by Martin Zweig
Table 32 lists the twelve such greatest bull markets from 1926 to 1993, in chronological order. By the way, the great bull market of the 1920s is not included here. First, the last portion of it, from 1926 (when this study began) to 1929, never had an eighteen-month period where the gain was large enough to make this listing. Second, any dynamic gains from 1921 to 1926 preceded the beginning of this research effort.
Leading off the table is the all-time greatest advance, which began June 1, 1932. It took only three months for the S&P to rise an incredible 154.5%, soaring from 4.40 to 9.31 in September. It’s worth remembering, however, that that enormous gain restored prices only to where they had been in December 1931 on the S&P. Unfortunately for investors in those days, the 1932 bull market was short-lived. By February 1933 the S&P had plunged to 5.53, a decline of 41.6%. A few days later the new president, Franklin D. Roosevelt, ordered a bank holiday (over five thousand banks had failed during the Depression). The stock market was closed for about two weeks, giving people time to reflect on the situation.
TABLE 32
GREATEST S&P 500 ADVANCES: 1926 to 1996
Date of Low
Maximum % Gain Within 18 Months of Low
6/1/32 +154.5
2/27/33 +120.6
3/31/38 +62.2
4/28/42 +60.2
6/13/49 +50.0
9/14/53 +65.2
10/22/57 +49.2
5/26/70 +51.2
10/3/74 +66.1
8/12/82 +68.6
12/13/84 +53.3
10/11/90
+52.1
On March 15, the first trading day after the bank holiday, the S&P spurted 16.6% above the previous closing prices. Despite some backing and filling after that for a few weeks, that really marked the beginning of the second great bull market of the 1930s. By July 18, just 4½ months after the February bottom, the S&P had risen a tremendous 120.6%. We have never seen anything quite like the two bull markets of the early 1930s, which ended the worst crash in history, from 1929 to 1932.
The most recent bull market to make the top twelve (as of this writing) started in October 1990. Its maximum gain within eighteen months was 52.1 %.
Alas, only geniuses and/or fibbers buy smack at the lows and hold all the way up. The rest of us mere mortals can only hope to develop indicators that might catch the bulk of the big moves. And to have a fighting chance, we must be resigned to giving up a fair number of points at the start in order to detect the type of tape momentum that makes buying safe, such as the buy spots generated by the advance/decline 2-to-1 ratio described in the momentum chapter. Indeed, that’s a good place to start.
The Advance/Decline Indicator is one of two ingredients that, when combined, have had an outstanding record in calling the bull market advances listed in table 32. Recall, from chapter 5, that when the number of stocks advancing leads the number of stocks declining by a 2-to-l ratio over a ten-day period, it is a rare and very bullish event. Just three months after such instances in the past, the Zweig Unweighted Price Index rose an additional 10.6%. The existence of a 2-to-l advance/decline figure (for ten days) is the first condition necessary to herald a major bull advance. For illustrative purposes, let’s call this factor a Super-Advance/Decline Ratio.
The second condition involves the Fed Indicator, which was fully explained in chapter 4. The Fed Indicator gains points when the Federal Reserve lowers either the discount rate or reserve requirements, and loses points when the Fed does the reverse. To verify the early stages of a powerful bull advance, the Fed Indicator must rise from a rating of zero points or less to a score of +3 points or more. (It requires a score of just +2 for the Fed Indicator to rate “extremely bullish,” but the requirement here is even more demanding.) If the Fed Indicator is +3 or higher, and then dips to scores of +2 or +1, and subsequently returns back to +3 or higher again, that would not produce the signal we are seeking. What we need is a move in the indicator from a negative or zero condition to a very, very positive condition. This usually requires at least two successive cuts in either the discount rate or reserve requirements. Let’s call this condition a Super-Bullish Fed Indicator.
What we would like to find is a Super-Advance/Decline Ratio and a Super-Bullish Fed Indicator reading simultaneously. It is sufficient if the two occur within a relatively brief span of one another. Testing has found that a three-month time frame is reasonable. Now, let’s put the two pieces—the Fed and the tape—together and hopefully load the shotgun. I’ll call the pair a double-barreled buy signal.
