October 13th, 2008

What Past Crash Bottoms Look Like

Yips, an up day for the record books. The S&P did hit the last resistance trendline as described here over the past couple of days and it didn’t bounce, it took off like a rocket. Up 11.58% today and, from the intra-day low of last Friday of 839.80, today’s close of 1003.32 represents a total 19.47% swing in two days. Most of us would be happy to have that sort of move over a year … but over less than two days?

This is when the “buy-and-holders” like Burton Malkiel, author of a Random Walk Down Wall Street, and professor of economics at Princeton trot out the familiar saw about how much investors who miss the biggest moves over a long period significantly under-perform the indexes. In today’s WSJ, Malkiel wrote in “Keep Your Money in the Market”,

“It is very tempting to try to time the market. We all have 20/20 hindsight. It is clear that selling stocks a year ago would have been an excellent strategy. But neither individuals nor investment professionals can consistently time the market….My own calculations show that in the aggregate, investors who moved money in and out of equity mutual funds underperformed the buy-an-hold investors by almost 3 percentage points per year during the 1995-2007 period.”

What a short memory we mortals have. Those who were out of the market since the end of last year and were out of the market today missed that 19.47% move up … but they also didn’t have to suffer the year-to-date 38.76% loss. I might compromise with those who have a regular and continual stream of cash to invest over the foreseeable future (like a monthly 401k contribution); for them staying fully invested might make sense. But for us who are living off our investments and not adding new moneys to the pot, we can’t afford to let that pot shrink. We have to time the market, move into cash before it tanks and buy again near the bottom.

With all the noise of having “hit a bottom last Friday”, let’s reiterate that “hitting bottom” isn’t a day or an event. It’s a process. Let’s see what the bottom of the Tech Bubble crashed looked like:

There was an initial 20.68%, 20-day pop from an extreme oversold position (27.91% decline over 2 months) similar to the decline over the past couple of months. After the initial bounce, the market moved in a horizontal channel for nearly a year before touching another high. As the moving averages caught up with the Index itself about 8 months later, the MTI signaled that risks of further declines were reduced sufficiently to invest again.

And what about the 1974 bottom:

The Oil Embargo Crash began in January 1973 and continued to October 1975 and lost nearly 50% in market values; the last leg ended in a double bottom that stretched 5 1/2 months. The initial recovery bounce netted a 20.6% increase. As many of us who suffered through the last secular bear market remember, that bottom was temporary. It wasn’t until 1980 and Jimmy Carter’s presidency came to an end that the earlier peak was surpassed. It wasn’t until September, 1982 that the next true Bull Market began.

I, too, am wondering whether today’s move was important or flash in the pan. As I wrote Friday, I’d taken a small position in SSO (the Proshares Ultra S&P 500 which doubles the Index moves). Unfortunately, 1) it was too small to make any substantial difference to my portfolio and 2) I sold it late afternoon and missed the remaining 40% of the move. I’m convinced I’m going to have an opportunity of buying it back at about the price I sold it … I just don’t know whether I will. There’s still much confidence building that has to take place before true upside momentum develops that propels the market much further.

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