Friday, June 16, 2006

Why This is Not *the* Bottom

Has the bear bottomed? That was the question I heard with surprising frequency after Thursday's rally. My answer has been, "No. It takes a lot more weakness to make for a cyclical bear market bottom."

Let's look at the historical record:

1966 cyclical bottom: 56% of all stocks make 52-week lows on August 29th.

1970 cyclical bottom: 58% of all stocks make 52-week lows on May 26th.

1974 cyclical bottom: 37% of all stocks make 52-week lows on September 13th.

1978 cyclical bottom: 30% of all stocks make 52-week lows on October 30th.

1980 cyclical bottom: 38% of all stocks make 52-week lows on March 27th.

1981 cyclical bottom: 31% of all stocks make 52-week lows on September 28th.

1987 cyclical bottom: 57% of all stocks make 52-week lows on October 20th.

1990 cyclical bottom: 35% of all stocks make 52-week lows on August 23rd.

1994 cyclical bottom: 23% of all stocks make 52-week lows on April 4th.

1998 cyclical bottom: 33% of all stocks make 52-week lows on August 31st.

2002 cyclical bottom: 27% of all stocks make 52-week lows on July 24th.

2006 cyclical bottom??: 8% of all stocks make 52-week lows on June 13th.

I don't think so.

Notice the average spacing of the cyclical bottoms. Those bottoms don't occur until bearishness is rampant, and that typically takes a large proportion of issues making fresh lows.

Notice something else very important: The point at which we hit maximum new lows is rarely the eventual price low for the cyclical decline. For instance, we had 27% of stocks making new lows in July, 2002, but we saw further price lows in October of that year and March of 2003. Similarly, we saw 31% of stocks making new lows in September, 1981, but didn't see actual price lows until August of 1982.

So what we're seeing in the current market is either a normal correction in a bull market (like we had in October, 2005 and May, 2004), or it is just the *start* of a full-fledged cyclical bear market that has much further to go. The quality of the next intermediate-term rally should go a long way toward identifying which scenario we're in.


Bruce said...

Thanks for that article on bottoms today...I find that information much more useful than the stuff u usualy do... not realy a critisim but a comparison. Aloha ' Bruce Russell

Jeff said...

Dr. Steenbarger, what are you calling the bottom of the 2002 low if prices continued? There was apparently a divergence in the "new lows" index with the price. Was it when the "new lows" reached a bottom?


Brett Steenbarger, Ph.D. said...

Hi Bruce,

Thanks for the feedback. I also find that big picture historical views of the market can be very helpful in gaining perspective.


Brett Steenbarger, Ph.D. said...

Yes, Jeff, it is a bit confusing. My bad. I am looking at bottoms as momentum lows: the points at which a maxmimum number of individual stocks make new lows. These tend to precede actual price lows for cyclical bottoms. The same is true on the upside. My point in the post is that we're nowhere near a cyclical momentum low if we compare to previous market cycles.


DrFox said...

Dear Dr. Steenbarger,

First of all, congratulations for the blog. Very nice and motivating reading.

I am curious about how should we monitor the actual state of the market to understand when ther will be a turning point from just a "normal correction" to a real downtrend?

Again, very nice blog, will go to my favorites.

Brett Steenbarger, Ph.D. said...

Thanks drfox, for the comments. You're asking, of course, the $64,000 question: How to distinguish bear market declines from normal corrections in a bull market. I don't have any foolproof answers to that dilemma, but I have found that historical analyses are helpful. I know what the average extent, duration, and indicator values are for bear market declines and normal corrections from 1966-2006. These norms allow me to profile moves as they occur to see whether or not they deviate from what has been historically expectable. One key, interestingly, is profiling the market rises: bull bounces in a bear market look *very* different from rises in a bull market. This is because much of the bull bounces in bear markets is due to short covering, not gradual new accumulation.

The other factors distinguishing normal declines and bear markets are changes of market leadership, changes in intermarket relationships, and changes in patterns of volatility. All three have been in play recently and, at least at this early juncture, up moves have much more closely resembled bounces in a bear market than the steady accumulation typical in bullish conditions.


Paolo Pezzutti said...

I do not believe this is the start of a bear market. We are very close to the end of the interest rates tightening. Commodities have already topped in fact. I believe the market will go through a non-directional volatile phase.

Brett Steenbarger, Ph.D. said...

Thanks for that perspective. Volatility has, indeed, picked up and we're getting meaningful intraday swings. Some markets (e.g., India, Middle East) have already fallen hard enough to make me doubt that these are normal corrections. Here and on the Trading Psychology Weblog, I will be tracking the measures of internal strength carefully to see if we indeed are bottoming vs. setting up a new leg down.


muckdog said...

The CNBC chatter (from "market technician") Bob Pisani was a bit noisy late in the week about "a bottom" in the market. Of course, with all the babes at CNBC, I can see why he's so focused on bottoms.

I think traders all have this "short the bounce" mentality. at least from reading around the boards. AAII is pretty bearish, too.

Good job on this blog. Bloglined ya.

Brett Steenbarger, Ph.D. said...

Thanks for the note. You're right about the bearishness, and it is altogether possible that we could put in a short-term bottom and get a nice bounce over the next couple of weeks. That could even vault some of the stronger large caps (GE, C, BA) to new highs. Will the broad market (esp. small and midcaps) and emerging markets continue to new bull market highs from here? I have my doubts, given the intermarket dynamics and changes in market leadership. Some sectors (housing, tech) are already arguably in bear markets.

The key, whether bear or bull, is to always view your leanings as hypotheses and to always be open to data that disconfirm your hypotheses. My worst losses have occurred when I've gotten married to opinions.


yinTrader said...

Hi Brett

In the short term, if crude oil futures go below $67, SPX should bottom, and yields will rise, giving a more positive outlook on the equity markets.

However, looking back on historic charts, we are due for a secular bear market.

It is then a matter of time the market will bottom, if my interpretation is correct.

Brett Steenbarger, Ph.D. said...

Thanks for your note. I find it very helpful to track interest rates, oil, currencies, gold, and emerging markets alongside U.S. equities to see which asset classes are leading and lagging. It is very useful in identifying themes as they emerge.