April 6th, 2008

Momentum is Tangible; Renewed Bear Market Crash Call

To start off, I want to apologize to all my friends as readers for not having written during this past week of turbulent market action but Uncle Sam’s IRS comes first. But now, thanks to the technology of Fidelity and Turbotax, I was able to seamlessly upload the past year’s hundreds of trades into my tax returns and now leave it to the IRS to try to sort through and audit if they so chose.

I wanted to comment, though, about an excellent article in last Sunday’s Week in Review (Op-Ed) section of the NY Times, April 6, 2008, entitled “How to Turn a Herd on Wall St.” by Benedict Carey. Carey asks a question I’ve been pondering myself lately:

“Experts have long known that a classic phenomenon called herd behavior has a great deal to do with the wild swings of panic and exuberance that can seize Wall Street in the wake of surprising economic news.

But lately they have tried to confront a related question: What makes a herd, financial or otherwise, stop and turn around? Specifically, behavioral experts want to know if there are psychological cues that can help transform this bear market into a bullish one.

‘The dynamics of these turning points are much harder to understand than the original herd behavior itself, perhaps particularly in economics, and the field is only just beginning to look at them,’ said Terrance Odean, a professor of finance at the University of California at Berkeley’s Haas School of Business.”

“You can’t ever be too earlier buying good stocks on the dips.” “You’ve got to own these stocks when no one else does.” It’s been disturbing seeing the talking heads (who now include many in the blogosphere, I’m dismayed to say) continually labeling one day or another as “the bottom”. I’m not sure it’s that they all want to claim the title as the one who “picked the bottom” or they don’t want to be caught sitting on the sidelines as the market ticks up 3, 5, 7% or more.

If you locked 20 fundamental analysts in a room and told them they be released only after they determined a fair value for each of the Dow Jones 30 stocks and then combined those into the average applying the appropriate factors, then you’d probably wind up with 20 different for “fairly-valued” DJ 30 Indexes. But you’d get pretty close to a consensus if you asked them for the direction of the DJ 30’s momentum. They’d probably all say we’re in a market correction looking for a bottom.

So what are individual investors like you and me to do? I’ve determined that while predicting when a turn will happen is futile but it’s relatively easy knowing when momentum has either reversed or when it’s driving the market in either a bull or bear direction.

Let’s look at the market’s action since it moved into its current trading range between 1275 and 1385 on January 15 (as a reminder, that’s down 11.5% from its high close of 1565.15 on October 9, 2007). The trading range spans 61 trading days almost exactly split between up and down days, as you might expect from a trading range:

The table clearly shows that even though the market has been stuck inside the range, big daily percentage swings have been fairly common. They can say “largest first day of the second quarter since 1938” or “first up week so far this week” …. it just doesn’t matter. Let’s look at a close-up chart of this trading range:

A picture is worth a thousand words. On April 1 when the market had its 3.6% move up, I wrote that, based on 44 years worth of stock market history, there was only a slightly better than 50/50 chance that the Index could successfully move above the 90-day moving average. Since it could just as easily drop back below the 60-day, as it did this past Friday, there was still no signal to confidently start buying stocks. As it turns out, it only took 8 trading days for the index to drop back below the 60-day moving average and the round-trip resulted in a mere .77% increase.

And where to from here? Unfortunately, from a Market Momentum perspective, the situation is not much different than it was on December 28, the last time the index was below the 60-day moving average. This past Friday, the market morphed into the same array as occurred 25 times over the past 45 years with the following consequences:

  • The index has stayed below the 60-day MA for an average 16 trading days; during that time it has declined an average 3.9%
  • Each occurrence in this array produced a market decline
  • The longest stretches have resulted in huge and swift market declines:

  • In most cases, the 60- and 90-day moving averages lag behind and above the index so that the next move out has been to cross back above the 60-day average, as it did on April 3.

I don’t consider myself a perma-bear but I’ve found myself writing about a bear market crash since February 11 in a post entitled “Bear Market Possible:Today’s MTI Deconstructed“. I wish I could jump on the bandwagon of calling the market bottom. Unfortunately, because of the action last week, it looks to me that things are going to only get worse from here rather than better.

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