So Far, 2012 Is Eerily Similar To 1987

Includes: DIA, QQQ, SPY
by: Zvi Bar

Over the past few weeks, the broad market has become generally weak, after starting off the year by making some impressive gains. Since the start of May, the S&P 500 (NYSEARCA:SPY) is down 7.35 percent. Nonetheless, the benchmark index is still up about three percent since the start of 2012.

Individuals may now wonder what will happen from here. Experts differ on whether the sell in May theory is legitimate over the long-term, but this year, selling the benchmark on May 1 would have locked in an 11.79 percent gain. See the Year-to-May-Day chart:(click charts to enlarge)

Issues can take the market in either direction. There is a decent chance Greece will exit the euro. Of course, there have been several such opportunities for Greece to exit it over the last three years. Additionally, it is not just Greece at stake, but also several subsequent European nations with debt issues, including Spain, Portugal, Italy and Ireland, among others, and further monetary easing is just as probable as an exiting sovereign. Other risk exist in the market, including continued Asian cooling, U.S. fiscal policy uncertainty and conflicts with Iran.

Again, experts differ on selling in May, and pretty much everyone who has a theory or system like that will admit that the system does not always work, but that it often works or works often enough. Moreover, whether or not it was a good idea to sell is somewhat irrelevant now, as you either did or you did not, and in either case you really only need to consider were the benchmark may be going next.

While history is often irrelevant, the recent history has certainly been volatile, and may yield some indication of what may come next. 2012 started off with one of the best historic January performances, with the S&P 500 gaining over 5 percent in the first month of the year. February was an equally strong month, with significant range-bound volatility hitting the market throughout March, April and thus far into May.

See a recent performance chart for the S&P 500:

This chart looks eerily similar to the same period at the end of 1986 and going into 1987. See the 1987 chart, below:

While the two are not mirror images of one another, the general pattern is close and consistent, both overall and on a per-month basis.

The larger benchmark ETFs, such as the Powershares QQQ (NASDAQ:QQQ), SPDR DJIA (NYSEARCA:DIA) and, of course, the SPDR S&P 500 (SPY), all have fairly similar chart patterns, due to the relatively high correlation amongst stocks lately. See the ETF comparison chart, below:

The tech heavy QQQ has outperformed the two broader benchmark-based ETFs. Much of the market's 2012 strength has been based upon the strength of the technology and financial sectors, both of which have recently corrected downward.

This recent decline is visible in high volume large-cap stocks such as Apple (NASDAQ:AAPL) and Bank of America (NYSE:BAC), both of which had initially appreciated far more than the market and subsequently declined considerably. JPMorgan (NYSE:JPM) also had a highly comparable chart, showing that the bank's recent hedging error occurred at a point of probable technical and/or psychological weakness for the market. On the contrary, bellwether Pfizer (NYSE:PFE) did not so noticeably benefit from in this broader market appreciation. See a 2012-to-date comparison chart for these four large caps:

Moreover, with its lower correlation to the broader market, PFE has not declined substantially over the last month, like these other large caps and the benchmark ETFs: See a 1-month equity comparison chart:

Correlations are high, and the last time broad market correlations were so high was in 1987. All of this is somewhat alarming because 1987 also included one of the market's most substantial short-term declines, when Black Monday occurred on October 19, 1987. The chart, below, shows the S&P 500 from mid-May through mid-December of 1987.

If the first half of this year is so similar to 1987, might the second half also contain similar characteristics and features? Black Monday aside, another noteworthy point that may not be so visible on the chart of the second half of 1987 is that the market actually appreciated by about 20 percent over the next three months, before stalling in September and then crashing in October. Those three months would have made a good year. See the May 20, 1987, to August 20, 1987, S&P 500 performance chart:

If the 2012 chart will continue to track the 1987 chart, then the market would have to appreciate over the coming two to three months. In mid-May of 1987, or exactly 25 years ago, Apple would have been a good short-term buy, having appreciated by over 40 percent in three months, and also a good long-term hold. Nonetheless, those gains were wiped out in Black Monday. Conversely, JPMorgan underperformed the market in advance of the crash: See the comparison chart below:

Similarly, JPM underperformed the broader market following the Black Monday decline, while Apple rebounded more quickly during the fourth quarter of 2012. See the follow-up chart:

As to the precise cause of the 1987 crash, opinions differ. The most popular explanation is selling by program traders, performing rapid stock executions based on external inputs, such as the price of related securities. This argument presumes that a series of events can cause computerized trading systems to all continuously sell, thereby driving down prices.

Another popular theory for the cause of the 1987 crash is that a dispute in monetary policy between the G7 nations, where the United States tightened policy faster than the Europeans, developed confidence issues across all currencies, and a crisis culminated when the Hong Kong market fell. Alternatively, the diverging policies may have caused increased risk among interest-rate sensitive equities, which in turn affected the broader stock market. There was also an issue regarding aggression between the U.S. and Iran, and on Black Monday, two U.S. warships shelled an Iranian oil platform in the Persian Gulf in response to a prior missile attack.

Whether the 1987 crash was caused by proprietary computerized trading, conflicting U.S. and European monetary policy issues, interest rate changes, an Asian crash or aggression in the Persian Gulf, these most commonly accepted causes are the very same fears that now plague the 2012 markets.

What is also rather interesting and somewhat coincidental is what Apple was marketing in 1987. Twenty-five years ago, Apple was claiming that internet usage was going to become as simple and common as using a phone, with integrated tools existing for learning, creating and collaborating. Apple also promoted future products that included interactive touch-screen tablets and an interactive computer-assistance program that is analogous to Siri, known as the Knowledge Navigator. Perhaps the promise of these future products and services helped Apple's 1987, and the actual delivery of them is helping its present.

Disclosure: I am long BAC.