How Bad Is the Bear? A Technical Look at Current Dow Trading

After spotting this headline on MarketWatch.com, I was struck by the phrase "short and shallow recession priced into the market". It seems to me that equities have been hit quite hard since peaking in October 2007, nothing short and shallow about it. So I wanted to see how bad the current decline is in an historical context, and where the market currently stands to get a sense of some potential expectations.

With a short and shallow recession priced into the market, investors eye the beginning of earnings season with some concern. And they have good reason: A number of analysts say 2008 profit expectations are too high.

I use the Dow Industrials to express and trade my directional opinion for equities in general, and while certainly limited in its breadth, it does offer some very good historical context. I have put together a table of the Dow going back 90 years (1920), using monthly data from TradeStation. I have used the following criteria to measure market declines; 1. The point decline and length (time in years) from a new record high in the DOW using an intra-month high to intra-month low; 2. The length (time in years) it has taken the Dow to set a new record high from a bear market low.

I have attempted to capture all declines greater than -10%, and have come up with 22 occurrences. In summary: on average, bear markets (high to low) have cost the Dow Industrials -24.21%, over a .83 year period. It takes an average of 2.21 years for the market to make a new record high (low to new record high). The median data is quite a bit tighter, showing a total decline of -18.04% during a .26 year period, with a total recovery time of .51 years.

click to enlarge

So where are we now? Since peaking at 14,198 in October 2007, the Dow has hit a low of 11,634 in January of this year, recording a loss of -18.05% over a .26 year period. What is really fascinating here is that the current bear market, as measured by this table, shows the current decline dead center of the historical sample. The Dow is currently ranked 11th in terms of its worst total loss, and tied for 10th for length of time in a bear market.

Therefore, I would argue there is the potential for the market to have already found its bottom, and will highlight a monthly chart of the Dow Industrials to show how this data dovetails nicely with a traditional technical outlook. Based on the attached monthly chart, I have argued that the current decline is a re-test of the 2000 high of 11,749 following the October 2006 breakout through this level. This support area coincides with the rising 40-month moving average, 11,804, and should be critical support to monitor going forward.

If the market can hold the recent lows and this long term moving average, then we should see the market recover, with the potential for new record highs for the Dow into the latter part of the year. The top of the 1995 channel is now at 15,526. Conversely, if the current recovery fails to hold, and we break to new lows on the year, then yes: the headline above is correct and the recession is much deeper than is what is already priced in. If the 11,634 low falls, get yourself braced for a test of the low end of the channel, coming in this month at 9,623.

Disclosure: Long

Comments

[User 143167]

Excluding those "bear" markets in the period without a recession and re-do your work, then you will find much worse Mean and Media numbers to swallow.

[JimHawthorne]

Interesting, indeed!
Do you note the neat 'head & shoulders' formation over the last couple of years, complete with double-top, coupled with the fact that any real or imagined testing of the 2000 highs as support is far from complete?
I also see an emerging pattern of lower highs and lows!
Your argument isn't compelling... even if I do hope you're right in the end!

[galewhitaker]

Roman
History is a great teacher. I think "things are different this time". Never before in history have energy prices been this expensive in relation to the incomes of the average worker. The prices of all the items we treasure (including food) are a function of the price of light sweet crude. Please read the "peak oil" blogs. The price of oil is nerver going to retreat because of the demand that is emerging from China and India and because oil is getting scarcer everyday. I think its possible that equities are worth far less in a world where oil costs $100 or more.

[irondoor91]

Oil will probably remain high priced in terms of dollars, but when the big unwind finally gets here and deflationary forces take hold, demand for all things oil-based will fall along with the price of everything else on this planet, and that includes the last and final inflatable, the commodities bubble. No more stock bubbles, no more real estate bubbles, no more derivatives bubbles. Why? No more liquidity available and thus no more leverage.