Journal of Technical Analysis (JOTA). Issue 12 (1981, November)

Market Technicians Association

JOURNAL Issue 12 November 1981

l’WRKE3 TECHNICIANS ASSOCIATION JOURNAL

Issue 12

November 1981

Published by : Market Technicians Association 70 Pine Street

New York, New York 10005

Copyright 1981 by Market Technicians Association

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Market Technicians Association Journal

Editor:

Anthony W. Tabell Delafield , Harvey, Tabell 909 State Road Princeton, New Jersey 08540

Associate Editor:

Roslyn Schwartz Delafield , Harvey, Tabell

Thanks to the following MTA members and subscribers for their part in the creation of this issue:

Bernadette M. Bartels John C . Brooks David Glickstein John R. McGinley , Jr. Arthur A. Merrill E. Michael Metz

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THE MTA JOURNAL

EDITORIAL

THE MTA AND CERTIFICATION: WHENCE E WHITHER? 13

Manv of the activities of the Market Technicians Association are highly visible. Others are less so. One particular area of endeavor which may be gaining a higher visibility threshold is work on the establishment of a certification program.

A year and a half ago, the MTA Board of Governors appointed a certification committee which, since that time has been hard at work.

Much progress has been made. The commitment, however, is not yet complete, and members should be aware of the issues involved. To this end, we present three articles. The first is a report to the membership by Bernadette Bartels, Chairman of the Certification Committee. This report covers the entire progress of the certification effort from its inception to date. The second is one by our immediate past president, John Brooks which argues in favor of continued progress toward the certification goal. Finally, we present a paper by Mike Metz raising some questions as to the current thrust of the program.

CERTIFICATION, A REPORT TO THE MEMBERSHIP

Bernadette M. Bartels WHY CERTIFICATION

John C . Brooks WHY CERTIFICATION???

E. Michael Metz

INDICATOR VISION Arthur A. Merrill

In this article, Arthur Merrill presents yet another example of what rigorous analysis of indicators is all about. Often there exists confusion, even among regular uses of technical indicators, as to whether they are most useful for the short, intermediate, or longer term. Mr. Merrill shows the results of significance testing for 29 indicators over five different time periods, and compares the relative significance of each indicator for each time period.

Arthur Merrill is a recipient of the MTA Award for Distinguished Contribution to Technical Analysis and an MTA founding member.

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Issue No, 12 Novalm-, 198.

NEW CHART PATTERNS John R. McGinley, Jr. 45

Your editor is at a loss for words in trying to comment on Mr. McGinley’s work. It must be read to be appreciated.

THE PRINCIPLE OF CONFIRMATION: A STUDY OF TWO TECHNICAL INDICATORS

David Clickstein

A decade or so ago, technical analysis tended to be challenged by academic work supporting the random walk and efficient market hypotheses. Much of this work was done as required presentations for advanced degrees. In recent years, as a welcome countervailing trend, many such presentations have constituted a defense of technical analysis utilizing much of the same statistical technique used in the earlier work. Such a defense is here presented by David Glickstein who submitted it as part of the requirements for his MBA degree at New York University. Mr. Glickstein is with the New York Life Insurance Company and gained his initial exposure to technical analysis working with one of the Market Technician Association’s long-time members, Ralph Block.

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THE LUBIN LECTURES The Stock Market’s Response to Changes in the Economy

Bernadette M. Bartels 61

In March of this year Bernadette Bartels, Past-President and Board Member of the Market Technicians Association received the signal honor of being asked to deliver one of the series of Lubin Lectures at Pace University. The prestige of these lectures is suggested in the Appendix which gives their history and the names of individuals previously so honored. The profession of technical analysis is also honored by Pace’s choice of Bernadette as a speaker and it is our privilege here to reprint the lecture which, as one would expect of Bernadette, turns out to be an excellent, concise summary of the stock market economic and political history of the past 30 years.

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MARKET TECHNICIANS ASSOCIATION

MEMBERSHIP AND SUBSCRIPTION INFORMATION

REGULAR MEMBERSHIP - $50 per year plus $10 one-time application fee.

Receives the Journal, the monthly MTA Newsletter, invitations to all meetings, voting member status and a discount on the Annual Seminar Fee. Eligibility requires that the emphasis of the applicant’s professional work involve technical analysis.

SUBSCRIBER 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 a discount on the Annual Seminar Fee.

ANNUAL SUBSCRIPTION TO THE MTA JOURNAL - $35 per year.

SINGLE ISSUES OF THE MTA JOURNAL (including back issues)

are available for $15.

The Market Technicians Association Journal is scheduled to be published three times each fiscal year, in approximately November, February and May.

An Annual Seminar is held each Spring.

Inquiries for Regular Membership and Subscriber Status should be directed to:

John Greeley Greeley Securities, Inc. 120 Broadway New York, New York 10005

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Editorial

THE GOOD CHART KEEPING SEAL OF APPROVAL

This edition of the Journal is being led off with three articles on the subject of Certification --- a lucid explanation by Bernadette Bartels on the progress of the Certification program to date, and two contributions by John Brooks and Mike Metz which serve as a tentative introduction to a debate on the subject of “Certification, Pro or Con”. These articles --- and this editorial --- are part of an effort to inform the MTA membership at large and interested non-member Journal readers of the existence of the Certification Program and to stimulate additional comments by interested parties.

There will be those readers who have been totally unaware that the subject was under discussion, and for complete details, they are referred herewith to Bernadette’s article. To summarize as concisely as possible, what is currently being contemplated is the establishment of a “Certified-l‘echnical- Analyst” designation, not necessarily under that precise title, and the awarding of that designation to some as-yet-undefined group of people who meet some as-yet-undefined set of criteria, presumably including the pass- ing of an examination --- all of this to be conducted, at least largely, under the auspices of the MTA.

Your editor has spent the last year as a member of the committee exploring this program, and the major message we have to convey as a result of this experience is that many people have worked long and hard and that the issues and alternatives are complex in the extreme. The membership in general should be involved in this process, however, if for no other reason beyond the fact that carrying the certification project to fruition will be expensive. Another fact not widely known among our membership may be that the MTA’s present financial condition, while perhaps unimpressive to those of us engaged dealing daily with large sums of money, is extremely healthy . Further progress on certification will, at a minimum, cause a noticable dent in that financial condition.

It has always seemed to us that a discussion on the merits of certification raises certain questions about the very spirit of technical analysis as it

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has historically been practiced. Those of us familiar, at either first or second hand, with the earliest pioneers of the art are aware of the fact that many of them were free souls, geniuses without a doubt, but geniuses who could be described, not uncharitably, as eccentric. One thinks, for example, of R .N . Elliot, who titled his original work “Nature’s Law” and had a tendency to treat his analyses as much as revealed religion as studies of the stock market. If the results of that analysis contributed less to the solution of all the world’s problems than he perhaps thought it did, they were nonetheless serious contributions and have come to be considered as such. However, those who feel themselves to be in possession of Revealed Truth tend to be anti-establishment figures, and one wonders how comfort- able Elliot --- along with many others --- would have been with any require- ment that he append a set of initials to his name.

While we are sensitive to this argument, we do not think that its force is overwhelming. The goal of the present certification project is not that of setting up a license to practice. Inrleed, we have learned that, were it to be construed as such an attempt, it would be set about with an almost incredible complex of legal restrictions. Thinking on the subject so far has envisioned a program largely modeled on the already highly successful C.F.A. program. The goal has been the establishment of a designation that most practitioners would be proud to place after their name, one which would be worth the expenditure of some effort in achieving. Those who wish to operate sans certification would continue to be free to do so and the public equally free to judge them accordingly.

Article II, Section 1A of the MTA constitution establishes as one of the association’s purposes “To establish, maintain, and encourage the highest standard of professional efforts and competence among technical analysts .I’ It is our view, quite simply, that there exists no group better qualified to judge and evaluate those standards than technicians themselves. We thus feel that efforts at development of a certification program are worthy

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of further support from this organization, both in continued labor on the part of its membership and expenditure of funds.

As time goes on, of course, any other tangible means of support will become evident. That support will come from our own proud wearing of whatever badge is ultimately created. There will be a temptation to make the attainment of that badge easier on ourselves than perhaps it should be. If we are to be leaders worthy of that name, that temptation should be resisted.

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THE MTA AND CERTIFICATION: WHENCE 8 WHITHER?

Many of the activities of the Market Technicians Association are highly visible. These incZude our annual seminar, monthly meetings, newszetter, and the Journal. Others are less visible and may indeed be unknown to many members such as our efforts in the areas of professional ethics, data alert, membership screening, education, etc. One particular area of endeavor which may be gaining a higher visibility threshold is work on the establishment of a certification program.

A year and a half ago, the MTA Board of Governors appointed a certification committee which, since that time has been hard at work. Many meetings have been held, and professional assistance has been employed in the area of task analysis. Further negotiation with testings services is currently being conducted.

Much progress has been made, in other words, toward the establishment of a formal certification program. The commitment to establishment of such a program, however, is not yet complete, and members should be aware of the directions currently being taken and the issues invoZved. To this end, we present three articles. The first is a report to the membership by Bernadette BarteZs, Chairman of the Certification Committee. This report covers the entire progress of the certification effort from its inception to date. The second is one by our immediate past president, John Brooks which argues in favor of continued progress toward the certification goal. Finally, we present a paper by Mike Metz raising some questions as to the current thrust of the program. The Journal actively soZicits response from the MTA membership at large on this important issue.

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CERTIFICATION

A REPORT TO THE MEMBERSHIP

Bernadette M. Bartels Shaw & Co.

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Background

The round table of technical analysts who founded our professional society identified as a goal the verification of a uniform knowledge of technical principles and standards of practice among analysts. During the summer of 1980, John Brooks, the newly elected President of the Market Techni- cians Association and a founding member, asked me to assume the responsibility for developing a program which might accomplish these particular objectives. After reviewing the question, I submitted my observations and recommendations in August, 1980. They are briefly outlined.

Preliminary Observations

As an observer of the scene, it seems to me that there is a need for outside expertise to lend objectivity when defining the methodology of analysts. Technical analysts tend to lose objectivity when discussing and evaluating their discipline. It is reminiscent of the relationship between a parent and a favored child. Emotion can at times cloud judgment.

In addition, to think we can create a program which will gain the respect of other professionals exclusively through an internal effort is, I believe, optimistic. There is no one person nor group of people within our organization that can possibly devote sufficient time to such an effort unless sub- sidized by their firms.

A solution to a problem always seems easier when it is reduced to its parts. Initially, we should consider establishing a testing procedure for entry level candidates or those who have acquired two to three years experience in technical analysis, preferably in a mentored environment. The certification of senior analysts would necessitate an entirely different approach and thus should be addressed at a later stage in the program. Consideration might

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be given to requiring an in-depth technical paper, a “white paper”, reviewed by the analyst’s peers.

