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Macro Economic Trends and Risks
Bear Market - An Historical Perspective

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By Pituophis
July 15, 2008

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On "Predicting"

There's been a lot of talk about bear markets and bottoms and predictions about what should or should not happen. I may have been overly pedantic earlier when i said we shouldn't try to predict, just react -- I suppose you could say that every time we make any kind of "investment" (I usually use the term "bet"), we are trying to predict the future. When I'm trying to "predict" what is about to happen I spend a lot of time looking at what HAS happened. People subscribe to different indicators to predict turning points, but what they're all doing is using the past to predict the future. What I mean by that is that when someone says we're near a bottom because the VIX is over 30 or the RSI is under 30 or Alpha Centauri is in Aquarius, what they are really saying is: "historically when this thing happened, this other thing usually followed."

What IS, Not What We Want It to Be

But looking at the past can be tricky too. I think where people go wrong with that is when they look for time period in the past that is similar to what they WANT to happen in the future. For example, a couple of months ago we had the largest single day move in the Dow that we'd had in five years and someone posted that the last time this happened was in October 2002, which of course had marked the bottom of that bear market. Could have happened. He had the right idea and he was looking close to the right place. At the time, I replied that if he looked back just a little further, to July of 2002, he would have seen a one day rally that percentage-wise was nearly double the current one, followed by a one month rally that saw the S&P 500 rise nearly 20%...and yet three months later the SPX would hit a new low. I didn't mean to say that he was wrong and I was right (though it did turn out that way -:), just that he should expand his horizons and look harder for some chart action that more closely mimics the current situation, rather than looking for some past action that if repeated would be positive for his portfolio.

The End and the Beginning of the Last Bear Market

I and others have posted about that July 2002 to March 2003 time period a number of times because of the similarities to some current market conditions and behaviors. For instance, it was the last time we've seen such large single day moves and the last time we've seen such oversold conditions. I think one simple reason that that time period keeps coming up is because we tend to look backward until we find what we are looking for and that is the first time period we come to. BUT, it has occurred to me that it really might be more informative to look at the last big top, in March 2000 and look forward. So I did that, and I believe there may be some helpful lessons there.

Is This Bear Weaker Than "Expected"?

DocO made some comments in a recent thread about the strength of this bear market being "less than expected." I didn't get that at all. As I said in that thread, it's pretty darn close to what I expected. And here's why: We are nine months from the November top in the SPX and we are down 22.3%. In December 2000, approximately nine months from the March 2000 top of 1553, a temporary bottom was put in at 1254.07, a mere 19.3% from the top (http://tinyurl.com/5mtbhu). This temporary bottom was immediately followed by a one-month rally that saw the SPX rise 10.2%. Of course the bottom bottom would not be put in until nearly two years later. I think we all remember the 2000-2002 bear market as a pretty vicious affair. But so far this one is worse. It doesn't make sense and it could lead to some poor investment decisions to "predict" that this bear market will unfold much more quickly than it has.

Oh, and the VIX, at that temporary bottom in December 2000 -- just 31.74. (http://tinyurl.com/57hd7y).
And the RSI for SPX during the whole selloff in November and December 2000 -- never went below 30.

One More Look at VIX and Oscillators -- Bottoms, bottoms, everywhere...

I imagine that most of your eyes are glazed over by now if you're still with me, but before I close I think I need to share a look I took at the Nasdaq -- after all, that bear market was more than anything else a tech selloff, whereas this time tech has been relatively stronger. Anyway, fast forward a couple of months to February 2001 (http://tinyurl.com/5rm3qv). This illustrates how hard it might be to call a bottom based on the VIX and oscillators such as RSI during a bear market. The Nasdaq stayed oversold without a significant bounce from the middle of February until the first week of April 2001 -- the RSI didn't rise above 40 and hit 30 and over and over and over but still didn't bounce. And by the middle of February when the RSI first started indicating extreme oversold conditions, the VIX was only 20.27. During this leg of this selloff which went from 2892 to 1620 or 44%, the VIX peaked at 34.72, but six points of that came on the day of the intermediate term bottom.
---During severe selloffs the VIX has sometimes not risen much higher than it is now...so maybe this IS the bottom
--And indexes can stay "oversold," as indicated by an oscillator such as RSI for a very long time...so maybe this is NOT the bottom. -:)



This is one of the posts where I've just run out of time and energy to write a decent closing paragraph -- I'll just say that I spend a lot of time looking at stuff like this; I think it helps me "predict" some things correctly now and then and I hope it helps you too.