The Obama Bottom

Written by  Dr. Declan Fallon: In June of this year I introduced the relationship between the S&P (SPY) and its key moving averages (20-, 50-, and 200-day MAs). At the time the greatest number of matches were made to the pre-crash scenario of 2001 with a similar match to the 2003 meltdown. The conclusion at the time was to wait for a break of the 200-day MA before fully investing long, but to expect declines of between 7% and 30%.

On October 6th I talked about the status of the decline and how the then 14% loss might not have been enough. I drew five conclusions from the state of the market at that time:

We are likely a couple of weeks from a bottom, but it is not impossible for this to take longer

During this period the market will see sharp losses, perhaps trimming 10-20% off where the markets lie now (Monday will be the start)

The subsequent rally will be short lived and will morph into a retest of the low

The retest will be the time to buy heavy

A significant bull market has a good chance of emerging from the quagmire - remember markets lead economic news.

So where do we stand with respect to these two articles?

Since the June piece the S&P went on to lose 34% to its October lows and from the time of the October article the S&P lost 20% to the low it made 4 days later.

The market followed the October 10th low with a brief rally which eventually lost steam and kicked off the retest move. This second decline was to make new lows for the Nasdaq and Nasdaq 100 (QQQQ) , but for the Dow (DIA) and S&P the October 10th low held as a second (higher) low was posted two weeks later.

Given the S&P has pushed someway from its second low after 6 days of modest gains, gains which were sufficient to break through the 20-day MA, where does the S&P (and likely global markets as a whole) stand now?

Back to the historic data. As of Tuesday's close the S&P finished 6.4% above its 20-day MA, 9.27% below its 50-day MA and a mind-numbing 26.8% below its 200-day MA. Where in the past have similar matches occurred?

Surprisingly, only two periods emerge: October 1974 and October 2002. Telling that both matches occurred in October, although neither coincided with a Presidential election.

Looking at the S&P for 1974 there was a break of sharply declining resistance similar to what occurred recently, but the 1974 bounce quickly faded into a more prolonged backtest of lows until the start of December. It was only after that test that the market was able to push higher. Will this be the Obama unwind?

The 2002 alternative is very similar in structure to the 1974 scenario with the eventual backtest taking just over 4 months as opposed to the month in 1974. We could see a reversal head-and-shoulder pattern take shape as happened in 2002 (if so the neckline will be at 1,005 which means the development of the right-hand-shoulder began yesterday).

Other points of interest
 

On Tuesday the S&P closed 6.4% above its 20-day MA. Since 1952, the highest it extended above the 20-day MA was 8.7% in August 1982. To put this in perspective, the ranking of Tuesday's close with respect to the 20-day MA is 46th out of 14,350 trading days (top 0.3%!). We are heading down....

The closing low of October 27th at 848 should be the reaction low for the bottom and not be violated (even if the absolute low occurred on October 10th). Intraday penetrations are acceptable.

On a closing basis we have a neckline at 1,005 and a target for a right-hand-shoulder of 899 (end-of-day close). Again, intraday volatility around this price is acceptable

Recent volatility is likely to deliver some variation to the actual pivot prices so use the above prices as guidelines (1% margin of error??).

The worst looks to be behind us but we won't really know until we see what happens when the 200-day MA comes into range; a solid cut through and it will be up and away; however, a negative response to the 200-day MA test could produce a 1932/2002 style scenario in 2009 bringing with it another big step lower. If there is a silver lining to the worst case scenario it's that the current picture suggests we have already reached the extremes of the 2002 capitulation and not the pseudo-capitulation generated after the September 11th attacks.

There is a new sheriff in town. It's time to look towards the future and put the past behind us - because the market will.

Comments

[Lars39:]

Good luck with the new sheriff.

2008 Nov 06 08:59 AM

[dshort:]

The S&P 500 hit its recent low eight trading days ago. If we look at the bear markets in the S&P 500 since 1950, we see that the bottoming process lasted anywhere from six weeks to eight months:

dshort.com/charts/bear...

Drawing trend lines on charts during bear markets is an entertaining pastime. But the impact of the looming global recession on today's markets may keep you busy redrawing those lines for many months to come. The real precedents could indeed date from the late 1920s.

The chart line I find the most troubling is a linear regression on a century or more of market closes. Take your pick:

dshort.com/charts/dow....
dshort.com/charts/SP50...

You can speculate about the new sheriff in town and past being behind us. But I think the past remains very relevant. Take a look at these two charts and ponder one simple concept: "regression to the mean," which frequently involves overshooting in the opposite direction.

