Trader’s Narrative

There are a few frameworks we can use to build a model of the stock market. We’ve looked at the Weinstein stage analysis of the market and compared the previous bear market to this one. A recent Morgan Stanley report authored by Teun Draaisma, Ronan Carr, Graham Secker, Edmund Ng, Matthew Garman provides a more nuanced model.

They looked at 19 historical secular bear markets. Most of them were in equity markets around the world but they also considered one bear market in gold. Then they looked at what happens in the aftermath of each secular bear market. The report identifies 4 separate stages:

1. a decline which on average slices market valuation by half in a little more than 2 years
2. a rebound or counter-trend rally - taking prices 70% higher in 17 months
3. a shallow correction which lasts almost as long as the rebound rally
4. finally a trading range which lasts almost 6 years

Click to see full size:

Applying this script, the current bear market showed a 56% decline from its peak in October 2007. That’s perfectly within the historical parameters.

In the next stage, the S&P 500 climbed +53% from the March 2009 lows. According to the historical pattern of secular bear markets, we would have expect the S&P 500 to climb 70% from its low to 1150. But if it had followed this pattern, then it would arrive there by July 2010. However, the S&P 500 has managed to climb two thirds of its allotted 70% counter rally in only 5 months. So this rally is anomalous because its slope is much, much steeper than the average historical one.

The third stage is understandable as such a large move usually gives back a portion due to profit taking. But the next and last stage is the most interesting.

This is where the market has to finally digest the consequences of what initiated the bear market in the first place. A trading range or base building - according to Weinstein’s model - is necessary because it sets the stage for the next bull market.

Broad multi-year trading ranges followed the initial rebound in 10 of 19 bear markets. In most cases, structural problems in the real economy acted as a headwind to a new bull market…

During this moribund time in the market, structural pains such as inflation, deflation, inordinate debt levels, unemployment, etc. work themselves through the economy.

But for now, the consequence of this research is that the counter trend rally which we seem to be in right now can go on for much longer than most anticipate. Even if we do manage to climb the remaining 20% to 1150 on the S&P 500, the market can take its time until the summer of next year. The report concludes:

If the aftermath of these 19 secular bear markets is anything to go by, the current rally could go on a bit longer; is likely to stall a few months before the first Fed rate hike, which we expect in Q3 of 2010 … and is likely to be followed by some sort of trading range for years to come because of the structural problems of financial sector and household deleveraging as well as the poor state of government finances.

But as the study itself proves, while the past may rhyme - it hardly ever repeats.

Examples of the Four Stages of Secular Bear Markets
The following charts are 4 examples of individual markets which demonstrate the stages mentioned above. Notice that while the trading range may sound boring, on average they have a +50% width, making them extremely tradeable and lucrative. For example, the first instance, the 1930’s experience had a trading range of +/- 147%:
Continue reading ‘The Aftermath Of Secular Bear Markets’

The stock market is a forward discounting mechanism so it usually bottoms much earlier than the economy. While the historic average length of recessions is about 15 months, the stock market has, on average, bottomed after only 6 months:

But notice how stock prices fall well before a recession officially starts. It isn’t that stock market troughs last less than recessions, but that they are shifted back in time.

As the chart shows, in recent times, the S&P 500 has not been as sprightly as before. Whereas before it would find its feet 6 months after the start of a recession, from 2000 to 2004 it took up to 24 months. That is a huge difference. And only time will tell if it was simply an outlier or significant shift.

If anything, this chart further reinforces the epic proportions of this current downturn. As I mentioned in the Weinstein stage analysis of the market, my expectation is for the market to weaken but to maintain its previous swing low. Then with some more backing and filling to allow the long term moving average to slow down and flatten, setting the stage for a lasting low.

Persevering readers will know of my admiration for Stan Weinstein and his classic book: Secrets for Profiting in Bull and Bear Markets

If you haven’t yet discovered this gem, don’t let the silly title fool you. Pick up a copy at Amazon - although, I just noticed that it is temporarily out of stock!

So either order it new and wait until it is available again or order one of the used copies and get it fast. But don’t leave this book out of your trading library. Whether novice or experienced, you’ll learn something because the principles outlined in Weinstein’s book are timeless. For other books that I recommend, check out the About section.

One of the major themes in the book is that at any point in time, any market is in one of four stages: basing, breakout or advance, topping, and decline. Each of these “stages” have specific characteristics which are rather simple to recognize.

No two market periods are alike since history never repeats. But sometimes, if you look closely, it may rhyme. So here’s a comparison of the past bear market to the current one, through the perspective of Stan Weinstein’s Stage Analysis.

Something which immediately jumps out at you, even at a cursory comparison, is the lack of powerful bear market rallies. During this bear market we just rolled over each time with no real effort by the bulls to put up a real fight.

During the last bear market, the S&P 500 Index rallied about 6 times (depending on how much you want to squint) to either approach or hit its 200 day moving average. For a few brief days in early 2002 it even traded above the ever descending long term moving average. In contrast, the most recent market action has pushed price below its long term moving average to an extent not seen since the 1929 crash.

Apart from that difference, the two bear markets do have a lot in common. To start, at the beginning of “Stage Three” the 200 day moving average flattens and the shorter, 50 day moving average crosses, falling below it (marked by “1″ on the charts).

If you want to nitpick, the long term moving average started to flatten out in early 2002 due to the massive rally from the depths of the abyss of the September 11th tragedy (marked by “a” on the charts). But the 50 day moving average remained well below it - it did not cross above it.

Throughout, the long term moving average slopes downward and holds its decline (marked by “2″ on chart) until late April 2003 when, finally, the long term moving average flattens and the 50 day moving average rises above it (marked by “3″ on the chart):
Continue reading ‘Comparison Of Bear Markets: Weinstein Stage Analysis’

Stan Weinstein was the guest for Market Monitor on Friday’s Nightly Business Report. In his previous interview back in September 2007, Weinstein warned of a potential bear market if we penetrated 12,800 on the Dow. If you follow the link, you can see a long term chart showing the significance of that level.

Of course, we did break through that level and we are in a bear market. So what about now?

Weinstein thinks that we are going through a bottoming process but it isn’t finished yet. He is still bearish, long term, but thinks that we may have hit a low short term. If the market can close above 9,800 he expects a rally. If it closes below 7,800 he expects it go even lower:

Moving Averages
A few readers asked me about the difference between 150 and 200 day moving averages. Weinstein mentions in the interview that he uses the 50 and 200 day moving averages, with the first for short term trading. There really isn’t a magical number. A long term moving average should represent the long term trend. Since there are approximately 200 trading days in a year, it makes sense to follow the 200 day moving average. But anything close to that level is fine as long as you stick to it.

Basing Sectors
If you are familiar with the stage analysis that Weinstein applies, he thinks that “select regional banks”, airlines and a few healthcare stocks are in stage 1 or basing. That doesn’t make them automatic buys, yet. They have to finish basing and break above with a volume burst. The financial sector has gotten clobered but the regional banks are different than the investment banks like Goldman Sachs (GS) and JP Morgan (JPM).

Worldwide Bear Market
Stan also mentions that this is a global bear market with stock markets across the world being mauled. I would go beyond that and say this is beyond a bear market like the one we saw in 1970 because everything is under forced liquidation, gold, oil, commodities, bonds, REITs, etc.

Watch the whole video for more details. And for up to the minute links to videos and articles like this, watch news.tradersnarrative.com