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Using History to Plan Near-Term Investing

by: Zignals October 11, 2008 | about stocks: DIA / QQQQ / SPY    

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By Dr. Declan Fallon

Search traffic for "market crash" soared Friday as markets worked on their daily 5% trim. Contrarians will take pleasure in this, but it doesn't ease the pain of the losses. News volume also increased sharply, another sign of saturation and capitulation.


The "1929 market crash" is the doom-and-gloom of choice for readers, followed closely by 1987. The 2000 meltdown didn't register amongst search topics.


In numeric terms we have exceeded the losses of 1987; the 36% loss in the S&P from high to low in 1987 was outdone by the 42% loss (and counting) we are now experiencing. Next on the crash watch is the 50% loss witnessed from 2000 to 2002; chief difference to this is the current loss will have occurred in about half the time it took the tech bubble to collapse.

What of 1929? The first step in 1929 saw a 48% loss for the Dow in 2 months (looking good so far) which was followed by a counter rally of 48% which took 5 months to complete. It was after this counter rally that the real pain set in.


In terms of decline structure, what we have is very similar to the first phase meltdown in 1929; the precipitous drop without relief. Not even the September 2001 decline came close, as the S&P then gave up 23% from August highs to September lows (albeit on the background of a year-long bear market), but even this 'milder' decline was followed by a 24% rally.

The real worry will be what happens after we relief rally (based on simple historic comparisons we could come back 42% from here). The 1929 story is well covered with its 83% discount, but the much neglected 2001-2002 drop sheared off 35% from 2001 high, or 18% from the September low. In addition, the latter part of 2002 and early 2003 was spent meandering in a scrappy, soul-searching trading range. Should we put ourselves in stasis until 2010?

Can one profit, or at least protect oneself in the current environment?

Unlike 1929, there is no shortage of inverse index funds and ETFs to invest in. How future restrictions (if any) on short selling affects these remains to be seen, but when the relief bounce plays out it will be time to take a look at some of these trading vehicles as insurance against a decline in your stock portfolio, or as a straight profit trade. Key moving averages (like the 50-day and 200-day MAs) are excellent lines in the sand to buy/sell these instruments. If your favourite stock breaks on volume through its 200-day MA, the chances are it's confirming a new bull trend. If your favourite stock retreats off its 200-day MA, then it may be time to sell and/or load up on an inverse ETF/fund (especially if the broader market confirms).

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This article has 11 comments:

  •  
    Oct 11 09:16 AM
    Yes you can profit in a panic by doing nothing. By the way 2000 was a crash greater than 1929. We are now in a panic which will soon be gone.
    Reply
  •  
    Oct 11 02:00 PM
    All technicals show an extremeley oversold condition. What has happened is that a small probability of having an economy implosion has scared people heavily and they have run for cover into the woods. As soon as the Armageddon probability dissapears, a huge rally should form...which doesnt mean that the economic problems are gone, but prices shouldstart to reflect reality.
    Reply
  •  
    Oct 11 02:27 PM
    Conspiracy of Fear

    I woke up this morning feeling fine. It’s a bright sunny fall day. My car was still in the driveway. The gas station was pumping gas at $2.79 per gallon. Traffic was normal. Best Buy was busy with the usual Friday payday trade. My job was still there. My bank ATM still worked. That is the reality of the day.

    The newspaper headlines read WORST EVER WEEK FOR THE DOW. My paper assets are now worth 20% less than they were a week ago. Jeepers, what is going on here?

    So I have to ask, what was the reality of the week?

    For starters, for every dollar I lost, someone made a dollar someplace. You can bet on that. The dollars didn’t just burn up or evaporate. The dollars are still there. For every sale, there was a buy. That means that wealth just changed hands. Someone picked my pockets. Someone got richer as I got poorer.

    Well, who would want to do that? Well, probably the same ones that cheered on the bull market in equities, housing, real estate, energy, gold and investing for the long term. Now, in light of the financial crisis in banking, the cheerleaders are propagating waves of fear overwhelming the average little guy. Stories of the crash of 29 lead the way. Sell your stuff at a loss, hoard cash. Don’t take a chance.

