Bulkowski's Forecast

Written and copyright © 2011-2013 by Thomas N. Bulkowski. All rights reserved.

This article looks at the historical performance of the Dow Jones industrials over the last 10 years according to forecasted behavior and how the Dow is expected to move in the coming decade.

Background and Methodology

The December 2011 issue of Active Trader magazine had an article titled, "Looking ahead to 2012" by Larry Williams. In it, he describes a method to forecast the future by using historical price behavior. In an earlier article, "Cycles and seasonals: A 2011 roadmap, January 2011," he provides a similar review.

Both articles are based on the work Edgar Lawrence Smith in the 1930s. Smith said that the stock market followed a 10-year cycle. Each year tended to repeat the behavior of the year a decade earlier. In other words, if you averaged all years ending in 1 (2001, 1991, 1981 and so on), that would give you a forecast for 2011. For 2012, you'd make a similar average, only use 2002, 1992, 1982, and so on.

That's what I did.

Warning

While the approach sounds easy, it does have some problems as you move from the monthly to weekly to daily scales. Monthly is easy. You take the closing price at the end of each month for all years ending in the target year (meaning 2001, 1991, 1981 and so on for years ending in 1) to get the forecast. Events like 9/11 where the markets were closed from 9/11/2001 to 9/16/2011 didn't matter much. I used the close closest to the end of the month. However, on the weekly and daily scales, those become a problem.

The daily scale is worse. January 3 might be a Tuesday in one year but it's a weekend in another. The average of those will be a mess because you could be leaving off big numbers. For example, back in 1928, the Dow was below 300. Today it's over 11,000. Leaving off the 11,000 reading will make the average of what remains much lower. Thus, the line tends to jump all over the place.

In that situation, I just used the prior day's close and copied that into the weekend (or into other gaps, like 9/11) and averaged the values as normal. That helped smooth out the curve.

Let me also say that my data only goes back to October 1928 (which I discard since it's not a full year). Williams appears to use data going back to 1900 and perhaps earlier. His results are more accurate than mine. In other words, the peaks and valleys you will see on my charts will be earlier or later than his. He may show an up trend and my charts do not. It's because of the missing data. For example, my charts use 8 samples and his use 10. That may not sound like much but it's huge when you are dealing with numbers that range so widely.

The monthly charts are the most accurate, followed in order by the weekly and daily charts.

2002-2011 Historical Forecast

I show a picture of the Dow industrials from January 2002 to November 2011 on the monthly scale as candlesticks. Below that is the forecast using the method described earlier in this article.

At A, the index turns higher but the forecast had already shown the index moving up.

At B, the index hit a relative peak and so did the forecast.

At C, both began the move higher into the peak at D.

At D, the index started the bear market run. The forecast showed the index peaking a few months earlier. That's ok, since it gives a good warning to begin liquidating.

The move from D to E shows the index plummeting but the forecast has it trending marginally higher.

Finally, the move from E to F shows the index recovering but the forecast is flat.

In other words, the forecast works some times and doesn't some times. My view is it's better than nothing. Clearly, in a few thousand years, when sufficient samples are available, it may be worth trusting. But until then, keep in mind that it could be inaccurate.

2012 Daily Forecast

Shown is the 2012 forecast for the Dow industrials made on 11/27/2011, using the daily scale. Part of January is cut off since the chart wouldn't fit on the page.

Going into March, the index climbs and then begins a long down turn into July where it forms a bottom. The index bounces up going into August and then drops again to make a lower low in October. After that, the index climbs to end the year below where it started.

The more accurate Williams forecast shows March 16 as the peak before the decline takes it down to June 20. Then we get a bounce up to August 28, weakness to September 28, and a rise up to the close in December. In his forecast, the end and start of the year are at about the same price. Thus, the bottom occurs in June and forms a stair-step rise from then on.

As I mentioned, the differences between mine and Williams's forecast is because I use less data.

2012-2015 Weekly Forecast

This is the Dow on the weekly scale, showing as much as I can fit on the chart.

It shows 2012 with a low in October and a nice climb from there, going into 2015. Clearly 2012 is not going to be a pleasant year but 2013 is going to be a buy-and-holder's dream!

At least for a year... 2014 shows price going nowhere except down slightly until near year end with a resumption of the move up starting in October and continuing to the end of 2015.

2012-2021 Monthly Forecast

This is the Dow forecast made on 11/27/2011 using the monthly scale and it covers a decade of price movement.

We see the same bottom in 2012 before a rise up to 2017. In the summer of 2017, the Dow peaks and begins what looks to be a bear market going into 2019. Then we get a bounce up which lasts until mid 2021.

When you think of the current economic picture and world events, this forecast is plausible. 2012 is going to be a rocky year just as this year has been.

After that, the world's economies should get in gear and the stock market should reflect that by posting higher highs.

If this forecast is correct, buy and hold should consider taking profits in early 2012 and then buy back in October with the potential to hold on to 2017.

-- Thomas Bulkowski

Written and copyright © 2011-2013 by Thomas N. Bulkowski. All rights reserved. A closed mouth gathers no foot.