-

Market Technicians Association

JOURNAL
ISSUE 4 FEBRUARY 1979
 IMARKET TECHNICIANS ASSOCIATION JOURNAL

Issue 4

February, 1979

PUBLISHED BY: MARKET TECHNICIANS ASSOCIATION

70 PINE STREET
NEW YORK, NEW YORK 10005
Direct inquiries to:
Fred R. Gruber, Editor
Market Technicians Association Journal
c/o United Jersey Bank
210 Main Street
Hackensack, New Jersey 07602

Copyright 1979 by Marke t Technicians Association

 MARKET TECHNICIANS ASSOCIATION JOURNAL

EDITOR:
Fred R. Gruber, C.F.A.
United Jersey Bank
210 Main Street
Hackensack, New Jersey 07602
ASSOCIATE EDITOR:

William DiIanni
Wellington Management Company
28 State Street
Boston, Massachusetts 02109

EDITORIAL ASSISTANT:
Ms. Cheryl Stafford, Wellington Management Co.

Thanks to Market Technicians Association members for their

part in the creation of this issue are owed to:

Robert Farrell
Howard Hebert
Stan Lipstadt
Arthur A. Merrill
Robert R. Prechter, Jr.
John Schulz
David L. Upshaw
 INDEX
MARKET TECHNICIANS ASSOCIATION JOURNAL - FEBRUARY 1979

Pages
Editor's Notes . . . . . . . . . . . . . . . . . . . . 4
MTA Fourth Annual Seminar Program . . . . . . . . . . 5
Indicator Analysis:
Stock Market Forecasting through the Interrelating
of Bond Prices and Stock Prices
By Roger Williams, Ph.D. . . . . . . . . . . . . . . 7 - 12
The Short Interest Ratio and Its Component Parts
By Thomas J. Kerrigan . . . . . . . . . . . . . . . . 13 - 17

General:
Portfolio Management by Robot: The Ultimate Put-Down
By Howard Hebert. . . . . . . . . . . . . l . . . . . 19 - 23
Smoother is Sharper
By David L. Upshaw. . . . . . . . . . . . . . . . . . 24 - 28
A Twenty-Year Business Slump? Not a Ghost of a Chance.
By John Schulz. . . . . . . . . . . . . . . . . . . . 31 - 33

Statistically Significant:
Fifty Years of Market Volatility
By Robert R. Prechter Jr. and Robert J. Farrell . . . 35 - 36
Percent Change in One Year - S&P 400 and D.J.I.A.
By Arthur A. Merrill. . . . . . . . . . . . . . . . . 37 - 38
Funds - Cash Position
By Arthur A. Merrill. . . . . . . . . . . . . . . . . 39 - 40

Book Reviews:
Elliott Wave Principle - Key to Stock Market Profits
Reviewed by Willlam DiIanni . . . . . . . . . . . . . 41 - 43
 EDITOR'S NOTES -
Technicians beware, I see signs of loss of momentum, or at the
very least consolidation in an issue. Its uptrend has been broken,
but hopefully the issue will simply go through a test here, find
new support and go on with renewed strength to new highs, and
with increased distribution besides. That's not an inconsistent
use of technical analysis descriptors when you realize that the

issue in question is the Market Technicians Association Journal

itself.

The smaller current issue again reflects the work of very few
contributors, many of whom were the mainstay of our past efforts
as well. There are no"Letters To and Through the MTA Journal"
this time - weren't there any reactions to past articles, or isn't
there furtherwork to be communicated on those subjects? If you've
considered our Journal to be worthwhile reading, how about preparing
your own contribution ? Let's make our May issue, for the Fourth
Annual MTA Seminar, special. (See page 29.)

For the first time we are showing subscription information within

our Journal. Pass it along to an interested party and help our
distribution. And again, even more importantly, send us a chart,
a report, a market letter or something you've produced or seen
recently which we can use in your Journal--the only publication
.
of its sort that I know of in the United States.

Fred R. Gruber
 THURSDAY, MAY 3 May 3-6,1979 10:30 am-MARKET LETTER WRITERS
Moderator:
4:00 pm-Registration Abe Cohen, President
150 - -150 Chartcraft, Inc.
6130 pm-Cocktails Panelists:
John Goddess, Editor
7:30 pm-Dinner The Master Indicator

9:00 pm-KEYNOTE SPEAKER

100 -100 Ian McAvity, Editor
Deliberations
William O’Neil, Chairman
William O’Neii & Co., Incorporated Stan Weinstein, Editor
Professional Tape Reader
50 .* 50
12:oO Noon-Lunch and Free Time

FRIDAY, MAY 4 6130 pm-Cocktails

0 . 0
7:30 am-Breakfast 7:30 pm-Dinner

9:OC am-STUDIES IN VOLUME 9:00 pm-“ IS THE WORLD COMING TC

AN END?”
Paneiists:
David Bostian, President Alan Abelson, Managing Editor
Bostian Research Associates Barron’s
Paul Desmond. President
Lowry‘s Reports, Inc.

IO:30 am-Coffee Break 4:45 pm-THE CHANGING NATURE OF SUNDAY, MAY 6

TECHNICAL ANALYSIS
10:45 am-ELLIOT WAVE: PURE FORM Speaker:
Stan West, Vice President. Business 7:30am-Breakfast
Panelists:
William Dilanni, Vice ?resident Research
Wellington Management New York Stock Exchange 9:00 am -OPTIONS
A. J. Frost, Panelists:
Dean of Elliott Wave Theory 7:30 pm-Dinner Mike Epstein, General Partner, Tradrng
Cowen & Co.
Rooert Prechter. Vice President
9:00 pm-MTA Annual Award GaFy Knight, Member
Merrill Lynch. Pierce, Fenner & Smith
Presentation Chicago Board Options Exchange
12:30 pm-Lunch and Free Time Morns Propp, President
Cygnet V Securities
3:00 pm-GROUP SELECTiON Steven Shobin. Assistant Vice President
TECHNIQUES
SATURDAY, MAY 5 Merrill Lynch, Pierce, Fenner 8 Smith
Panelists:
David Diamond, Vice President 7:30am-Breakfast 1 :OO pm-Lunch
Boston Company
Steven Leuthold, Vice President. 9:00 am-WORKSHOP: SHORT-TERM
Director TRADING INDEX-
.- Funds. inc. APPROACHES AND I ‘Registrantsare encouragedto submit
RESULTS’ ’ slrategies employing the Shorr-Term
David Uoshaw, Vice President Trading index !hat they would like t9
Drexel Burnham Lambert. Inc. Speaker: see tested.
Anthony Tabeli, Associate : Pleasesubmitany testable strategy
Deiafield, Harvey, Tabell Division I alongwith your registration form.
4:30 pm-Coffee Break of Janney, Montgomery. Scott I

SEE OVER FOR REGISTPATION FORH

 MARKET TECHNICIANS ASSOCIATION
MEMBERSHIP AND SUBSCRIPTION INFORMATION

~RIZGULAR LMEMBERSHIP - $50 per year plus $10 one-time application fee
Receives the Journal, the frequent MTA Newsletter, invitations
to all meetings, voting member status and a discount on the
Annual Seminar. Eligibility requires that the emphasis of the
applicant's professional work involve technical analysis.

SUBSRIBER STATUS - $50 per year plus $10 one-time application fee
Receives the Journal and the MTA Newsletter - which contains
shorter articles on technical analysis - and the subscriber
receives special announcements of the MTA meetings open to
The New York Society of Security Analysts and/or the public,
plus some discount on the Annual Seminar.

