Tuesday, November 28, 2006

Big Bear Days: What Comes Next?

Monday's market was unusual in a couple of respects. First, there was tremendous short-term bearish sentiment, as measured by the NYSE TICK. Recall that the TICK is measuring the number of stocks in the NYSE Composite Index that are trading at their offer price minus the number trading at their bid. My Adjusted TICK measure simply transforms this data series to obtain a zero mean. Monday's Cumulative Adjusted TICK reading was -1418, the third lowest reading since July, 2003 (N = 839 trading days). What that means is that, across the broad universe of NYSE stocks, traders were hitting bids. Sellers were bailing out at the bidders' prices, taking whatever the market would give them.

Monday's market was also unusual in that the ratio of stocks displaying significant downside momentum outnumbered those with significant upside momentum by a ratio of over 10:1. Indeed, since July, 2003, we've only had five other occasions in which this ratio was so lopsided. My measure of upside and downside momentum, which I call "Demand" and "Supply" and track every day in the Weblog, simply tracks the number of stocks closing 2 standard deviations above and below their short- and intermediate-term moving averages.

So what we had on Monday was a big bear day: lots of traders hitting bids across a broad range of stocks, sending the vast majority of issues well below their moving averages.

Since July, 2003, we've had 15 trading days in which we've had the ratio of stocks with downside momentum exceed those with upside momentum by over 5:1 *and* an Adjusted TICK daily reading below -1000. The next day, the market (SPY) was up 11 times, down 2, and unchanged 2 for an average gain of .30%. That is much stronger than the average single-day gain of .04% over the total sample.

Four days after a big bear day, SPY was up by an average .50% (11 up, 4 down), again stronger than the average four-day gain of .16% for the entire sample.

Ten days after the big bear day, SPY was up by an average 1.07% (12 up, 3 down), once again much stronger than the average ten-day gain of .40% over the entire sample.

So what we've seen is a tendency to bounce following big bear days, probably as a function of bargain hunting. Note, however, that this analysis covers most of the recent bull market. What we're really finding out with the analysis is that, in bull markets, selling squalls tend to right themselves. If the bull is healthy, we should see some evidence of those bargain hunters. Conversely, it's when no bargain hunters emerge that big bear days turn into big bear weeks and months.


John Wheatcroft said...

I see this as the "day or days after Thanksgiving syndrome".

As a result of a quick and dirty analysis - In 4 of the last 5 years the SPY has lost 1% plus in the day or in the first several days of the week following Thanksgiving (from the Friday's close the day after Thanksgiving). Then it rebounds 1% or more immediately. Since the last 5 years constitute both "bull" and "bear" markets this might be the springboard to the "Santa Claus Rally" we hear about.

In the only year in the last 5 not to honor this scenario (2003) the market just kept going up.

Brett Steenbarger, Ph.D. said...

Thanks for the observation, John; it's an interesting pattern. A lot of fundamental things are happening in the marketplace--dollar making new lows vs. Euro; bonds making new highs on economic weakness; gold at a multi-month high--that make me think that more is at work here than year-end dynamics.


Peter Bernhardt said...

Hey Brett,

Interesting observation. What has me concerned, though, is the weakness in the dollar. This is more of factor, I believe, than the so-called Thanksgiving syndrome.

I also believe this bull market is overextended.

I'm probably going to just sit on my hands today and see where the market goes. But it really does look like this is the beginning of a significant correction.


John Wheatcroft said...

Could be - but the USD has been on the decline for about 10 years and it spikes down in this area about once a year now, oil has been higher than now, and gold has been higher still - yet during all of that the market kept going up. Did the pit suddenly wake up and say - holy cow look at all of that - sell! sell! sell!?

Admitedly there is a weakening in the economy but I don't think the economy really ever recovered - the market did somewhat but the market is not the economy (as my econ101 prof was careful to point out). Our manufacturing base has been crumbling for years. If it wasn't for healthcare and construction our job market would be non-existant.

So if the market has been booming through a weakening economy why couldn't this be a Santa Claus Rally?

Then as I learned many many many years ago (don't know how old you are but you were probably just a youngster at the time) the best time to buy is when the "economy" is weak. Prices never get better.

Just some random thoughts on a very complex subject.

Brett Steenbarger, Ph.D. said...

Hi Peter,

As long as large traders--including institutions--are leaning to the sell side (which has been the case on the Weblog measures leading up to this decline), I will also be keeping my powder dry. Most of the patterns I trade, however, are 1-5 days in duration, so that allows for a bit of nimbleness. Thanks for your note--


Brett Steenbarger, Ph.D. said...

Hi John,

My concern isn't just that the economy is weak; it's that it's weakening. And with dollar weakness, it's not clear to me that the Fed has a lot of room to ease and stimulate the economy.

That having been said, it is after selling binges such as we've had that we tend to get favorable returns. So, yes, maybe after the bear gets everyone scared, Santa can still arrive in time for Xmas!


b hong said...

Hi Dr Steenbarger
Great series of posts - topical and useful. As traders, we must always be aware of the character of the market. What it is, and not what we want it to be. Your reminders, backed with statistics, are that the markets are dynamic. And we must consider the data, and not our emotions in our trading is one of the most useful things that you post. I really enjoy them as they always seem to come right on time. Thanks
Bruce Hong, MD
(this is just a brief note of thanks _no need to post)

Brett Steenbarger, Ph.D. said...

Hi Bruce,

Thanks for your kind note. You make an important point: markets are dynamic. Historical patterns can point in a certain direction, but it's current supply and demand that will dictate short-term price movement. It's when we see those two aspects aligned: historical odds and current supply/demand that some excellent trading opportunities occur.