As you know, in recent months I have been tracking the S&P 500 index as it has descended into a classic “Bear Market” trade down that appears remarkably similar to the nearly 50% selloff that it experienced in the wake of the “dot-com” bust.But aside from technical similarities (that I will cover again in a later “Twin Peaks” post) I would like to share an interesting chart that I whipped up in an attempt to better reveal the trend and volatility inherent in the broad index and more importantly, the role volatility plays in signaling a bottom to a market selloff.
One important aspect to consider before delving into the chart is the true temperament of the bottoming process.
Reflecting a bit on markets and human nature, I believe that any real bottoming to the stock market must come with some significant struggle between market participants in an effort to establish value.
Unlike the current Wall Street consensus, I don’t believe that this struggle can take place in just a few trading days and further be founded on just a few key events, even substantial events such as the Bear Stearns debacle.
I see the market bottoming process as a prolonged and uncertain fight resulting in significant thrashing about, lasting at least as long as it takes to establish some “real” confidence about the outcome of the crisis that initially brought about the contraction.
In order to better visualize this market struggle I created two simple indices, one that plots the positive percent change of consecutive trading days and one that plots the negative.
So, for the “positive” index I add up the percent change on consecutive “up days” and if there is a “down day” the index goes back to 0.
For the negative index, on the other hand, I sum the percent change of consecutive “negative” “down days” and set it back to 0 if there is an “up day”.
Along with these indices I plot a 30 day moving average of each as well as the S&P 500 index itself.
This chart starts in 1969 and is simply huge (but loads well in the browser) so click the following to load it up and make sure it zooms in completely.
Notice, scrolling from left to right (1969 to today), that there have been six recessions in the U.S. since 1969 (indicated by the rectangular overlays) and that in general, the distribution of consecutive up and down days becomes more erratic and amplified during (and surrounding) the recessionary periods and noticeably more quite in-between.Notice also that between 1992 and 1996 there was fairly even and essentially quiet trading leading into the dot-com boom but then the trading became markedly more volatile, eventually leading to the crescendo of the dot-com peak.
After the peak was established in 2000, the volatility continued only to be amplified dramatically during 2002 to early 2003, the period that would ultimately establish the bottom of the market downturn.
Now, study the period between 2004 and the middle of 2007 which appears to show very low volatility somewhat similar to, if not even a bit more quiet than, the period that preceded the dot-com boom.
Today though, the volatility has reappeared but it’s important to note that it is very new and still fairly low.
So, my contention is simply that the S&P 500 has not bottomed as the REAL struggle has yet to even take place and given the truly immense nature of our latest crisis (housing, mortgage, credit and consumer), it is altogether likely that we will see a considerable amount of thrashing and volatility resulting in a prolonged trade down that will last at least until there is some “real” confidence established.