Single issues of the MTA Journal (including back issues) are

available for: $5 to regular members or subscribers
$10 to non-members or non-subscribers

The Market Technicians Association Journal is intended to be

published three times each fiscal year, in approximately November,
February and May. An Annual Seminar is held each spring.
Inquiries for membership, subscription or single issues should
be directed to: Mr. William DiIanni
MTA c/o Wellington Mgt. Co.
28 State Street
Boston, Mass. 02109

RESERVATION FORM

$ 250, Non-Members
Name

Firm

Address

City State Zip

Home Phone Business Phone

Full Names of all in Party

REMIT ONLY SEMINAR FEE TO: Skytop rates include: three (3) nights lodging with three meats
Market Technicians Association daily. Package rates: $156 per person, single occupancy;
Post Office Box 264 St 41 per person, double occupancy, plus gratuities and taxes.
Port Washington, New York 11050 No credit cards accepted.
EARLY REGISTRATION TO FEBRUARY 28- 16% DISCOUNT
SPACE LIMITED TO FIRST 150 PAID ATTENDEES

- 6-
 STOCK MARKET FORECASTING THROUGH THE INTERRELATING

OF BOND PRICES AND STOCK PRICES

by Roger Williams, Ph.D.
St. John's University

There has been considerable discussion of bond yields, stock

yields, interest rates and stock prices in the past. For
some purposes, it may well be better to compare bond prices
and stock prices directly. Bond yields and stock prices
are unlike objects, whereas bond prices and stock prices
are comparable. Looking at matters this way also focuses
on possibilities for capital gains and losses in both vehicles.
For our purposes, we have found it appropriate to use the
Standard and Poor's 500 Composite Index as the measure of
common stock prices, and Standard and Poor's Index of Prices
per $100 of High Grade Corporate Bonds for fixed income.
The long-term trend of stock prices has been generally
upward, while the long-term path of bond prices has usually
been downward since World War II. Tables I and II present
major cyclical swings in monthly stock prices and bond
prices during the period 1945-1978, with peak and trough
dates as selected by the author. Stock prices have shown
more numerous cyclical swings than bond prices during the
1945-1978 period.
Stock price peaks with no bond price counterpart were clearly
demonstrated in 1961 and 1968. With other stock price peaks,
bond prices led the way downward, but the length of the
lead was highly variable and sometimes very long. When
leads are extremely long, they are often of very limited
use. Despite these various qualifications, bond price
movements are useful in identifying stock price peaks.
During our review period, stock price peaks always occurred
when the general trend of bond prices was downward.
Again comparing Table I and Table II, there were stock lows
in 1947 and 1962, with no low in bond prices. The recovery
of bond prices lagged by one month in 1970 and five to eight
months in 1974-1975, but in five other cases, bond prices
led on the way up. When bond prices move up, there is a
very favorable signal for stock prices, and the lead has
always been under a year, and usually much shorter.
Another way of looking at bond prices and stock prices is to
note periods when they move in the same direction and when
they move in opposite directions. In Chart I, we have scored
+2 when both prices are rising on a month to month basis, +l
when stock prices alone are rising, -1 when stock prices alone

- 7-
are falling and a -2 when both stock prices and bond prices
are falling. Identification of stock market peaks is not
always clear, but they are often preceded by two or more
monthly scores of +2. Seven out of nine peaks have been followed
very quickly by two or more readings of -2, the exceptions
being 1953 and 1961-1962.
Stock market lows have typically been marked within two
months by a sharp improvement from negative numbers to
positive numbers. The present position of the market looks
favorable, since there was a sharp move from -2 in November
1976 to a +l in December of 1978, and January numbers add
further confirmation.
Chart II presents a ratio of bond prices divided by stock
prices, a measure of relative price action. We have inverted
the scale so that increases indicate favorable relative
action for stock prices and declines represent unfavorable
relative price action for stocks. Market peaks have been
typically preceded by a rather long period of rising relative
price action, but this method does not provide a good method
for quickly identifying market peaks. There is normally a
rather clear descent towards market lows and there is a
distinct change of direction when the market passes from
decline to recovery. The bond price/stock price ratio is
a very valuable ratio in identifying major stock market lows.
Narket history since the stock market peak in late 1976
clearly points to a major stock market low in March 1978.
Recovery of the bond price/stock price ratio since then
has proceeded in a traditional manner, and the S & P 500 is
still well below its earlier peak.
Bond price lows have been most useful as an advance indicator
for stock market lows. A rise in bond prices is very favorable
for the stock market and the lead has usually been much shorter -
than a year. The ratio of bond prices divided by stock
prices (inverted) is also a valuable clue, with increases
(favorable relative price action for stocks) suggesting upward
movement for the stock market. The most unfavorable sign
for the stock market would be a sharp switch from both bond
and stock prices moving up (a +2) to both moving down (a -2).
The most favorable sign would be a sharp switch from a negative
(-2) to a positive (+2).

Author's Note: I wish to thank Natasha Spearman-Isip for

assistance in the preparation of this paper.

- 8-
 Table I
STOCK ?RICE CYCLES
(Standard and Poor's 500)
Peaks Troughs
May 1946 May 1947
June 1948 June 1949
January 1953 September 1953
July 1956 December 1957
July 1959 October 1960
December 1961 June 1962
January 1966 October 1966
December 1968 May 1970
January 1973 December 1974
September 1976 March 1978

Table II
BOND PRICE CYCLES
(Standard and Poor's High Grade Corporate Bonds)
Peaks Troughs
March, April 1946 August, September,
October, November, 1948
January, February, March 1950 June 1953
April 1954 September 1957
January 1958 January 1960
February 1963 September 1966
February 1967 July 1970
January 1972 May, August 1975
December 1976

- 9-
CH.A-?T 1 DIRECTION OF BOND PRICES AND STOCK PRICES-

+2 Both prices moving up on a month to month basis

i-1 Only stock prices moving up
-1 Only stock prices moving dct;n
-2 Bond prices and stock prices both moving down
?= peak T= trough
All scales are equal for each period

-
 T-trough

6.S
7.k

2.0-
-
:L P T
1965-1969
l-O_ -
1.2 -
1.4- -- -- -I
.s--- 1970-1973 -
IL
.7-
.8--
.9- -~-___-.-- ----- ___ - ~-_-
_--___.~--
c-
::-
.i-
-
.8-

