October 23rd, 2008

Strategy As Market Nears the Bottom

I may be premature but it feels like we’re pretty close to the bottom — I just can’t believe this Crash is going to be worst than the 2000-2003 or the 1973-74 and approaching the extent of the Big One, 1929-32. Those who’ve followed the MTI and moved into cash early this year have weathered the brunt of the storm. We don’t want to waste all the patience and perseverance in some hasty, bad decisions as the market bottoms. Like most participants and observers, though, the extent and the speed of the market’s decline this past year leaves me in a predicament as to a strategy for the Bear Market’s end and the early phases of the next recovery (the accumulation phase of the next Bull Market’s life cycle).

You may recall that towards the end of last year, I collected closing values for the S&P 500 index back to 1963 and calculated four moving averages (60-, 90-, 180- and 300-day) and the position of the Index itself relative to those averages (mathematically, 120 possible combinations in total). Actually, 93 of the possible combinations occurred and some combinations for as little as a few days.

Owning the S&P 500 index for the entire 45 years assuming a $1000 initial investment would return $22,404 by 12/31/07. I then conducted a binary test on each of the 93 combinations asking whether owning each of the combinations, one at a time, or not increased or decreased the ending value. I came up with 32 out of the 93 combinations during which not owning the Index increased the ending value, more than doubling it to $50,171.

One of those “don’t own” conditions occured on 12/27/07 with no favorable signal since. Hence, the bearish call soon after returning to this blog on February 11, 2007 in “Bear Market Possible: Today’s MTI Deconstructed“. And what are the conditions allowing for a re-entry into the market? That “all clear” signal will come only when the Index crosses above the 180-day moving average and that’s about 45% higher than current levels. Of course, the low level of the Index is now pulling the MA’s down fairly quickly but when’s the earliest prospect for this cross and what level?

How high would the index have to rise before the MTI signalled it was safe (based on historical precedence) to own stocks again? When would a market recovery no longer be considered a “bear trap” or a “suckers’ rally”? I did some simple, linear extrapolations and came up with the following objectives:

  • Because the decline has been so steep and the moving averages are lagging so far behind, the Index would need to increase by 33% from today’s close to 1173 by year-end for an all-clear signal.
  • A lesser and slower recovery of 24% to 1114 would lead to an “all clear” on approximately March 1, 2008.

So what’s the strategy? This post is getting too long so I’ll continue tomorrow.

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