Table 33 lists all the double-barrel buy signals since 1926. Since 1932, there were only twelve such potent signs. Carefully examine the dates of the double-barreled buy signals and compare them to the dates in table 32, which show the beginnings of the ten greatest bull markets since 1926. The respective pairs of dates fit very closely. For example, the first double-barreled buy came on July 21, 1932, just two weeks after the Dow Industrials bottomed and about six weeks after the S&P 500 made its low. Without exception, all the double-barreled buys came early enough in the respective bull markets to catch a significant portion of the subsequent advances.
The second column of table 33 shows how the S&P 500 Index performed one month after the dates of the double-barreled buy signals. In the 1932 case the S&P rose a sensational 48.7% in just a month. That, of course, is unlikely to be duplicated. But the market was higher in ten of the other twelve cases through 1992, and the compounded return for the S&P showed a gain of 7.4% just one month after the double-barreled buys.
The other columns in table 33 show how the S&P fared three months, six months, twelve months, and eighteen months after the double-barreled buy signals. Three months after the buys, the compound return for the S&P was up 12.1%, six months later up 18.4%, twelve months later 26.1%, and a year and a half later it had risen a solid 36.1%.
Now let’s consider that eighteen-month performance following the twelve double-barreled buy signals. A $10,000 investment in the S&P 500 would have grown to $405,004 in a total of 17.2 years (the holding period is adjusted for the 1932–33 overlap). The 36.1% return per eighteen-month period is equal to a very healthy 22.4% annualized profit. By contrast, from January 1926, when the study began, to January 1993, a buy-and-hold investor would have seen $10,000 grow to only $339,836. And, because he had his money invested for almost 67 years, his annualized rate of return (not including dividends) would have been only 5.4%, not even one-quarter the annualized return following the double-barreled buys. Moreover, in the 49.8 years that did not fall within eighteen months after double-barreled buys, $10,000 would have actually shriveled to $8,391, an annualized loss of .3%. In other words, one could rightfully say that all of the gains and then some that the market has seen since 1926 have occurred in the eighteen-month spans following double-barreled buy signals, and that the rest of the time one would have actually lost money in the stock market.
TABLE 33
DOUBLE-BARRELED BUYS VS. ZWEIG INDEX: 1926 to 1996
% Change in S&P 500
Date of Buy
1 Month
3 Month
6 Month
12 Month
18 Month
7/21/32 +48.7 +35.0 +40.6 +85.5 * +85.0*
5/26/33 +16.4 +20.8 +7.5 +4.4 +1.9
4/16/38 -5.1 +14.1 +25.0 +4.1 +20.0
9/14/42 +10.3 +10.2 +29.4 +39.1 +42.9
7/13/49 +3.7 +8.1 +12.8 +12.9 +42.8
2/15/54 +2.0 +10.6 +18.0 +41.7 +61.9
1/24/58 -2.5 +3.4 +11.8 +34.3 +43.0
12/4/70 +1.9 +9.5 +13.2 +8.5 +22.7
1/10/75 +7.9 +15.4 +30.6 +30.8 +44.6
8/23/82 +6.6 +14.5 +26.4 +40.2 +32.9
1/23/85 +1.2 +2.6 +8.6 +15.2 +34.6
2/5/91
+7.0
+7.8
+11.2
+17.0
+19.4
$10,000 becomes:
$23,590 $39538 $75,598 $161,144 $405,004
Return/Period =
+7.4% +12.1% +18.4% 26.1% +36.
1%
Table 34 shows how the Zweig Unweighted Price Index fared after the double-barreled buys. The bottom line on the table shows that the ZUPI rose 11.2% one month later, 18.0% three months later, 24.5% six months later, 40.9% twelve months later, and a big 53.8% after eighteen months. Following the approach above, had you invested $10,000 in the ZUPI (or an approximation of it) and held for eighteen months after these potent signals, you would have run your bankroll up to $1,757,118, a superlative annualized return of 53.8%.