- 11 -
aRRr3 EKNDPIiIcEs
P = peak, stock prices
'@ trough, stock prices

- 12 -
Originally published in the
November/December 1374
lieprinted with pe,mLssion
by Thomas J. Kerr&n
First National Sank of Boston
The Short Interest Ratio, published monthly in
Barron’s, is considered a reliable indicator of
future market direction by most members of the
technical school of security analysis. It is com-
puted by dividing the number of shares sold short
on the .New York Stock Exchange as of the fif-
teenth of the month (or before if the fifteenth falls
on a non-business day), by the average daily
volume of shares traded for the month ending on
that sameday. The number of sharesshoned total
is released by the Exchange three businessdays
later. Barron’s, which is published weekly, com-
putes and publishesthe ratio in the issuefollowing
the Exchange’s re!easeof the sharesshorted total.
Technicians claim that, for the market as a
whole as well as for individual stocks, the foilowing
are bullish:
1) a large number of sharesshorted;
2) a rising trend in sharesshorted;
3) a relatively high Short Interest Ratio;
4) a rising trend in the Short Interest Ratio.
Conveneiy, the following are bearish:
1) a small number of sharesshorted;
2) a failing trend in sharesshorted;
3) a relatively low Short Interest Ratio;
4) a falling trend in the Short Interest Ratio.
Studies of the predictive value of short interest
figures relative to individual stocks have produced
negative results.1.2In addition, Barton Biggsclaims
1. Barton M. Biggs, “The Shon Interest-A
Proverb,” Financial Analyszs kurnal, July/August
1966. pages 111-116.
2. Randall D. Smirh. “%on Interest and Stock Market
Prices,” Financial ,dnalysrs Journal, Yovem-
beaDecember1968. pages15I- 154.
- 13 -
Financial Analysts Journal
that a iailing trend in shares shoned should
iogically coincide with a rise in the stock in that
the excess of short covering over short selling
would create a condition of demand exceeding
supply.
To evaluate these conflicting claims. [he author
analyzed 300 monthly Short Interest Ratios riom
October 1952 to May 1969 (seeTabie A). The 200
Shon interest Ratios were ranked according to the
numeric difference between the rario snd the ratio
one, two. three and four months later. The period
showing the greatest drop in the Shorr Interest
Rario was ranked one, and the period showing the
greatest rise in the Short Interest Ratio was ranked
200. The 200 rankings were then grouped into
declles.
The price action for the Standard and Poor’s
500 Stock Average during the two periods was
compared with the Short Interest Ratio changes in
two ways. In the fira, an arithmetic average of the
corresponding S&P’s 500 change-swas computed
for each decide. These were then ranked from one
to ten. In the second computation, changes in the
S&P 500 for the individual periods were ranked
from one to 200, and the average rank for each
decile computed. These were also ranked from one
to ten. These ranks were then correfared with the
Short Interest Ratio change ranks. (The same
methodology was used in Tables C, D and E.)
As can be seenfrom the table, the average of the
20 top ranked one-month Short Interest Ratio
False changeswas -0.4 11. The average S&P 500 change
for this top decile was +2.95 per cent. Using the
S&P 500 ranking method we find that the average
rank for this decile was 59.3. Both the average S&P
500 change ( + 2.95 per cent) and the average rank
oi S&P 500 changes(59.3) ranked this decile first
in terms of market performance in the first month.
In the two, three and four month columns of the
table the top ranked S&P 500 changes once again
 coincided with the top ranked average Short In-
terest Ratio differences. After four months the only
Short Interest Ratio deciles that corresponded to
S&P 500 losses were deciles nine and ten. The
disparity between Standard and Poor’s Averages
3; SSOl JO for deciles one and ten grew from 1.94 per cent af-
-I "leg s IO wee ter one month (2.95 to 1.Ol per cent) to 11.74 per
E
gi cent after four months [ ( + 10.27 per cent) -
SSOl JO
51 (- 1.47 per cent) J. The ascending degrees of rank
correlation from one to four months would appear
to contradict the technicians’ claim that a falling
ratio is bearish.
a8eJaAv
The preceding is of no value, however, unless
1 one can anticipate the future direction of the Short
srlw d4S Interest Ratio. Table B is an analysis of the 200
1 aBeJay 10 yuey
Short Interest Ratios and the ensuing changes in
I
SSOl them one, two, three and four months later. In this
: '0 ufe9 'b d9S table the starting values for the ratios are ranked
j 10 bpq a[leJaAy
from one to 2Oa with the highest 20 ratios assigned
-1
f SSOl JO to the top decile. In this case, the average starting
Lo! w 01 10 rue8 value for the top 20 ratios was 2.003. In the table
gi both the average change occurring for each Short
SSOl JO Interest Ratio decile one, two, three and four
months later and the ranks of the average change
are ranked from one to ten. Thus the top decile
a3uaJajjq group of Short Interest Ratios shows drops of
‘MI’S 0.211, 0.293. 0.312 and 0.398 for one, two, three
a8eJany
and four months respectively. Because these drops
are the largest for any decile, they all rank one.
Examining the tenth decile of starting ratios, we
I ’
find a steady rise from a starting average ratio of
SSOl
: JO U!P3 % d*S
0.827 to an average ratio four months later of
; 10 ye8 a8eJaAy 1.126. The high coefficients of rank correlation,
i &. particularly in the two, three and four month
!Z SSOl JO
figures, indicate that the ratio displayed a strong
tendency to move toward its average value (1.325).

Market Prediction
At this point we can draw two conclusions:
aauaJafi!a 1) Movements of the Short Interest Ratio
‘MI’S correlate with corresponding movements of
aSeJay
Standard and Poor’s Stock Average.
2) The future direction of the Short Interest
Ratio can be predicted, based on the rela-
tionship of the current ratio to the average
ratio.
Using conclusions 1 and 2, can we not predict
future market direction based on the level of the
Short Interest Ratio? Table C indicates that indeed
we can. Once again, as in Table B, the short in-
terest ratios have been ranked from high to low
and grouped into deciles. This table shows a strong
correlation between Short Interest Ratio levels and
ensuing S&P 500 changes. Examining the top
decile of short interest ratios we find that S&P’s
500 average advanced 2.62, 4.07, 6.48 and 8.31 in
one, two, three and four months respectively.
These advances, as well as the average ranks of the
advances, all ranked first in the ten decile rankings.
At the other end of the scale the tenth decile Short
I
dIIOJg oqe)

i
- 14 -
r Interest Ratios usually ied to tenth defile S&P 500
changes. As in TCie A, :he spread between S&P’s
500 percentage gam jioss) for dedes one and :en
steadily widens. The percentage differences are
3.20, 4.33, 6.02 and 9.49 ior one, two, three and
four months respefzively. Once again rhe coeti-
clents of rank coneiation rise to high Ieve!s aiter
three and four months.
Thus there is some compatibility between the
claims oi the technicians and Biw’ bindings.The
:echnicians’ assenion that a hi& Short Interes:
Ratio is bullish and 3 low ratio bearish is jup-
ported by Tabie C. However. this is trJe oniy
becausehigh ratios do not stay high long, and as
they drop the market :ends to rise. This, of course,
supports Bigs’ claim.
Trends in the ratio are only apt to develop. how-
ever, when the ratio is at 1 retatively high or low
level. Trying to predic: the dire&on of the ratio by
means of trends atone appears to be folly. For
example, if Ihe ratio rises for three consecutive
months from a low of 1.OOto 1.SOthe chancesoi it
continuing to rise the foilowing month are !ow due
to the fact that ir has becometoo high. .A study of
month-to-month Trendsin the ratio <or the 100-
month period produced more reversals of trends
than continuations.
The Components of the Short Interest Ratio
Often overiooked is the fact that average daily
volume hasa role in [he Shon Interest Ratio equal
in importance :o rota1sharessold short. For exam-
ple, if the number oi shareshoned and average
daily volume rose an equal percentage. the ratio
would remain the same.To discover the relative
importance of sharesjnorted versus average daily
volume, the data from Table ,A was broken down
in Tables D and E.
Table D is an analysisof the etiect of changesin
total shares jold short on rhe performance of
Standard and Poor’s 500 Stock Average. Table X
indicated a strong correlation between changesin
the Short Interest Ratio and changesin the S&P
500, with drops in the Short Interest Ratio accom-
panied by above average gains in Standard and
Poor’s 500 Stock Average, leading us to the pre-
liminary conclusion that a drop in sharesshorted
should be bullish. Thus, in Table D, which has iso-
lated the numerator of the Short Interest Ratio, a
drop in sharessold short would also causea drop
in the Short Interest Ratio uniessthe denominator
of the ratio (average daily voiume) dropped by a
greater percentagethan the numerator.
In Table D the 10 months having the great:st
percentagedrop in sharesshorted are ranked in the
tint deciie and those displaying the larges: per-
centageincreasein sharesshorted are ranked in !he
tenth deciie. As might be expected, the 10 months
showing the largest three-month increasein shares
shorted (+ 38.32 per cent), coincided with the
poorest performing S&P 500 decile (-0.68 per

- 15 -
 cent). However, the whole table does not fare as
well. For example, reading across the top decile for
one through four months (i.e., those 20 months
having the largest percentage drop in shares short-
ed) the decile ranks of the S&P 500 average only a
mildly favorable 3.87. The top ranked Standard
and Poor’s decile corresponded to shares shorted
deciles five, five, three and four for months one,
two, three and four respectively. The only im-
pressive rank correlation coefficient is the four-
month rank of average S&P’s 500 gain or loss
(+0.88 per cent).
Table E analyzes the effect of volume changes
on the performance of Standard and Poor’s 500
Stock Average. Note that a rise in average daily
j ! WQ! diS volume would raise the denominator of the Short
al)eJaq10yueu Interest Ratio, thus causing the ratio to fall (unless
SSOl JO offset by a percentage rise in the numerator at least
"'Yl X dOS F' as great as the percentage rise in the denominator).
yueu alleJarv Thus, advances in average daily volume were con-
SSOl JO
sidered bullish and the 20 periods for each time in-
w % 10 wx terval (one, two, three and four months) with the
greatest percentage increases in average daily
SSOl JO we3 volume were placed in the first decile. As can be
seen in the two. three and four month columns of
the table. there is a wide disparity between both the
stock averages and the average ranks for deciles
one and ten. After four months the percentage
change disparity exceeds 10 per cent [ ( + 8.94 per
cent) - (- 1.41 per cent) 1. In Table D the corre-
sponding disparity is only 2.72 per cent (4.34
- 1.62 per cent). The four month average rank dif-
ference for Table E is 92.4 (47.3 - 139.7) versus
only 6.5 for Table D (91.1 -97.6). Comparing
ssol JO we3 Tables D and E on a month-by-month basis we
I
l"agJad 00s d5'S find only one occasion out of eight where the cor-
relation coefficient in Table D is higher than its
I
wex dBS counterpart in Table E, with the rank correlation
, a8eJaby jo rueg
coefficients in Table E 0.335 higher than the
SSOl JO corresponding coefficients in Table D on average.
_I "'Yl % dBS P
B' yuex a8eJany Conclusions
9;
5
I
SSOl JC
I) During the period of this study the Short In-
I'
5:
uw % 10 vex
terest Ratio proved to be an excellent tool for fore-
Bi
casting the future direction of the market.
0
SSOl JO U!Fs
2) Although the number of shares sold short is
wJad 00s d4s one of the components in computing the Short In-
terest Ratio, its contribution to the predictive value
of the ratio during the period of this study is
o!lex
BwlJels alleJady
minor.
3) The ratio’s past effectiveness is due mainly to
the tendency for volume to be relatively high
during bull markets and relatively low during bear
markets.
4) For the Short Interest Ratio to perform as
well in the future as it did during the period of this
study, the volume patterns of future bull-bear
cycles must strongly resemble those of the
past-something for which, unfortunately, we have
no guarantee. 8

