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Op-Ed: Revisiting the Analog Model


Will the history of 1938-1942 repeat itself?

Editor's Note: Scott Hamann is the president of Durango Capital Management LLC in Durango, Colorado. Scott has been involved in the financial markets for 16 years as a trader, broker and investment banker. This is his first op-ed for the 'Ville.

I've been watching the analog model for a few years now. As of yet, the market hasn't deviated from it in any meaningful way, as the following chart (from IBD) shows:

Click to enlarge

From March 1937 to April 1938, the Dow Jones Industrial dropped roughly 50% over the course of 55 weeks. Currently, the NASDAQ has dropped about 47% from its high on October 31, 2007 to the current low of 1493 on October 24, 2008 over the course of 51 weeks.

Next week would be the fifty-fifth week of the decline in the NASDAQ composite; a 50% decline would be around 1430 on the index. (It's at 1499 as of this writing).

Looking Forward

Big rally ahead? Between April 1938 and November 1938, the Dow staged a 62% rally over that 8-month period before ultimately turning and heading lower.

While it's hard to fathom at this point, a rally of 62% over the next 8 months in the NASDAQ from 1430 (should we dip lower and follow the analog model) would reach the 2300 level by July 2009. The interesting thing about that level on the NASDAQ is that 2300 is where the market was trading prior to the start of the panic leg of this bear market.

The market, like a criminal, often returns to the scene of the crime.

In The Defensive Case Does Not Hold, I argued for a trading low in the S&P 500. While I still believe that 840 in the S&P 500 may hold, a move to the downside that runs stops situated below those lows before advancing higher certainly isn't out of the question. It would fit in well with the aforementioned scenario in the NASDAQ.

Finally, as Toddo says, "History doesn't repeat itself - but it often rhymes." The analog model has been fascinating to watch over the last few years. Though I don't put too much emphasis on it in my trading, the analog model was key in alerting me to the possibility of a large decline on the horizon over a year ago.
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