S&P: Hyper Exuberance Brings 66% Chance of New Lows Ahead

While very impressive, the stock market’s rate of advance is cause for concern rather than a Bullish argument. You have to look all the way back to the move off of the final low in 1932 to find a rally that advanced faster than the rate of the current rally, and further look to the initial low in 1929 to find a rally of comparable speed. Not even during the “Irrational Exuberance” years of the 1990s did the S&P advance this rapidly. The difference this time around, is that the government is cheering on Hyper Exuberance instead of questioning it. Maybe it is their only hope of a “stimulus” that could bring the economy out of the current mess.

While the S&P drop from 2007 was only 57.69%, the rally in 1932 came after an 86% drop in 1929. That move retraced 51.96% of the loss from the 1929 top, over the course of 13.5 months. It advanced at a rate of .43% a day, and did have higher speeds of advancement within it. However, after it topped in July 1933; that high level was not seen again until February 1946. Further, the high in 1929 was not exceeded until October 1954. If the current rally were to retrace 51.96% of the loss from the October 2007 high, it would carry the S&P to 1139. If it then followed the same path as the 1930’s, the market would not surpass the 1139 level until 2022; and not climb above the 2007 high until 2030. With a little better than 100 S&P points to 1139, there is not much reward to risk; judging from history. If you miss getting out at the high, a similar 13 year period is a long time to wait. When you look back and see a never before in history situation, you must ask the question: What is different this time?

Below I have posted a chart of historical moves in the S&P near 40% or better. The chart shows the dates, prices, highs, lows, % moves, lows after the move, and the rate of the advance. As you can see the average rate of advance for these great moves is .14% a day. Currently we are advancing at a rate of .32% a day which is very abnormal. There have only been 3 other times when the rate was above .19% a day, and only once when the rate was above the current rate as mentioned above. The 1932 rally advanced at a rate of .43%/ a day and was followed by a 33.93% decline. The second greatest speed is equal to the current rate of .32%/ a day. This was the Bear Market Rally that followed the initial drop in 1929. That move was followed by an 83.02% decline. The only other move that was anywhere close to the current move; was a rate of .28%/ a day in 1938, which was followed by a 45.83% decline. If you took the average decline after such great advancements, you would end up at a low in the S&P of 473.78 sometime within the next 884 days. Levels from least to worst case scenario would equate to 684, (just above 666), 561, (well below 666), and 175 (extremely below 666), using the declines that followed rallies of this magnitude. Looking to history, it also means that there is 2of 3 or a 66% chance that the S&P will hit a new low.

Since the rally from the initial low in 1929 is the most comparable, it a rally that warrants further attention. We have already matched and exceeded the rally in terms of % gain and days of length. However, if you look to proportional levels comparing the initial decline then to the initial decline now; it yields some higher levels. Since the initial decline in 1929 was only 44.56% compared to 46.77% in 2009, it could equate to a level of 1070 using the October 2007 high, or 1042 using the secondary high in May 2008. The high Monday at 1035 is very close to the 1042 and already satisfies time requirements. With my proprietary Gurk Oscillator turning down August 25 for a sell signal, this could mark a high. In addition, if you look at the chart below, these levels are also near the 38.2% Fibonacci arc retracement level (highlighted with a circle) of the 1982 to 2007 Bull move. This move is proven to hold significance since it caught the 666 low with the 61.8% retracement (green circle). Coincidentally, if the next move down were to go towards the 473 level mentioned above, it is right near the 76.4% retracement level shown with the silver arc. (also highlighted with a circle)

One of my best teachers, Alan Shaw, had a saying that always stuck in my head.

If a storm blows by and knocks a few shingles off your roof, then it’s no big deal. If a wrecker and a crane bash your house in, it is going to be a long time before it is back to normal.

I think the decline from 2007 would qualify as a wrecker and a crane, since it was the worst decline since 1929. Alan would expand upon the quote and say “the bigger the drop the longer the need for time of repair”. A foundation must be built if the market is to be sustained, and the current rate of advancement does not make for a well built foundation. To start with the knocked down wreckage has not even been cleaned up. The best thing that could have happened to the market is for it to have sat around flat on the low for many months, and then begin to rally.

The market however, is energy in motion illustrated with charts. The current advance is a counter action that is following a primary action. The speed and magnitude of this counter action is indicating rough times ahead. In fact, the strength of the ascent will only further power the strength of the descent. I have been cautious all along, but with Hyper Exuberance running rampant, now is definitely the time to remember the old saying Buyer Beware.

Comments

[Vinsanity:]

i can see the sky thru my roof already...i need a TARP.

Aug 25 10:33 AM

[Joe H.:]

Scarry,but likly if not probably.Iam already in levered short ETF's.

Aug 25 01:55 PM

[thiazole:]

The roughly 3% GDP decline that this recession has brought pales in comparison to the 43% GDP decline seen between 1929 and 1933, so why the obsession with comparing the two? This is much more like the 1974 recession and the markets have been rising at a similar pace as that seen in 1975. Yes, you had an overreaction to bad news in March which caused the market to fall too far - as a result, it quickly returned to the level it should have crashed. If you ignore that initial part of the rise, the market has actually been underperforming 1975.

Aug 25 03:22 PM

[thiazole:]

Here is a chart to illustrate my point. This is a % decline and rise for the Dow from 73-75 compared to 2007-now. I centered the bottoms of both charts (ie, the Dec 1974 bottom is lined up with the March 2009 bottom), but other wise the time frames are not altered. As you can see, the market in 2009 rose very rapidly from the artificial bottom (which was based in panic of a banking sector collapse) but has since risen at a lackluster pace compared to 1975.
tinyurl.com/mcs76x

Aug 25 03:56 PM

[greenshoots...:]

thiazole,
Corporate earnings had the biggest collapse in US history in 2008, not even close to what happened in 1929.

