Wednesday, May 21, 2014

Waiting for the Shoe to Drop

When is the stock market going to do a real correction?  That's the big question.  Right now, I can scarcely imagine entering the stock markets.  As Chris Hunter on Seeking Alpha says (quoting Andrew Lapthorne of SocGen):
"The number of 1% down days for the S&P 500 in any given year has averaged 27 since 1969; the S&P 500 has seen just sixteen 1% down days over the last 12 months. It has now been 468 days since a market correction of 10% or more, the fourth longest period on record, and, as we show below, the annualized peak to trough loss has only been 5% compared to typical annual drawdown of 15%."
So the S&P 500 has just under 60% of the number of moderate correction days as normal, the time from a moderately big correction is the fourth longest on record, and we're supposed to believe everything is peachy?  It could well be within the bounds of normal variations, but I don't know all the factors present in those previous years; was the Fed as heavily involved as they are now, for example.  Just before the start of the year I posted this chart:
We were at point 3 on this expanding wedge and have essentially just moved sideways since then - you can see the DJIA at that point was around 16500; today it closed at 16533.  Comparing the left side of the chart to the right, before and after the start of the blue lines, you can see a progression of continually higher highs and higher lows on the left.  For example, the low on the line of 1990 was above 1989 and below 1991.  That's a normal expanding market.  After 1998, the pattern of snap backs shows up.  The ugly thing is what happens during the first to second year after the yearly tick has hit the upper resistance limit.  You can see that there is typically a very large pull back within these two year periods.  That will be in 2014 to 2015; for what it's worth, many big crashes tend to come in the fall, around the end of the Fed.Gov fiscal year (September 30). It looks like the target for the snap back is around 6000. 

Dow 6000?  There would be blood in the streets.  Even if that doesn't happen, we're overdue for a correction of 20% or more. As Bill Bonner says, 
Because, as anyone who understands the phenomenon of mean reversion will tell you, the longer something remains an outlier, the more likely it is to revert back to the average.

In this case, it means the longer US stocks go without a meaningful correction, the more statistically likely a meaningful correction becomes.
Just when that shoe drops is the big question. 


  1. I got out of the stock market after the last big drop, losing a quarter million in both stocks and real estate was enough for me. Money is in tangibles now, things I can trade or sell.

  2. There are a number of unusual factors. There is quantitative easing which supposedly is being reduced 10% a month. There is massive printing and borrowing to prop up the federal budget. There is the unbelievably low interest rate for investors and savers. Then there are the many foriegn contries which are really worse off then we are and their investors and billionaires need someplace to put their money. And of course their are the arab shiekdoms with billions and billions to move around. Each of these factors will be affected by different externalities but most right now are pushing them to a safe haven which is or appears to be the American stock market (and of course PM's). There isn't a lot else to attract investors. In spite of our disasterous policies and our failing economy we might ride this wave for years. But I'm not sure we will. Something will happen; a black swan event, a actual crash in some critical sector, North Korea bombing SK or Iran bombing Israel, etc. Somethng will trigger it and when it happens it could be the biggest crash in history. I say could be because so many of the underlying factors will remain the same and maybe as odd and ironic as it sounds the U.S. could ride this out better then most countries, again because what other choices do investors have. Almsot without exception all the self-styled "experts" who have predicted a terrible crash were wrong or at least premature in their predictions. This is not to say it won't happen but to point out that no one knows. The biggest difficulty in predicting something like this is people react to the situation and that changes the situation. That is what creates bubbles, bursts bubbles, causes crashes and causes boom/bull markets.
    My guess is at best we are in for a long slog with high unemployment and getting worse and higher debt and more government programs and increasing inflation possibly at some tipping point becoming runaway inflation in most commodities but not everything. I think too that it is likely that we will see some level of open warfare which will bring it's own economic confusion with it. The crystal ball is muddy but most prognasticators agree things look bad and are getting worse.

  3. Anon, 1808

    Hard to add anything to that. Looking at the time delays in the previous snap backs, I'm starting to think 2015, not this year. We may start a correction this year. Probably will. But the Dow 6000 won't happen until 2015. As a rough planning date that I may revise, I'm thinking September to October 2015.

    Why then? Most US market crashes happen in September or October by this entry in Wikipedia So it's just playing the odds of the most likely timing.

    And Brigid - there's a ton of wisdom in that simple statement. It's just a shame that wisdom cost so much. Still less than it's going to cost next time, but still...