History Favors the Bulls

by: Chris Ciovacco

Global stock markets remain in a state of positive fundamental and technical alignment. In this article, we will explore:

  • Positive drivers for GDP and the end of the recession
  • A historically significant turn in the S&P 500’s 200-day SMA
  • Corrections within the context of a bull market

Improving Fundamentals

On Thursday, leading economic indicators (LEIs) posted their the fourth consecutive monthly gain. Global LEIs recently posted their biggest monthly gain since 1975. Going forward, low earnings expectations (relative to the prior year), which we have now, often result in positive earnings surprises as we leave a recession.

Strong Technicals and Historical Support (1929-2009)

In an August 3, 2009 Seeking Alpha article, New Bullish Signals Emerge, we suggested that it was significant when the slope of the S&P 500’s 200 day moving average turned up on July 29th. In order to better understand how significant the turn in the 200-day might be, we studied market history going back to 1929.

The recent bear market took 517 calendar days to unfold (Oct 2007-Mar 2009) and resulted in a 58% decline in the S&P 500 Index. In order to make a realistic comparison to the events of 2007-2009, we looked for historical bear markets (1929-2003) with large percentage declines (>35%) that took at least 515 calendar days to unfold from peak to trough. Five cases meet the criteria since 1929; following the lows in 1932, 1942, 1970, 1974, and 2002. The study looked at the Dow (1929-1950) and the S&P 500 (1950-2009).

The composite graph below is the average path of the five cases cited after the 200-day moving average turned up, NOT from the market bottom. The chart below assumes you "missed the bottom" and bought when the 200-day turned up. In 2009, the 200-day moving average turned up on July 29th when the S&P 500 was trading at 975, which is represented hypothetically by Point A below. If the market follows the historical composite, Point B hypothetically would occur in the fall of 2010.

Chart 1 shows the composite performance 315 trading days after the 200-day moving average turned up in the Dow or S&P 500 following bear market declines of 35% or more (1932, 1942, 1970, 1974, and 2002).

In order to review bear markets similar to our recent experience, we looked at prior declines lasting at least 515 calendar days. More detailed information concerning this study and the transition from a bear to a bull can be found in Evidence of New Bull Markets & Favored Asset Classes, which is available for download in PDF format.

Positive GDPs Numbers on the Way?

Weekly jobless claims can help us possibly spot the end of a recession. Initial claims peaked in the first quarter of this year and have since declined significantly. Businesses reduced inventories at a record pace in the last two quarters. Rebuilding of inventories in the coming quarters will add to GDP. Car and truck sales were hit hard during the recession. Increased sales helped by the clunkers program will also be a positive for GDP.

Government spending, one of the few bright spots in GDP in recent quarters, should continue as planned stimulus spending hits a high water mark in 2010. Housing has been a negative component of GDP for numerous quarters. Recent data suggests housing’s drag on GDP should lessen or even become additive in future quarters. From a historical standpoint, steep economic downturns are usually followed by better than expected recoveries. The recent financial meltdown certainly qualifies as a steep downturn.

Corrections Are a Part of All Bull Markets

When corrections are in full swing, it always makes sense to review the big picture. We have covered the topics below numerous times in the past, but we will do so again because they remain important and they can help us deal with our biggest enemy – our emotions. The concepts below are far from the only way to make buy and sell decisions, but they do serve as a big picture framework to help us make better calls during corrections. The final chart will show the state of the current financial landscape within the context of the rules.

Click on charts and tables to view larger versions.

In recent weeks, we have been experiencing volatility within the context of a bull market, just like the red circles above. The table below shows the state of the markets relative to the concepts presented above as of August 19, 2009. Asset class behavior since the March 2009 lows has followed the historical script very closely (we have seen what you would expect to see at the start of a new bull and the end of a recession, which historically supports further gains).

The chart above can help us control our fear and avoid making emotional decisions. The results support erring on the side of holding as long as bull market conditions exist (as they do today). If conditions change, we will adjust accordingly. Until they do, we will remain in the mindset of longer-term investing.

The evidence continues to support higher stock prices in the months ahead. There is no compelling reason to believe recent corrections have been anything more than that - normal corrections (see red circles in chart above) within a bull market.

Above are excerpts taken from the August 2009 - Asset Class Outlook, which is available for download.

Disclosure: The author and CCM clients have numerous positions, including exposure to U.S. tech stocks, foreign currencies (long and short), emerging market stocks, foreign bonds, and commodities.