The cost for creating a program would be high, particularly when one con- siders the relatively small number of analysts practicing technical analysis compared to other specialty groups. There are 150 members of the Market Technicians Association versus over 5,000 members of the New York Society of Security Analysts, just one branch organization of the Financial Analysts Federation. Thus it would be necessary to adopt an approach which would provide a means for recapturing costs in the future.

Approach

One approach would be the creation of a structured data base which would have multiple applications aside from testing. It might serve as a source for developing a training program, a marketable product, which would help us to recoup the costs involved in the development process. Costs can be justified if a program is designed which will have a potentially larger market than the Market Technicians Association. It must be one which can be adapted to the needs of educational institutions and other professional as- sociations .

A pre-packaged training program is a saleable item. Its market potential becomes far broader than just the Market Technicans Association. It might be attractive to the academic community. Training Directors at member firms have already indicated their need for such material. It is attractive as a learning experience for professional and lay people. It provides the opportunity to recover costs.

Recommendations

Market analysts employ many interdependent techniques and theories in making decisions. The decision may appear simple, but the process is in fact complex. To simplify the methodology employed it must be slowed to a logical or step-by-step progression of thought. An approach to this definition, or simplification of methodology, is task analysis. It slows the thinking process by forcing one to enumerate the steps in the thinking process. Each step of the decision is outlined. One cannot assume any foreknowledge of the subject exists. This process is widely used as the source or the foundation for the development of training programs and, in our case, would serve as the pri- mary source for the contents of a testing process as well. A search of financial institutions indicated that Jane Brundage of Kingman Brundage, Inc. a consulting firm, had been responsible for developing training programs at large financial institutions, such as Chase Manhattan and Chemical Bank. Her work included a task analysis of investment departments.

My recommendation to the President and the Board of Directors was that MS. Brundage be hired to develop a task analysis of technical analysis, with initial funding not to exceed $5,000.00, all expenditures being subject to the approval of the Board of Directors.

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The Board approved my recommendation of experts to serve as data sources for the task analysis. They were:

1. Robert Farrell, Merrill Lynch, to provide an overview of market analysis.

2. Ralph Acampora, Kidder Peabody, to explain the structure and form of technical analysis.

3. Arthur Merrill, Merrill Analysis, to share his knowledge of market indicators.

4. Newton Zinder, E .F. Hutton, to discuss short-term market theory.

5. William DiIanni , Wellington Fund, to explain long-term market theory.

During phase two of the program these members will serve as participants on an Advisory Committee to the Board of Directors with Anthony Tabell, of Delafield , Harvey, Tabell and Michael M&z of Oppenheimer & Co. I have been serving as Chair of the committee. John Brooks, initiator of the program, was added to the Advisory Committee during August, 1981 after his term as President expired. Charles Comer, Vice President, Market Techni- cians Association, was designated as the Executive Committee’s Representa- tive . The Advisory Committee is to provide the Board of Directors with its recommendations as to a certification program or its alternatives.

Implementation

The data experts were interviewed and the material structured by Jane B rundage . It was coordinated and returned to the experts for their critical comments. The task analysis was revised and submitted to the President of the Market Technicians Association on May 12, 1981 along with suggestions and comments for the future of the project. The task analysis confirmed a commonality of knowledge and its application. As completed, the study has multiple applications due to its inherent flexibility. Its costs remained within the scope of the budget.

Current Activities

The Advisory Committee has had two meetings this fall for the purpose of interviewing testing services to ascertain what support and services they would provide, as well as estimating the costs required to develop a test.

A service will help us to weight the content of the data as to its relative importance, determine the form the examination should take, help us write the actual test, administer and evaluate the test and coordinate our effort to ensure the continuation of the testing program. The development cost is unresolved, but it is estimated to be between $25,000.00-$30,000.00 for the first level of the testing program.

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One such meeting was with Professor Marvin Sontag, Department of Psychol- ogy , Columbia University, a specialist in measurement and evaluation. The second meeting was with Dr. 0. Whitefield Broome, Jr., Executive Director of the Institute of Chartered Financial Analysts, and Darwin M. Bayston, Programs Director of the Institute of Chartered Financial Analysts. A third meeting will be with representatives of the Professional Examination Service and is not scheduled as yet.

Future Tasks

The final meetings of the Advisory Committee will be to evaluate the total accomplishments to date, to define the goals of our association in this particular area once again, to evaluate the impact of a testing program on our membership eligibility and to make final recommendations to the Board for either an alternative approach or the implementation of the next phase. In addition to the practical development and administration of an examination, there are external matters which must be considered, such as the need to comply with the Equal Employment Opportunities Act, the Truth in Testing laws and the liabilities the Association will assume by administering an examination of professionals.

The principles, philosophy and measurement tools of the technical analyst make analysis of the stock market viable. The effectiveness of the conclus- ions depends upon the talent of the user. Medical, legal and accounting disciplines are tested regularly. Many pass the examinations but only a handful become outstanding practitioners. The talents of the user make the difference. I believe the same applies in the world of technical analysis. Analysts should not be intimidated by the prospect of a testing program.

The question which must be decided is whether a certification program is important to preserving the professional stature, tradition and integrity of the Market Technicians Association. If so, the difficulties can be resolved and the responsibilities assumed.

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W!-iY CERTIFICATION

John C . Brooks The Robinson-Humphrey Company, Inc.

The question of certification for the Market Technicians Association has been with us since 1976. As one of the staunchest supporters of an official certification program in our organization, I have been asked to take the “pro” side of a debate.

It seems to me that our organization has two possible courses of action. We can certify ourselves which is, of course, the easiest way and very inexpensive. However, what do we end up with? It is my contention that, in the financial industry, there are probably 200 full-time professional technicians that could meet the MTA’s admission standards. Since certification would be based upon membership in the MTA, we would wind up with a maximum of 200 certification certificates hanging on walls, and once again, as technicians , we would be turning inward, towards our own little club, when in fact we have a golden opportunity to elevate our profession to something beyond Joe Granvilleism. We must constantly keep in mind we are a highly competitive business. Our counterparts on the fundamental side have their certificates also. However, their certificate of certification, the CFA, has, over the last few years, elevated itself to a very prestigious award. The reason this has occured is because, to obtain this award, hard work and time in the business are the main ingre- dients. By presenting ourselves with our own plaque --- without a study program, without requiring a test, or without being certified through a university --- what we are doing is watering down our own certificate of merit.

Our second course of action would be to go along with the full certification idea. As last year’s president, I presented to the board of directors a report on the completion of what I would estimate to be a third of the needed work. This would call for the utilization of a testing service, admittedly expensive, the establishment of a test, also expensive, and the alignment with a respected university which could administer a test for us. We must keep in mind that going through the expense and the hard work of certification on a formal basis does a number of things for -

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our organization. It gives us a starting ground to build a testing program over the years that will be as respected as any other certification program in the country. This does not come overnight, of course, and does not come from the first examination. It takes time, and it takes many people working to bring the program to a respectable level that gives credence to a certification plaque.

We must also keep in mind that this program is not really for our current members although all should be expected to participate. This program is for the people that are still in school that will be coming up in the years to come, so that they can acquire some guidelines for learning just what technical analysis is. It is a means for us to enhance our professional image significantly over the long term. Since 1973, when the MTA was first organized, it has always been our goal to elevate our profession. In everything we have done over the last 8 years, we have aspired to pro- fessionalizm . One only has to look at thetop-notch job that has been done on the Journal, the highly successful seminars we have sponsored, the monthly meetings with top names in our business, or just the general increase in numbers of very professional people we have attracted both through our subscription and membership lists. It is my feeling and the feeling of many members I have spoken to over the years that this professional approach should be carried on in connection with the certification program.

I am fully aware of the expenses that will be incurred on behalf of this endeavor, but I am just as much aware, as both a founding member and last year’s president, that our organization has never been based on the premise that we were a money-making organization. The money that we have accumulated over the years has been accumulated for precisely this type of work -- fostering long-term growth of Technical Analysis. The use of our funds for this type of project is exactly what was intended when the constitution of our organization was first written down. As for the time that is needed to arrange and organize a certification program, we have found over the years that our members have been more than willing to put in the necessary hours. As has been previously stated in memos and messages to the organization, no test can be put together without full approval of a blue-ribbon panel, which will examine the questions for the test itself to insure that the testers have properly worded each question and to make sure that the types of questions that are used fit our type of organization.

In conclusion, I think it is very important to remember that we are dealing with a long-term project. I believe firmly that if the project is not done on a highly professional basis with outside help, we run the risk of having a very weak foundation in the future. I believe it is of vital interest to the MTA to get behind the full-certification approach so that in years to come we can all look back and be very proud of what we have accomplished.

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WHY CERTIFICATI3N???

E. R’lichael Metz Oppenheimer and Co.

In considering the proposed certification project, members should first address themselves to several key issues. First, what are the objectives hoped to be achieved by creation of the certification program? Second, will the program achieve these objectives? Third, does the association have the financial and other means to develop the program properly?

The purposes of certification may include: (1) raising the prestige of the profession of technical analysis ; (2) raising the prestige of the MTA to a level where it will be generally recognized as the official arbiter of quali- fications for practice of the profession; (3) diminishing the ease of entry into the field; (4) enhancing the professional status and employment opportunities of present practitioners who, presumably, would be grand- fathered into certification.

The subsequent consideration is whether any or all of these objectives are worth attempting to achieve.

Assuming these objectives are desirable, the next issue is whether certification would achieve these objectives.

The final question, and the one on which I offer an opinion, is whether alternative means can be used to accomplish the same ends. In my view, the MTA has already made singular progress in raising the prestige of the organization and of its constitutent practitioners. It has done this through its information and educational program for security analysts and portfolio managers through the publication of this journal, through the sponsorship of the annual seminar, and generally by the highly professional conduct of its activist members.

These programs have been conducted with the commitment of only limited funds, and by member efforts that have been conscientious but not overly time consuming. I believe the objectives of the Association can be best served through continuation of these programs and development of others rather than through development of a certification program.

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INDICATOR VISION

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ARTHUR A. MERRILL Merrill Analysis, Inc.

In this article, Arthur Merrill presents yet another example of what rigorous anaZysis of indicators is all about. Often there exists confusion, even among regular users of technical indicators, as to whether they are most useful for the short, intermediate, or longer term. Mr. Merrill shows the results of significance testing for 29 indicators over five different time periods, and compares the reZative significance of each indicator for each time period.

Arthur MerrilZ is a recipient of the MTA Award for Distinguished Contribution to Technical Analysis and an MTA founding member.

The Problem

Stock market indicators never agree. Which should be believed? Which have the best record of performance for the short term? Medium term? Long term?

The Test

This paper presents the results of a test of 29 indicators through the 12 years beginning January 1, 1969 and ending December 31. It’s a good period for a test, since the Dow began the period at 943.75 and ended only slightly higher at 963.99. How well did the 29 indicators call the swings in this span?

