Friday, July 27, 2007

Views on a Bearish Market: What Comes Next

* Five Weak Days - Over the past five trading sessions, declining stocks have constituted over 60% of issues traded on the NYSE. Going back to 1990, we've only had 69 such occasions. The market bias going forward in the S&P 500 Index ($SPX) has been bullish 5 - 20 days out. Indeed, SPX has averaged a gain of 3.21% when we look 20 days out (51 up, 18 down). That's much stronger than the average 20-day gain of .72% (2682 up, 1659 down) for the remainder of the sample. Among the dates with weakness most similar to the current situation have been 9/2001; 5/2004; 8/1998; 5/2006; 7/2002; 10/2002, 3/2007, and 4/1994. All were up 10 days later and most were good longer-term buying opportunities.

* Perspective From SentimenTrader - Jason Goepfert's excellent service notes that we had 23% of NYSE issues traded hit 52-week lows on Thursday, one of the highest readings in the past four decades. He notes bullish intermediate-term average returns going forward following such occasions. His commentary re: this market is worth reading.

* Perspective From Market Tells - Rennie Yang's fine newsletter notes that we've had 2 days in the past three in which 90% or more of the volume has been to the downside. This is rare, but has led to near-term market strength when it's occurred. He also notes favorable expectations following a jump in the VIX such as we had on Thursday. I also strongly recommend his commentary on the current market.

* My Commentary - When we were making new highs, I highlighted cracks in the market foundation. Now we're making new lows and the historical odds are shifting to the bulls. It doesn't mean we can't go lower; indeed, it's not unusual for high momentum bear moves to test their lows at least once and sometimes more than that. Nonetheless, the historical record suggests that we are entering a period in which it makes sense to start shopping for good stocks that have been unfairly beaten up during this period of risk aversion. It's when we start to see the market making new price lows with fewer stocks participating in the decline that I will become particularly aggressive to the buy side. As long as we see that risk-averse trade continue (Yen strength; money poured into Treasuries, lowering yields; weaker performance from small caps; weak NYSE TICK), I won't be bottom fishing for other than short-term trades.

* Recommended Readings on the Bear Move - Trader Mike, who had a great call on the market retracing its move to the bottom of its recent price channel, chronicles the technical damage to stocks. Charles Kirk posts a number of excellent links on the edge of this market move, including an eye-opening article on how mutual funds have been abandoning stocks lately. The Big Picture notes the shift in credit sentiment as a driver of this market correction. Abnormal Returns offers a number of views on the bear, including rising spreads on high yield bonds; credit market concerns and their impact, and a regime shift in portfolio management.


Bert Hancock said...

Hi Brett,

Love your info and analyes as usual.
It seems like "a broken record," to use an old phrase, regarding expecting stocks to rebound smartly over X amount of days or weeks whenever we have a downturn.

As you said, this can of course change, but one tends to go with the odds. Having said that, maybe those odds simply are due to the fact the markets as a whole have gone up tremendously the past 15 or so years, so it's natural that gains will be more readily available after such losses--basically a stronger reversion to the mean gains, if you will.

What do you think and do you feel this particular time with all the credit woes, etc, could easily be different? ('course, trying to say "things will be different this time" is often a foolish approach)

Brett Steenbarger, Ph.D. said...

Hi Bert,

Thanks for the excellent comment. No question that recent history (1982-2007) has had a bullish cast, coloring historical studies. That is why I use these studies as background only, not as mechanical trading ideas. It's when current market action confirms the historical patterns that I become more aggressive in pursuing an idea. It's certainly possible that the current housing and credit situation will lead to a full-fledged bear market; modeling patterns across past bear markets would provide some indication of potential risk in buying defined dips.


techfarmer said...

Great article.

What do you think of my thoughts regarding the $SPX:

I'm looking at three indicators on the S&P 500 and all three seem to suggest we are at or near the bottom:
1. Stocks in S&P 500 that are above 50 day moving average.
2. Stocks in S&P 500 that are above the 200 day moving average.
3. The 10 day moving average on the Put-Call Ratio.

All three suggest that we are very oversold. $SPX is around 1458. But resistance at 200 day moving average (1447) seems to be a good target, for one last round of capitulation.

This might complete an ABC correction. I formulated a possible scenario in early June, and it's possible that the entire scenario may play out as predicted?


Brett Steenbarger, Ph.D. said...

Hi TechFarmer,

Thanks for the interesting links. We're certainly oversold and, in recent years, that's produced fine returns over intermediate and longer time periods.