June 29th, 2010
If the 12-month oscillator discussed yesterday wasn’t enough sufficient evidence for you, “Reversion to the Mean” is another argument for why 900-950 could be the price target bottom of this correction.
Many long-time readers remember back in 2009 when trying to divine the bottom of the Financial Crises Crash we used the Reversion to the Mean to gauge a price target. On May 1, 2009, even as few were sure whether the market had even hit a serious bottom on March 9 or whether it the subsequent rise was merely bear trap, 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.”
On May 1, 2009 the market closed at 877 and the actual 2009 close turned out to be 1115; not too a bad projection, if I don’t say so myself. But with the market swooning today, what’s the likelihood of 1250-1275 by the end of this year and, if the decline continues, how low might it go? Since Reversion to the Mean was so reliable in calling the bottom, can it offer clues for gauging the current correction. Where might the this correction end?
For those who don’t recall, here’s the Reversion to the Mean chart updated with today’s close (click on image to enlarge):
The 1968-82 Secular Bear Market saw the S&P 500 move from the top boundary to just beyond the bottom bottom boundary, each boundary being 44% away from a long-term 7.5% growth rate center line since 1939. The Tech Bubble took the market beyond the top boundary and the Financial Crises Crash brought the market just below the bottom boundary, exactly the same as happened in 1974.
My May 2009 projection of 1250-75 by year-end 2010 assumed that the market would follow a similar tract to that of the 1974-75 period. Here’s what that track looks like after zooming in on the above chart:
The red line in the above chart is the path of the 1974-75 recovery and the blue line is the current market; the green upward sloping line is the bottom boundary of the Reversion to the Mean chart.
The correction we’re in the midst of now didn’t happen in the prior Bear Market until the second and third years of that recovery. If it continues, where’s its price objective? The bottom boundary line served as a support in 2009 and could do so again:
The boundary trendline is also in the 900-925 range and coincides with yesterday’s oscillator discussion.