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The Method

Each indicator was asked each week, “Are you bullish? Bearish? On the fence?” In most cases it was assumed that the indicator was trying to say something when it was unusually high (in the top 25%, or perhaps 10% of all of the weeks) or unusually low (in the lowest 25%, or 10%). The method of interpreting each indicator is described on the following pages.

The correctness of the forecast in each week was then evaluated five ways: Did the Dow close higher, or lower, one week after the forecast?

Five weeks later? Thirteen weeks later? Twenty-six weeks later? Fifty-two weeks later?

A batting average was then calculated for each indicator for each of the five time periods: (Hits) X lOO%/(Hits + Misses).

The batting averages were then ranked from best to poorest. The rank position from one (best) to 29 (poorest) is presented in the charts in this paper. The good short-term indicators have curves which are high on the left; the good long-term indicators are high on the right side of each chart.

Accuracv

The percent accuracy isn’t startling. Investment decisions should never be based on a single indicator. The highest score for the various time spans was:

1 Week 60.9% 5 Weeks 59.6%

13 Weeks 61.7% 26 Weeks 66.3% 52 Weeks 68.9%

It’s interesting to note that the best scores were for the longer time spans.

Significance

The significance of the results has been tested by Chi-squared. The results are presented by the bullets at the bottom of the charts:

One bullet: l

Two bullets: l

l

Three bullets: l

l

5% level; probably significant 1% level ; significant

0.1% level ; highly significant

l

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Indicator Definitions

The descriptions in this paper are very brief, but none of the indicators is “proprietary” or secret. Details are available. The report, “Market Indicators and Growth Company Ratings” gives additional material.

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-. WEEKS -

2D-DJI NEW HIGHS OR LCWS

-- WEEKS - -

--WEEKS--

2E-DJI /I3 WEEK AVER

5 13 2t 52

--WEEKS--

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TRENDS?

2A

Six Month Average Direction

An equivalent exponential average of the DJ Industrials was used, with multipliers of 0.074 and 0.926. A rise in the average was called bullish and a decline bearish.

2B - 5% Swing Direction

Swings of the DJI of less than 5% were filtered out. The direction of the resultant swing was called bullish if rising and bearish if declining.

2D - DJ Industrials New Highs of Lows

If the DJI was making new highs in a swing of more than 5%, it was called bullish; if it was making new lows, it was called bearish.

2E

DJI /13-Week Average

An equivalent exponential was used for the 13 week (multipliers of 0.14 and 0.86). If the Dow was above this average, it was called bullish; if below, bearish.

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21=- DJI 52 WEEKIZZ WL t.K

IO

i

: -4 .I /' ax

ti '

1 20 \

I 1

\.//

30 - .- .-.- __

I 5 13 2G 52 I 5 13 2G 52

--WEEKS-- -- WEEKS - -

i. I’ I

ii 1 RANSPORTATION

7.% ABOVE IO WEEK f3 30 WEEK

,ot -- -- I 3 13 2G 52

-- WEEKS - -

-2% -

2F - 52 Week126 Week

Equivalent exponential averages were used. Multipliers : 26 Week: 0.074 and 0,926 52 Week: 0.038 and 0.962

If the 52 week was above the 26 week: Bullish. If below: Bearish.

6 - Transportation

Each week the index is rated in Technical Trends, by judgment, based on performance relative to the Industrials. These judgments, as reported, were put to the test.

7 - % Above 10 Week and 30 Week

This is the number of stocks above the two moving averages, as reported by Investors’ Intelligence. The index was rated bullish when the 10 week was above the 30 week and bearish when below.

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14. MOST ACTIVE STOCKS 14. MOST ACTIVE STOCKS ,-.- -~~ __----- --.~ ,-.- -~~ __----- --.~

, , IO. IO.

zo- zo-

30f

30f 4 4

I I 5 5 I3 13 EG EG 52 52

--WEEKS-- --WEEKS--

16. NEW HIGHS/LOWS (STOCKS)

I 5 I3 2G 52

-- WEEKS - -

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SIGNS OF SPECULATION?

14 -

Most Active Stocks

Source : BARRON’S. BARRON’S average is divided by the NYSE composite average, to correct for inflation and the general level of prices. An exponential average is used with multipliers of 0.67 and 0.33. Above 70.9: Bullish. Below 57.2: Bearish (the quartiles).

16 -

New Highs /Lows (Stocks)

This is a ten-day average of daily figures of:

(New highs)/(New highs + New lows)

Bearish : above 0.82 Bullish : below 0.30 (quartiles)

_-

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23,VOLUME UP DAYS/DOWN DAYS 24. VOLUME UP HOURS/DOWN 11

HOUAC 1 1 L L

I 5 13 ZG 52

--WEEKS--

25. VOLUME PRICE AGREEMENT 25. VOLUME PRICE AGREEMENT

I 5 13 2G 52

--WEEKS--

3OL--J-----

I 5 13 2G 52 --WEEKS --

27. INVESTORS CONFIDENCE I[

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4)

,o-.- --d--m,H-----.L

5 I3 2G 52

--WEEKS--

29. A-D NON- CUMULATIVE

I ;/-------~z~~

-.wEEnS--

ZG 32

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ENTHUSIASM?

23 - Volume Up Days/Down Days

The volume of the last five rising days is divided by the volume of the last five declining days.

Bullish : above 1.05 Bearish : below 0.95

24 - Volume Up Hours/Down Hours

Some hours of the week tend to be more active than others. Each hour was corrected for this tendency; the resultant average volume in the rising hours of the week was divided by the average volume in declining hours.

Bullish: above 1.11 Bearish : below 1.03 (quartiles)

25 - Volume Price Agreement

If Daily Prices and Volume move in the same direction four or five times in a week, it is rated bullish ; if they disagree four or five times, it is rated bearish.

27 - Investors’ Confidence

This is a ratio of the P/E of the 30 rapidly- growing companies listed in Technical Trends to the P/E of the DJ Industrials.

Bearish : above 1.11 Bullish : below 0.71 (quartiles)

29 -

A/D Non-Cumulative

This is a two-week average of the daily difference between advances and declines, expressed as a percent of the number of issues traded.

Bullish : above +13.9 Bearish : below -18.2

(These are the deciles, which far exceeded the quartiles in performance. )

-33-

32.A.D DIVERGENCE OSCILLATOR 33. ASE PRICE DIVERGENCE

--WEEKS-- --WEEKS--

34. % CHANGE IN ONE YEAR

30 c f f t

I z, 13 26 52

-- WEEKS - -

-. -34-

LEADERSHIP?

32 - A-D Divergence Oscillator

A cumulative curve of the Advances minus Declines is compared to the DJI by means of a regression line.

B ulhsh : DJI more than 4.32% above expected: Bearish : more than 1.36% below expected (quartiles)

33 - ASE Price Deviation

The ASE price index is compared to the Dow by means of a regression line.

Bullish : ASE is below expected Bearish : above expected

34 - % Change in One Year

Bullish : when the DJI , in percent of the previous year, is above the S&P, expressed as a percent of the previous year Bearish : when below the S&P (400)

r - 35-

42. SEASONAL

-. WEEKS - -

SEASONAL?

42

Bullish : months of January, July, December Bearish : months of February, June, September

56. SHORT INTEREST

I 5 I3 2c 52

-- WEEKS - -

57. FUNDS CASH POSITION

I 5 I3 2G 52

-- WEEKS - -

T

- 36-

POTENTIAL BUYING?

56 -

Short Interest

The short interest is divided by the average volume of trading per day.

Bullish : above 1.57 days B earish : ‘below 1.21 days (quartiles)

57 -

Funds Cash

Source : Investment Company Institute. Cash and other liquid assets, in percent of total net assets.

Bullish : above 9.3% B earis h : below 6.4%

Note : Indicator 62 Percent Bearish could be placed in this category. Subscribers to beyrish services are out of stocks and are prospective purchasers.

r

-37-

74. ODD LOT SHORT SALFS 76 NON~MFMl3ER CI~OR rs

I 5 I3 2t 52

-. WEEKS - -

I 5 13 2G 52 -- WEEKS - -

77. NON-MEMBER/SPEC. SHORTS

I 5 I3 2G 52

--WEEKS - -

-38-

UNSOPHISTICATED ACTIVITY?

74 - Odd Lot Short Sales

A five-day average of odd lot short sales, as a percent of the average of total odd lot purchases and sales.

Bullish : above 1.53% Bearish : below 0.63% (quartiles)

76 - Non-Member Short Sales

This is the round lot short sales by non-members of the NYSE , in percent of total round lot volume.

Bullish : above 1.80 Bearish : below 1.14 (quartiles)

77 - Non-Member /Specialist Shorts

This indicator, developed by John McGinley and Walter Deemer, is an 8- week moving average.

Bullish : above 0.51 Bearish : below 0.34 (quartiles)

62. PERCENT BEARISH

Y--T---l-----f7

t t i\ ! r I ,I) L----I..--- L.-.-- 1. .L

I 5 I3 ZG 72

-- WEEKS - -

65. MEMBER TRADING

I 5 13 2G 52

--WEEKS--

63.MEMBERS’ SHORT SALES

I 5 13 26 52

-- WEEKS - -

67. SECONDARIES

I 5 13 26 52

-- WEEKS - -

69. NEGATIVE VOL. DIVERGENCE

-- WEEKS - -

- 40-

SOPHISTICATED ACTIVITY?

62 - Percent Bearish

Source : Investor’s Intelligence. This is the number of bearish advisory services expressed as a percent of total. in the Potential Buying category.

This indicator could be placed


63

Members Short Sales

Short sales, members of the NY SE, in percent of round lot volume.


65 - Member Trading

The difference between member purchases and sales, corrected for odd lot trading, expressed as a 13-week equivalent exponential average (multipliers 0.86 and 0.14).

Bullish : above +16 Bearish : below minus 391

67 - Secondaries

This is a four-week average.

Bullish : below 1.2

69

Bearish : above 5.2

Negative Volume Divergence

Advances minus declines on quiet days, in percent of total stocks traded, is compared to the total for all days in the week. The days in the week are corrected for their natural tendencies (low Mondays and Fridays).

Bullish : NVD more than 0.2 above Bearish: more than 8.3 below

-41-

91-FREE HESEAVES

I 3 I3 2G 52

-- WEEKS - -

FEDERAL RESERVE ACTION?

91 -

Free Reserves

A five-week average is used.

