Trader’s Narrative

Here is a chart plotting every single major rally in the Dow Jones Industrial index since 1900:

Source: Chart of the Day

While the Dow has surpassed its highs from last month, this has not been confirmed by other major indexes. In any case, there have been 27 significant rallies in the past 109 years of market history - not counting the current one. That’s about one for every 4 years. Paul Desmond of Lowry Research pointed out this four year cycle as one of his reasons for believing this to be a real bull market.

About three quarters of the rallies resulted in a gain of 30%-150%, lasting 200-800 trading days (9.5 months to 3.2 years). These are the data points highlighted in the blue shaded box above. The current rally is just shy of making it as it is too short in duration.

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The stock market’s resilience was in good form today as it inched ahead, managing to recover from the shallow pull back of 3 weeks ago. The Dow Jones even managed to put in a new high for the year while the S&P 500 index and the Nasdaq were not far behind. I’m not sure if this shallow pullback is what Lowry had in mind when they cautioned against jumping with both feed into their intermediate buy signal.

The tongue in cheek title of this post is inspired by the classic Kubric film, “Dr. Strangelove“. I thought of it when I looked at today’s chart of the day showing the subsequent returns for the worst yearly returns of the Dow Jones:

Source: Chart of the Day

The 15 largest annual declines in the history of the Dow usually lead to a reversion to the mean. But not always. The 1930’s were as you’d expect, a wild card where bad simply got worse. Of course, back then you didn’t have the Fed opening the liquidity spigots like today. The only other outlier is 1978 which was slightly down during the brutal 1970’s bear market. Not surprisingly, when we step back and get some real perspective, cycles are obvious and we tend to go from bad to better. This is basically what I argued that Why Long Term Investors Should Consider Buying:

Can things get worse? Of course. But at this point, if you have a long term time horizon, a cast iron stomach for risk, the data suggests you should be taking small positions and slowly adding to them cautiously, even if the market continues to tank. That may sound crazy, but where we are right now in market history, only comes about very rarely.

Boy did things get worse. And if you were foolhardy (or smart?) enough to have an unemotional take on the market and a long term view, stepping into the abyss wouldn’t have been all that horrible. You would have been buying into a decline but in 4 short months, it would be all over.

In fact, we’re starting to see signs of real strength in the market. For example, the number of new 52 week highs in the US markets has recovered to pre-crisis levels:

Source: Bloomberg

Usually any measure reaching bear market tops sends shivers down one’s spine but keep in mind that this metric has not reached an extreme level. For example, consider that it was much, much higher towards the end of 2003 or early 2000 (not shown on the above chart). Both extremely unfortunate times to be long the equity markets. Right now however, we’re just seeing some resilience not speculative mania.

Yes, yes, I know the market is pricing in some insane numbers, including ginormous positive GDP growth and totally ignoring unemployment and a half-a-dozen other factors. What you have to remember is that the market does this all the time. In a bear market, it ignores bullish arguments repeatedly - until it doesn’t. And vice versa. So why argue?

Last week we took a look at a recent research report from Morgan Stanley on the aftermath of secular bear markets. Although in that article I featured this chart comparing the Nasdaq market from its peak in 2000 to now with the infamous Dow Jones Industrial index top in 1929, it deserves another mention. You can click on the graph to see it in full size:

I’m always fascinated by the fractal nature of the stock market. But I’m not convinced this isn’t just a random coincidence. Here’s another chart from Bloomberg comparing the S&P 500 with the Nikkei:

Again, an uncanny similarity. Again and again, markets seem to follow the same script. Or rather, the individual participants act with synchronous precision to create and unravel manias.

Another interesting comparison I mentioned a while ago is this year’s spring rally in the S&P 500 with that 6 years ago: Comparing Flag Formations: Then & Now. But where we part company from the past is when we look at the magnitude of this most recent rally.

This surge has offered no real opportunities for those who hesitated at its inception and waited for a pull back. In fact, the rally from the March 2009 lows has been the sharpest we’ve had in 40+ years:

If you consider each rally chronologically, something becomes noticeable: with the exception of the 1982 example, each subsequent bull market rally has been slightly sharper than the previous one. Maybe there is a pattern there. But it is hard to statistically defend since the observable sample is so small.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

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• Dow By Any Other Name

For the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back regularly since there are interesting links added throughout the week.

Europe’s Week Ahead

The debate that is continuing to rage is whether this is a bear market rally or a bull market. Although I find it interesting that the topic has somewhat shifted. Now it is whether this is a secular bull market or a cyclical. To throw a log on the fire, here is some interesting historical data.

If you were to take the relative distance of the Dow to its simple long term average and watched for when it fell at least 10% below it and then subsequently, rose 10% above it, you would have a very lazy but incredibly profitable way to time the market.

Eighteen of the last 21 times the Dow rallied from at least 10 percent below the 200-day level to 10 percent above, it posted gains during the next 12 months

Source: Bloomberg

We reviewed something close to this simple system recently. Instead of waiting for an index’s price to drop and then regain composure, we simply looked at the extremes. Or how far it would stretch below its long term trend in order to indicate to us a ripe time to go long the market.

While valid, the problem with the signal that I suggested back in March 2009 is that it is difficult to tell exactly when we’ve hit “extreme”. As with the recent behavior of the volatility index (VIX) it is clear that although an indicator can set a certain range for a long time, in the blink of an eye, you are presented with an outlier. In such a situation, what was once considered the shore becomes very deep water indeed.

Since I prefer the Standard’s & Poors 500 index, I decided to take a look at its historical performance using the same criteria from 1950 to today.

First, I recorded when the percentage distance from the simple 200 moving average fell under -10%. And then when it rose above +10%, I walked forward 3 time frames, 90 trading days, 180 trading days and 265 trading days to find out how the market performed. I realize that the above article from Bloomberg is probably using regular calendar days not trading days but I don’t think that is a material difference.

September 14 1953 -9.39%
April 8 1954 +10.19%
90 days later: +13.4% higher
180 days later: +29.07% higher
365 days later: +39.04% higher
Continue reading ‘S&P 500 Buy Signal That’s Worked Since 1950’s’