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Tuesday, September 22, 2009

Market Down Big... Market Up Big... Market Typical Continues to Go Up

While this may not be as catchy as the Pub Power signal detailed last week, what I'll dub as the "5 and 5" and "1 and 1" is rather interesting.

What is it?

I noticed that at the end of August, the year over year change in the S&P index was more than 21% down, but the 6 month change was more than 25% up. The bearish case is that things have come too far, too fast, whereas the bullish case is that we still have ground to make up.

Lets see what history has to show us. First I took a look at S&P 500 data from 1950 onward. Since that date, whenever the S&P was down more than 5% over the previous 12 months at month end, BUT 6 month returns were up more than 5% (we'll call this "5 and 5"), we have seen a continued rally in the S&P 500 in each of the 11 months (all within five periods - 1958, 1962-3, 1970, 1975, and 1988).



Digging Deeper

Each of the red points in the chart below represent those periods shown above (i.e. the "5 and 5"), but now we go back 100 years to 1909. The blue dots are similar, but represent the forward 12 month change in the S&P 500 when equities dropped more than 1% over 12 months, but have gained more than 1% over the more recent 6 month period (i.e. the 1 and 1").



Historical data seems to indicate that now may in fact be a time to buy as the average 12 month change in the index following a "1 and 1" is a robust 13.1% and a "5 and 5" is an uber-strong 16.7%.

BUYER BEWARE

The only time we saw a massive (i.e. greater than 20%) loss during a 12 month period following a "5 and 5" was in May 1930, a period in which the market had first rebounded from the initial market crash of what would be the Great Depression. By the Summer of 1932, the S&P was more than 80% lower.

And as an anonymous reader comments:

Buying at these levels is basically gambling (unless you can find some out of favour sectors that haven't run). I am bullish long term but you cant just keep going up parabolic. Reality has to set in eventually. Whether we consolidate from here, correct meaningfully, or go sideways is anyones guess.
Update:

Traders Narrative with an alternative view showing what typically happens when the market is more than 20% above it's 200 day moving average.

Source: Irrational Exuberance