Thursday, March 19, 2009

S&P 500 Index, Elliott Wave Count

I am posting one possible Elliott Wave Count for the SP500. To keep things simple I have labelled two cycles with black being the higher one and red being the lower one. If this wave count is correct, the index will continue to make new lows after the current rally has ended. The green line would be the extreme upper limit of the current rally. The irregular wave two would explain the apparent seven waves in the leg down from early February to early March. The EWP only allows one to see "possibilities" and as always this is only one of the possibilites at this time.

Monday, March 16, 2009

S&P 500 Index...a 580 % rate of return

During a good year in a strong bull market one might see a 20 percent net gain. As one lengthens the period of time, the percentage gain per year drops. For a good 5 year period the average year may be closer to 15 percent per year, compounded annually.

Taking an even longer historic view, if one goes back to the 1930s time period for the Dow Jones Industrial Average, the annual equivalent rate of return over about 80 years is in-the-order-of 3 percent to 6 percent per year. The 3-6 % spread comes from using peaks or lows at both ends. These numbers suggest that the longer one is invested, the more likely they are to see lower returns of rate.

At the other end of the rate spectrum, consider the market rally over the last 10 calendar days. The media has been focusing on how the markets have risen for the last 5 trading days. This rally has produced a very impressive short-term rate of return.

The SP500 Index rose from a low of 667 on March 6 to a high today of 774. This was a point gain of 107 points over the starting level of 667. A total gain of 16 percent over 10 calendar days. This is equivalent to an annual gain of 584 percent per day. The two ends of this spectrum are 3 percent and 580 percent. Interesting numbers here.

Based on nothing more than the 500 % + unsustainable rate of return recently we should not be surprised to see the markets drop significantly over the next few days.

March 6th SP500 Rally Update

Following up on my post of March 6th , I am posting today's chart for the S&P 500 Index. The rally that began at that time continues to climb.
For anyone familar with statistical probability, ask yourself what are the odds that someone could have predicted this rally, on the day it began, if the stock market is really just a random walk. I know it is not an impossibility with a random walk but keep in mind here that I do not make a lot of these forecasts. I am not a roulette wheel being spun 7 days per week for years on end. Its quite a different situation. Very few trials here.

As I monitor this rally and ponder my trading decisions I am now trying to see where this rally might end, in terms of it's upper extreme limit. Strong rallies like this one are always temporary, at least in the short-term.

The end of a bear rally, if I am correct in this longer-term expectation, is always harder to call than the start of the rally. My crystal ball is not that clear. A degree of uncertainty is something one must always live with when forecasting the market. The degree of uncertainty varies over time.

There are several possible upper limits, the closest one being near 810. As always, the market will decide if this limit is the most appropriate or not. It all depends upon how much bullishness remains out there in stock market land.

Sunday, March 15, 2009

Financial Advisors are Learning

I am starting to see signs of the rosy picture painted by those who give financial advice change. A few years ago the typical story was ‘invest money in the stock market if you don’t need it for 5-7 years’. Sound familiar? Now, more and more, I hear them saying things like ‘if you have a time horizon of a few decades’ etc.

The undeniable market history, coupled with the severity of the current bear market, is forcing the financial advisors closer and closer to seeing how the market really works. I expect a lot of them are reviewing and rethinking what they were taught in financial advisor seminars etc. I also expect that the majority of them are also taking a big hit on their personal finances.

It will be interesting to see what their literature says a few years from now.

Wednesday, March 11, 2009

Predicting the Random Walk?

In my post on Friday, March 6th I discussed the possibility of the start of a rally for the SP500 Index. The upward turn at level 667 did develop into a relatively significant rally. I have circled the rally on the updated chart. It will be interesting to monitor to see where the market goes from here.

The success of this prediction may be viewed as possible evidence that the stock market is not just a random walk. That does not mean that there is no randomness in the stock market.

Monday, March 9, 2009

A Random Walk and Black Swans

Statistical experts say that stock price fluctuation over time is a random walk. If that is true , then why does the market increase in value over time?

I calculated the annual equivalent compound return for the Dow Jones Industrial Average from the low of 41 in 1932 (after the 1929 crash) to the most recent low of 6440 in 2009. It comes to about 6.75 percent compounded over 77 years. In other words, $1 would have appeared to have increased to $157 dollars.

The starting point and ending point of these types of calculations will make a relatively large difference. For example, if I use the 1992 peak of 381 and compare it to the 6,440 low in 2009 I get a an apparent annual compound return of only 3.75 percent. Yikes...put my money in saving bonds!

However, we should view this apparent increase as "an illusion" due to the effects of inflation over the last 80 years. We know that $1 in 1929 or 1932 bought a lot more "things" than $1 buys today in 2009.

If we subtract inflation from the stock market long term increase then prices may not have really gone up at all.

