2006 Stock Market Forecast

SUMMARY

The trend in the US stock market averages should be upward during the first 3 months of 2006 and then downward for the following 7 or 8 months. At the 2006 high point the Dow Industrials will probably be trading at 11500 or a little higher, while the S&P 500 index will reach the 1350 level.

The drop from the 2006 high point should be relatively brief and shallow. It will probably last 8 months or so and carry the averages down 20 to 25% from their 2006 highs.

REVIEW OF 2005 FORECAST

Here is the summarizing paragraph from the 2005 forecast:

Let's now summarize the deductions I have drawn from Lindsay's timing methods. First, 2005 should be a generally bullish year. The bull market top could come as early as July 19, 2005 (3P-DH) or as late as January 31, 2006 (15 year 3 month period). My best guess is that in any case the market will trade essentially sideways after July 19, 2005 but that no really bad drop will occur until 2006 begins.

With the exception of the Dow Industrials all the major averages did trend gradually higher over the course of 2005. The 2005 forecast predicted the most dynamic up move for the first half of 2005 but in fact the first half was essentially a flat period for the averages while the second half was a little more bullish.

The 2005 forecast also estimated the likely top in 2005 for the S&P 500:

The subsequent 1974-1976 bull market sent prices up 77%. A comparable advance from the 2002 low of 768 predicts a 2005 top at 1350.

As this is being written the S&P 500 has had its closing high for 2005 so far at 1275.80 on December 14, still a fair distance from 1350.

FORECASTING METHODS

This forecast for stock prices in 2006 is based largely on the techniques of George Lindsay. I will work out some implications of Lindsay’s long time periods, his method of basic advances and declines and finally of the ongoing Three Peaks and a Domed House formation for stock trends during 2006.

LONG TIME PERIODS

According to Lindsay’s theory, bull market tops tend to develop about 15 years and 3 months from previous bear market lows. Bear market lows tend to develop about 12 years and 8 months from previous bull market tops.

In the current situation we want to determine if a bull market top is likely during 2006. An important bear market low occurred in October 1990 prior to the start of the first Gulf war and in the midst of the savings and loan crisis. Counting forward 15 years and 3 months brings us to January 2006. This would lead us to expect an end to the advance from the 2002 lows very soon and then a bear market of some magnitude.

The advance from the October 1990 lows ended temporarily on January 31, 1994. Adding 12 years and 8 months to this date brings us to October 1, 2006 as an approximate time for a bear market low in 2006.

THE 20 YEAR CYCLE

Lindsay also put considerable emphasis on what he believed was a 20 year cycle in stock prices.

Looking back 20 years from 2006 we find that stock prices advanced sharply during the first 3 months of 1986 and then moved sideways the rest of the year. The first 8 months of the following year, 1987, were very bullish.

Looking back 40 years we find a bull market top on February 9, 1966 which was followed by a 25% drop ending on October 10, 1966. The first 9 months of 1967 were very bullish.

Looking back 60 years we find a bull market top on May 29, 1946 which was followed by a 23% drop ending on October 9, 1946. The October 1946 low held throughout the following year but the market was only able to advance about 15% during the first 7 months of 1947.

Looking back 80 years we find a sideways market during 1926 with high points in February and August and lows in March and October. The following year was very bullish.

Looking back 100 years we find a bull market top in January 1906 but a year during which the market moved essentially sideways. Unlike the previous 4 examples above, the following year, 1907, was very bearish.

THE FOUR YEAR CYCLE

There appears to be a very pronounced 4 year cycle in stock prices which has been very evident over the past 60 years. The last low of this cycle was in October 2002 and the next low would then be predicted for October 2006. One can also note that prices have moved upward for more than 2 years subsequent to the October 2002 low. This “right translation” means that the longer term cycles are on average moving upward as well. From this I conclude that the next bear market low will be visibly above the 2002 low.

THE EVIDENCE THUS FAR

Lindsay’s long time periods, the 20 year cycle and the 4 year cycle are all pointing to the same conclusion. There should be a bull market top during the first half of 2006 and probably sometime during the first 3 months of the year. The subsequent low should occur during the last 3 months of 2006 and very probably in October. The drop from the 2005 high should be modest by bear market standards and will probably carry the averages down about 20 to 25% from their 2006 highs.

THE CURRENT BASIC ADVANCE

Lindsay’s most basic timing method was his theory of basic advances and declines. According to Lindsay the bull and bear markets in the stock market averages show surprising consistency in the amount of time they take from start to finish measured in calendar days.

In the current situation my best estimate is that the current basic advance began from the low on March 12, 2003 around 789 in the S&P 500. According to Lindsay’s theory it should be (in his terminology) either a long or an extended advance. The longest extended advance in my records is 996 calendar days. Measured from March 12, 2003 this would predict an end to the basic advance for December 2, 2005.

Of course the S&P 500 has advanced past this last date. This may not prove to be a problem because in Lindsay’s theory the end of every extended basic advance is followed by what he called a “sideways movement”, a period of months during which the averages make little or no net progress. Sideways movements of more than 5 months are generally followed by long bear markets. But Lindsay’s long time periods and the 20 and 4 year cycles are predicting a short bear market. So I conclude that if a sideways movement has begun it should last less than five months and so end by early April, 2006. After the sideways period ends prices will move steadily downward.

THREE PEAKS AND A DOMED HOUSE

The generally sideways market of the past two years has provided at least three or four examples of possible major examples of Lindsay’s Three Peaks and a Domed House formation. I have commented on these on my blog and in previous annual forecasts. Right now I think a major formation is underway in the Dow. The three peaks of this formation occurred in January, March and July of 2005. The separating decline ended in October and the domed house part of the formation began from the October 13, 2005 low. I have identified point 14 of this formation as October 28, 2005 and Lindsay’s rule is to measure forward 7 months and 10 days to arrive at the likely time for the top of the domed house rally. That would be about June 7, 2006.

However, I have presented other evidence above that the bull market top will come before the end of this 7 month and 10 day period. So my best guess now is that the June 7 date will time either the right shoulder of the domed house or the recovery rally immediate after that.

HOW HIGH ?

I have many reasons for thinking the S&P will reach the 1350 level at the 2006 top. The simplest one was cited above in the quotation from the 2005 forecast. A proportional rally in the Dow would carry it to 11500. A subsequent drop of 20% would bring the S&P down to 1080 and the Dow down to 9200.

SUMMARY

The first three months of 2006 should be bullish ones and the S&P 500 should manage to reach the 1350 level during that time. A bear market is then expected to start and should carry the S&P down to a low around 1080 in October 2006.