Are We Seeing a Bogus Dip?

Many traders are engaged in backfitting the current rally, comparing to selected past performance.

What if the starting point is wrong?

In an interview with CNBC, James Paulsen suggests that the March selloff was a false starting point for measuring the current rally. He has an interesting argument, making the following points:

• We are early in the recovery from a recession (thirty days). Rallies do not stop this soon.
• The March low was a "false bottom" based upon a run on the bank stocks, something that proved to be false.
• The "alternative bottom" was 850 in the S&P 500. This was the low in February and April. Viewed from this viewpoint, people would see a "ten month bottom and we are just starting to recover."

The Paulsen viewpoint is completely consistent with our prior articles on dubious backfitting of data. It deserves consideration.

Related Notes

We also note the vigorous debate on interpreting September, led by Tadas Viskanta at Abnormal Returns. We are delighted to see the thoughtful articles at this site, an important addition to the valuable daily links. (We also appreciate the mention!)

The interpretation of September has much to do with the current rally. Many expect September selling since we have moved so far. The Paulsen piece is a valuable addition to this debate.

There is also many current assertions about market valuation. This is a key to interpreting the rally, an important topic for another day.

Comments

[C.S. Jefferson:]

There were two potential bottoms in the markets. The crash of 2008--which I contend was the real bottom--and the index low of March 2009, whereby approximately 40% of the underlying S&P 500 was higher despite the average telling a different story.

If anything, March may have been the retest that everyone seems to be anticipating now. It may, as a contrarian, be the reason this market can drive much higher from here! Or, at minimum, not sell off as so many doom and gloomers are predicting day after day--regardless, you have to pay to stay in the game and that means purchasing insurance against long investment themes,

It's just an opinion, but I wrote about this earlier which, if interested, you can refer to my blog

Sep 04 03:42 AM

[DaMamba:]

Why are you calling the bottom of march a retest? Is it possible that you just want to explain to yourself that your predictions are right? Since when do bottoms not count as bottoms when they were caused by runs on bank stocks?I think every major bottom in the stock market is caused by an extreme in psychology of investors.That this time the extreme was the fear of the financial system collapsing doesnt make the bottom any less real.

Sep 04 04:35 AM

[Roger Knights:]

I didn't expect the Nov. low to be broken until much later than it was, although I was very bearish at year-end. Instead, I thought the 2009 market would decline by about 5% per month for many months. So the idea that the March low should be adjusted upward, because its excessiveness didn't mirror the real heart of the market, is defensibly creative thinking by Paulsen. It's an ingenious defense of the bullish case.

Here's the most ingenious / creative / satanic case for bearishness, from an Aug. 24 SA article: seekingalpha.com/artic...

Sep 04 05:14 AM

[Tom Armistead:]

Because unemplyment was equally high back in 1982, I did some pattern fitting for that time period to the March lows. That suggests there might be another 10% or more advance before a real correction. Fundamentals were probably stronger back then.

Good article, I like Paulson's argument. Graphing things long term, using quarterly data, if you insert 3/9 into the data you get a "Y" shaped bottom.

Sep 04 05:56 AM

[enigmaman:]

there are many people who think they do know , very few who say they are sure they know and fewer yet willing to bet everything that they do know, so all we are left with are "definitely maybes" and then when we finally all know, there will be plenty coming forward to say "I told you so" but none of them are so sure now that they will not hedge their bets, so what good is any of what they have to say today

Sep 04 08:33 AM

[Fabien Hug:]

The extreme level of government intervention and the very loose monetary policy before and after this crisis make comparisons impossible. Many say that Bernanke saved us from another great depression. I think that happened in 2001, particularly after 9-11. Now, we are in unchartered territories but still can rely upon the fact that loose monetary policies and government stimuli will keep going. You can trust them with that. I did when Bernanke said; "I will do whatever it takes"... Will it work is a question for much later because the whole world is following. It will take more than comparisons and ethics to stop that train.

Sep 04 09:19 AM

[enigmaman:]

Bernanke monetary medicine has worked but for how much longer, sooner or later the strategy will produce diminishing returns, if we are not out of the woods by then, what will he have left to throw at the economy to stop it from back sliding, it like when people try to save a beached whale, it beached itself for a reason and in 99% of the time nothing anybody does to try and save it works, push them back into the water, hold them up but as soon as you let them go it beaches itself again and soon dies, I beleive the ecoinomy is going to work the same way, it wont dioe but it will be in the ICU for a long while with the bills adding up and it coming due


On Sep 04 09:19 AM Fabien Hug wrote:

> The extreme level of government intervention and the very loose monetary
> policy before and after this crisis make comparisons impossible.
> Many say that Bernanke saved us from another great depression. I
> think that happened in 2001, particularly after 9-11. Now, we are
> in unchartered territories but still can rely upon the fact that
> loose monetary policies and government stimuli will keep going. You
> can trust them with that. I did when Bernanke said; "I will do whatever
> it takes"... Will it work is a question for much later because the
> whole world is following. It will take more than comparisons and
> ethics to stop that train.