- 16 -
/.

saleuS :UI :~oqS

,o a:ualaMq
:uaxad 38elafly

tuey sajeys
;saialul UOUS
A PAGE FOR NOTES

- 18 -
PORTFOLIO MANAGEMENT BY ROBOT: THE ULTIMATE PUT-DOWN
Howard Hebert - Newhard, Cook & Company

Few will disagree with the fact that the last decade has brought
more change to the professional investment field than any other time in
living memory. Much of the change has been caused by some serious
questioning of the traditional methods employed in stock selection, port-
folio management, market timing and the art of successful investing in
general. With each new thread of truth brought to light by one camp
came a reciprocal put-down to another. Consider the following hypo-
thetical commentaries and their inferences :

Efficient market academician to the fundamental analyst:

“Stock prices fully reflect all available information at any given time.
New information, therefore is discounted too quickly in the market place
to be acted upon profitably.”
Translation: “Four times earnings and a ten percent yield
you say. I wonder if anyone else is aware of this ? Ho Hum. ”

Random walk theorist to the technical analyst: “In moving

toward equilibrium, a securities price movement is completely inde-
pendent of all previous movements.”
Translation: “You people are an arcane bunch of weirdos
practicing an amusing yet futile form of tarot reading.”

Fund sponsor to bank trust department: “After considerable

deliberation, the board has decided to instruct you to index our plan.”
Translation: “If your =.gg of MBA’s, CFA’s, economists,
et. al. could pick stocks as well as the kid in our shipping department,
we wouldn’t have to be going through this falderal.”

Modern portfolio theorist to anyone within earshot of ivory

tower: “Alpha, beta, R2, correlation coefficient and extra market
covariance. I’
Translation: “You poor pitiful simpletons. How can you expect
to gain a modicum of success while wallowing down there in your quagmire
of ignorance. ”

Not to be outdone in this intimidation game, we have decided to

enter our robot portfolio manager, Phil Stone (short for Philosopher’s
Stone - you won’t find the term in your MPT manual), into the foray.
As you will see, Phil will succeed in putting down in one fell swoop all
of the above contestants by means of an ancient and mysterious science
that somehow has been largely overlooked in the investment field. Phil’s
secret weapon is . . . . . . . . . . . arithmetic.

- 19 -
 Although Phil is not as cute as Star War’s R2D2, he is however
endowed with an incredible memory and a way with numbers that is dazzling.

To explain Phil’s portfolio management technique it is necessary

to raise a term for discussion that may not be entirely familiar to all. The
term is percentile strength. It’s not a complicated subject and can be easily
understood and utilized by all of us who have survived Jr, High School math.

PERCENTILE STRENGTH: THE COMMON DENOMINATOR OF STOCK PRICE

MOVEMENT

The best way to approach this subject is to exercise your imagination

for a moment and visualize a huge wall chart upon which is posted in graphic
form, the price action of hundreds or even thousands of stocks over a given
time frame. Do you get the picture ? A sea of squiggly lines that may be a
delight to the chartist but to everyone else a scene of ocular chaos.

Instead of the above, perhaps a different method of presentation that

would sort this unruly gang of stock prices into an understandable order would
serve some useful purpose.

Suppose first we list these stocks by degree of price change over the
given period. After performing the necessary arithmetic let’s say we find
that Acme Electronics had advanced 250% and this was the greatest gain re-
corded by any. We would place Acme at the top of our list and then go on to
discover what stock was the second best performer and position it directly
below and so on until the entire collection was correctly arranged in descending
order of performance. Now by bracketing the list in percentile ranks an
accurate label of current performance value can be affixed to each stock. If the
universe was comprised of say 4000 stocks, the top 40 would be called 99’s,
performing better than 99% of the constituents and the bottom 40 would be in
the zero percentile, performing better than none. There would be 40 stocks
in each of the remaining 98 slots and the average strength of all would of course
be 50.

Now advance the time frame by one week and repeat the entire pro-
cedure. We may now find that Acme was replaced in the 99th percentile by
some other stock. This means that Acme was forced to a lower number simply
because everybody has to be someplace. Although many individual stocks may
have changed positions, the average of all would still be the same . . . . 50.

This sort of work performed on your pocket calculator every week

would obviously drive you crazy. Luckily the information can easily be obtained
from several computerized sources. Besides ourselves, a number of advisory
services and some brokerage houses produce this type of data. All are based on
different time frames with varying sized universes and of course the actual com-
putations of the stren,gth figures are somewhat more complicated than the above
simplification. But you get the main idea: an accurate measurement of relative
price action where average performance is always described at the mid-field
50 yard line.

- 20 -
 Though this ongoing process of percentile strength ranking has con-
siderable practicai value by itself, some other tri&s can be employed to im-
prove the output. One, by making a couple or more passes at the raw data
and skewing the arithmetic a little bit to give more or less emphasis to the
most recent prices, a determination can be made as to the current direction
in strength each stock is trending. Stocks that are making unusually rapid
moves through the ranks can be filtered out and identified. In our work we
simply call these “I? stocks (accelerating rapidly Qward in strength) or
“D” stocks (accelerating rapidly -Downward in strengtt. )

Another benefit can be obtained by fooling the computer a little bit.

Computers in many ways are pretty dumb machines. They’ll believe anything
you tell them to believe. We told ours for instance that a dollar bill was in
fact a stock and as such it’s cllrrent quotation ($1.00 always) should be included
right along with all the other data. The value of this exercise is *that the exact
strength of dormant cash, now related to stock prices, is always spelled out.
If ‘he strength of cash is greater than 50, then the majority of stock prices must
be in downtrends. If the stren,@ of cash becomes greater than the average
strength of the stocks in my portfolio, I must be in trouble, etc.

We also tricked our computer into believing the S & P 500 composite
average was a single stock. Because the S & P is Ehe decreed standard to which
all of us are ultimately compared, it is e-xtremely important to know what this
index is doing when compared to the real world of stock price movement. If
the S & P were really depicting ‘Lhe price action of the typical stock, it’s per-
centile strength of course would be a constant 50. But this is seldom the case
and many times it is not even c 10se. So, when the S & P’s strength is less than
.50, it should be easy to overperform and vice-versa.

Xow back to Phil, the robot portfolio manager.

The objectives we laid down for Phil’s portfolio were simple enough.
These were:

Objective 32: Appreciate in value.

Objective #3: Beat the S & P.
Objective 41: Realize objectives 82 and $3.

Because of objective +3 and also to restrain Phil from going rampant

in low priced super beta stocks, we thought it only fair to restrict his selections
to those 500 stocks that make up the S & P Composite.

13 stocks were to be held when fully invested. This was just an arbitrary
number on our part and could have been considerably greater. The efficient market
people tell ils that if a portfolio exceeds a dozen or so issues it should “correlate”
with the market. The implication being that good or bad luck is sufficiently
neutralized through adequate diversification.

Perhaps this is a good time to e,xpose Phil’s portfolio management logic.

This can best be done with a flow chart diagram.

- 21 -
I
N
N
I

3.
4.
I5

-.‘1’11~
.-
stocks.

Iowcst perccntl le strength fwlcling.

