Introduction

After rallying some 1,000 points in two weeks leading up to the Fed's anticlimactic quarter-point rate cut on Tuesday, December 11, the Dow Jones Industrial Average plummeted 294 points on the announcement, then relinquished all of a massive 271.75-point opening gain and then some the next day, before rebounding late to finish the session modestly in the black.

What does this recent sharp reversal lower portend for stocks? Among the possibilities:

1. The decline is an isolated incident and will stay relatively contained if the damage hasn't been done already
2. The decline will stay contained but serve as a precursor to a larger retracement from higher levels
3. This decline will unravel into a substantial retracement
4. This represents the beginning of a second wave down in the recent correction that could significantly undercut the lows. We consider the least likely possibility to be
5. This is a resumption of a bear market. For reasons (such as the favorable interest-rate backdrop) detailed in previous reports - including the November newsletter - we are strongly convinced that this is not a bear market. Since the 10% plunge to a November 26 bottom in the S&P 500 followed a late 7th-year top, we think it could prove revealing to look at prior significant late 7th-year highs and lows to guide our expectations going forward. We'll start with the unlikeliest scenario.

Bear Markets Lasting Into the 8th Year

1937-38: The stock market crashed in October 1937. But amid an intensifying severe recession, an 18% rally persisting into early January in both the Dow and S&P 500 (Figure 2) followed a Thanksgiving Eve low.Another collapse to a much lower bottom ensued in March, giving way to a 60% Dow advance into November 1938.

1947-48: After an intermediate bear market rally high on July 24, 1947, the S&P (Figure 3) slid to February 14, matched that low over a month later, and then leaped 23% to a 22-month high on June 15, 1948. A final bottom arrived in June 1949.

1977-78: November 2, 1977 marked the low for the year in the S&P 500. The subsequent rally petered out by November 25, however. The bear market ended on March 1, 1978

Late 7th-Year Bear Market Bottoms

Though we haven't fallen nearly enough to meet the criteria for a bear market, these examples are still relevant based on seasonality.

1907: The old Dow Industrials (the S&P wasn't tabulated daily until 1928) bottomed on November 15, 1907 after a long, deep bear market. A retracement took place in December, but stocks staged an even-greater correction between January 14 and February 13, 1908

1917: In its latest 7th-year final low, the Dow didn't hit bottom until December 19, 1917. After a 24% explosion in the next two months, the Industrials gave back 8% from February 19 to April 11, 1918

1957: A comparatively mild bear market (-22%) climaxed on October 22, 1957. The first subsequent correction (-5.5%) unfolded between November 29 and December 17, followed by another small retracement from February 4 to February 25, 1958.

1987: Black Monday (October 19, 1987) served up by far the worst single-day percentage loss (-22.6%) in the history of the Dow, but "Terrible Tuesday" (October 20) marked the intraday low. The S&P actually made its closing low on December 4. A sharp retracement from January 5-21, 1988 was the first of many such corrections as the bull market chopped higher through 1988.

Corrections in the Stock Market Lasting Into the 8th Year

1897-98: The Dow fell sharply to November 8, 1897, and then rallied to January 7, only to slip to a succession of new lows culminating on March 25, 1898

1967-68: The S&P fell from September 25 to November 8, 1967, rebounded to January 12, and then wrapped up a 10% correction by March 5, 1968.

Late 7th-Year Correction Lows

Because we believe the correction has already bottomed, these are the best fits for our current situation.

1927: The Dow fell 10% in October 1927, and then spent most of the initial 2 months of 1928 in a retracement from a January 3 record high, resulting in a higher bottom on February 20, 1928.

1997: Circuit breakers kicked in on October 27, shutting down the NYSE on a greater-than-550-point Dow decline. A 7%S&P correction between December 5, 1997 and January 12, 1998 temporarily wiped away most of the ensuing runup.

Summary

We had thought that any sizable retracement of the recent advance would most probably develop after the New Year from nearer the all-time highs. That could still happen.

Despite the recent immense volatility, the averages still retain the bulk of their gains. The precedents cited above show that late 7th-year lows are almost invariably followed by a low of at least minor significance early (between January and April) in the succeeding annum.

From a strictly seasonal standpoint, 7th-year November bottoms pack the greatest relevance, and all of them (except 1977) supported rallies lasting at least into early January.

A Note on the NASDAQ

In our latest newsletter (Past Present Futures), published on November 26, the day of the stock market low, we said, "there is a good chance that the Dow is near the end of the correction."

We added, "However, the decline in NASDAQ, as the last average to top, could well carry into the New Year. Given the degree of skittishness in the market, buyers figure to feel more comfortable tiptoeing back into blue chips first."

Since then, the NASDAQ Composite has climbed barely 5% through December 13. The Dow is up over 6%, and the S&P 500 5.8%. The small-stock Russell 2000 has gained just 4.6%.If a more significant retracement occurs, we still could be right about NASDAQ. However, the index would probably need to underperform by a bigger margin than seen to date.