Sep 04 09:46 AM

[Tony Petroski:]

I agree with some of the thrust of the article as well as several commenters (even if they appear to be opposing each other). The annual daily chart of the S@P is ugly, but you have a very sharp V-shaped bottom starting roughly around Feb. 1 and ending mid-March. The movement isn't organic, if that's the right word. It has an artificial or manipulated feel as there was a panic that the government was going to take over the banks resulting in a final sell-off (for now?) of the banks and everything else followed by a rapid rise as cooler heads prevailed.

I agree with an earlier commenter that just because the slide was caused by a temporary panic and not a more fundamental reason does not negate the fact that it was a low and a bottom. On the other hand, how many participated in that action either on the sell side or the buy side, and if you "color in" the bottom of that V you get a level of about 775-800 on the S@P and perhaps a rise of 25% on the S@P for many more market participants.

Translation for the bulls: Let the good times roll.

Tom Armistead wrote: "Because unemplyment was equally high back in 1982, I did some pattern fitting for that time period to the March lows. That suggests there might be another 10% or more advance before a real correction. Fundamentals were probably stronger back then.

I agree with Tom that the early '80's with the unemployment rate of over 10% is a good place to look for comparisons. Tom, your "Fundamentals were probably stronger back then" is an understatement to say the least. We were coming off the Carter malaise period of stagflation. Voelker was wringing out inflation with higher interest rates and much of the pain was over by then, and the Kemp-Roth tax cuts were already in place albeit intentionally delayed over a three-year period in order to allow the Democratic Congress to squash them if they could. They couldn't and the rest is history.

On that timeline, we are in the early days of the Carter period with inflation and higher interest rates to come, much pain yet to endure, and perhaps a higher unemployment rate than in the early '80's unless working for the government sops up several percent.

Sep 04 11:37 AM

[sickofthehype:]

It's all quite simple actually.

Too many are calling for this sell-off and for this retest of lows in March.

As we all know when you hear the herd preaching, they're always wrong. Higher it is.

Not to say this won't end badly, because it will - but I believe we have a window of opportunity at hand

Sep 04 11:59 AM

[GMak:]

I like this topic - "What if the starting point is wrong" OR should I say "What if the Morality is Wrong"...

I only believe in fundamental. That is what I was taught in college.

If I say the last bull market started in the early-90s when the tech/internet bubble took off and the market raked up 3-plus times return until Y2K. After the tech bubble finally burst, Mr. Greenspan decided to lower interest rates enough to expand the housing bubble instead. I supposed we all still remember how many junk mails begging you to claim (not apply, claim!) your credit prizes because your house had gone up 3x within six years. I remember my neighbor spent over $140k (from the house ATM, of course) on a BMW and a Mercedes. BAC went from $14 to $48 in seven short years; Countrywide doubling every year; mortgage brokers taking clients to French Laundry and Per Se. All these signs were telling me the party was about to be over because my grandfather told me what people did in the early 70's.

I really wish investors can wake up and look at the bigger picture. What is better for the next few generations? Who is responsible for paying back those $Trillions? GS is making $200MM a day, CEOs are soon to rake hundreds of millions dollars of bonus from "restoring share prices". People asked me if I was jealous seeing these mortgage bankers and investment bankers making the millions. What good is it if they build their wealth on all these foreclosed homeowners and the poor retirees. I remember very clear, swine flu was on the front page for less than a week; Ken Lewis/John Thain got more headlines than a pandemic which affects hundreds of millions of people (Come on, media!) Last but not least, Our own government "hire" these thieves to rob us.

It may be inappropriate to express my personal perspective in this blog, but at least I feel much better now.

Sep 04 12:19 PM

[Chris Butler_:]

Curve fitting. That's all Paulsen is doing. I can't believe such weak logic has enabled this man to stay in his profession for as long as it has.

His first point about how, historically, rallies do not end after 30 days is absurd. "Real estate never goes down on a national scale." Historicism is dangerous when applied to markets. The market does not care what happened in each of the last 20 recessions. You know what kind of rally ends after 30 days? A 30-day rally.

His second point is essentially don't count the March low because it was caused by a bank run. Absurd again. Since when have technicians assessed the cause of market bottoms and thrown some out because, well, that hardly ever happens. Please. Feel free to revise history if you'd like, but stay away from my money.

Finally, the whole notion of an "alternative bottom," aside from begging for a punchline, is pertinent only to those living in an "alternative reality." The reality in which I dwell and invest makes tops and bottoms that can be verified through the passage of time and they can bee seen with a naked eye on a chart.

For those of you that buy the "alternative bottom" thesis, perhaps you should have "alternatively sold" at the "alternative top" in the S&P 500 yesterday. What? You don't remember when the S&P 500 soared to 2,000? Oh. Maybe that was just *my* alternative reality. My bad.

Sep 04 12:31 PM