Another thing that occurs with a stock index is that stocks that drop in price below a certain minimum threshold value are periodically culled from the index and replaced with the lastest hot stocks. That's a little like dead people in a study group being placed with new live ones. This factor may also contribute to the apparent increase in the index over time. The real market increase may be lower than what the indexes suggest. The index was never designed to model the growth in the stock market.

With a random walk, we can say that if one waits long enough the true value of the DJIA can be expected to return to the starting point from time to time.

The current bear market may be just that...a "run" of values that happens by chance to be moving the markets back closer to the starting point.

And, Black Swans may just be the market randomly heading back to the starting point as should be expected with a random walk.

The problem I have with all of this is that I have called so many turns that even if the numbers, on their own, fit well into a statistical distribution, one having the appearance of a random walk, I have seen too much evidence to the contrary to believe it.

However, I can understand how others with less knowledge could come to that conclusion. That conclusion on their part would be perfectly logical. I guess, in a sense, good market predictions to those people would be just another Black Swan.

Sunday, March 8, 2009

Immature Bald Eagle

For a change of pace here is a photo I recently received from friends of ours. It is a photo of an immature Bald Eagle on the ocean shoreline on the east side of Vancouver Island. I presume it was taken with a telephoto lens. The younger birds don't have the characteristic white head until they are a few years old. The younger ones are also significantly larger than the older ones. This one already has "the stern look", the large curved beak and the large yellow feet.

Friday, March 6, 2009

SP500 Possible Temporary Bottom Today

Every so often I recognize what appears to be a very likely turning point in an index. The SP500 may well have made one of those turns today (March 6) at the low of 666.79. This is based in part on my Elliott Wave Count. If the rally does occur I see it as only another pause in a continued downturn.

The interesting thing about this is that my analysis allows me to see "the possibility" of a relatively important market turn as it occurs. Only Elliott allows one to see this sort of thing.

Time will tell if the market has started a sideways or rally pattern. The market always has the option of going deeper still before it makes the next rally. In any event it appears to be due for a somewhat larger rally at this time.

Thursday, March 5, 2009

Another Bull Trap Snaps Shut

Over the last couple of days a rally of about 100 points occurred on the SP500 US stock index. This little rally naturally had people wondering if this was going to be a large rally or perhaps the end of the bear market. The rationale being...if the market is down 50 percent surely it can't go much lower. I'm sure that there people thinking/hoping the same thing when the 1929 stock market decline was at a 50 percent loss point. It eventually went to -89 %.

This morning that little 2 day bull trap closed and the SP500 made a new low.

It is also worth noting that another example of a bull trap closing occurred today on the Canadian side of the boarder. Canadian National Railways Company (CNR on TSX exchange) has finished a sideways move that began back on November 21. At that time the low was $38.9. The price has dropped to $38.5 so far today.

These "technical events" are measurable scientific evidence that the bear market is alive and well and that the best bet these days is for lower lows.

These breakouts to new lows do not tell us where and when the bear bottom will occur but they do warn us that the bottom will occur somewhere in the future at some lower level.

Tuesday, March 3, 2009

Bear Market Bottom

No I'm not seeing any signs of a bottom yet. However, I thought I would discuss it a little to give readers a feel for where I am on this important question.

The stock markets in North America have recently started to fall below what can be described as a more or less sideways price move that began in the October to November 2008 time frame. Because the markets have now decided to go lower any hope of a bottom in that area has been lost.

The technical door has now been opened to "the possibility" of a much deeper bear market. By worse case I mean something as deep, and yes, perhaps even a little deeper than the 1929 crash (-89 %). At this time, for me at least this is an academic question. I will take it as it comes and try to profit from it. For now "I'm betting" on lower lows for the next while.

Believe it or not, another 1929 type event would be "within normal market technical boundaries".

Government officials and so called experts like Warren Buffet don't really understand how the stock markets work. If Warren really understood he would not be in such a loss position today. The problem is not subprime mortgages or foolish investments by banks or insurance companies. And even the crooks don't really count on a larger scale. These are only the "symptoms" of the underlying, broader problem.

The underlying fundamental problem is that "we" (in the broadest sense) have lived beyond our means for decades. Extremes include expensive winter holidays by working class people, mini-castle homes, two cars and replacing "things" because we just wanted something new. Paying ridiculous prices for stock issues. And, businesses that can only function with a bank loan. And I will throw in...believing in the flawed thesis of the buy and hold forever approach to investing.

In short....western society (and perhaps the world) have/had a spending problem. And, everyone has run out of money and credit. This is not a "confidence" problem. If a bum on the street has great confidence but no money or credit he still can't afford a taxi ride.

I'm not expecting the US and Canadian stimulus spending plans to turn things around. If someone is bankrupt giving them cash or a loan they can't afford only stalls off the inevitable a little longer.

With respect to the stock market, I see many stocks on both sides of the Canada/US border that still have "the potential" to continue much lower and take the indexes with them.

The chart shows how the TSX Composite Index has recently broken below its November 2008 low.