June 4th, 2012
There are two kinds of investors: those who try to predict the market’s future direction from what they understand to be the truth of today’s events and those who try to understand past events and project them as models for what the future might hold. In other words, those who view the market in fundamental economic terms and those who see the market in terms of supply and demand for stocks. As you might have surmised, I belong in the latter camp. I gravitate to the technical approach and look to the past for analogs that might guide me in looking at possible market direction today.
For quite some time, I’ve seen similarities between the end of the 1970′s secular bear market and this generation’s secular bear market that began with the Tech Bubble Crash. I’ve been calling it my “Reversion to the Mean” chart. For example, in “The Magic Number is Actually 7.5% per Year” from October 11, 2008, in the depths of the Financial Crisis Crash, I wrote:
“The good news is that …. the Index came within 6% of the bottom boundary (intra-day 839 low vs. 789) boundary); we should be near very the bottom. The bad news is that projecting forward to the end of 2009, the lower boundary increases to only 858, or still below Friday’s close.
There will be bounces but, in all likelihood, it will be a long time (several years) before the Index touches 1400 again. Unfortunately, the “buy-and-holders” are going to feel extremely frustrated. Market timing will be extremely important. You’ll have to trade gingerly taking advantage of recovery moves. You’ll have to be patient and not expect a robust Bull Market to return anytime soon. Shed poor performing stocks and, as market weakness appears, become defensive to conserve your capital.”
And then on Obama’s Inauguration on January 17, 2009, I wrote:
“Granted this is a bad recession; some even call it the beginnings of a depression. It’s not only here but it’s worldwide. Has the market fully baked in the economic distress? Has the market adequately reflected the $trillions that has been created to stave off further effects? Will the market deviate from the mean more than the 9.98% of 1982 (making today’s low at least approximately 725)?
Without getting political, I thing that investor psychology (as well as that of the general populous) see’s the Inauguration as a new beginning and psychology is the other half of the market (economics being the first). Ronald Reagan took office in January 20, 1981 and the country sighed a deep sigh of relieve as Jimmy Carter left office leaving behind the high oil prices and high interest rates; the hostages were released in Iran that same afternoon. Barack Obama is being inaugurated and perhaps we’ll be as lucky.”
Then, on May 2, 2011 in “Reversion to the Mean-Redux” I wrote:
“Following this track literally [superimposing the exit from the 1970's secular bear market exactly on to recovery from the 2009 Financial Crisis Crash] means that the market could be heading into some murky water. We may soon stall out, retreat again and not see the current level again until sometime in 2013. If the recovery time frame over which the economy and the market took to come out of the 1970′s secular bear market were followed precisely again, then a new market high won’t be seen until around the beginning of 2015.
I have no idea and care little today to know what underlying fundamentals will be used to explain in the future the market’s then behavior. “Reversion to the mean” merely establishes the boundaries within which the consequences of all these underlying dynamics might ultimately be realized.”
Finally, this past January 30 in “That Old 1978-82 Analog Again” I wrote:
“On the one hand, we might actually be escaping the Bear Market sooner than I had originally anticipated but, on the other hand, the analog may still be in play and we’re looking at a possible reversal for the remainder of 2012 in order to get back closer to the analog.
I guess if I had to choose between swallowing my pride at having missed a “forecast” and accepting the upside break out or meeting the forecast but delaying the opportunity of seeing a higher market again ….. I’ll live with having missed a forecast.”
I guess we didn’t dodge the bullet since we’re just about back to where we were when the above was written. But now, six months latter, what does the analog look like now (click on image to enlarge)?
The black line is the actual index and the blue is the projection based on the exit from the 70′s secular bear market. The 70′s secular bear market low point was in September 1974 and a new high wasn’t established until 1980, over 5 years later. The analog assumes that the low of the current secular bear market was the 2009 Financial Crisis Crash; overlaying the 1970′s track beginning at that low point produces a new high sometime in 2015.
In the Weekly Recap Report sent to Members yesterday, I indicated 5 possible support areas on which the market could pivot and begin another leg higher. However, the sixth lower level is the bottom boundary of the “Reversal to the Mean” channel indicated in the chart above. While the 1970′s analog foretells of a nice bull market to 2015 and beyond it also implies that the current correction could stretch all the way down to around 1000 in the S&P 500.
The similarities between the exit from the 1970′s secular bear market and today are many. What we do know is that the exit process takes a long time. Let’s hope that one of the trendlines indicated yesterday offer firm support and the market won’t need to revert all the way back to the lower boundary as it did in the months immediately preceding Ronald Regan’s election.