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Taking the "Long" View


Don't you know it's different this time!?


There have been some very interesting readings being given off by the market over the past few weeks, and now's as good a time as any to step back and recap a few of them.

First, though, I want to address a couple of points that I've seen repeatedly about the idea of us having already seen an intermediate-term market low.

One of the big knocks against it is that the correction hasn't been deep enough. I don't really understand that argument, but let's just look at the facts. I did an in-depth study of every intermediate-term low in the S&P 500 (^SPX) from 1950 through the present (there were 62 lows that qualified). They had to mark at least a three-month price low both before and after that date, so they could only be identified in hindsight, but I wanted to see how our current decline stacked up against them.

The chart below shows the decline that each one underwent from the previous 52-week high to the date of the intermediate-term low, with each blue bar representing one of the corrections.

Click here to enlarge.

The median percentage decline was -10.2%. Notice the "You are here" arrow – it is very close to average. The current decline has been exceptionally quick, though there were five other declines of shorter duration.

Something else I've seen postulated is that we're now in a higher-volatility environment, which likely means lower prices going forward.

I don't really get that argument, either. I went back over the history of the Dow Jones Industrial Average (^DJI) from 1896 through the present to find any other time that that index had a historical volatility under 20% for more than 1,000 trading days, then saw a bout of increased volatility.

The chart below shows the first of six instances that we've seen in the history of the Dow. It is representative of most of them.

Click here to enlarge.

After the 21-day historical volatility on the Dow rose over 20% after having gone more than 1,000 under that figure, the index lost another 7% of its value before rising more than 15% over the next few months.

Out of the six precedents we have, four of them saw a drop of 4% - 7% over the next couple of weeks before they formed a low. The other two examples didn't suffer any drawdown. Every one of the six, after undergoing some short-term pain, rallied between 10% - 20% over the next three months.

It's notable that this year, the Dow dropped 7% between when it recorded a historical volatility figure over 20% to the August 16 low.

Oh, and a note about volume. Last week was not a low-volume recovery. It was, in fact, the highest-volume week in many years when occurring during one of the last two weeks of August. These two weeks have marked either the lowest volume of the year, or very close to it (only late December comes close) for many, many years.

Also, we scored record-high volume in the days before last week's recovery. It is perfectly natural for volume to decline as the market recovers. Look at past lows, and objectively observe the volume pattern. When the low comes in a panic, on record volume, the recovery has an extremely consistent tendency to progress on successively lower volume. There may be valid reasons to sell here, but "low" volume isn't one of them.

Some other interesting bits:

  • Short-term T-Bills enjoyed one of the wildest flight-to-quality runs in history over the past couple of weeks. While there are some structural reasons for that, the overriding cause was panic, pure and simple. Every other time in history we've seen this kind of run on short-term government paper, stocks have rallied in the intermediate-term.

  • Breadth has given some of the worst readings in the past 40 years. Some might consider that a bad sign, but they likely don't look at history. Every time in the past 20 years breadth has been as bad as it was during the past several weeks, stocks have formed major intermediate-term lows. Prior to the past 20 years, it wasn't as consistent, but still very bullish looking forward.

  • New lows on August 16 numbered over 1,000 on the NYSE for only the second time in history. Expressed as a percentage of all stocks traded, it hit 33%. Again, over the past 20 years that kind of figure has resulted in major lows every time, and even prior to the past 20 years, it has returned very positive expectations.

  • August 16's reversal on record volume was a rare event for that magnitude. Historical comparisons turned up dates that were very similar to the oversold readings listed just above – meaning that markets have had a tendency to see reversals like that day when coming out of extreme circumstances.

  • Corporate insiders have been buying extremely aggressively, notching some of the highest buying interest in at least five years. All sources I use confirm that fact, though to varying degrees. All seem to be in agreement that insider buying is the highest it's been in at least five years.

I'm sure I'm missing some, but you get the point. Ever since August 16, the markets have been conforming to the script we see at most intermediate-term market bottoms. It has been absolutely classic, which may mean it's too pat and not likely to repeat, but that was also the argument in March (and last summer…). Additional testing of the low on the 16th would be par for the course, but I wouldn't want to see more closes below that low.

I don't know about the long-term: the studies I've looked at were inconclusive on that time frame, so I'm most interested in the intermediate-term of one to three months. The evidence that I've seen is stacked heavily in favor of a continued recovery. A continual drip lower that sets new lows would be rare indeed and would trigger the bear markets of the 1970's as the only historical comparisons I can find.

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