"Email of the day (1) on Friday prompted me to write to support the wise reply from David.

"I have been investing for over 20 years with sufficient success to be able to retire from full-time work in my early/mid-50's. Now I work part-time only and for pleasure! Until 2008 I had not had a down year (12% drawdown that year), and then in early 2009 I made a foolish mistake and sold one-third of my portfolio in January 2009 just as the bear was bottoming out. Fortunately I realised my mistake in April 2009 and bought back in, though at higher prices than I sold. That salutary lesson knocked a good deal of arrogance and complacency out of me. As a result I spent some time doing a very rigorous analysis of various indicators that could have been a better guide to timing major sell and buy decisions than were my emotions in January 2009! The analysis focused on USA data, because of the Wall Street leash effect - even though my investments are mostly in emerging markets and commodities.

"The result is that I have come to fully agree with David and Eoin in giving precedence to monetary policy above all else. As FullerMoney says often:

'Monetary policy trumps everything.' My analysis of markets from the 1970's onwards showed that the (inverted) yield curve is the best predictor of a lengthy bear market ahead. The inversion, driven by rapidly rising short-term interest rates, was often coupled with high and rising Treasury yields (bond prices falling due to higher interest rates). Rising interest rates and movement towards an inverted yield curve occurred ahead of all three major bear markets since the 1970's. A yield curve falling to zero or below ('inverting') was a sure indicator - at least over the past 40 years - of recession and falling markets ahead.

" The three long bear markets:

1) 1/1981-7/1982 with a fall of 27% on the S&P500
2) 4/2000-10/2002 with a fall of 49%
3) 10/2007-4/2009 with a fall of 56%

were all heralded by a negative yield curve appearing either at the same time as markets started to fall (4/2000) or in advance of the fall (7/2006, 15 months in advance; and 10/1978, 27 months in advance). A negative yield curve always led to a bear market but it did not help with assessing the timing - the charts and especially the longer (200 or 300 day) moving averages were the only indicator that helped with timing.

"The dominance of monetary factors over all else was shown by the observation that if yield curve, interest rates and Treasury yields were all benign, that over-rode any of the other technical indicators (oil price, inflation, chart moving averages) that may have been flashing 'red'. Since the 1970's, if the yield curve was positive but the 200 day moving average was in danger or even breached, then a short-term 'correction' was underway rather than a full-blown lengthy bear market. There are numerous examples: 4/1977-4/1978, 1/1984-7/1984, 10/1986, 10/1987, 7/1990- 1/1991, 10/1992, 4/1994-1/1995, 10/1998, 7/2004, 10/2005.

"Whilst the yield curve was the most important indicator (and had to be below zero for a bear market to appear), US Treasuries were also important as an indicator of trouble ahead and they could confirm the warning given by the yield curve, but only if the yield curve is negative:

1. Rising US Treasury yields 10/1980-7/1982 together with rising interest rates and inverted yield curve heralded a bear market from 1/1981-4/1982
2. Rising yields 7/1999-7/2000 in parallel with rising interest rates and inverted yield curve 4/2000-10/2000) and also a high oil price heralded the bear market 2000-2003
3. Rising yields 7/2006-10/2006 also in parallel with these other indicators was again a warning of the bear market that began 10/2007

"However, Treasury yields alone were not sufficient to signal a bear market ahead:

4. Rising yields 7/1983-7/1984 and also rising interest rates 4/1984-7/1984 occurred at same time as a market correction 1/1984-7/1984 but there was not a bear market. The yield curve stayed above zero.
5. Rising yields 1/1994-1/1995 together with rising oil price 7/1994-10/1994 and rising interest rising rates 7/1994-10/1995 did not initiate a bear market. The yield curve was positive.

"This indicates that the yield curve is likely to dominate other factors. The 1987 market drop of -34% was larger than a 'correction' (usually defined as a drop of <20%) however it was short (essentially 3 months). The yield curve and other monetary indicators gave no warning of this fall which was essentially a panic following a too-rapid rise in the market in the previous 9 months. At the bottom in December 1987, values were back to where they had been in January 1987.

"All this data is available in the Chart Library, and can be verified by subscribers. I hope this is helpful to the writer of Email of the day (1) on Friday. It looks to me as if conditions are currently quite benign - yield curve strongly positive, low non-rising interest rates, US Treasury yields stable.

"All this supports David and Eoin's contention that we remain in a bull market. Of course, the past is not a perfect guide to the future. Watchfulness is always required, together with a willingness to change one's mind if the facts change. And hopefully I will be wiser next time we are suffering a bear market bottom!

"Finally, I am very much looking forward to joining Eoin at the Chart Seminar on May 13-14 in London."

David Fuller's view Thank you so much for this diligent and detailed study contributed in the spirit of Empowerment Through Knowledge. I recommend that subscribers study the full email because the data is all there and can be verified in the Chart Library. It will shorten a steep learning curve in terms of bear markets, not least by reducing overreactions to normal corrections within bull trends.

As this excellent email points out, 1987 was the exception, being a short but very dramatic bear market which was not forewarned by an inverted yield curve. There is a reason for this. The bull trend prior to October 1987's crash was the first in which S&P futures were available. Institutional investors referred to them as "portfolio insurance", giving them license to speculate for longer in dangerous conditions, knowing that they could hedge their entire portfolios by shorting stock market futures, if necessary. This was theoretically true but when the stock market fell persistently during the week before the crash, including a DJIA sell-off of 4.6% on Friday 16th October, many institutional investors placed large orders to sell S&P futures short on the following Monday morning. It opened around 20% lower.

Fortunately, there had been other warning signs. Stock markets had accelerated higher, none more than Australia, for several months before commencing top formation development in August 1987. The DJIA and many other stock market indices formed large, churning top formations (the Type-3 ending, as taught at TCS) before the crash occurred. As I recall, several central banks, including the Bundesbank, raised interest rates during the week before the crash, because they were worried about importing inflation due to a weak US dollar.