Wednesday, July 25, 2007

When New Lows in the Stock Market Explode

I notice that we made over 1500 fresh 65-day lows across the NYSE, NASDAQ, and ASE on Tuesday. Since 2004 (N = 858 trading days), that's been a pretty rare occurrence. Interestingly, following the 10 occasions in which we've exceeded 1500 new 65-day lows, the S&P 500 Index (SPY) has been up five days later all 10 times, by an average of 1.00%. By contrast, the average five-day gain for the remainder of the sample has been .17% (473 up, 346 down).

Nor have superior returns following an explosion of 65-day highs been limited to a short time horizon. When we look 30 days following the days in which we've had more than 1500 new 65 day lows, SPY has been up by an average of 4.28% (9 up, 1 down). Even when we relax the criteria and examine all occasions in which we've had more than 1000 new 65-day lows (N = 39), SPY has been up 30 days later by an average of 3.26% (35 up, 4 down).

In short, declines such as the recent pullback have been excellent opportunities to step up to the plate and buy stocks. It's been when no one has wanted a broad range of issues--pushing many of them to multi-month lows--that investors have found relative value.
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8 comments:

Mr GG said...

Brett, would it matter what these days are and what the S&P had been doing during prior to those days?

Brett Steenbarger, Ph.D. said...

Hi Mr. GG,

Those days, for obvious reasons, occurred following significant market corrections. It is certainly possible that returns would be different in a bear market environment.

Brett

Dr Bruce Hong said...

Hi Dr Brett
It's one thing to be a contrarian. Many are because of philosophical or constitutional reasons. But you show HOW to be a contrarian.

For amny of us who grew up in the 60's and were told not distrust authority, It's easy to say that they're contrarians. But I doubt that most think things through or do the research that you do.

Brett Steenbarger, Ph.D. said...

Hi Bruce,

Thanks for the note. The key is to sometimes be a contrarian when it comes to contrarian opinion! It's during the big trends that fading moves breaks down.

Brett

T. said...

Elaborating on GG's comment, my findings suggest that all prior significant explosions in new lows during this bull market have occurred after a few % drop. In which case, an explosion of new lows represents an epitome of fear and rejection. However, is it possible that when this explosion happens at the very peak, or close to it, it signifies profound breadth problems (a dissociation of the 'soldiers' from the leading 'generals')?

Something else that may contribute to the sense that we need to construct the study differently, is the fact that this market has changed character in the past few months with big caps leading the way. Do you happen do have new lows data for dates before 2003? Unfortunately, my data only runs to 2003. If you do have the data, may I ask where you get it?

Thanks,
T.

Dr Bruce Hong said...

Hi Brett
You meant to publish this post today (July 26), right? Just joking.
But it does illustrate that "past performance in no guarantee of future results" and that we have to react to the markets, and not allow ourselves to be biased in our expectations.

Brett Steenbarger, Ph.D. said...

Hi T,

You raise an excellent question. I'll be taking longer-term looks at market weakness shortly. I don't have the 65-day high/low data going back to prior bear markets, but do have breadth data going back decades. Thanks for the note--

Brett

Brett Steenbarger, Ph.D. said...

Hi Bruce,

You're absolutely right; past historical performance is no guarantee of the future, though it certainly beats ignorance. I consider the historical patterns to be a kind of heads up. That heads up was invaluable in pointing out the market weakness at the top, but it took actual market action to confirm the warning. Thanks for the perspective--

Brett