Bullish: above $40,000,000 Bearish: below minus $932,000,000 (quartiles)

-42-

Weights, proportional to logarithms of chi squared: Weeks :

Indicator 2B. 5% Swing Direction

2D. New highs or lows in swing

2E. DJI Above 13 week 2F. DJ 26 week below 52 week

6. Transportation 7. Percent above moving aver.

14. Most Active stocks

16. New Highs/Lows

24. Vol. up hours/down hours

29. A-D non. cum. deciles

32. A-D Divergence oscillator

33. ASE Price Divergence

34. Percent change in year

42. Seasonal

56. Short Interest

57. Funds Cash

62. Sentiment; inv. advisors

63. Short sales, members

66. Member Trading

74.Odd Lot short interest

76. non-member short

77. non-member/specialist sh.

70. Customer option balance

79. Premiums puts/calls

91. Free Reserves

e 3

4

9 0 8 0

4 3

7

0

0

0

0

5

10 10

3

0

0

4

7

0

0

0

1

3

0 0

0 1

0 2

0

0 2

0

0

0 2

2

1

0

0

0

0

0

0

0

0

0

5

0 0

0

0

0 0 2

0

0 2

0

2

2

3

3

5

0

0

0

0

0 2

0

0

0

13 - 2

0

0 0

0 0

0

0

0

2

5

0

6

0

2

4

2

0

0

1

5

5 2

5

3

26 52 6 5

0 0 0 0 0 4

0 0 0 0

0 3

0 5

3 0 2 0

8 3

0 2

5 4

4 0

4 5

3 9 0 6

2 4

6 0

2 0

0 6 4 5 4 0 2 2

3 0 B:This test was based on 5% swings of the DJI, rather than

on time spans. It has been used for the front page “Balance ” of Technical Trends.

Merrill Analysis Inc.

Box 228 Chappaqua NY 10514

08 09 81

-43-

intentionally blank

-44-

MEN Cl-MT PAllERNS

John R. McGinley, Jr. Van Cleef, Jordan & Wood, Inc.

Your editor is at a loss for words in trying to comment on MC McGinZey’s work. It must be read to be appreciated

During some research done in connection with the Certified Technical Ana- lyst program, some new and unusual chart formations were uncovered. Rather than wait for the completion of the program, these discoveries were thought important enough to warrent promulgation immediately to the membership .

It must be remembered that, while only recently discovered, these patterns have been around for millions of years, since the dawn of man. The fact the sun never fully rose on them should not off-put the serious analyst. On the contrary, as we all are, no less a personage than Arthur Merrill has already done rigorous work on one of them, terming it probably the the most revelent of his career. Those who would term these discoveries as beside the point are probably “quants” and therefore irrelevant. Those who would say “so what?” are probably.

No serious efforts - other than Arthur’s - have to my certain knowledge been made to date. It is with this in mind I submit these patterns to the membership with the fervent hope that further time will not be wasted. Feel free to use and treat these as if they were your own.

Two final notes: Back data is not available from Wally Deemer for $3.00, and those without their shots for promulgation should contract John Brooks.

--4.5

THE HOLIDAY GAP”

MARttm iNDEX (N Y.S.E ) -

/

_-

.-__ --*. - .-- .---- ,b :

m-i (N Y.S.EJ mmi~kr+o~~wp I

---

i-- A- --.-.. ___c__ ---- ---~-

,A- I.. --A. .1_ -- __-_.-- I

--

*Arthur feels the days before and after a holiday definitely are. And I agree. Reader feelback is encouraged, sis are often over-looked.

as the benefits of horizontal analy-

POLISH IF NOT . . . THEN PATTERN

Then This. If not this.. . (Sorry, John)

- 46-

THE DOUBLE-HELIX SPIRAL

* Or the other way around

THE ITALIAN TREND

(Sorry, Ralph)

- 47-

intentionally blank

-48-

THE PRINCIPLE OF CONFIfWTION: A STUDY OF Two TECHNICAL INDICATORS

DAVID GLICKSTEIN New York Life Insurance Company

A decade or so ago, technicaZ analysis tended to be challenged by academic work supporting the random walk and efficient market hypotheses. Much of this work was done as required presentations for advanced degrees. In recent years, as a welcome countervaizing trend, many such presentations have constituted a defense of technical analysis utilizing much of the same statistical technique used in the earlier work. Such a defense is here presented by David Glickstein who submitted it as part of the requirements for his MBA degree at New York University. Mr. Glickstein is with the New York Life Insurance Company and gained his initial exposure to technicaZ analysis working with one of the Market Technician Association’s Zong-time members, Ralph Block.

The two basic assumptions of Dow Theory-type technical stock market analysis are that (1) “the averages in their day-to-day fluctuations discount everything known, everything foreseeable, and every conditi n P which can affect the supply of or the demand for corporate securities ,‘I and (2) the market moves in trends, upward or downward, over periods of time. The term “technical” as applied to stock (and other) market analysis refers to the study of the action of the market itself, the interchange of supply and demand which determines prices, rather than the study of factors impacting that interchange, which is known as fundamental analysis.

The first of the above assumptions is shared by those who subscribe to the “efficient-market hypothesis, ” who would be likely to add that the averages discount all information instantaneously. The second assumption, regarding the existence of trends in the market, would likely be warmly disputed by efficient-market theorists, who by and large maintain that the

--49-

movements of the market averages follow a “random walk. ”

The dispute becomes more pronounced when the technical analyst states that it is possible, to some extent, to identify and predict the continuations and turning points in market trends, to evaluate relative strength or weakness in the market, and to profit from such analysis. The tools of the technician are charts of past movements in prices and trading volume, and various indicators of the mood, or sentiment of market participants. Probably the most central method involves examining the co-movements of two averages, such as the Dow Jones Industrials and the Dow Jones Transportation Aver- age, to see if they “confi rm” one another. That is, for instance, when the Industrials reach a high above their previous high, and the Transports do the same around the same time, the uptrend in the Industrials is considered to have been confirmed.

One of the hypotheses of efficient-markets theory is that it should not be possible, if markets are efficient, to predict future price movements profitably from the study of past ones. Nevertheless, this is what the technical analyst claims to do.

There have been a number of studies done over the years examining various aspects of technical analysis. Few, if any, of them found anything of merit in its approaches. In the words of one writer, “. . .it seems curious that there has not been widespread recognition among financial analysts that the patterns of tee pica1 analysis may be little, if anything, more than a statistical artifact. ” Another study found ” . . .no evidence of profitable fore- casting ability. . . .” ingthe “head and shoulders” reversal patterns many technicians swear by.

Despite these and other studies with similar results, technical analysis has continued to exist, with its practitioners being employed by most, if not all, major investment firms. Recently, in fact, there appears to have been a growth of interest in technical analysis on the part of institutional participants in the stock market. It is possible that these sophisticated money managers have become highly confused and irrational and are resorting to “witch doctors” in their panic. It seems more likely, however, that they see some merit in the approach. They may feel it to be helpful to them with respect to improving the timing of their moves into and out of the market, which factor has become increasingly critical in today’s volatile markets.

A characteristic of most of the academic studies done on technical analysis seems to be that whatever aspect of the approach was being tested was more or less abstracted from the approach as a whole, or else subjected to an imposed, unrealistic rule such as a trading filter. A classic example of this abstraction is that Levy’s test of “head and shoulders” patterns neglected to take trading volume into account, even though it is an integral part of that type of analysis. There appear to have been few, if any, attempts to evaluate the methods of technical analysis as they are used in practice. The author felt it would be interesting, and possibly useful, to attempt such an evaluation.

- 50-

In the course of doing project work with Mr. Ralph Bloch, a veteran technician and vice president for investment strategy at Moseley, Hallgarten, Estabrook & Weeden, Inc., the author found that Mr. Bloch relied most heavily on confirmations and divergences between the Dow Jones Industrial Average and (1) the Advance-Decline line and (2) the Dow Jones Transpor- tation Average. The Advance-Decline line depicts graphically a cumulative running total (sometimes taken over ten days, sometimes long-term) of the number of stocks that advanced in price minus the number that declined each day. It indicates breadth in the market, which is thought to -be useful in evaluating the strength of movements in a narrowly based index like the Dow Jones Industrials. The Dow Jones Transportation Average has been used to confirm the movements of the Industrials since the turn of the century at least, when Dow Theory was first propounded by Charles H. Dow in the Wall Street Journal. At that time the transportation average consisted only of railroad stocks. The Industrials were considered to be an index of productive activity and the Rails one of distributive activity, both of which needed to be sound in order to have a healthy economy and, hence a healthy stock market. Presently the Transports include other transporta - tion issues as well, and, while the rails do not “move the nation” as they once did, the index is still a supplementary barometer of speculation in the market and is thus thought to be of some use.

The technician’s assumption would be that if confirmation occurs between the Industrials and either or (more strongly) both of these supplementary indicators, the trend indicated by the confirmation would be likely to continue . If confirmation were not taking place, the averages would be said to be “out of gear”, and the trend in the industrials would be less likely to continue.

This was something that could be tested. Confirmations are visible on charts, and subsequent movements in the averages are a matter of record. The author wanted to test whether there exists any statistically identifiable connection between confirmations and subsequent continuations of trends.

The ExDeriment : Methodolav and Results

Since the objective was simply to see whether a relationship existed between two kinds of events (confirmation and trend continuation) that was other than random in nature, a contingency table was constructed and data gathered for it as follows.

When the Industrials made a new high above their previous high (or low below their previous low) , the Advance-Decline line and the Transports were examined for similar behavior. If confirmation took place within four trading days (an arbitrarily chosen time horizon) of the new high or low in the Industrials, it was recorded as such. It was also recorded whether or not the Industrials subsequently continued their trend. There was no time limit placed on how long the Industrials could take to “penetrate” their previous high or low; it should be noted, however, that this usually took place within five or fewer days, and very seldom took more than two weeks to occur. On the other hand, if (in the case of a top, for instance), a new low was reached before a new high, the Industrials were considered to have “failed” and confirmation on the downside was examined.

- 51-

EXHIBIT I

Subsequent Action : CONFIRMATION

DJT A-D

New High (4129) (5i972)

No New High (6$16)

New Low (33%

No New Low (425)

BY:

BOTH

196 (188.90)

(22908)

171 (153.94)

(2k:Os)

Column Totals : 85 108 387 51 631

ROW NEITHER TOTALS

(2:fi89) 308

(?91, 36

(2E29) 251

(2891) 36

Note : Expected frequencies in parentheses.

Chi-square score : 70.405, 7 degrees of freedom. Due to low expected frequencies, the second and ffurth cells in the first and fourth columns were combined in calculating X .

-52-

If no confirmation was present for a number of consecutive days immediately preceding a reversal, one instance of nonconfirmation and noncontinuation of trend was recorded.

Daily New York Stock Exchange data for the years 1971-1980 were used. Intraday highs and lows, rather than closing figures, were employed in examining confirmations. This was done mainly because Mr. Bloch employs the intraday figures in his work. The author does not believe that the use of closing figures would have altered the results of the test significantly.