2008 Nov 06 09:16 AM

[Schweizer:]

With a time-proven bear market low "requirement" of a PE of 8 on forward earnings, and forward earnings expected now to be $50-$60, the S&P500 needs to get under 500 to find a real lasting bottom.

That is much more relevant than trendlines or moving averages.

It will happen.

2008 Nov 06 09:27 AM

[bricki:]

This article has a lot in common with other renowned fields - phrenology, astrology, cheiromancy and tasseography.

2008 Nov 06 09:36 AM

[Prudent Man...:]

Is a Left Wing Government good for stocks?

Look at what happened in the seventies and you can get an idea of where the economy and general market is going.

Those folks in NYC, in their inherent hubris, forget when states like Wyoming and Idaho had to bail them out from their left wing local government policies.

2008 Nov 06 09:41 AM

[Jake2:]

Lars 39: Keep your eyes on the old sheriff and his deputies. They're a bunch of incompetents. Look what they did to the economy, the deficit, etc. "W' stands for wrong, and "Watch 'em!" They'll steal the silver on the way out.

2008 Nov 06 10:58 AM

[Zignals:]

"You can speculate about the new sheriff in town and past being behind us. But I think the past remains very relevant. Take a look at these two charts and ponder one simple concept: "regression to the mean," which frequently involves overshooting in the opposite direction. "

Interesting charts. If you look at the period from 1880 to 1910 (S&P) the market continously traded above the regression line. From 1910 to 2000 the market spent the majority of its time below the regression line. One can argue since 2000 we have entered a 'positive phase' where markets trade above the line.

At some point the line will break, but we might have to wait decades before it does.

2008 Nov 07 08:22 AM

[Zignals:]

> Is a Left Wing Government good for stocks?

Mixed government is best for stocks. By 2010 elections we will be three years into a cyclical bear market within a secular bear market and the psychological damage this will have caused. The electorate may look to give control of the House to Republicans which from a policy perspective shifts things center and gives confidence to the market.

Are you arguing the Right Wing Government we had was good for stocks?

>
> Look at what happened in the seventies and you can get an idea of
> where the economy and general market is going.

The market bottomed in the early seventies.

The economic damage has already been done, now it's a question of gritting teeth, supporting boutique (small) businesses which will fill the void, and getting the economy back on its feet.

>
> Those folks in NYC, in their inherent hubris, forget when states
> like Wyoming and Idaho had to bail them out from their left wing
> local government policies.

*Every* tax payer had to bail out Wall Street. Don't ge me wrong, if execs are willing to accept their outrageous pay deals they should also accept the responsibilty of going to jail if they get things wrong....

2008 Nov 07 08:32 AM

[Zignals:]

> With a time-proven bear market low "requirement&q... of a
> PE of 8 on forward earnings, and forward earnings expected now to
> be $50-$60, the S&P500 needs to get under 500 to find a real
> lasting bottom.
>
> That is much more relevant than trendlines or moving averages.

> It will happen.

When you factor price into a decision making process you are dealing with a technical; so P/E is a hybrid technical/fundamental indicator and is as relevant as any trendline or moving average.

Given that, I would be surprised to see a S&P below 500. Each new quarter will revise for the forward P/E and therefore the projected target for a "bottom".

2008 Nov 07 08:41 AM

[Zignals:]

> This article has a lot in common with other renowned fields - phrenology,
> astrology, cheiromancy and tasseography.

Technicals are a tool. Fundamentals are a tool.

Technical Analysis is about measuring probability; the probability of buyers ('support') or sellers ('resistance') taking control of the market. What I have attempted to illustrate is how fearful the market have become by overselling relative to key moving averages and how this provides an opportunity.

If I am reading correctly from your previous comments you have been dipping in to the market since last August because you perceived value in the market. Since the top in October 2007 the market struggled to regain its 200-day MA in November 2007 and May 2008. In August 2008 it struggled to break through its 50-day MA. Now its struggling to get past its 20-day MA. Just as these moving averages acted as support through the cyclical bull market from 2002-2007 now they are acting as resistance. But when the 20-day MA is acting as resistance you need to consider this state won't last long and markets will soon be pushing through (and higher)?

Fundamentals doesn't deliver in this respect. How can anyone believe in pure fundamentals after the events of the past year?

The time Uranus went all retrograde was in the balance sheets and earnings of AIG, Bear, Lehmans et al (not to forget Enron and Worldcom).

2008 Nov 07 09:00 AM