 Now for the results of this dehumanized experiment. We gave Phil
an assumed one million dollars to ply his magic with as of 3-7-74. As it turns
out this date produced the most disappointing “whipsaw” buy signal ever generated
by our work and provided the acid test of worst possible starting conditions: fully
invested in a crashing market.

As of this date, l-3-79, our robot’s portfolio is worth $2,037,7 92.

A gain of 1040/o! You’ll have to agree that this is a very good record when com-
pared to his approved list and bogey, the S & P 500 which has advanced 3%.

The question that usually arises at this time is turnover. Surely Phil
Stone must be churning the account with an incredible amount of short term trades,
right ? Not so. Phil’s average of 54 transactions over the nearly five year period
produced a realized gain of 30.8% and was held 55 weeks. Furthermore, sub-
stantially all of Phil’s significant gains were long term while the majority of his
losses were short term.

And there you have it. If Phi l’s performance were monitored by the
experts he surely would have been persistently in the top decile of equity managers.
To carry this one step further, if total ego decimation has not been complete, it
is interesting to note the things that Phil doesn’t know and can not do when compared
to his intelligent and experienced human counterparts.

1. Phil can’t read. All of the wisdom available in the Wall Street
Journal, Barrens, Pensions & Investments and other scholarly pub-
lications is completely out of reach for Phi 1.

2. Phil doesn’t know the meaning of price-earnings ratios, interest

rates, dividend yields, cash flow, etc.

3. Phil can’t perform any of the contemporary technical analysis

functions. He doesn’t lmow a head and shoulders formation from a
Kansas plain.

4. He is unaware of the current political climate or for that matter if

World War III has come to pass.

And yet, one can’t help but wonder what would have occurred if Phil
were the portfolio’s slave rather than its’ master. What if Phil was not allowed
to respond to all of the minor strength fluctuations of cash equivalent and the S & P
in such a knee jerk fashion ? What if the robots’ yes-no bullish/bearish market
mentality were tempered to a degree by some sound objective economic reasoning?
Or maybe augmented to include some standard technical analysis ? What if Phil’s
approved list were humanly screened to include only fundamentally logical consider-
ations rather than a sterile, unchanging list of 500 stocks.

What if . . . . . . . . . . . . . . . . . . . ?

- 23 -
 SMOOTHER IS SHARPER

Moving Averages Add Another

Dimension To Point-and-Figure Charts
by David I,. Upshaw
Introduction
Technicians and investors who are interested in technical analysis use
a variety of charts in a variety of ways. Nany chart users admire the
compactness and ease of posting offered by point-and-figure charts,
but they also like the moving-average smoothing techniques that can be
applied to daily, weekly, or even monthly bar charts.
It is possible to compute moving averages for point-and-figure charts
and to apply the same kinds of analysis to those averages that are ap-
plied to bar-chart moving averages. This article tells how.

The Why and How of Moving Averages

Security prices and some other kinds of data that are used in techni-
cal analysis can change suddenly. We use averages of prices over var-
ious time periods to smooth out those short-term fluctuations and re-
veal long-term patterns. For example, a commonly used and widely un-
derstood average, which is printed in several security chart publica-
tions, is the 200-day moving average. (A simpler version is an aver-
age constructed from the latest 30 weekly closing prices, or the 30-
week moving average.)
The titles of these averages: "200-day moving average," "30-week mov-
ing average," and others, all specify a time period. Because a point-
and-q'&igure chart depends on the direction of price movement and rever-
sals in that direction rather than on the passage of time for its pro-
file, moving-average-analysis techniques might not appear to apply.
But they do. Point-and-figure chart users, who also like the smooth-
ing effects of moving averages, can combine both approaches.
For starters let's review one way of constructing a conventional, time-
based, moving average and then transfer that technique to a point-and-
figure chart. Let us assume that we would like to derive a 5-week
average of the price of XYZ stock. The closing prices of the stock
for the last 5 weeks are as follows:

week 1 21.500 (five weeks ago)

2 21.625
3 20.375
4 20.750
5 22.500 (latest week)
SUKI 106.750

- 24 -
 average = 106.75 + 5 = 21.350
The S-week average price is 21.350.
When the next week 's closing price becomes available, it is added t0
the j-week total, and the price of 5 weeks ago is deducted from that
figure. The new total is then divided by 5 to obtain the current
5-week average figure. Assume the new price is 23.30.

old total ' 106.750

plus: new price 23.000
minus: price 5-weeks ago 21.500
equals: new total 108.250
new average = 108.250 d 5 = 21.650

Point-and-Fisure Chart Moving Averages

The same technique is used to compute a moving average for a point-
and figure chart, with one more stew. Because a point-and-figure
chart has no time basis and, therefore, no dailv 2 or weeklv closing
prices, we need to find substitutes for those closing xrices. Those
substitute prices are the average Carithmetic mean) prices of the
highest and iowest values posted. in each of the ooint-a .nd-ficr-
column

u-e chart. Instead of time periods, columns are used to compu .te
averages. Thus we speak of a j-column averaue, a lo-col:&mn av 'erage,
and so on. Note carefully that a j-week moving average is not the
same thing as a j-column moving average. A column of Frices In a
point-and-figure chart can take a few days, weeks, or even mon ths to
complete, depencing on the stock's volatility and the reversal unit
upon which the chart is based.

A moving average of any desired number of columns .:an be computed for

a point-and-figure chart as follows: when a price reversal occurs,
thereby ending the posting of prices in a column, the high price and
the low price of the now-completed column are added, then divided by
two to derive the average (arithmetic mean) orice
& of that column. An
example: a 3-point reversal chart of a $50 stock shows an advance
from 50 to 56. A reversal to 53 "closes" the 50 to 56 column. The
low--50 --is added to the high--56. The sum--106--is divided by 2,
and the mean price--53--can be used in the construction of moving av-
erages of any desired number of columns. For a 5-coluinn average, the
5 most recent column means are averaged. For a lo-column average, the
10 most recent column means are averaged, and so on.

Bow To Use The Moving Averages

The application of rnoving averages to Doint-and-f -igure price data is

- 25 -
limited only by the inventiveness of the user, as is true of moving
averages applied to bar-chart data. This section outlines two meth-
ods of using the moving averages, both of which are taken from bar-
chart moving-average analysis techniques.
The first and simplest method is the plotting of the desired average
or averages directly onto the point-and-figure chart. On the charts
of the Dow industrials on the last page that illustrate this article,
a 20-column moving average is plotted. It is the heavy line that runs
through the point-and-figure postings. "Buy" and "sell" signals can
be generated by the crossings of these averages just as they are from
bar-chart moving averages. The criteria for such signals, such as
the amount of penetration of the average and the trend of the average
at the time of its penetration, are decisions best made by each user
of the technique.
Remember that the moving average is always posted one column behind,
or to the left of, the column that contains current price postings,
because the final mean price of a column can't be computed until that
column is closed by a price reversal that moves the price plots to
the next column of the chart. Thus, a moving average can't literally
be crossed by current price action, but that is of no practical con-
cern, particularly if a 20-column or 30-column moving average is used.
These values change relatively little from one column to the next.
T:he second technique, illustrated by the lower part of the Dow charts,
involves the computation of percentage spreads between two or more
moving averages, and plotting these spreads on the chart beneath the
price plots. For this analysis, I compute a 5-column average, a lo-
column average, and a 20-column average. (Only the latter is posted
on the chart shown here.)
Three percentage differences between these averages are computed and
posted on the chart under the heading "Moving Average Spreads." The
percentage spread between the 5- and lo-column averages-is labeled
U5/lo.ti The spread between the lo- and 20-column averages shows as a
line marked "10/20," and a third line, identified as "5/20," shows
the percentage spread between the 5- and 2C-column averages.
The general purposes of these moving average spreads are to give indi-
cations of overbought and oversold conditions and to reveal increasing/
decreasing rates of price change. There are no hard-and-fast rules
for the interpretation of these oscillators: analvsts who use this
technique will apply their own expertise or define their own "rules."
The same techniques you may now be apolying to bar-chart moving aver-
ages can be applied to point- and-figure-chart moving averages. Some
of the patterns that I look for are described in the following para-
graphs.
I think of the lo/20 moving average ratio, shown as a solid line, as
a sort of "major trend" indicator. I interpret the four possible

- 26 -
trends of this line as =‘oliows:

lo/20 ?osition Interoretation

3elow zero and rising Rate of price decline slowing
Above zero and rising Rate of price advance increasing
Above zero and falling Rate of price advance siowing
Below zero and falling Rate of grice decline increasing

The lo/20 line can also be used as an overbought/oversold indicator.