In constructing the contingency table, the four possibilities regarding confirmation or absence thereof were arrayed across the top, forming columns. The four possibilities for subsequent action (i.e. , continuation of trend or noncontinuation, for both highs and lows) were arrayed along the left side of the table, forming rows. (See Exhibit I .) Upside and downside action was segregated at first, in the event of a significant discrepancy in ” signallin g . ”

In contingency analysis, after the types of events and subsequent actions have been isolated and the data gathered, a test is made to determine whether the distribution of the data conforms to a random (normal) distribution or not -- that is, to determine whether there is or is not an other- than-pance relationship between the events. The test is performed using the X (chi-squared) statistic, which is a distribution that tests for “good- ness of fit” of a set of data with a random distribution.

In this type of analysis, one usually tests one’s results against a hypothesis of independence or randomness. This is called the “null hypothesis.” In the case at hand, we tested the data against the null hypothesis that “There is no connection other than chance between confirmations by the Advance- Decline line and/or the Transports, and subsequent continuation of trends in the Dow Jones Industrials .”

The X2 statistic is calculated as follows : First, an expected frequency for each cell of the contingency table is calculated. In the case of the cell in the first row, first column (see Exhibit I), the probability of upside confirmation by only the Transports being followed by the Industrials continuing to a further new high is given by the product of the probability of any confirmation by the Transports and the probability of any new high in the Industrials. Using the totals of the first column and the first row, each divided by the total number of observations in the table, to estimate these two probabilities, we get (47+10+21+7) /631 = 85/631 for the first probability, and 47+49+196+16)/631 = 308/631 for the second one. Multiplying these two gives the probability within the table of upside confirmation by the Trans- ports only, followed by the Industrials continuing to a further new high. In a sample size of 631 we would expect to find

631 x -_8? 85x308 631

x 308 = = For 631 631

41.49 occurrences of this type of event.

the second cell of the first row, we get an expected frequency of 1087r-308

631 = 52.72, and so on.

-53-

EXHIBIT II

Subsequent Actions :

DJT

Continued Trend

(7F30)

Did Not Continue Trend

Column Totals: 85 108 387 51 631

CONFIRMATI.ON BY:

ROW A-D BOTH NEITHER TOTALS

(959368) 367 559

(342.84) (::. 18)

(1?32) (4?16) $!. 82) 72

X2 = 60.779, 3 degrees of freedom.

-54-

EXHlBlT III A. B. C

DJT Confirms New High

Subsequent Action :

New High

Yes No -

(7F52) 243 (235.48)

308

(2?52) (:648, 36 No New High

263 * 81 344

x2 = 9.744

DJT Confirms New Low

Subsequent Action :

New Low 192 (182.78) (6:!22)

251

(2k722) (19978, 36

209 78 287

No New Low

X2 = 13.645

DJT Confirms Trend

Subsequent Action :

435 124 (418.14) (140.86)

559

72

Trend Continues

(5?86) (18!:4) Trend Does Not Continue

472 159 631

X2 = 23.646

-55-

Subsequent Action :

New High

No New H&h

EXHIBIT IV A, B, C

A-D Confirms New High

Yes

245 (231.90)

(8;. 10)

259

X2 = 28.610

No -

(7PlO)

(i290,

85

Subsequent Action :

A-D Confirms New Low

New Low

No New Low

215 (206.40)

(&SO,

236

(SiliSO)

(i”40,

51

X2 = 16.072

A-D Confirms Trend

Subsequent ’ Action :

Trend Continues 460 99

Trend Does Not Continue

(438.52) (120.48)

(5::48) (1::52)

495 136

X2 = 42.780

308

36

344

251

36

287

559

72

631

-56-

02ce expected frequencies are obtained for all the cells in the yble, the X statistic is calculated according to the formula x2 =-(f - e) where f -. - is the observed frequency for each cell and e is the expecfed frequency for each cell, with (f - e>2/e calculated separately for each cell of the table.

We reject the null hypothesjs of independence at the level significance if the value obtained for X is greater than the value of X for (r-1) (k-l) degrees of freedom, where r is the number of rows in the contingency table and k is the number of columns.

The level of significance indicates a point on the horizontal axis under the chi-square distribution, to the right of which point lies * = some percentage of the area under the curve. The fa&her out to the right, i.e. , the smaller theqnumber, the less like&y the data are to conform to a random distribution and the more strongly one’s rejection of the null hypothesis of independence can be made.

In cases where the expected frequencies of some cells are less than 5, it is usually recommended to combine some of the cells and subtyct one degree of freedom for2each cell eliminated before performing the X test. This is because the X statistic used here has only approximately a chi-square distribution. This point is mentioned here because four cells in the sixteen- cell table in Exhibit I do have expected frequencies less than five. The second and fourth cells in the first and fourth columns were combined within their respective columns, resulting in seven, rather than nine, degrees of freedom for the table.

The X2 score for this table is 70.405, with 7 degrees of freedom. We were able to reject the null hypothesis of independence at the w = .005 level of significance, or a 99.5 percent confidence interval. The data were also ar- ranged showing only trend continuation (with no distinction between highs and lows) and so as to show each of the two indicators individually. (See Exhibits II, III, and IV.) In each case, the null hypothesis of independence was to be rejected at the same level of significance.

From these results it can be concluded that there is a strong, non-random connection between confirmations and continuation of trends in the Dow Jones Industrial Average. This relationship holds for both the upside and the downside, for both the Advance-Decline line and the Transports, individually and together. This can be taken as an indication of validity for the technical principle of confirmation, at least when practiced with these indi- caters.

A further note needs to be added here concerning non confirmations. These are often quite strong signals of an impending reversal, and usually take some time (frequently weeks) to develop. This tendency may shed some light on the reason the “Neither” column in Exhibits I and II appears some- what (perhaps surprisingly) biased toward trend continuation. (Remember that in cases where nonconfirmation was present on a number of successive days immediately prior to reversal, the entry was of one instance only of nonconfirmation and noncontinuation. ) This seems to bear out the premise

-57-

of Dow Theory that a trend tends to continue until something occurs to definitively reverse it. An extremely interesting pair of statistics are the following : Of 13 declines of 10 percent or more in the DJIA during the decade, 11 were signalled by nonconfirmations on the part of the Advance- Decline line. On the other, down, side, all five major bottoms in the Industrials were signalled by nonconfirmations in the Transports.

Another point concerning nonconfirmations and their accuracy and useful- ness in the context of this test is that the test was designed primarily to examine confirmations and their relationship to the continuation of trends. Nonconfirmations and their implication for the technician are more or less the obverse of that, a different test would be appropriate to evaluate them. The author only mentions the statistics on their signalling power as a matter of interest ; much more work is needed in the area.

When the author was discussing his findings with Dr. Jeffrey Simonoff, Assistant Professor of Statistics at New York University Graduate School of Business Administration, he was encouragied to read an article by P .M .E . Altham on the problem of having inflated X scores when using: data that mav be seriallv corrslated , i.e. where consecutive observations are distinct- ly non-independent. In summarv, the article contains the derivation for a chi-sauare “deflator” to be used in such instances. If, for instance, consecutive f bservations are found to be dependent, resulting in a “ridiculouslv large” X score (some were in the two- and three-hundreds), one would examine progressively more and more distant observations until serial correlation was no longer being observed. In the example of dependent consecutive observations, one might look at every third, fourth, fifth, and SO on, until the nhenomenon of denendence disaooeared. 3The “deflator” would allow one to locate the lower boundarv of the “true” X score for one’s data, which would be somewhere between the original score and times

the original, where r is the number of observations apart a 2&l& i lK dependence is no longer observed. If dependence disappeared at the point of every fifth observation, the real chi-square score could be as low as l/9 the original.

Since our results seemed to indicate the presence of some trending, this could have presented a problem. However, a number of studies done by Eugene F. Fama have shown that there is somewhere between extremely slight and no serial correlation in the daily movements of the Dow Jones Industrial Average. These studies provided further evidence that markets are efficient and do not move in trends. Leaving that issue aside for the moment, the results of those tests would seem to be sufficient evidence for us to allow our chi-square scores to stand as they are.

The juxtaposition of our results with possible evidence of efficient markets does bring up a very interesting question, however, to wit: If it is possible to discern market trends and their likelihood of continuance by use of confirmation /divergence analysis, what does that say about the efficiency of markets ? Can the efficient market hypothesis coexist with technical analysis that works? As to the latter, it will have to, if the results of this test are any indication. It seems, though, that the two main sticking

-58-

-

points are (1) the speed at which the market assimilates new information into prices and (2) the question of trends and whether they can be identified and profited from.

This study (along with a number of others) appears to indicate that information is assimilated less than instantaneouslv into market prices. It seems fairly safe to say that some market participants understand or get news sooner than others. It follows that if their understanding is correct, they should be able to profit by it. Someone who is closely involved with the workings of the market would be more likely to comprehend it correctly and thus profitably than someone who is not so familiar. This study also indicates that trends can be identified by use of technical tools, which may add a little further weight to the argument. The fact is that regardless of whether it is theoretical1 +. possible for trends to be identified and money made from such ldenti ication, it is done in practice. Considering the tenure of technical analysis if nothing else, that should not be too surprising. Since the stock market is composed of people, whose activities fall (usually) into recognizable patterns, it seems reasonable that the study of those patterns should be useful to those who can do it correctly.

The question of market efficiency is essentially an academic one. The difference in view between the technician and the efficient market theorist may be essentially that the former sees the market as a human phenomenon while the latter views it as an “economic machine” of some kind. The author is not sure that the two views are necessarily fundamentally different. It does appear that over some period of time, the stock market is efficient with respect to information impacting prices. That period of time is almost certainly longer than an instant, at least in a significant number of cases. If that is so, it would imply trends existing during periods of assimilation. If those trends can be identified by the use of technical indicators or other means, above-average profits should be possible. In any case, it seems obvious that some participants do and will understand the implications of information for price movements better than others. If that is taken as a denial of market efficiency, so be it. The author feels that it only tends to put realistic parameters on the discussion if such facts of life are acknow- ledged . It may yet be possible for academics and practitioners to discuss the same phenomena in terms that would be of interest and of use to both.

-59-

Footnotes

1.

‘2.

3.

4.

5.

Robert D. Edwards and John Magee, Technical Analysis of Stock Trends, Fifth Ed. (Boston, Massachusetts; John Magee Inc. , 1966)) p. 13.

Harry V. Roberts, “Stock Market Patterns and Financial Analysis: Methodological Suggestions , ” Journal of Finance (March 1959)) p . 1.

Robert A. Levy, “The Predictive Significance of Five Point Chart Patterns:’ Journal of Business (July 1971) .

Patricia M . E . Altham , “Detecting Relationships between Categorical Variables observed over Time: a Problem of deflating a Chi- squared Statistic, ” Applied Statistics (Vol. 28, No. 2), pp. 115-125.

Eugene F. Fama, “The Behavior of Stock Market Prices,” Journal of Business (January 1965), pp. 34-105.