    The reality of it is, they have exhausted feeding upon each other and are now feeding upon us. And it’s working. They are picking our pockets again. And we are helping them. Just as in 29, some are getting rich at the expense of others. Someone is buying up your fire sale assets. And we are saying thank goodness I got out with something.

    The reality is that if there were no sellers, prices would skyrocket because there would only be buyers. The reality is that business fundamentals don’t dictate the fire sale. The P/E ratio of SPY is 13.5, well below the historic S&P average. The 30 year average P/E is around 18. The 20 year around 22.

    The reality is, this ain’t 1929. The reality is that the nation will survive the market, as it always has. The reality is the money will be in different pockets when it comes out the other side and we will have helped them.
    Reply
  •  
    Oct 11 03:12 PM
    @phillips49

    Did you just watch Oliver Stone's Wall Street recently and decide to repeat the "zero sum game" message? News flash. That was a movie.

    This, however, is real life where concepts like money creation are very real. Yes, lots of money evaporated this week -- lots of money that was created out of thin air in the past. More will evaporate in the coming weeks/months/years.

    Just think about this -- there are around $60 trillion in credit default swaps in existence. The GDP of the world is only around $55 trillion. Only the naive believe that everything is fine and can easily be fixed by politicians that don't understand.
    Reply
  •  
    Oct 11 07:42 PM
    Responding to "cheekybastards&q... comment......
    numbers can be thrown about FOREVER....it only adds fuel to the fire and selling pressure.......big surprise, but consumers have been living off of credit for YEARS (i still know for a fact my parents have not paid off their house)....Eventually however, they will.
    IMHO: The "credit crisis" and "Is Your Money Safe" headlines on CNBC are a bit overdone at this point and it's time to invest when the blood on Wall Street is at it's deepest.....
    As far as 200 MDA...good for chartists looking for short term bounce plays.....if i remember correctly however JNJ and USO were doing both. An "exit" strategy is nothing more than a stop "loss" order IMHO......and YES, you WILL take a loss (only to see it rebound sometimes!!!). Sorry, but myself, i don't trust those who claim themselves "chartists" because it does not work all the time. IMHO, you want companies with strong fundamentals or index funds as the article outlines if you cannot find good stocks...
    Reply
  •  
    Oct 11 07:43 PM
    Smartstops;

    I like your timely ads... Er, I mean comments.
    Rikiki
    Reply
  •  
    Oct 11 07:53 PM
    I like this picture with the article showing the 5/12/2000 end date.
    so i pulled 5/12/2000 DJI price: 10,600
    also, this is showing a 86% return trough to peak and even ignores "near term" 1933 recovery
    lol....what a joke
    Reply
  •  
    Oct 11 07:59 PM
    btw (in all fairness to bears AND bulls) NO mention on ETFs so a couple of funds......
    SIJ: 2x inverse Dow Jones
    UXI: 2x leverage positive Dow Jones index
    Rydex also provides some funds (i.e. REC/RFN)
    Reply
  •  
    Oct 11 11:43 PM
    Your graph's percentages are very wrong. The two 48% boxes are different sizes...I appreciate the information though. I believe that we'll have a currency crisis for Christmas, and look to ultra-inverse for the Holidays.
    Reply
  •  
    Oct 11 11:52 PM
    ********************* Live to fight another day **********************...

    It is different each time. With so many large financial institutions failing it has set the panic, very justifiably. There was no bank failure panic in ’73, ’87 or ‘01. With all the derivative exposure that no one can fathom the risk– there is a lot of real fear. Every asset class has crashed nothing seems safe. What do you do with your money – cash or gold?

    It will likely get lot worse before things turn around. Selling out is a very valid option still - live to fight another day.
    Reply
  •  
    Oct 17 12:02 AM
    SmartStops, stop using these forums to promote your business/web site!
    Reply
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