Each st,ock or average has its own pattern, but f 0 r the DCW, reversals
of the lo/20 line from -5% or lower and +59 or a--> hi-her have orovided
some good clues to major trend changes. On the charts, theLDoints
numbered 1, 2, 3, and 4 show where k-7 L,,e LO/20 lixe turned up >rom -j%
or lower. Point 2 was followed by the continuation of the 1373-1374
bear market; the otlher three points provided gocd clues to be&'L;er
marktt action. Points that are lettered A, 3, C, and D show where
t-a-i
.nP 10/2C line turned down from levels of +5 or ihig.her. The dcwn-
C-drnS from above +3 have led market Desks by longer time periods than
the upturns from -3 have led market iows.

The j/l0 line, drawn as a dashed line, tends to lead the turns of the
IO/20 l>ecause it is based on the shorter moving averages. "he j/20
line (dotted line! shows the widest range of the three lines because
it depicts the spread between the shcrtest moving average and the
longest. Notice the extremeiy depressed readings reached by the Y/23
line near t,he major market lows. Xotice , too, that near points 3 and
a- I the 5/20 line's action diverged from the price action 0 f the Dow
by Y efusinq to cjo to new lows even though the averace itself was still
falling. The principles of divergence and non-confirmation that you
may now be using can also be applied to this technique.

December 4, 1978
Drexel Burnham Lambert
Reprinted With Permission

Acknowledgment

In 1968 I met a technician named Gilbert Foster, who was then working
and who still works in Denver. Gil was t5e first _3ersonl an-d so far
the only person I know of, to apply moving averages to ooint-and-fic-
. d
ure charts. I am indebted to Gil for the method of constructing the
moving averages described in this article. The methods of analyzing
the averages outlined here are ones I have used for several years in
working Smith bar-chart moving averages.
- 27 -
 .
B
f
P
f

- 28 -
Use this page to advise the MARKET TECHNICIANS ASSOCIATION
JOURNAL of what you can do to help make the next issue
special.

Send to: Fred R. Gruber, Editor

c/o United Jersey Bank
210 Main Street
Hackensack, New Jersey
07602

I will do the following:

- 29 -
This page intentionally left blank.

-_

- 30 -
 Originally published in Dun's Review, November 1978

Reprinted with permission of the author, an NTA member.

A Twenty-Year Business Slump? Not a Ghost of a Char,ce.

JOHN SCHULZ

The ghost of Xkolai Dimitrievich Kon- to send Kondratieff to perish in Siberia. show that these waves tended to consist
dratieff haunts many an economist and In short, it seems that quite a few of the of upswings and downswings having
businessman these days, carrying warn- “best and the brightest” want to push this roughly equal durations. Kondratieff as-
ings that the United States is about to country toward centralized planning, serted that these waves and their compo-
enter upon an economic slump that will brandishing a long Kondratieff down- nent swings are attributable to the in-
last twenty years. Like all ghosts, swing as a weapon of persuasion. And herent mechanism of a capitalist econo-
Kondratieff s doesn’t stand close inspec- -the ultimate ‘irony-economist Walt my. That landed him in Siberia. Or-
tion, but it frightens people nonetheless. W. Rostow, another believer, proposes thodox Marxism holds that capitalism is
Take this year’s annual report of the centralized planning to deal with the bound to self-destruct; hence. any theory
Bank for International Settlements- dangers of a Kondratieff upswing. claiming it would survive and flourish in
headquartered in Basle, majority-owned Who was Kondratieff and what did he the wake of recurrent crises had to be
by the central banks of the leading in- say? A professor at the Soviet Agricultur- “reactionary.” Thus. Kondratieff s theo-
dustrial nations and thus presumably a al Academy and director of the Business ry was literaily the death of him.
bastion of card-carrying conservative Research Institute of Moscow. he pub- Here is the core of Kondratieff s thesis
opinion. Viewing deep-rooted problems lished in 1925 a paper captioned “The (in his own words, translated into English
in its constituents’ economies. the B.I.S. Major Economic Cycles,” which ap- from the 1926 German version): “The
declares that “such maladjustments sug- peared the following year in a German relevant data which we were able to quote
gest the possibility of a slowdown of the translation. It was not until 1935 that cover about 140 years. This period com-
Kondratieff-type after several decades of Harvard’s Review ~j- Economics and prises two-and-one-half cycles. .The
virtually uninterrupted growth.” Statistics made the text available in Eng- following limits of these cycles. .can be
Or take Jay W. Forrester. professor of lish under the title of -‘The Long Waves presented as being the most probable:
management at Massachusetts Institute in Economic Life.” Kondratieff wrote: “First !ong wave- I. The rise lasted
of Technology and a “believer.” His new “There is. .reason to assume the ex- from the end of the 1780s or the begin-
computer model of the U. S. economy istence of long waves of average length ning of the 1790s until 1810-17. 2. The
indicates (to him) that the peak of a of about lifty years in the capitalist decline lasted from 1810-17 until
“Kondratieff wave” has been passed and economy.” and he presented statistics to 1844-51. conrinued on page 135
that, without new planning policies, we
face a lengthv period of economic
doldrums. Simrlarly, 77~ New Yorker
magazine, always ready to take a sophis-
ticated, literate swipe at free enterprise,
joined the parade with a lengthy article
by economist Robert L. Heilbroner as-
serting that only an “institutional” shift
to economic planning can give a new
measure of life, “albeit a limited one,”
to the capitalist system.
Push for Planning
Perhaps not surprisingly, The New
Yorker article displays a predilection for
citing Marx, John Kenneth Galbraith,
David Gordon (“a leading young Ameri-
can Marxist scholar”), Branko Horvath
(“a widely known Yugoslavian econo-
mist”) and Paul Erdman (The Crash o/
‘79). Somewhat remarkably, Gordon the
Marxist shares concepts that led Stalin

John W. Schuiz, veteran rrockbroker and mon-

ey manager, is a senior vice presidenr of Brean
.Murray. Fosrer Securities Inc.. (I .Vew York
Srock Exchange member firm. Schulz: Believers in the K-wave want to push the U.S. toward central planning

