Market Like 1987 Again?

With Thursday being a downside rout that closed near the low for the day, stocks normally see two way action during the next morning before the opportunity for a stronger move comes after lunch. When markets are in the throes of a decline and I would hesitate to call this a decline of significance at this point, many of us turn to history for price analogs. The crash of 1987 really began to unravel the week before which was options expiration week.

Downside momentum kept building from Wednesday’s open and Friday was a disaster. Stocks crashed on Monday as a confluence of events unfolded not limited to newly appointed Fed Chair,Alan Greenspan, raising rates too quickly, Treasury Secretary James Baker announcing that the U.S. would not defend the dollar and this new, cutting edge institutional risk management program called portfolio insurance which essentially sold more S&P 500 futures the lower stock prices went. And the lower stock prices went, the more contracts that were sold. It was a snowball or pile on effect, much like the Flash Crashes of 2010 and 2015. Anyway, I bring this up not because I think stocks are going to crash 20% on Monday. I don’t. It’s just an interesting tidbit which you may hear about in the media, especially from the gloom and doom crowd.

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Follow Up to Post Crash Behavior

Last week, I wrote a piece here and in Street$marts entitled, Post Crash Behavior Leading to Dow 20,000. If you haven’t read it, I think it’s a worthwhile read (of course I do since I wrote it!) whether you agree with the content or not. Subsequently, I was really excited to join CNBC’s Fast Money to discuss my research. A few things I want to add.

I used the word “crash” very liberally in my study. After “bubble”, crash is probably the most overused word in investing. True, historic stock market crashes typically only occur once in an investing lifetime. They are such emotional affairs and require years of setting up. It’s that perfect storm. We saw one in 1929 as well as 1987. The rest are really just large declines that accelerated like a crash. You can call them crashettes or mini crashes.

As Mark Twain said a “few” years ago, history rhymes, it doesn’t repeat. No two market environments or rallies or corrections are exactly alike. The market does its best to confound the masses most of the time. I remember in 1998 that the NASDAQ 100 actually went from its August mini crash when Russia defaulted on her debt, straight back to all-time highs in September, only to see another mini crash in October when Long-Term Capital blew up. The masses were generally hopping on board the tech train until the tech wreck hit a few weeks later.

If you look closely at my study, 2011 looks very similar to 1998 and 1987 for the most part, but not exactly. 1989, 1994, 1997 and 2010 are not highly alike although 1989 and 1997 are the most alike of the group. 2015’s price decline is similar to 2010.

In the end, it’s much healthier for the stock market to thrash around for 4-6 weeks and test the mettle of both bull and bear. That kind of constructive repair from all the damage done during the decline would set the market up for a potentially powerful fourth quarter rally. I would be very concerned if stocks just took off higher from here without looking back.

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Post Crash Behavior Leading to Dow 20,000

The day before Flash Crash II last week, I opined that the bottoming process could begin as early as last week. From my seat, it did. One week removed from the mini crash or crashette and stocks took it hard on the chin again. China was blamed, but that’s only a cover story and coincidence. However, unlike August 24, we did not see another Flash Crash. There was no panic. The selling was fairly orderly, which can be viewed as a good thing and a not so good thing. Volume was on the light side. Market internals were abhorrent.

In short, stocks are shaking out from mini crash type action according to history. Of all the declines since the bull market launched in 2009, including the 20% one in 2011, the current correction gives the bears the most ammunition to claim that a new bear market has started. But before you jump to conclusions, read on…

I remain steadfast that while the bull market may continue to be old, wrinkly and not exactly the pillar of health, it is nonetheless alive. That’s the same conclusion I have drawn during each and every decline since 2010. The final peak lies ahead of us and that’s very likely to be north of 20,000 on the Dow.

I know. I know. I am crazy.

Who in their right mind would forecast fresh all-time highs ahead, let alone Dow 20,000 with China imploding and global recession supposedly all but a certainty. And there is always a risk I am wrong, but I do love being in a camp by myself!

So getting back to the action since August 24, you can see a few different ways in light green arrows on the chart below on how this bottoming action may play out. I chose those paths by looking at other similar action. There weren’t many over the past 30 years where a bull market peak was so close. That was criteria number one. The bull market peak was within two months of the crash.

Defining the actual crash isn’t as easy. It’s easy to spot in hindsight and you can certainly feel it when it’s happening. It’s rapid downside acceleration without any intervening rallies that usually leads to a 3%+ down day at the end.

I am going to take you through each occurrence to compare and contrast starting with the most recent. The years will be listed on each chart along with the “crash”, one of the most overused words in investing lexicon, and then where the final bottom was before stocks took off again to the upside.

On the surface, 2011 and 2015 look very similar although the decline in 2011 was more damaging and deeper. It took roughly six weeks to bottom.

2010 is next. That’s where we saw the first Flash Crash which doesn’t seem all that bad on the surface. This week’s action looks very similar to the three day rally immediately after the Flash Crash. The final bottom was eight weeks later and at prices significantly below the crash, something very unusual.

1998 is next and that looks exactly like what we saw in 2011. In fact, I wrote an article after the crash in 2011 forecasting that the final bottom would be a mirror image of the 1998 decline. In both instances, the decline was more than 20% and the final bottom was six weeks after the crash.

1997 is below and that crash behavior doesn’t really behave like the rest. Stocks pulled back a little, but the crash was essentially a one day decline that was sharply reversed the very next day.

1994 is next and while the decline was not even 10%, the post crash action was very similar to most other periods. I marked the final bottom 11 weeks later because that was low from which stocks finally rallied, but you can certainly argue that it was right at the day of the crash.

1989 has some similarities to 1997 in that it was essentially a one day outlier decline based on the leveraged buyout craze imploding with takeovers in United and American Airlines falling apart with Donald Trump involved. The bottoming process was fairly quick and not very painful with the final bottom occurring roughly four weeks later.

Finally, the greatest crash of the modern investing era was seen in 1987. Similar to 9/11, most people remember where they were and what they thought as the day unfolded. I recall my father launching a new discount brokerage business that very day. While I thought the timing could not have been worse, he often said that it was perfect since none of his clients lost any money on that day as there were no clients yet!

As with most of the other crash periods, the final bottom was seen some weeks later, six in this case.

Crashes, mini crashes, crashettes are all very emotional events. The most panic is typically seen during the crash when the market makes its internal or momentum low. There is usually a rally and subsequent final bottom some weeks later. The only caveat I will add is that the more pervasive the sentiment towards this behavior, the more the market will morph and confound the masses.

As always, please do not hesitate to contact me directly by hitting reply to this email or by calling the office at 203.389.3553.

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Bulls Hanging On…

Here is yesterday’s segment from CNBC’s Closing Bell. http://www.investfortomorrow.com/InMedia.asp

We have month and quarter end on Thursday so I would discount any unusual action until the new month begins next week. The bulls are hanging in, trying to push the S&P 500 to an all time high and I think that should be seen since it’s only a few points away here. But my comments from the other day still hold. I see the Dow’s potential upside as 15,100 and the downside as 13,700. There are enough cracks to warrant action, but not enough to worry about the bull market ending.

So far, 2013 looks a lot like how 2012 and 2011 began. And for those who remember, this has the look and feel of 1987 for different reasons although I am definitely NOT calling for a crash!

Enjoy the holiday shortened week for those of us who have it off! I think Good Friday is the only day where Wall Street is closed but not much else is.

Again, Happy Passover and Easter for those who observe those holidays!

Paul

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