Interesting Times: From 40% Below the 200 Day Moving Average to 20% Above

We've seen some remarkable things the past few years, both in the economy and in the markets. Much of what one has learned could be thrown out the window; I'd contend in much of these times someone with 10,000 days of experience in the markets has little advantage over someone with 1 day. Yet another quite amazing statistic below via BeSpoke blog.

Long(er) time readers will know back in October 2008 and literally by the day in late February/early March 2009 I was detailing how historic the "rubber band" of the market had been pulled back from its key long term moving average: the 200 day. [August 29, 2009: March 6, 2009 - Generational Bottom? What was Fund My Mutual Fund Saying] For those who were not around, the theory here was simply the farther we get from the "normal" (or trend) the more vicious the snap back.

When September/October 2008 hit, I mentioned how rare it would be to see the S&P 500 fall 30% from the 200 day moving average. Even in the crash of 1987 that had not happened. Even during the worst of 2002 (and if you did not live it, you would not understand it - it was Chinese water torture; no offense to Chinese water) it did not happen; although it was close.

So using any sort of "probability factor" ... as bad as fall 2008 was, we were attempting to get long to some degree as the market swooned using history as our guide once we became very oversold - i.e. mid to upper 20% away from the 200 day moving average. But of course we had the epic week in October 2008 when the markets lost 20% in 5 sessions; effectively repeating the 1 day disaster that was October 19, 1987 but over a handful of sessions. Yet we STILL did not stop going down. Not until something akin to 38% below the 200 day moving average did the rubber band snap back... that was the "Obama/Geithner will save us" rally that took us into early January 2009.

And then the next epic swoon began... so I sat there again using history, but this time instead of using a high 20%/30% level of pullback as my guide, I was using fall 2008. Going into the week where we ultimately bottomed, we were down 32% versus the 200 day moving average. In any other time in the last few decades, this would be unheard of - but we had just done it a few months earlier. And lower, and lower, and lower we went - until we breached (temporarily) the 38% level and actually hit near 40% below the 200 day average. We were making new history - so soon after we just made it. So we experienced 2 sell offs, the type of which anyone with a few decades of experience had never encountered.


From there? It's been straight up... and now we have the type of rally those of us in the markets the past few decades have never encountered. Even in the bubble of 1999/early 2000 (in which more of the animal spirits were on NASDAQ rather than the S&P 500) the S&P 500 did not reach the 'overbought' level it is now; 20% over the S&P 500. Nor did the furious 2003 rally from the hellacious year that was 2002. We only have had a few episodes in these 25+ years where we reached this high over the 200 day moving average, and none of them came directly off historic oversold levels.

So once more here we sit at an extreme, but in complete contrast to what happened in fall 2008 and winter 2009. Extremes on both ends; and back to back. As I wrote yesterday, it is difficult simply to find any individual stock stuck below its 200 day moving average [78 Stocks Below the 200 Day Moving Average] We are extremely overbought on this basis, but that does not mean we cannot make new records. We learned that just half a year ago - and now we have a government and central bank trying to push us in the "right direction". But if you play probabilities - you need to start marking notes. Because when it snaps, we can expect the rubber hand to inflict pain - just as it did on the other side.

If you are struggling in this market, don't feel bad. You are living historic moment after historic moment.... first in the economy, and now in the market - with a lot of "strange forces" [IMO] working behind the scenes. If on the other hand you are doing well as you ignore all precedent, congrats on that. As I said, someone who has 1 day of experience nowadays probably has as much chance to prosper as someone with many years. Precedent has become useless. Anyone betting on moving from the greatest oversold condition of the past 25 years not 7 months ago, to matching the greatest overbought condition, is someone whose trading journal I'd like to review (specifically his/her thoughts in March and April 09). It's one thing to move from extreme oversold to "not oversold", but quite another to go directly from maximum oversold to maximum overbought with nary a break in between.

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2 amazing statistics to leave you with:

#1 It took over 2.75 years to rally 60% from the October 2002 lows... we did not see a 60% gain until July 2005. We've repeated that performance in less than 6.5 months in 2009.