TABLE 34
DOUBLE-BARRELED BUYS VS. ZWEIG INDEX: 1926 to 1996
% Change in Zweig Index
Date of Buy
1 Month
3 Month
6 Month
12 Month
18 Month
7/21/32 +64.3 +54.5 +39.6 +189.6 * +189.6*
5/26/33 +27.1 +31.2 +4.3 +48.9 +22.4
4/16/38 -2.6 +28.8 +37.9 +10.3 +49.8
9/14/42 +12.5 +12.3 +57.4 +77.1 +96.1
7/1/49 +5.7 +12.5 +20.2 +18.5 +58.3
2/15/54 +.8 +5.5 +19.2 +44.2 +49.3
1/24/58 -1.4 +4.4 +15.4 +48.9 +58.2
12/4/70 +4.8 +19.8 +21.8 +7.6 +19.6
1/10/75 +21.1 +18.2 +38.9 +34.6 +59.6
8/23/82 +8.1 +24.2 +38.4 +57.1 +47.1
1/23/58 +3.7 +2.9 +11.0 +17.1 +29.0
2/5/91
+10.8
+13.6
+13.9
+27.2
+24.6
$10,000 becomes:
$35,631 $72,583 $139,359 $612,018 $1,757,118
Return/period =
+11.2% +18.0% +24.5% +40.9% +53.8%
Conversely, one who had bought and held the ZUPI for almost 67 years would have seen $10,000 grow to only $603,134, an annualized gain of 6.3%. That’s about one-fifth the annualized return made by following the double-barreled buys. In the 49.8 years not falling within eighteen months of the double-barreled buys, a $10,000 ZUPI investment would have shrunk to $3,432, an annualized loss of 2.1%.
So, since 1932 there were only twelve double-barreled buy signals in history, and, incredibly, each one corresponded with the early stages of the eleven most powerful bull markets in the past six decades. The double-barreled buy signals produced terrific profits, with both the S&P 500 and the ZUPI going higher in every single holding period from three months to eighteen months.
THREE CRUCIAL CONDITIONS FOR BEAR MARKETS
I’ve now given you a method, using two indicators, that helps call major bull markets. Now, let’s talk about bear markets. First, in order to avoid confusion, I’ll define a bear market as a decline of at least 15% in each of three important stock averages: the Dow Jones Industrials, the S&P 500 Index, and the Zweig Unweighted Price Index (or the Value Line Index, if you prefer). There are declines in which one or even two of these three averages have gone down by 15%, but not all three. Those might be borderline bear markets, intermediate declines, or just mixed markets in which some segments are in bear trends and others are not. But in this section I’m just concerned about the really significant bear moves; therefore, I’m insisting that all three averages decline substantially in order to reach our benchmark.
There’s one minor exception to my definition, and that is the period from the mid-1920s to the mid-1930s. That span was extraordinarily volatile, and in the context of normal trading in those days, a 15% decline was no big deal. For example, in just three trading days, from July 18, 1933, to July 21, 1933, the Dow Industrials plunged 18.4%, declining from 108.67 to 88.71.
Prior to that nasty spill the market had been extraordinarily strong. Gigantic speculation was fueled at that time by the so-called alcohol stocks and by shares of those companies involved in agriculture that stood to benefit by the end of Prohibition. The state legislatures around the country were voting one by one to repeal the Eighteenth Amendment prohibiting the sale of alcohol or liquor in the United States. As the vote to repeal mounted, so did share prices on the anticipation that the liquor and related companies would make enormous profits.
In July 1933, two southern states broke away from the hardcore prohibitionist sentiment in that area of the country and voted for repeal. That was good news for the end of Prohibition, but it had been anticipated by the stock market, which had rallied with a frenzy prior to the announcements. When the “good news” struck, speculators began to sell their stocks to nail down profits. (Wall Street professionals often operate on the old adage, “Buy on the rumor; sell on the news.”) As the leading speculative stocks—the alcohols—broke down, most other stocks fell along with them. Simultaneously, commodity markets also collapsed as speculators tried to cash in their profits on rye, corn, and other grains that might have benefited from the end of Prohibition.
Still, that was not much of a decline in July when one considers that in February the Dow had been 50.16—less than one-half mid-July prices—or that within several weeks most of that sell-off had been recouped. There were a few other less extreme examples of these quick sell-offs during that time.
