December 3rd, 2009

Reversion to the Mean Still On Track

This morning’s Labor Report was a shocker but I’m not convinced that “pleasant surprise” expectation hadn’t already been baked into the market. Hasn’t everyone been talking, month-after-month, about labor market improvements in terms of continually smaller increases in the unemployment rate? So, if the numbers remain unrevised, then the risk has flipped from upside on pleasant surprises to now finally risk of downside move from unpleasant surprises.

I’m going to stick with the report I had drafted before the announcement because I believe it’s still relevant.

==================================================

We’ve arrived here at the Southern Command Post on the West Coast of Florida, I’ve set up the wi-fi network, installed a new wide-screen second monitor to my system and am ready to go.

I had a lot of time over the past several days while driving to ponder where this market may be headed and my thoughts often drifted back to where we have come from. During the depths of the Crash from October to April we continually looked for precedents to divine what the future. We looked to the 1929-32 Great Depression Market Crash and the 2000-03 Tech Bubble Crash. We also dissected the 12-year secular bear market of the 1970’s looking for similarities between that era’s oil shortages, politics, currency situation and stock market and the present situation.

Along with the Coppock Curve, a very long-term indicator that gave me some confidence in March that we had reach the bottom was something I labeled “Reversion to the Mean”. The Indicator statistically determines through regression analysis of the S&P 500 Index since 1939, the market’s growth and the upper and lower boundary (at two standard deviations) of its volatility around the mean. In a May 1 piece entitled “Measuring Market’s Health: Moving Averages, Coppock Curve, Mean Reversion” I wrote:

“….while we’re holding our breath that all these signals ultimately follow through with a promise similar to past experience, it could also mean that we’re not going to see the all time highs of 1500+ for some time. If the market follows the track of the 1974-75 Bear Market, the highest we might see the market by Year-End 2009 is 1050-1075 and 1250-1275 by Year-End 2010. While that’s a respectable 20+% gain for next year, it’s not the sort of volatility we’ve grown accustomed to over past several months. But then again, who needs that level of volatility.”

Flash forward seven months and we see that the market has actually followed fairly closely the trajectory of the 1974-75 Bear Market.

The high so far this year was today’s intra-day high of 1119.13, marginally higher than the 1075 forecast on May 1 when the Index as 877.52. If the market continues on the 1974-76 track then we should look forward to a minor correction back to around 1000 followed by another upleg carrying the Index above 1225 by next year-end:

The projection is calculated simply by applying the ratio of the 1974-76 index to the extrapolated lower boundary of the long-term regression line so the Index’s future path is a copy of the path it traced in the prior period:

Last May, I thought there was a slim chance that the two recoveries could follow nearly identical paths. It will be amazing to see whether the correction on in the forecast actdually materializes.

Subscribe below or click here to learn more about help for navigating turbulent markets.
  • Mike

    Was there a typo?

    If the market continues on the 1974-76 track then we should look forward to a minor correction back to around 1000 followed by another upleg carrying the Index above 1225 by year-end

    Did you mean "above 1125 by year-end"?

  • Joe

    Mike,

    Meant "1225 by next year-end". Thanks you for the correction.

  • Anonymous

    If you follow 2004, the market should go to 1156, correct to 1064, and then go to 1125 at the end of next year…

  • Joe

    Actually, "go to 1156, correct to 1017, and then go to 1247 before ending the year at 1216" ….but who's quibbling. A correction is in the cards.

  • Anonymous

    Guru, Appreciate your post..But each sectors in S&P is different now compared to 2004 . Most sectors (XLK, XLB & XLE) are bigger except XLF.

    So SPX in 2010 should be higher than SPX in 2004

  • Minnesotalee

    I'll stick to my technical guns: the SP500 at 1295 by end of March 2010. We will get pullbacks but no big corrections until this PO is met.

  • College Paper Writing

    Many institutions limit access to their online information. Making this information available will be an asset to all.

  • dissertation writing

    Hello my friend! I want to say that this article is awesome, nice written and include almost all vital info. I would like to see more posts like this.

  • Pingback: Consolidation or Reveral, That is the Question? | Stock Chartist()