The author is indebted to Ralph Bloch, Dr. Rolf E. Wubbels, and Dr. Jeffrey Simonoff for their invaluable assistance, advice and encouragement. Any errors are of course my own.

- 60-

ME LLIHN LECTLRES

The Stock IW-ket's !?esfmise to Chunges in the Econany

BERNADETTE i!!l. BARTELS Vice President

Shaw & Co.

In March of this year Bernadette Bartels, Past-President and Board Member of the Market Technicians Association received the signal honor of being asked to deliver one of the series of Lubin Lectures at Pace University. The prestige of these lectures is suggested in the Appendix which gives their history and the names of individuals previously so honored. The profession of technical analysis is also honored by Pace’s choice of Bernadette as a speaker and it is our privilege here to reprint the lecture which, as one would expect of Bernadette, turns out to be an excellent , concise summary of the stock market economic and political history of the past 30 years.

introduction

In Wall Street terms, I am a technician. In Great Britain, we are referred to as chartists, and on the wonderful world of Wall $treet Week, I and my peers are irreverently referred to as “The Elves”.

The discipline is approximately 100 years old. It was fathered by a man named Charles Dow, the creator of the Dow Jones Industrial Average which you see quoted in the newspaper every day.

A technician such as myself evaluates supply/demand forces within the marketplace. A basic tool is the chart. As you know, it has price changes on the upper part and trading volume on the lower half. The

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buy and sell transactions reported on the ticker tape are entered on a chart for future review. The longer the price and volume history, the more significant the chart becomes. This is the nub of technical analysis. The technician recognizes that some buy and sell decisions are randomly made - just happen by chance - but believes they are for the most part interrelated.

One might compare the expertise of the technican to that of a successful auction house as Sotheby’s or Christy’s. We are aware of a persistent or growing demand for particular valuable objects. We understand a buyer’s resistence or hesitancy to buy items when bids climb to peak prices after which a price collapse occurred in the past. We are well aware of speculative and fad investing, and also know that, at relatively high price levels, the supply of goods once rarely seen, will suddenly become readily available for sale. (Silver)

A fundamental analyst concentrates upon the study of the balance sheet of a company to determine overvaluation and undervaluation of a stock in the marketplace. The technician believes that the market price of a stock, like an art object, does not necessarily, nor indeed usually, at any given time, coincide with its intrinsic value. Periodically, its value remains overlooked for long periods of time. Yet on the other hand, investor enthusiasm may create a market value for a stock far in excess of intrinsic value and a company’s achievable earnings and dividend potential. The tendency of price trends to persist and of investors behavior to reoccur enables the market analyst to recognize and to anticipate potentially favorable or un- favorable investment etiironments (e. g. the introduction of gambling stocks). Indeed, the recognition of extremes in investor psychology is one of the market analysts’ unique contributions to the field of investment technicques. Technical analysis attempts to cope with these shifts in investor confidence.

Fundamental analysis and technical analysis are complementary and in fact, interdependent. Over the past 20 years, there has been an information explosion. New tools are being created to help the evaluation process. With increased information, technicians or market analysts now incorporate money flows, banking statistics, and interest rates in their work. Money flows tend to impinge on stock prices as well as corporate earnings. In- terest rates tend to influence the market valuation of current and prospective earnings and dividends. The escalating trend of interest rates produces riskless, high-return, money-market instruments which act as a competitive force for investment dollars (e.g. money market funds or the weekly treasury bill auction).

Lastly, and by my standards, most importantly, the market analyst is the historian of the stock market. Through this role, a study of the market and its response to the economy is possible. As you know, I studied history under the skillful guidance of Dr. Miriam Moran, our Vice- President of University Admissions. A major contribution from my liberal arts training was the refinement of a capacity to recognize the interdepen- dence of events and to evaluate their impact over long periods of time.

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A pebble tossed into a ~001 is an isolated action. The rinoles that are oroduced contribute in a minor wav to the natural force of erosion or the wearing down process which has existed since the pool was first formed. So too, one cannot fracture or isolate economic events into independent time frames. By removing them from events taking place in the total environment, the overview is destroyed.

As the economy is an everchanging yet ongoing force, so too is the stock market in its anticipation of that changing force. Investors have a keen sensitivity to change (e . g. , Alvin Toffler - Future Shock). Investors are also optimistic Y patient,

-- and must possess a sense of humor.

Their accurate response to change is so dependable, the U.S. Department of Commerce, in its monthly Business Conditions Digest, includes stock market prices as a leading indicator of potential change in the economy. It is the market analyst who attempts to place investor response to changes into the longer sweep of stock market history. This morning, I’m wearing my hat as a stock market historian. In that capacity, I should like to outline pertinent political/economic changes over the past three decades. The objective is not to judge decisions but to understand their impact upon the bottom line, then to trace investors response in the stock market over .the same period. Lastly, I will discuss some changes that are taking place m the marketplace today.

The 1940's

The second world war ended in 1945. It left the United States militarily and economically the strongest nation in the world. As so often happens, we did not recognize our own strength. The commentators on the scene were certain that once the demand for military goods and services was eliminated, the economy of the country would flounder. A depression mentality dominated. Most of the adult population had experienced the 1930’s depression. No one seemed to grasp the possibility that a boom period might develop.

Another common reaction was a distrust of the stock market and anyone associated with it. After all, many believed it was the excesses of Wall Street during the 1920’s that created the depression of the 1930’s. It was to be avoided.

When Harry Truman was elected President of the United States in 1948, the Dow Jones Industrial Average was at 190.

Unemployment was running at 3.8%.

The budget showed a surplus of 8.9 billion dollars after a tax cut.

Our balance of payments showed a surplus of 3.3 billion dollars.

The United States held over 60% of the world’s gold reserves, then priced at $35 an ounce.

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Because central banks could convert their dollar holdings into gold and due to the relative strength of the economy of the United States, the dollar became the standard for international transactions.

The demand for consumer- goods continued to build. There had been a sharp increase in family formations at the end of the war and the needs of these new families for housing, appliances, and services had been totally underestimated.

Wall Street continued to slumber. In 1949, one of the popular weekly maga- zines of the day, Colliers, made a survey of 5,000 of its readers regarding ___- the stock market. 64% believed that livestock was traded on the New York Stock Exchange. Few had security accounts or had ever been in a broker- age firm. And very few would ever trust a stockbroker. Obviously, an educational process was needed.

The 1950’s

Each decade has its own distinctive characteristics. As the transition years are taking place, the changes are subtle and frequently difficult to define. The depression mentality of the 1940’s was to carry into the 1950’s. It wasn’t until December 1954 that Business Week, in its last editorial for the year, carried the headline, ‘1954 - Turninsint in History’. It stated, “Certainly 1954 would go down as the year when we conquered the depression phobia. ” Previously, every slowdown in the economy was heralded as the beginning of a new depression.

If there are catch words to highlight the decade of the 50’s, one might say, “Confident, stable, preppie ,military/industrial complex, McCarthyism, Cold War, Sputnik, television. ”

In 1952, Dwight D . Eisenhower was elected President of the United States and remained President until 1960. More than any other administration in post-World-War-II history, the Eisenhower administration memoirs, fiscal histories, and diaries contain a preponderance of determined statements on the need to avoid inflation and reduce the federal budget.

Fiscal stimulation was to be avoided, business initiatives to be created.

The administration felt it was its moral responsibility to provide the nation with a balanced budget. Stimulation of the economy as a means of influ- encing voters, if it would lead to imbalances in the economy, was deemed unacceptable. Election periods were devoid of attempts to accelerate the growth of real disposable income of voters.

This approach created a strong sense of confidence on the part of investors as to the stability of the economy and the future of the country. The leadership was in strong hands. Enough turmoil had been experienced during the 193Ols and the war years of the 1940’s.

In the second year of the decade, Keith Funston was elected President of the New York Stock Exchange. He conceived the marketing concept,

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Investing in America. under thattitle.

The Reader’s Digest carried an article he wrote -7 It was to receive w%e circulation. It was a beginning of an educational process for investors. One was encouraged to “buy a share in America.” A public hesitancy still persisted, but individual investors realized that, if they bought the shares of mutual funds they would be provided with a diversification of investment. Risk would be reduced. All their eggs wouldn’t be in one basket. In 1950 there were fewer than 100 funds with 939,000 holders representing $2.5 billion in assets. By 1960 there would be 161 funds with $17 billion in assets and 4.9 million holders.

In 1950, “Engine Charlie” Wilson, the then President of General Motors announced that, in the future, the balance of the pension funds of this major corporation would be shifted away from bonds and into common stocks. Many other corporations decided to follow suit. In 1955, pension funds owned $5.3 billion in common stock. Within five years they would add $45 billion.

Investors were interested in heavy industrial stocks with glamour provided by television stocks, those new innovations - computers - semiconductors, and conglomerates. Ah, they were the spice.

To the chagrin of President Eisenhower - inflation - which had been relatively limited in its growth from 1952 to 1956 began to climb during the last three years of the decade. Budget cutbacks were ordered. Eisenhower was later to write, “Critics overlooked the inflationary psychology which prevailed during the mid-1950’s and which I thought it necessary to defeat .”

As he was not running for re-election in 1960, he felt the timing would be excellent for strong action. The Executive Branch and the Federal Reserve, under the Chairmanship of William McChesney Martin, made a concerted effort to eliminate excesses in the economy and the federal budget. It was successful.

The Bottom Line: 1960, the first year of the new decade was to end with a $300 million surplus in the federal budget. The budget wouldn’t register a surplus again until 1969.

The 1960’s

In 1967, Dr. Paul Samuelson was to comment, “Eisenhower had created conditions which were helpful to the long expansion which we have had in the 1960’s and which perhaps we still are having.”

As the economic decisions made in 1960 were to impact that decade, they would also strongly influence decisions made by the White House in the early 1970’s as well.

1960 was an election year. Mr. Richard Nixon was to run as the incumbent party’s candidate. In March 1960, Dr. Arthur Burns, former Chair- man of President Eisenhower’s Council on Economic Advisors, paid Mr.

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Nixon a visit. He explained that, unless some decisive action was taken, an economic dip would hit a low point in October just before the election. At the request of the Vice President, President Eisenhower placed a pro- posal by Arthur Burns on the agenda for the next cabinet meeting. Several cabinet members did not agree with Dr. Burns’ forecast, and, even assuming he might be right, the remaining members did not approve using the spending and credit powers of the federal government to influence the economy.

Two years later, the defeated Mr. Nixon was to write, “Unfortunately Arthur Burns turned out to be a good prophet. The bottom of the 1960 dip did come in October and the economy started to move un in November, after it was too late to effect the election returns. In @tober, usuallv a month of rising emolovment , the iobless rolls increased bv 452,000. All the soeeches, television broadcasts, and precinct work in the world could not counteract’ that hard fact.”