There have been fifteen bear markets since 1919 that meet the above criteria. They are listed in table 35. Although there is no single common thread among all of them, at least one of three critical conditions was present near the beginning or during a fair portion of each of the bear markets. These three conditions all have highly negative implications for the market. The presence of any single one does not necessarily guarantee that a bear market will commence right away, but there has not been a bear market in the past seven decades that did not have at least one of these conditions.
The first is extreme deflation. I measure extreme deflation by looking at the Producer Price Index (previously called the Wholesale Price Index), which the government publishes monthly, and I check for major declines. Such a decline would be a 10% drop in producer prices on a six-month average of annualized month-to-month changes.
TABLE 35
MAJOR BEAR MARKETS: 1919 to 1996
Bear Markets
Extreme Deflation
Very High P/E Radio
Inverted Yield Curve
% Decline in Dow industrials
1919–1921 yes yes -47.6
1923 yes -18.6
1929–1932 yes yes yes -89.2
1933 yes -37.2
1937–1938 yes -49.1
1939–1942 yes -41.3
1946–1949 yes -24.0
1956–1957 yes -19.4
1962 yes -27.1
1966 yes yes -25.2
1969–1970 yes yes -36.1
1973–1974 yes yes -45.1
1978–1980 yes -16.4
1981–1982 yes -24.1
1987 *
yes
-36.1
Average: (15 cases) -35.8$
I know that sounds like a mouthful, but here’s how I calculate it. To keep it relatively simple, suppose that January’s Producer Price Index is 100 and February’s is 99. That’s a 1% drop for the month, which annualized (without bothering to compound) would be -12%. In other words, multiply the monthly change by 12 (that’s not exactly correct when compounding, but it’s close enough for our purposes). You would then take the last six months of such changes, add them up, and divide by six to get the average change for the six months. If that number is -10% or worse, then you have extreme deflation. This condition has not been present for several decades.
Recall, from chapter 3, that extreme deflation is a sign of an economy in dire trouble. When manufacturers and retailers cannot sell their goods, they cut prices. When even the price cuts fail to stimulate sales, additional reductions are made. The end result is collapsing prices and lousy sales, the norm during depressions. Stocks, of course, have not done well during depressions, nor during periods of extreme deflation. Graph P (pp. 186–187) shows the Producer Price Index plotted back to 1948.
As seen on the graph, extreme deflation was present during four of the bear markets, 1919–21, 1929–32, 1933, and 1937–38. The first of these coincided with the 1920 depression, and the other three w
ith the Great Depression of the thirties, which actually was divided into two economic phases, one in the early thirties (encompassing two bear markets) and then a relapse in 1937.
The second very bearish condition for stocks is ultrahigh price/earnings ratios. The price/earnings ratio is the market price of the stock divided by the last twelve months of earnings per share. For the market averages, the P/E ratio would be the value of the average itself divided by average earnings for the stocks in that average. Dow Jones and Standard & Poor’s regularly calculate the P/E ratios for their respective averages. For the market as a whole, P/E’s in the 10–14 area are roughly normal. Very low P/E’s, in the 6-8 zone, tend to be bullish for the long run, while P/E’s in the upper teens and twenties generally reflect excessive speculation, gross overvaluations, and poor future stock price performance.
Graph Q (pp. 188–189) shows the P/E ratio on the S&P 500 plotted back to 1926. I have found that when the S&P 500’s P/E reaches 18 or greater, or if the Dow Industrials’ P/E reaches 20 or more, that is sufficient to trigger a bearish indication. The exception to this rule would be during a severe business downturn, when corporate profits have been hacked so low that P/E ratios are high only because earnings are down.
For example, suppose that during a bear market the price of a major stock average falls from 100 to 50, a very large 50% decline. Suppose that at or near the bull market high, when the price average was 100, earnings for that average were $5. The P/E at that time would have been 20, tripping a warning signal for stocks. But suppose that during the bear market, the economy collapsed and earnings for the stock average were unusually depressed at just $1. The P/E ratio for the average at that point would be 50, but that is not a very stable or meaningful P/E ratio, because the earnings are underwater. If one normalized earnings over the previous several years, they certainly would have been much greater than recession-eroded earnings. In other words, the average earnings for several years would give a much more meaningful P/E ratio during those rare periods when earnings are abnormally depressed.