- 31 -
 “Second long wave- 1. The rise lasted
from 1844-51 until 1870-75. 2. The de-
cline lasted from 1870-75 until 1890-96.
“Third long wave-l. The rise lasted
from 1890-96 until 1914-20. 2. The de-
cline probably begins in the years
1914-20.”
People promptly were-and still are-
fascinated by the pattern that Kon-
dratieff thus revealed. True. he gave
himself five-to-seven years leeway at each
of his long waves’ peaks and troughs. But
his assertion that these waves had an
“average length of about fifty years”
stuck and soon became dogma to his
followers. The implications of regular
periodicity and forecasting capabilities
seemingly were irresistible. What’s more.
by the time Kondratieff could be read
in English (1935), the Great Depression
appeared to confirm his theory. It had
begun ten years after the last K-peak.
much like the two previous long and deep
could not yet be documented at all. That
left only one-and-a-half waves for whtch
there was a seemingly plausible case-
certainly not an acceptable basis for a
sweeping, long-term economic theory.
In-depth research done since the 1920s
-much if not most of it under the aegis
of the National Bureau of Economic
Research-has yielded no support for
Kondratieff s dating of long-wave peaks
and troughs. Thus, former Federal Re-
serve Chairman Arthur F. Burns and
Wesley Mitchell, co-authors of the
massive Measuring Business Cycles
(1946). noted the dearth of data before
1860 and examined literally hundreds of
statistical series for the vears since then.
They found it “impossible to come to
serious grips with the problem whether
business cycles tend to move in cycles
within Kondratieff s periods.” Research
after 1946 seems to have shed httle or
no additional light.
The most detailed critique of
Kondratieffs theory yet to appear was
done by George Garvey. then with the
National Bureau, and ran in the Novem-
ber 1943 issue of Harvard’s Review of
Economics and Statistics. Garvey. re-
garded by many as the foremost author-
ity on the subject, also found himself
unable to verify Kondratieff s dating of
long-wave peaks and troughs. What’s
depressions, which began in late 1825 and
late 1873. Both had come relatively early
in their respective K-downswings.
What, therefore, could be more rztion-
al than to conclude that the next long
K-wave would peak near 1970 and be
followed by a K-downswing, including
a characteristically severe and prolonged
business contraction in its earlier stages,
a multi-year doldrum pertod in its later
phase and a final long-wave trough near
the year 2000? That. at any rate. is the
party line as plugged by today’s Kon-
dratieff fans. with the “ultras” predicting
a vicious deflationary collapse as a prr-
requisite for the next K-upswing.
Scanty Data
Kondratieff s theory sounds im-
pressively simple, scientific and plaus-
ible. There is? perhaps fortuntately. only
one thing wrong with it: It won’t stand
up to careful examination. A lot of work
more. he accused Kondratieff of. in .ef-
feet. cooking the data to fit his theory:
“Less arbitrariness. .and closer con-
formity to his own rules for the de-
termination of turning points would have
resulted in a much less uniform picture
than the one Kondratieff presented.”
“Decomposing” Statistics
Garvey also pointed out that different
accepted methods of”decomposing” any
given series of statistics (that is, making
adjustments to uncover basic trends) will
yield different results and. furthermore.
that the use of moving averages-Kon-
dratieff used a nine-year movmg average
-provides no reliable proof of cyclicali-
ty. because different moving-average pe-
riods will produce different periodicities.
Garvey concluded flatly: “The theory
offered by Kondratieff to explain the
cyclical recurrence of long cycles has no
empirical foundation.”
Another major problem with the theo-
ry is that the long K-waves are not visible
to the naked eye-for the simple reason
that. as you may now suspect. they don’t
rea$ exist, at least in overall business
actrvuy. Take a look at a graph of real
U.S. Gross National Product since late
in the eighteenth century. What you see
is a long upward sweep. noticeably inter-
rupted only during the very early 1800s.
- 32 -
was done on its underlying data and
assumptions during the two decades after
Kondratieff first went public. Most of it
concluded that the existence of the long
K-waves could not be factually
documented as an economic phenome-
non recurring with predictably regular
periodicity. But that work of thirty-to-
forty years ago is now buried in library
stacks, and latter-day Kondratieffniks
carefully refrain from dusting it off.
The first and most glaring trouble with
Kondratieffs theory is the paucity of
data on which he based his conclusions.
He could use only four series of statistics
to define the upswing of his first wave
and only three more to date the down-
swing. For the timing of the second wave
and the upswing of the third wave, he
eventually had 25 series. In other words,
at the time he published the theory, the
first long K-wave was poorly document-
ed and the downswing of the third wave
the Civil War years and the early 1930s:
no regular periodicity here. Instead, real
GNP was significantly greater at each
trough registered in the Kondratieff cycle
than it was at the preceding K-peak-
notwithstanding numerous shorter-term
recessions, a good many crises and sever-
al deep and lengthy depressions. Even in
Kondratieffs time, it must have been
plain to any other observer that his
“downswings”-one running from
1810-17 to 1844-51 and the other from
1870-75 to 1890-96spanned decades of
enormous economic growth.
Capping it all. the theory’s forecasting
record to date has been conspicuously,
though not surprisingly, lousy. In 1926.
Kondratieff had to place his third-wave
peak as “probably” in 1914-20. Ten years
later. it was plain that any third K-wave
peak had to be dated 1929-and thus any
subsequent K-trough could be expected
in the late 1940s or in the 1950s.
Unfortunately, World War I1 in-
terfered. setting off a real wave of eco-
nomic expansion that began in the late
1930s and has not visibly ended yet, some
sixty years after tbe last “official” K-
peak. At any rate. some modern Kon-
dratieff followers insist on placing “ide-
al” wave peaks m 1814. I864 and 1920.
with troughs in 1843. 1869 and 1940..
continued
 If there is one area in which
Kondratiefrs long waves may have had
some validity, it’s.in rhe fluctuations of
wholesale prices. Here, long-term peaks
and troughs did coincide roughly with
Kondratieifj dating from the early 1800s
to the eariy 1900s. But the long down-
swings m prices did not inhibit ongoing,
longer-term economic growth. In fact,
dtspite the impact of two mammoth
wartime inflations (the War of 1512 and
:he Civil War). wholesale prices were
lower at the end oirhe nineteenth century
rhan at its beginning, while real GNP
grew more than a hundredfoid.
Although {here is evidence that pros-
perity phases tend to be iengthier when
prices are rising than when they are
failing, the postwar price deflation5 ofthe
nineteenth century mostly tended to pro-
mote vigorous business expansion by
making a steadily growing volume of
goods and services increasingiy ac-
cesslble to a ra?,idiy grswing population.
Thus, the pnct derlation forecast by
today’s Kondratieffniks for the rest of
this century need not be a threat to
economic we&being-ii it does indeed
materialize. To be sure, some of the
severe business crises of the past 200
years are traceable to rapid and drastic
contractions in the money supply, which
could account for failing prices-even
the 1929-33 Great Depression can be
attributed in the main to a disastrously
deflationary Federal Reserve policy.
But similar “errors” are almost c:rtain
to be avolded. If 50, what rational basis
is left for expecting a severe K-down-
wave in economic activity stretching over
the next twenty years’? In any case, as far
as prices are concerned, Kondratieff’s
:heory has now gone far off the track:
Sixty years after the latest K-peak in
wholesale prices. there is still no end to
rising prices anywhere in sight.
An Awesome Gamble
What’s in Kondrarieff’s theory for rhe
business planner and the investment
strateqst? Probabiy nothing much, 2x-
cept the remote chance of being
phenomenally right for the wrong reason
-an awesome gamble of the kind that
Sewell Avery of Montgomery Ward fame
took and lost thirty years ago when he
hoarded his company’s cash and refused
to modernize in anticipation of a post-
war collapse that was, at the time, widely
expected but that never materialized.
Very long-range forecasting and pian-
ning may be the “in” thing, but it’s a risky
way to go. Remember those ultra-long-
term planners, the institutional portfolio
managers who hoarded “one-decision”
growth stocks, the kind you only bought
- 33 -
and never had to sell? Well, :hey came
to gr:ef when no one was isft to keep
buying :he stocks at ever-rising prices.
Today, many of the same money man-
agers are playing Sewetl Avery’5 game,
explicitly or !mpiicitly betting on a K-
type deflation and warehousing cash in-
stead of buying equities at historicaily
modest vaiuations.
Few men. proiessors included, have
had the genius to envisage the shape of
things X-to-50 years ahead with anv
tolerable degree of error. Kondracieif
certainly was not one of them; his view
of the past-as-prologue is not reconcii-
able with demonstrable reaiity, and :Ime
has just about run out on his theory of
the future. It’s unsettling that today’s
inteiiigentsia should seek to revive and
invoke Tim in what is beginning to look
like a broadening power-play promotion
for Planned Capitalism. Maybe they just
have no sounder Tremises.
It’s tough enough to cope with the
shorter-term business and investment
cycles, :hose reckoned in years rather
than decades or generations, without
trying to figure out which professor, dead
or aiive, or whose computer program has
the right game plan for the next quarter-
century. Besides, long before you can
know the answer, it’ll be your job or your
money That’s on the tiring line. --END
A PAGE FOR NOTES

- 34 -
FARXET ANALYSIS REPORT by Robert - .*a-.
R. ?rec”+ar, ;r.
Harket Specialist
Reprinted with Denission
OrlgFklly published 5/d/78 and Robert J. Yarre11
Xerrill Lynch Vice President and yanager

FIFTY YEARS OF MARKET VOLATILITY

The volatility of the stock market, as measured by the monthly average of the
daily percentage range in the S&P 500 stock index, was the subject of a recent
study published in the Statistical Bulletin of the Securities and gxchange
Commission. On the accompanying chart, ;re have those volatility readings
plotted against a chart of the montihly average of the daily closing prices for
the S&P 500 index in order to assess the character of the current market in
terms of volatility.

