December 21st, 2009

More Evidence A Correction Is On The Way

I took time this weekend to read what other bloggers thought might be the Market’s future and felt relieved to see that everyone is confused and pretty much sitting on the fence waiting for the winner of this Bull/Bear battle. Most see a convincing breakout, either way, from the narrow channel the market’s been in since the beginning of November as the indicator as to whether the bull market will resume or we go into the long-awaited correction. You know my feeling but I thought I’d take another look and see whether I could find other clues in the Market’s past.

The Market’s dramatic, quick recovery hides something profound (love that word; it means “of deep meaning; of great and broadly inclusive significance“) in the charts: the rate and extent to which the market has run ahead of the recovery. There have been bull markets in the past and I wondered how those markets compared this one since March. The metric I used were the ratios of the Index to its 200- and 300-day moving averages. To determine how typical this bull run was, I calculated the percentage that the Index was ahead of its moving averages:

Since March 12, 1963 (the extent of my database, there have been 11779 trading days, thousands of corrections, many bull and bear markets, several Market Crashes. In this volume of history, I thought we could find some precedents that would tells how typical this bull market recovery has been. Here’s what I found (click to enlarge):

The current recovery has carried the Index to levels that are atypically ahead of its moving averages. In other words, the March-October move that repaired the damage caused by the financial panic was so powerful because the devastation that preceded was so deep (the Index had never been so far below its moving averages). When were those trading days farther to the left of today’s positions (i.e., when the Index was farther above its moving averages)?

With respect to the 300-DMA, they were the 1982-3 recovery and the 1997 mini-crash resulting from the Asia financial crises (sound similar to today?). When the Index was exceedingly ahead of its moving average in 1983, it went into 7 to 8 month horizontal channel of about 10% followed by a further 8% decline over the next six months before resuming the bull market. The 1997 correction was a 10%, six-month horizontal channel followed by an upside breakout and continuation of the bull market.

The 1975 bull market (the market went up 45% over 6 months to July), saw a 15-17% correction to allow the 200-day moving average to catch up to the index. The Index actually saw support in that moving average and bounced off of it twice before continuing its upward momentum.

The market was very much ahead of itself this October and it will take 6-8 months until either it corrects closer to the moving averages or remains in a horizontal channel allowing the moving averages to catch up to the index. Until evidence proves otherwise, I’m sticking scenario painted earlier in “Reversion to the Mean Still On Track” at the beginning of December.

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