#2 If the market rallies at the same pace in the future as it has the past 6.5 months, the market will surpass all time highs by February 2010. All time high on S&P 500 is 1565. If we repeat the same 60% gain of the past 6.5 months in the next 6.5 months (taking us to March 31st, 2010) we'd be at S&P 1715. Boo Yah.

Comments

[predictorma...:]

At what point do fundamentals take hold? I feel this rally is all about money managers needing to beat averages. A major event (remember what the Bhutto assassination did Dec 07?) could really have an effect.

When everyone runs for the doors (a lesson learned in 2008- run early) it could be very scary.

I cannot decide whether to jump back in or not. I feel like I'm at the grocery store, and wonder whether it makes sense to change lines or not, and whether I will regret it once I do.

Sep 18 08:36 AM

[Michael Clark:]

That's a very interesting chart.

One thing we keep forgetting. The Market and the Economy are not really linked. Oh, we hear and say they are. "Investors sold today over concerns that unemployment was gaining momentum..." This is a rational explanation of an irrational being, an emotional reaction to a myriad of related and unrelated events. The stock market is not rational. The stock market is a herd of emotions acting out their fears in great waves: (1) greed is the fear of missing out on profits -- panic buying; (2) fear of losing profits in a sell-off -- panic-selling. The rational part is how we 'talk' about our behavior, rationalize it. But the behavior is ALL emotion.

We can see this is this most recent stock rally. Reason suggests caution, given the picture many are seeing of limited possibilities of business expansion over the next decade. Spain, one of the worst-looking economies in the world, is rallying right next to all the other global markets. Why is Spain rallying right in lock-step with France, Germany, China, Taiwan? The herd doesn't want to miss out. The rational facade talks about price-earnings ratios, and debt-to-cash ratios, but the real rational investor often panics if HIS stock loses 10% in a pullback. He may not sell -- but that doesn't mean he's not panicking on the inside. And is his stock gains 15%, he is probably not thinking about the prospect his stock might be overvalued, but he is probably thinking about how rich he feels, what an intelligent man he is, to have made such a good play in the market.

The stock market is fueled by psychology and emotion. Reason is used to attempt to explain the emotional behavior (panic on the affirmative side or panic on the negative side).

Is the current market over-rally caused by ration, sober men viewing long-term probabilities of company earnings power over the next decade -- or is it: I'd better get mine before it's too late? There may be a little bit of the former; but I'd bet there is a lot more of the later. 'Frothy' -- isn't that the word for too much emotion sloshing around inside too little reason? A PE of 140 on the S&P 500 says some investors are getting a bit ahead of their qualitative reasoning.

Sep 18 10:02 AM

[Roger Knights:]

Boing ... Boing ... What will the Slinky do next?

(Great article after great article, BTW.)

Sep 18 10:04 AM

[Roger Knights:]

Boing ... Boing ... What will the Slinky do next?

(Great article after great article, BTW.)

Sep 18 10:04 AM

[igggy:]

I think with so much money on the sidelines the market will just keep drifting up. I will be buying the dips.

Sep 18 11:53 PM

[enigmaman:]

exactly the reason why past history, charts, theories etc are basically meaningless because none can predict the future with any certainty, only is best guess and then you have a better then 50/50 of being wrong. If this market does not correct to any big degree then the market pundits will keep this event handy to justify their future predictions and so we will have new way of looking at the market, clear as mud

Sep 19 06:31 AM

[Tom the Mon...:]

Interesting chart, comment and replies. Also can't help feeling markets are 'frothy' but I took a punt and recently bought a Nov 09 call option on the ASX 200 index. I always seem to have a mental wrestling match - attempting to reconcile where I think it will go (correction coming) to where I think all the other market participants will actually take the market. With great trepidation, I bet on momentum continuing a little longer.....partly because I just can't see a whole lot of stimulus being removed for a while yet. I suppose I secretly like the continuing 'tickle' that stimulus appears to be giving to the markets. On fundamentals I feel pretty nervous but 'nothing ventured, nothing gained.' I probably should have studied pysch at university.

Sep 20 10:50 PM