June 28th, 2010

Another 15% to the Bottom

The market is so boring and unrewarding these days that I’m afraid that many of you are going to lose your patience, throw in the towel and revert back to buying mutual funds or index funds. Even worse, you’re going to think that the problem is with you or your approach, that everyone else is making money but you’re doing something wrong.

Trust me, there’s not much anyone can do in the kinds of markets we’ve been experiencing to make themselves some real money. It’s not a matter of better stock picking. Shorting individual stocks or sectors or indexes runs into the same frustrations and disappointments. The market today is no better or worse off than it was at its high in September 2009.

But it’s not like it couldn’t have been foreseen. On October 23, 2009, in a piece entitled “More Evidence We’re Approaching a Top“, I should a chart of the 12-month oscillator for the S&P 500 Index and made the following points (click on the for more information):

  • Usually, after the market has several back-to-back exceptional 12-month runs (where returns over the previous 12-month exceed 25%) it is followed by several back-to-back months of negative 20% return.
  • when the market has a sharp sell-off, or negative back-to-back 12-month returns of over 30% (see 1932, 1937, 1974, 2002, 2008), there follows a bounce back of 25-30% returns. It’s fairly regular and predictable.
  • nothing continues growing forever. Moves much beyond the extent of repair that’s already been achieved [S&P 500 closed at 1079.60 that day] is inconsistent with market history going back to the Depression.
  • the annual changes moving forward will decline to the point that somewhere in 2010, the market will be no higher and, yes, possibly lower than 1080.

Fast forward to today and we find that the market has topped out in April at 1217.28 and is now back to where it was when I wrote the piece. And what does that oscillator show today (click on image to enlarge)?

The chart shows the oscillator today at 15% and still dropping. During the long 2004 correction coming out of the Tech Bubble crash, the oscillator never went into the negative. In other words, there was no 12-month period showing a loss even though the market remained relatively flat for over 9 months.

However, the typical recovery doesn’t begin without the oscillator dropping to the dashed blue line, or -16%. I’ve projected that a decline to around 900 sometime in the second half would bring the oscillator down approximately that far (see red dashed line).

I’m not a perma-bear and I don’t want to see further declines any more than the next investor. But we started getting prepared early this year by moving nearly 50% into cash and hedging the remainder with shorts, etc. The sooner the rest of this correction can begin and end in earnest, the sooner we’ll get the next leg of the bull market.

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  • forcast

    Hello sir,
    Wonderful review, I mean your oscillator on my site, hoping that you would agree
    Meri and good luck to you

  • bodotdot

    Could this anticipated 15% drop signal a entry point for SDS, short-term?

  • Joe

    That's exactly the way I'm playing it.