The impact of the political cycle upon the economic cycle has long been debated. The periodicity or timing of the stock market tends to confirm a correlation does exist. I will discuss this interrelationship between political, economic, and stock market cycles this morning.

The slowing of the economy worked to the advantage of the Democratic candidate, John Fitzgerald Kennedy. He proposed economic growth without inflation. His theme was “Get America Moving Again. ” Five-percent unemployment was termed unacceptable. The tax structure was to be - modified, tax incentives created for business. Prices would be kept in line by exerting federal pressure to curb the wage demands of unions and to discourage business from raising prices.

The decade was certain to meet its promise of the “Soaring 60’s.” The thoughts of depressions and stock market crashes were considered a thing of the past. IBM’s earnings would increase at least 10% every year. In- stitutional holdings of equities equalled approximately 20% of all listed stocks. It was a period of hot new issues, small-business investment companies, high-technology stocks, and stock-market speculation. It was a decade which began with dreams but ended in disillusionment.

An economic concept of the Kennedy administration was to lower taxes. This would produce a greater profit for business. Its expansion would stimulate the economy and produce greater tax receipts for the federal government. The concept of a full-employment budget was introduced for the first time. A budget was presented that would be balanced, assuming there was full employment. This new concept caught the imagina- tion of everyone. That sizable deficits might actually exist was considered temporary - until the economic boom began. Although President Kennedy intended to produce a balanced budget, indeed a surplus, this was never achieved.

The Bottom Line: The 1962 Deficit was $7.1 billion.

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In November 1963, the baton of leadership was prematurely passed to Lyndon Johnson. He accepted the economic concepts of the Kennedy administration, but in addition, introduced ambitious social reforms. Programs for housing, health, education, and welfare were funded by “Matching Dollars.” The federal government would provide 75% of the funds if the state and local governments came up with the rest. The incentives to establish programs on the local level were enormous.

In August 1965, the North Vietnamese attacked an American destroyer in the Bay of Tonkin. Congress immediately passed the Bay of Tonkin Reso- lution, authorizing the President to take military action against North Vietnam.

An escalation of the war in Vietnam and the weight of the “Great Society” expenditures produced still greater pressure on the already unbalanced budget.

The Bottom Line: The federal budget deficit was $1.6 billion in 1965; it more than doubled in 1966, reaching $3.8 billion and more than doubled again in 1967, climbing to $8.7 billion. Fiscal measures to neutralize the impact of defense outlays were postponed. It wasn’t until 1967 that the administration introduced a temporary tax surcharge. Debate delayed its enactment for one year until June, 1968. By 1968, the deficit was at $25.2 billion.

The annual increases in the Consumer Price Index, or CPI, began to accelerate. We use the CPI as a reference for the inflation rate. Between 1965 and 1969, the CPI was to increase 15.3% versus an increase of 15.2% for the entire decade of the 1950’s. During the 1970’s, the CPI was to climb over 100%.

The dollar was still convertible into gold during the 1960’s. As our deficits mounted, the foreign central banks, who were holders of dollars, became more and more inclined to hold the metal - gold, rather than the paper - the dollar. By January 1968, the Treasury Department gold reserve drop- ped below $12 billion above the reserve required to back the dollar.

In March 1968, Lyndon Johnson declared he would not run for reelection. In November, the Republicans once again gained control of the White House. Their successful candidate was Richard M. Nixon. The Federal Reserve was still chaired by William McChesney Martin - President Eisenhower’s appointee - although he was looking forward to retirement. Mr. Martin had been urg- ing tighter monetary and fiscal policy. He stressed an unpopular theme, “We are in a war-time economy. ”

In 1969, to reverse the declining value of the dollar and to tackle the inflation problem, Regulation Q, setting strict limits on interest rates on time deposits, was imposed. Loan demand climbed, but banks could not raise their interest rates to attract substantial depositors. These deposits were necessary to fund loans.

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Earlier in the decade, corporate treasurers had been encouraged to reduce liquidity to invest cash balances --- by doing so, the value of their dollar would be protected from inflation. The theme was “Making your dollars work for you! ” The loss of bank credit severely hampered liquidity and the internal operations of many companies. The most noted failure of the period was the Penn Central bankrupty in June 1970.

The Bottom Line: The combined efforts of the Federal Reserve with its tight monetary policy and the tax surcharge imposed by the Legislative Branch produced a $3.2 billion surplus in the budget, the first since 1960.

In the fall of 1969, Mr. William McChesney Martin was to retire from the Federal Reserve. President Nixon requested Arthur Burns, his 1960 advi- sor, to assume the Chairmanship. The White House exerted pressure on the Federal Reserve to ease the plight of the banking and industrial com- munities. At the swearing-in ceremony, the President requested, “Dr. Burns, please give us money. ” Credit restrictions were eased.

If one was to use a phrase to describe the 1970’s, it would have to be the Dismal Decade. In the early years of the decade, we experienced devaluation and debasement of the currency, persistent budget deficits, recognition of our dependence upon other nations for our energy, and the final destruction of the post-World-War-II stock market.

Due to President Nixon’s unpleasant experience in the 1960 election, political considerations rather than economic ones were to dominate decisions. The full employment budget concept was accepted. In January 1971, President Nixon was to tell Congress, “The full employment budget idea is in the nature of a self-fulfilling prophecy. By operating as if we were at full employment, we will help to bring about full employment.” A policy of benign neglect was adopted toward the dollar, resulting in massive speculation in our currency. In 1971, higher interest rates abroad caused tor- rents of dollars to flow out of the United States. For the one week ending August 13, $3.7 billion moved into foreign central banks. We faced a risk of a major run on our gold stock. By mid-August, the gold window was closed. The dollar was no longer “as good as gold.”

By December 1971, gold was revalued to $38 an ounce from $35. President Nixon announced the devaluation of the dollar. In mid-December, the Smithsonian Agreement was signed by the Group of 10, representatives of the central banks of the leading industrial nations of the world. It would replace the Bretton Woods Agreement. There would no longer be a fixed rate of exchange or commitment to defend currencies.

1972 was again an election year. In preparation for the election, staff members of the Office of Management and Budget assessed the effects of economic conditions on the outcome of Presidential elections. The conclusion : There was a strong impact. The findings were reported to the White House staff in the fall of 1971. Good economic times create good election results.

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Credit was eased s Disposable income was to increase 3.3%. The Republi- cans retained possession of the White House. By August 1972, gold was selling at $70 an ounce.

The Bottom Line: A 23.4-billion-dollar deficit.

January 1973: the Vietnam ceasefire was signed.

The Watergate Scandal broke in the first quarter.

There was a second devaluation of the dollar, rampant inflationary pres- sures , soaring gold prices, currency attacks, flights from the dollar, and sliding stock prices. By July, the dollar was plunging 2% a day in the currency markets. On top of this, OPEC imposed an oil embargo in October.

By April 3, 1974, gold had climbed to $197 an ounce.

In early August, Gerald Ford was sworn in as President. In September, the Federal Reserve began to ease credit. The country began to enter the worst recession/depression since the 1930’s. Unemployment was mount- ing rapidly yet inflation persisted. The term stagflation was coined to describe this condition.

The 1974 federal-budget deficit was $4.7 billion, down from $23.4 billion in 1972 and $14.8 billion in 1973. Investors felt perhaps the recession would end our inflationary spiral. In January, gold began to decline from its peak of $197. By mid-April 143 U.S. companies reduced or omitted dividends. To counteract the sharp slowdown in the economy, federal expenditures were increased.

Once again the country was stimulated out of a recession, but the results were costly.

The Bottom Line : The fiscal-1975 budget was to register a deficit of $45.1 billion followed by a $66.5 billion deficit in 1976.

During the fall of 1976, President Ford was warned the economy was beginning to soften, but he refused to adopt further short-term stimulative solutions. The slowdown in the economy and the earlier pardon of Presi- dent Nixon were credited with creating a turnover in the White House.

Jimmy Carter, a Democrat, was elected President. One particularly interesting aspect of this Presidency was the decision to delay restrictive poli- cies in the economy until a point in time when they resulted in a recession during the re-election period. 1980 as in 1960 would find the economy at its lowest point right at election time.

I guess Mr. Carter never read Mr. Nixon’s book, Six Crises. As in 1960, the incumbent party lost possession of the White House.

The Bottom Line: Fiscal 1980’s budget would show a deficit of $58.99

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billion. The New Year of 1981 would begin with the country under the leadership of a new President. debt of $937 billion.

The public would be shouldering a federal Within 6 weeks after the new President was to assume

office, he would have to request an increase in the federal debt limit.

The Stock Market

It is not uncommon for people today to shake their heads and say, “I just don’t understand the stock market anymore.” It becomes a little more understandable when one realizes that investors in the stock market are trying to anticipate changes in the underlying economy. And look what has been happening in the economy. Take a look at a chart of the Dow Jones Industrial Average to see how investors have responded to evolving conditions over the past 30 years.

During the 1950’s, the stability and steady growth in the economy produced the beginning of the post-World-War-II bull market. It was a 15-year period during which the buy-and-hold philosophy of investment was a certain winner During that period, although the stock market anticipated slowdowns, as well as recessions, in the economy, the declines from peak to trough aver- aged 11 months in duration with corrections averaging 20%. Each low point was higher than the previous low. So the odds favored the probability of higher prices if one held onto one’s stock position during a correction.

Investors buy stock when they perceive an improving environment for investments. They sell stock as the outlook becomes less optimistic, and they hold stock when they feel confident in the sustainability of the over- all improved environment. During the exciting early years of the 1960’s, when new economic concepts were being developed, the investor remained patiently confident. The response was, “Although there were changes taking place in the economy, the changes would certainly be ones of improvement .I’

Speculation is always present in the stock market. There will always be someone who will take a higher risk. It is often difficult to pinpoint when speculation builds into mania. Writers enjoy profiling these particularly colorful periods in the stock market, but, in actuality, it is a condition which builds over a long period of time.

(1) After the 1962 decline, students of the market began to observe that corrections were quickly completed.

(2) The most frequently-quoted economists assured us the solution to economic stagnation had been found. Downturns in the economy could be easily reversed. If this solution could be achieved, then one might assume higher risk in selecting stocks for investment. The inherent growth pattern in the economy would assure a profit.

(3) Institutional demand for stocks contined to grow. In 1962, institutions owned $70.5 billion worth of stock. By 1969, they held $162.5 billion.

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Popular financial publications carried articles proving quantitatively that the growing demand for stocks by pension funds was so great relative to the

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number of public companies and the rate of new companies going public, there would never be enough shares to fill the need -- That is an example of excessive speculative thought. Just as with silver -- at a price level --- supply will accommodate the demand.

In 1966, the stock market reached a high of 995 in the Dow Industrial Average. It was the last advance in the decade during which there would be an active participation by a broad representation of all stocks listed on the New York Stock Exchange. This desired condition would not occur again until 1975.

