by 2016 or 2017 which would vindicate the Bearish Analysts. 

Meanwhile after the 2nd Shoulder completes then another significant Bull Market would follow for several years with the projected long term target around 24,000 based on the length from the Head to the Neckline.  This would eventually make all of the Bullish Analysts look like geniuses with their recent Dow 20,000 predictions.   Finally keep in mind this chart is based on Inflation Adjusted values so it will not look the same using nominal values which most are used to seeing.

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