March 19th, 2008

Is Today’s 4% Move a Follow Through Day?

Today reminds me of the article I wrote just last week when the Fed last took significant and unprecedented action. Here’s what I wrote:

Most everyone is calling yesterday’s market the “best day in five years” (how can you not, it’s a statistical fact) and yet, to me, it feels similar to the market’s intra-day reversal on January 22. Boy, do we have short memories. On that day, the Fed shocked the Market with a late afternoon, unprecedented 75 basis-point emergency cut plus a 75 basis-point cut in the discount window…..I’m not worried if I missed yesterday’s move and if I’m still heavy into UltraShorts and commodity and forex type ETFs. I’ll have many opportunities to jump back in with both feet with more opportunities and less risk.”

If you’re like me, right now you scrambling around looking for some insight about today’s 4.24% increase in the S&P 500 Index. Does this one now confirm a bottom? Should I jump back into the market with both feet or continue to hold back?

Thankfully, I have an “emotion regulator” in the MTI, my Market Timing Indicator, that indicates that today’s bounce hasn’t yet signaled that it’s safe to go “all in” with acceptable risks.

I dealt with days like today in my book about Market Timing. I talked about the host of academic studies purportedly proving that if you happened to be out of the market missed days on which the market had large moves, you’d be disadvantaged relative to a buy-and-hold strategy. I concluded that:

The following table shows each of the 11,280 trading days that had either a gain or a loss of over 4% over 44 years between March, 1963 and December, 2007. There haven’t been many: actually there were 19 days of 4% or more gains and only 14 of losses of 4% or more. What’s most surprising is that, because they were often bounces at the bottoms of crashes or corrections, the MTI had dictated that the investor not own any stocks but to be 100% in cash on 14 of 19 of the best market days since March 1963.

But yet, if the MTI had been followed rigorously, the returns would have been astronomical relative to the performance of the S&P 500 Index.

Here’s the referenced table:

What’s most important to note is that several of the days with moves of over 4% occurred at the top or bottom of a major market crash. But even more important is to notice the level of the S&P 500 Index at the next day in the table; note that the index is at approximately the same level.

My conclusion is that a big move day, a day when the index moves 4% or more, happens infrequently and when it does, it doesn’t represent the first step in an extended move up as evidenced by the level of the index in the future. Resumed buying is safe only when the index moves above several of the moving averages (the 300-day, 180-day, and the 90-day).

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