The growth of inflation was attracting attention. A by-product of persistent, significant inflation was the search by investors for companies whose earnings-growth rate would outpace that of inflation. In 1969, when the Federal Reserve tightened available credit, a panic hit the grossly over- valued stock market. The viability of illiquid industrial and financial corporations was seriously doubted.

The stock market’s low in 1970 was the first time in post-World-War-II history that a correction in the market ended at a lower low than the previous low. The breadth of the market had peaked in 1966. It was the actual end of the post-World-War-II market despite subsequent advances. However, the May 1970 low was to mark the formal conclusion of the bull market. The market declined for 18 months and registered a 36% correction.

When it became apparent that the new Nixon Administration would set aside the earlier efforts to moderate inflation’s growth, investment dollars surged into the common stocks of approximately 250 outstanding multi-national companies whose management, international markets, and earnings growth would successfully provide an earnings performance capable of keeping pace with inflation. This did not include the companies of smoke sta’ck America (e.g., the steels - chemicals).

The peak in the stock-market averages would occur in January 1973, coin- ciding with the signing of the Vietnam Peace Pact.

Once again, the worry of a post-war slow down dominated investors’ thinking. Once the demands created by the war were removed from the economy, a sharp economic correction would occur.

In the fall of 1973, OPEC imposed an oil embargo. A negative investor response developed, but, after some c.onsideration, it was concluded that, of all the nations of the world, the United States was best equipped to meet the crisis.

The stock market stabilized and rallied for a brief period.

The combined post-war adjustments, the Watergate Scandal, which began to explode in the first quarter of the year, and the OPEC restrictions broke the confidence of investors. Inflation, as expressed by the Consumer Price Index, rose 14.77%, on an annual basis, between 1973 and 1974.

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The stock market was to enter a decline which was to last 22 months and produce a 45% correction in prices.

By December 1974, the stocks of the Dow Industrial Average were selling below their book value for the first time since 1949. Investors recognized we had had three years of declining deficits. The trend was encouraging.

Under the new conservative leadership of Gerald Ford, we would certainly conquer our problems. The Consumer Price Index was continuing to rise, but at a slower rate. Value levels in the stock market were considered a buy of a lifetime. In retrospect, stocks were to again sell below their book value in 1975, 1976, 1979, and in 1980.

1975 was a strong year in the market. By August, the economy began to advance. It was later to be shown that much of the improvement was due to government stimulation.

1976 was an election year. The market entered a 65-point trading range which prevailed through September. As Jimmy Carter’s popular strength began to climb, the stock market began to weaken. There was a brief post-election rally, but 1977 was to be a down year for the Dow industrial stocks, with investors opting to buy the previously neglected shares of smaller companies. Once again, the $-year cycle was starting to unfold in the marketplace.

Earlier I had mentioned the political/economic cycle. You’ll note there was a low in the stock market in 1962, again in 1966, in1970, 1974, and here in 1978. A pattern has been evolving which seems to confirm that political parties in power tend to stimulate the economy, beginning approximately a year and a half before the Presidential election. A correction of the over- swings resulting in the economy are undertaken during the first two years following an election. As a result ,peaks in the stock market tend to coincide with election years, troughs following two years later. If one was to take an average of market cycles since 1949, from trough to peak to trough, they tend to spend 33 months advancing, 14 months declining.

The Dow Jones Industrial Average has not been able to convincingly penetrate the 1000 area in the Dow since 1966.

The 1966 high was 995 DJIA.

The 1968 high was 985 DJIA.

The January 1973 high was 1051.

The September 1976 high was 1014.

And the January 1981 high was 1004.

The stock market has been within a limited trading range for 15 years despite the increase in earnings, dividend payout, and book value of the

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underlying companies. Market volatility and limited expectations are accepted by investors. They buy stocks when the DJIA drops below 825 and scale sell as the market advances above 900 DJIA. Confidence in the future must be restored, but more than hope is needed. The bottom line must confirm an improvement. Listen to the rhetoric but look to the figures.

There are specific observations that can be made:

The abuse or misunderstanding of the economic system is not the exclusive failure of any one political party. There have been notable disappointments on both sides.

A determined leader can make a difference in altering the inflation trend. Dwight D. Eisenhower marshalled a successful attempt in 1960 which provided the foundation for economic stability for much of that decade. In 1969, William McChesney Martin as Chairman of the Federal Reserve Board, launched a successful attack on inflation and a defense of the dollar in 1969.

Evan a declining rate of inflation can foster a very profitable period in the stock market. A third year of declining federal deficits produced a major bull move in the stock market in 1975, lasting until September 1976.

The abandonment of the battle against inflation in 1970 and again in 1975 has produced a pervasive, quickly-ignited, speculative psychology. This condition should persist until confidence is reestablished in national leadership. It will become fixed if this is not soon accomplished.

The approach to the stock market today is “Give me a trend and I’ll trade it .” It has added volatility and the rapid acceptance and abandonment of investment vehicles. As an example, the pension fund results are in for the full year of 1980. It has shown that successful portfolio managers, those that have achieved results higher than the actual market’s average, have tended to buy stocks whose price volatility or Beta is greater than that of the market averages. Managers who traded aggressively did the best. This generally happens in an advancing market. Those with turnover rates of more than 57% of asset holdings showed a median gain of 40.8%. That of the S&P 500 is 32.5%. The median results of fixed-income accounts was 2.3% for the full year. If fixed-income portfolios had been in cash, the median return would have been 13.5%.

These results will undoubtedly encourage more portfolio managers to adopt an aggressive approach in the marketplace. Corporations on the other hand, will tend to emphasize equity investments over fixed income or bond holdings .

A fairly consistent effort to alter inflationary psychology has been in effect at the Federal Reserve since Paul Volcker assumed the Chair in the Fall of 1979. Some achievements have been obtained, particularly in the commodity markets through the rapid imposition of high interest rates sapping speculative profitability. If this groundwork can be capitalized upon by the new administration, due to the already weakened commodity markets,

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positive results might well be rapidly achieved.

A change in trend is being acted upon by investors. Since 1976 due to consistently increasing interest rates, investors have conscientiously sought oat companies that have been self-sufficient as far as capital needs are concerned (e . g. , oil companies). The acceptance of less efficient companies (as the steel companies) began with the November election results as their earnings should benefit from lower-cost capital.

There is great optimism that the program of the new administration will be successful. It incorporates some of the ideas of the Kennedy Administra- tion with tax incentives for industry and the consumers, but it also incorporates massive budget cuts.

Kennedy had inherited a budget surplus. This time there is little margin for error. The risks are high, but they are well calculated.

The landslide victory in 1980, as Eisenhower’s in 1952, has provided the Reagan Administration with a mandate for change. It knows it is an economic mandate - with a balanced budget as the ultimate objective. Unlike the Nixon Administration, Reagan’s decisions should tend to be weighted by economic rather than political considerations.

But keep your eye on the bottom line.

No one has ever had a simple answer to the riddle of the stock market. If someone issues such a claim, watch out. As the late Gerald Loeb once observed, “Once you think you’ve found the key to the stock market, some son of a gun is going to change the locks.”

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Appendix - The Lubin Lectures

The Lubin Lectures began at Pace University in 1974. Their purpose is to draw speakers from the business community who will lecture upon serious topics of national and global concern. The audience is composed of representatives of the business world, academic life, and the public at large. The lectures are designed to tie the business world closer to the academic community, to stimulate an interest in business careers, and to extend the services of the University further into the community.

Pace University is a private, coeducational institution composed of eight schools located on three comprehensive campuses, one in New York City and two in Westchester County. The Lubin Schools of Business include the School of Business Administration and the Graduate School of Business. These two schools serve over 11,000 of the University’s student body which numbers over 25,000 students. At the baccalaureate level, approximately 60% of the students major in accounting.

The lectures are sponsored by Joseph I. Lubin, a gifted and dedicated Pace alumni. Dr. Lubin has been a trustee of Pace University since 1961. A graduate of New York University Law School, he also serves on the Board of Trustees of New York University and Syracuse University. He is an Overseer of Yeshiva University and the Albert Einstein College of Medicine. Because of his efforts on behalf of these institutions, he has been a recipient of honorary degrees from each school. He was a founding partner of Eisner & Lubin, an accountancy firm with branches nation- wide. For over ten years, he served as Chairman of the New York State Board of Certified Public Accountants.

The chronology of Lubin Lectures provides an indication of the range and depth of subjects treated by the lecturers.

1974

Rawleigh Warner Chairman of the Board Mobil Oil Corporation

William S harwell Vice President, Operations The New York Telephone Company

Paul Kolton Chairman American Stock Exchange

David Rockefeller Chairman of the Board The Chase Manhattan Bank

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1975

John de Butts Chairman of the Board American Telephone and Telegraph Company

William F. May Chairman and Chief Executive Officer American Can Company

Harry E. Ekblom Chairman, President, and Chief Executive Officer European-American Banking Corporation

1976

Maurice R. Greenberg President American International Group, Inc.

Bart M. Stevens Senior Vice President, Former President Office Products Division IBM Corporation

Donald T. Regan Chairman Merrill Lynch, Pierce, Fenner & Smith

1977

Ian K. MacGregor Chairman and Chief Executive Officer AMAX, Inc.

William Jovanovich Chairman Harcourt Brace Jovanovich , Inc.

Richard R. Shinn President Metropolitan Life Insurance Company

1978

Donald V . Seibert Chairman and Chief Executive Officer J .C . Penney Company

David J. Mahoney Chairman of the Board and Chief Executive Officer Norton Simon, Inc.

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.

1979

Gunter 0. Eser Member, Executive Board Lufthansa German Airlines

Charles G. Steele Managing Partner Deloitte Haskins & Sells-USA

John F. McGillicuddy Chairman of the Board, President and Chief Executive Officer Manufacturers Hanover Corp. and Manufacturers Hanover Trust

1980

James S . Schoff, Jr. President Bloomingdale’s

William S . Brennen Chairman of the Board and Chief Executive Officer The Greenwich Savings Bank

1981

Bernadette M. Bartels Vice President Shaw & Co.

M . MacKinnon President and Chief Operating Officer CIBA - Geigy Corporation

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Sources

The Arena of International Finance, Charles Coombs

Business Conditions Digest, August 1974, September 1979

Constitution and Code of Ethics of Market Technicians Association

The Dow Jones Irwin Business Almanac 1977, 1978

Economic Report to The President, January, 1978, Count il of Economic Advisors -

Flow of Funds Report,

How The World Works, Jude Wanniski

1978 Department of the Treasury

The International Monetary System, Robert Solomon

The Last BuII Market, Robert Sobel

The New York Times

Political Control of the Economy, Edward R. Tufte

The WaII Street Journal

Wisdom of WalI Street ---

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Journal of Technical Analysis (JOTA). Issue 12 (1981, November)

Economy & Finance