December 14th, 2008

What Does 2009 Look Like From This Vantage Point

As the market enters the final 10 days of trading (excluding the two half days before Christmas and New Years), most are maintaining their composure by looking forward to the possibilities a New Year brings rather than looking back on the third worst performance in market history (but the worst decline in a single year). According to statistics pulled together by the Bespoke Investment Group, if the November 20 low of 752.44 turns out, in fact, to be the low, this Bear Market will be behind only:

The relevant question is where might we be going from here? I read many opinions and here are a few I found most interesting:

  • “….history also suggests that if we are to see a rebound, however nascent, the probability is highest for a resurgence starting in the middle of next year. First, since the 1970s, the time between the first and last market lows in any given bear market is an average of seven to eight months. If historical trends hold true, this suggests we could see a bottoming out by the middle of next year. That’s consistent and plausible, especially since other data shows U.S. recessions, on average, last 14.6 months – which also points to a bottoming out in late spring or early summer.

    But the biggest indicator of all that we may see a bullish rebound in late spring or early summer – however slight – is admittedly based on emotion. Literally. Small investors have fled the stock markets in droves, and so far they’ve yanked more than $175 billion from the markets, with nearly 50% of that coming out during October alone. Granted, this is a mere 3.2% of the $5.5 trillion invested in stock market funds, according to Forbes, but it’s the first year that net equity flows have been negative since … a drum roll please … 2002.

    History shows that small investors may be the most telling of all Contrarian indicators. According to TrimTabs, the Investment Company Institute and our own proprietary research, individual investors have a remarkable habit of rushing in near market tops and fleeing near market bottoms.

    That means that long-term investors seeking the best wealth-building opportunities should find the immediate price declines we see ahead to be some of the most compelling buying opportunities of their investing lifetimes.” (from MondayMorning, 11/28/08)

  • “The bottom line is the stock volatility witnessed during the Great Stock Panic of 2008 was off the charts. It was literally unprecedented even for a stock panic. Never before have the stock markets been so volatile, and so unforgiving, for so long. But the very extremeness of this episode argues strongly against its sustainability. The markets abhor extremes so hyper-volatility must yield to normal and then low volatility.

    If you can take the long view, suppress your own emotions and ignore the mainstream herd’s, the opportunities presented by this stock panic are vast beyond belief. Since there is blood flowing in the streets, and no one wants stocks, fortunes will be made by the brave few contrarians willing to buy when everyone else is selling. I am going to be one of them, and you can be too.” (from Zeall’s Stock Panic Volatility, 12/12/08)

  • “In looking at the timeline of when recessions are announced in relation to when they actually began, we see that the official announcement from NBER that the economy is in a recession means that the recession is actually fairly close to ending. Looking back at the last five recessions, we find that a recession has, on average, already been in place a full seven months before the NBER announcement was made (this time it has been 12 months) and that the actual end of the recession typically comes just 4 months after the official pronouncement.

    When you overlay the S&P 500 on the recession timeline, we find the following. First, stocks typically begin to discount a recession in advance of the recession – in this case the bull market peak occurred three months before the economy entered the contraction. Next, we see that stocks typically enjoy a minor bear-market rally in the two months following the official word from NBER. And then from there, stocks encounter a series of fits and starts – including a new low – before ultimately embarking on a new bull market about eight months after the recession announcement has been made.

    So, cutting to the chase, if history repeats, we can expect a modest rally into year-end which, unfortunately should be followed by a new low into January/February. This low will likely be caused by some additional bad news that scares the last lot of sellers out of the market. And in this case, we could argue that this event would coincide with the final redemptions from the hedge fund community.

    But, from there, stocks could embark on a meaningful rally, which will bring hope back into the equation. And although this falls into the speculation category, if history is our guide, this is a rally that could be worth pursuing.” (from Top Guns Trading, 12/7/08)

I can’t predict the future any more than the next guy. That’s why I’m sticking with the game plan; it’s worked so far. We’re going to let the market tell us when it’s no longer in pain and is recovering. Back-testing through nearly 45 years of stock market history, I’ve determined that there’s little risk of “recidivism” when the S&P 500 Index (now at 879) crosses crosses above its 180-day moving average (now at 1197).

I know it looks like quite a stretch but the market’s rapid descent beginning in August (38.71% between 8/11 to 11/21) is beginning to have a more pronounced impact on the moving averages and accelerating their convergence with the index itself someplace around 975-1000 sometime in March-May (in the absence of another leg down for the market). However, if the retest of the lows fails and the market declines further, below 752.44, then waiting for that confirmation signal will have paid off.

So don’t be swept away by all the talk of a “happy New Year”. Wait for the market’s confirmation that things will be different.

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