January 22nd, 2006

Putting the Stock Market Decline in Perspective

It’s difficult maintaining a degree of objectivity when so much of the news last week was so negative. A good summing up of the weeks events could be found in IBD’s “The Big Picture”, excerpts from which included:

    • Google led the Nasdaq decline…heavily weighted on several major indexes.
    • Day’s action featured big losses by other megacap stocks…Citigroup and GE…Motorola, Apple, Yahoo and Intel, bellwethers that fizzled on bearish earnings reports and outlooks earlier
    • Oil topped $68 a barrel, gaining 7% for the week….shut down in Nigeria due to civil unrest
    • Bigger overhanging factor remains Iran.
    • …report earlier in the week of a threatening Osama Bin Laden audiotape
    • put-call ratio jumped to .94. A level of 1.0 or higher indicates extreme fear….A high fear factor is actually a positive sign for the market [my emphasis added].

In Sunday’s NY Times business section article “Yesterday’s Winning Formulas are Starting to Show Their Age” we furthermore learned:

    • From the Leuthold Group: small-cap stocks, as well as the overall domestic stock market, are likely to slow down….current string of small-cap outperformance is “long in the tooth”
    • their [small-caps] momentum has slowed. And this fundamental deterioration has begun to show up in trading patterns. For the first time in six years, fewer than 50 percent of small caps are outperforming the S&P 500
    • From Grantham, Mayo, Van Otterloo: we live in a reliably mean-reverting world..every six and a quarter years, on average, assets return to their fair valuation….small caps will underperform larger stocks over the next seven years…an average annual decline of 1.7% for small caps vs a 1.2% decline for the 1000 largest.
    • Further appreciation in Japanese stocks…favors investment in commodities generally with timber investments a clear favorite
    • From Jim Rogers:Commodities are in a long bull marco h that should run for a decade or more….the current surge should continue until at least 2014.
    • Gold will make an all-time high reaching more than $875 an ounce.
    • Financial stocks are especially vulnerable because people who work in the sector seem to be making too much money.
    • William J. O’Neill of IBD: favors the medical sector and those involved in Internet content….both groups attracting institutional buyers
    • The current market resembles that of 1935…a long-term recovery phase and the country is doing better and better all the time….the rally of 1935 led to a bad break downward in 1937.

What are we supposed to think? What are we supposed to do? Should we have panicked and sold on Friday as the market was dropping? Is Monday morning on the open to late? (Not mentioned in any of this is the fact that Friday was an options expiration day.) What we really need to do is to stick to our trading rules and look at some of our own statistics to put things into perspective and help us navigate this market.

I looked at the S&P500 back to 1990 and found the following facts:

  • Over the 15 years from 1/21/1991 and 1/20/2006 (years which include both the bubble and its subsequent “crash”), there were a total of 3,783 trading days.
  • There were more down days (1948) than up days (1835) in the S&P500.
  • Of the 1948 down days, there were 131 declines of greater percentage that Friday’s 1.833% and 88 with greater than the 23.55 point declines.
  • Over the 30 and 60 days following those greater declines, the S&P500 average was over 3% higher.

In fact, the 1st and 2nd greatest declines occurred nearly 24 months before the peak and the 3rd and 4th greatest declines were after the peak had been reached:

Some would say “so what!”, or what relevance are arcane historical facts. The point I’m trying to make is that a decline as large as Friday’s, is not that unusual and has happened as often in the middle of a bull market as in a bear market.

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