We are in the midst of the biggest credit deleveraging the world has ever seen. In the 1930s, there were virtually no such thing as consumer credit.

This is nothing like 1974, in fact, there is nothing like this in history. 90% drop in corporate profits, 30% drop in housing prices, 100% rise in unemployment rate. And GDP went from 5% to negative 6%, a 11% net change which is much worse then 1974.

75% of this economy is based on consumer spending, and consumer spending is falling off a cliff as the past 10 years of credit nonsense unwinds.

Thus, I don't know how can you rule out any possible scenerio at this time. Once the $3 trillion of government liquidity stops holding up the market, then what?

Aug 25 04:16 PM

[greenshoots...:]

And you simply cannot compare market behavior to behaviors 30 or 80 years ago. This market is nothing like those time periods. Today we have trillions in derivatives and futures, program trading, algorithms, hyper trading, exchange arbitrage, etc. None of which even existed back then. This market is completely in control by technology and factors MUCH more powerful then simply supply/demand.

Example: If State Street or Goldman Sachs decides to unwind its $30 billion dollar SPX futures position, this market will collapse regardless of supply or regardless of technicals. Or vice versa.

Another reason past comparisons simply do not seem relevant.

Aug 25 04:21 PM

[William Occam:]

Long term S&P looks like a German Shepherd hiding in the dark. I imagine that qualifies as a double top.

Aug 25 06:47 PM

[Common Cents:]

While I agree with your conclusion that it is a good time for "buyer beware" ...Comparing charts/stats of things that happened 30 and 80 years ago does not seem very valuable to me. Charting/TA/stats "works" because it represent the emotions/psychology/be... of market participants. In "normal" times it seems likely that those human traits recur frequently and hence looking at the charts might be somewhat helpful to traders. However, I'm fairly sure the emotions/psychology/be... of market participants is different today than it was 30 and 80 years ago.

For example, the perceived reason for the drop was different each time, the government's reaction to market drops was different in each case, the pace of information flow is very different, the world is a smaller place today, demographics are different, etc.. Factors such as this will cause market participants to react emotionally/psychologi... differently than in the past. Hence their behavior will be different and the chart will be different.

Your last analogy of a major storm is interesting. I would add that if the house is old and big when the big storm wrecks your house...you are less likely to build it backup.. If it is new and small ...it gets rebuilt...maybe even better than before. The demographics of investors in the US is older now. They may not have the energy/desire/time..to rebuild the house. The demographics of many emerging markets is smaller and younger....they may rebuild a new/better house.....so I'd continue to look outside the US for opportunities.

Aug 25 10:43 PM

[thiazole:]

Most of those statistics aren't much worse than 1974 and some are actually better. 5% quarterly +6% quarterly does NOT equal 11% yearly - it equals 1/4 of 5% + 1/4 of 6% = less than 3%. In 1974, the declines in GDP were actually worse than that. If you added the quarterly GDP growth like you did for this recession, they would add to -12.5% from Q1 1974 to Q1 1975.

Also, you have $3 trillion working against a meager $1.35 trillion of goods on the shelves: research.stlouisfed.or... The bears always forget that inventories are shrinking and continue to shrink at an alarming pace. How do you rebuild inventories without hiring a bunch of people and making significant contributions to the GDP? Our biggest risk over the next year is that we have shortages and rampant inflation.
75% of our economy is based on consumer spending? So what. These numbers are constantly changing as the economy evolves. These numbers were much lower just 10 years ago, yet the economy was just fine. It is a flaw to assume that consumer spending must continue to grow as a % of the economy or the economy will parish.


On Aug 25 04:16 PM greenshoots4everyone wrote:

> thiazole,
> Corporate earnings had the biggest collapse in US history in 2008,
> not even close to what happened in 1929.
>
> We are in the midst of the biggest credit deleveraging the world
> has ever seen. In the 1930s, there were virtually no such thing as
> consumer credit.
>
> This is nothing like 1974, in fact, there is nothing like this in
> history. 90% drop in corporate profits, 30% drop in housing prices,
> 100% rise in unemployment rate. And GDP went from 5% to negative
> 6%, a 11% net change which is much worse then 1974.
>
> 75% of this economy is based on consumer spending, and consumer spending
> is falling off a cliff as the past 10 years of credit nonsense unwinds.
>
>
> Thus, I don't know how can you rule out any possible scenerio at
> this time. Once the $3 trillion of government liquidity stops holding
> up the market, then what?

Aug 26 10:20 AM

[thiazole:]

Just because you don't understand those things, doesn't mean they are magic. If we strip down supply, we eventually have to remanufacture those goods. Derivatives and futures and trading programs and any other red herrings that you can think of won't change that simply reality.


On Aug 25 04:21 PM greenshoots4everyone wrote:

> And you simply cannot compare market behavior to behaviors 30 or
> 80 years ago. This market is nothing like those time periods. Today
> we have trillions in derivatives and futures, program trading, algorithms,
> hyper trading, exchange arbitrage, etc. None of which even existed
> back then. This market is completely in control by technology and
> factors MUCH more powerful then simply supply/demand.
>
> Example: If State Street or Goldman Sachs decides to unwind its $30
> billion dollar SPX futures position, this market will collapse regardless
> of supply or regardless of technicals. Or vice versa.
>
> Another reason past comparisons simply do not seem relevant.

Aug 26 10:23 AM