There has been a lot of interesting discussion over the past several weeks concerning the cyclical state of the market. Most of the commentary has been based on what I refer to as the trough synchronized, simple harmonic relationship, time domain approach to cyclical analysis. I thought I would take this opportunity to throw my hat back into the ring using the spectral approach of cyclical analysis.
I believe most of the current uncertainty about the cyclical state of the market is due to the the phenomena Hurst referred to as amplitude modulation of the cyclical components. The math can be somewhat complex but the effect is readily apparent. It is most troublesome when it occurs in the longer waves. When the amplitude contracts, it becomes very difficult to visually identify the cyclical lows in the price action. Even spectrally when the amplitude drops below a certain threshold it becomes difficult to isolate the price wave. The weekly chart of the S&P 500 below illustrates the effect. The dominancy envelope shown is the sum of the waves longer than the 80 week wave (i.e. sigma L). Instead of using Hurst’s constant width approach, it is constructed so that it expands and contracts with the amplitude of the waves contained within the envelope. Ever since the prior 4 year low (yellow arrow) the amplitude of the 80 week wave contracted greatly as evidenced by the narrowing of the envelope. I have commented on this in prior posts. Over the last several months it can be seen that the envelope has expanded greatly (hence the title). This is due primarily to the expansion of the amplitude of the 40 and 80 week waves (not shown).
The chart below is a daily chart of the ES futures. The two price waves shown at the bottom of the chart are the 40 day and the 20 week waves. The price action is cycling down into the next 20 week low. Unfortunately it is impossible to forecast as to whether the 40 day low will straddle like it did in February, but a certain pattern suggests that it might. There is usually very little difference between a phasing analysis using the time domain approach and the spectral domain approach. You will notice however that the spectral approach paints a significantly different picture than the analyses presented by David in his most recent webinars. As mentioned at the beginning, I believe this difference is due to the large amount of amplitude modulation currently present in the market. I would advise caution.
Barring a decline of Biblical proportions over the next few months, there is a very high probability that the index has seen the absolute low of the 4 year wave. There is some unusual phasing of the longer waves which most likely will keep me on my toes for the remainder of 2016.