Some preliminary observations can be made on the basis of a general inspection

of the data. First, the 1973-74 decline was accompanied by the highest
volatility since 1946. Second, the market decline in 1938 was the last
decline previous to 1973-74 to register two peaks of more than 3.0 on the
volatility scale, indicating that the 1973-74 bear market was the most
volatile decline in 35 years.

Xost important to us, however, iS that several declines since 1928 were
accompanied by very low volatility (below 1. j) , which is contrary to the
normal character of declining markets. ‘Je found that market behavior in each
of those iow volatility periods of decline followed a similar pattern (see
table below). First, the market experienced a severe, highly volatile decline
such as occurred in the bear markets of 1929-32, 1937-38, 7946 and 1973-74.
In each of those cases, the low in the market was followed by a’ recovery phase
-- 7932-34, 1938-39, 1947-48 and 1975-76 -- in which the market dispiayed
fairly high volatility compared with that in most advances. The I1t e s t ”
declines following those recovery periods -- 1934-35, 1939-42, 1948-49, and
1977-78 -- always were characterized by low volatility, when unpleasant
memories of the preceding bear market were reEdled and stoc’ks became one of
the least favored investment vehicles. Those periods are marked with straight
dark lines on the chart. In the history of these data, such declines
presented buying opportunities for the long term during periods of low
valuation for stocks.

1929-1932 1932-1934 1934-1935

1937-1938 1938-1939 1939-i942
1946 1947-1948 1948-1949
1973-1974 1975-1975 1977-1973

SL?!MARY

The present market resembles those periods since 1928 during which stocks
declined sluggishly following a rebound from a major bear market low. if we
take a long-term view, three precedents in terms of volatility indica%e t’ha t
the stock market appears currently to be in a basebuilding phase prior to the
eventual resumption of a secular bull market.

- 35 -
- 36 -
Cspyright 1973 @ Xrhur A. Merrill

{-,V’tiip this mai?

&* - rial is Izrotecred ‘by copyright,
x-5 do not object to quotation ii a name-and-
aderess credit 52-e is inc!udeci: Art’zur A.
Mexill, 30x 223, Chappaqua NY !03!-1)

13 09 78
 “A
~t30
:AR

I-.-
-1-20

-tlO ~~~~
-..--. ---.
0*

--. . -

-.
- i-
J7-
:“
::__
...‘..
-20

-30
-.--..

.-__._

--.-----
. ..-J-l-
:vLJ
.-
..’
.-.
Fs
.‘.-
..-;-
..:.
.i
---
- _.--
--
.I FM rsono

, , , , ~~~~--1-7
PERCENT CHANGE IN ONE YEAR
Copyright 1978 @ Arthur A.Merrill 1 FUNDS-CASH POSITION 1

(While this material is Trotected by

copyright, we do not object to quotation if
a name-and-address credit line is
included: Arthur A. Merrill, Box 228
Chappaqua NY 10514)
- 40 -
 ELLIOTT WAVE IRINCIPLE
Key to Stock Market Profits

by A.J. Frost and Robert Prech-ter

Published by New Classics Library 1978

Reviewed by William DiIanni, V.P.

Wellington Management Company

To date there haven't been many books of any real importance written on
the Elliott Wave Principle. But even so, this book by A.J. Frost and Robert
Prechter is by far the most useful and comprehensive for both the beginner
and the veteran. The beginner will find Elliott's theories clearly delineated
in principle and flawlessly diagrammed. The more knowledgeable reader will
find many nuances and interpretations which will sharpen his own convictions,
whether the reader agrees with the authors' personal interpretations or not.

The book is divided into two logical parts: Part I, Elliott Theory; and
Part II, Elliott Applied. Theory is "basic Elliott", from its simple and
complex concepts of impulse and corrective waves to their perplexing Fibonacci
measurements. The rules are clearly stated and potentially confusing areas
adequately explained. Reading Elliott in the original can be difficult and
somewhat confusing, since Elliott rarely used repetition or many graphic
examples where one diagram should do. Application runs the gamut from ratio
analysis of time and amplitude to much longer cycles, as supercycle, grand
super cycle and even a millennium cycle; also commodities, gold and individual
securities.

The Wave Principle by R.N. Elliott in 1938 was an original landmark work
of tremendous magnitude. But original theories in any field carry within them
the seeds of pervasiveness. In other words, the genius of the originator
rushes to apply them to literally every facet of the subject, and sometimes to
things beyond. The theories are meant to transcend everything to a unified
manner without exception and without limitation. This was true of many
momentous theories, as those of Aristotle, Newton, Darwin, Einstein and many
others of lesser light. At times it can be done. But sometimes the object
becomes too far removed from the scope of the theory; or is actually beyond
the reach of the source; or is in reality a new entity.

- 41 -
 Elliott waves, as a "reflection of the mass psyche", extend their influ-
ence over all categories of human activity. The authors, however, caution against
against strict use when Elliott 's theories are applied to individual issues.
"'When to make a move in the investment field is more important than what issue
to trade. Stock selection is of secondary importance compared to timing. It
is relatively easy to select sound stocks in essential industries if this is
what one is after, but the question always to be weighed is when to buy it."
This is especially true of options.

Further on they say: "The progress of general business activity is well

reflected by the Wave Principle, while each individual area of activity has
its own essence, its own life expectancy and a set of forces which may relate
to it alone."

The interplay of investors' general knowledge and human psychology is key

to the wave patterns generated in the broad market averages. Here is where
Elliott and Dow overlap. As Charles J. Collins observes in the foreward:
"Elliott . . . incorporated what Dow discovered but went beyond Dow's theory
in comprehensiveness and exactitude. Both men had sensed the involutions of
the human equation that dominated market movements -but Dow painted with broad
strokes of the brush and Elliott in detail, with greater breadth."

Moreover, Charles Dow in formulating his principles, did not suggest that
the interaction of the Industrials and Transports be used primarily as a fore-
caster of the stock market, but rather as an economic barometer. However, its
application to the better understanding of the stock market was its necessary
corollary. Elliott would not disagree with that at all, but went a step
further in isolating the degree. "The foremost aim of this wave classifica-
tion is to determine where we are in the stock market cycle."

But when it comes to individual stocks, "basic textbook technical analy-

sis" should be used rather than "forcing the stock's action into an Elliott
count that may or may not exist." This is not to say that its application
to individual issues is unreliable, but that the "fuzzy" ones should be left
to traditional technical studies.

Furthermore, theories are sometimes more comfortable in the abstract.

For instance, their application to large secular cycles can be downright
starry, and at first blush, even fatalistic. But the authors are quick to
point out that "the Elliott Wave Principle is a law of probability and rela-
tive degree, not a law of inevitability". Thank God for that. Yet the
section suggesting that all larger waves are likely to reach a peak around
1983, even from a millennium viewpoint, is alarming. This is especially true
when one overlays Benner's cycles, and others not mentioned in this book, as
various sunspot cycles and the fact that all planets will be horizontally
lined up in one direction around that time in sort of a perfect linear least
squares fit. The probability of extensive earthquakes and the risks of other
terrestial havoc will increase. Hopefully, the leveraged gravitational pull
exerted on our planet will not be in the direction the wave count suggests ,
for the market.

- 42 -
 Ehtt Waves in Descending Magniivde

1983! 19a3z i983Z

/ / I
I
I
r4
197%51/

I978
,Y Cycle

J Grand Supercyde

hot to scale)

Millennium Cycle

In sum, this book is extremely well done. It is clear, brief and bold.
It should stimulate activity in the use of the Xave Principle by other market
analysts previously not too well acquainted with it. As a devotee myself, Z
sincerely hope the book elevates interest to a h.igh plateau of study ar,d
respectability, and that its impact will be more than fleeting.

It is obvious that the authors spent much time and effort on the book.
It is equally obvious that Robert Prechter supplied the entlhusiasm of :7Out:?,
and the dean, A.J. Frost, the experience and wisdom of age. The blending or'
these qualities was perfection itself, and worthy of Francois Xauriac's dictum:
"To write is to hand oneself over."

Indeed, the book should be at the elbow of avery marlcet analyst. The
r'ibonacci cost of $21 could be logarithmically spiralled 'lo a modest fortxe.
L;
-= not in dollars, tl?en in knowledge.

- 43 -
A PAGE FOR NOTES

- 44 -