Hyper Exuberance brings a 66% chance of New Lows ahead for the SP Using History

By: Christopher Gurkovic | Tue, Aug 25, 2009
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While very impressive, the stock market's rate of advance is cause for concern; rather than a Bullish argument. You have to look all the way back to the move off of the final low in 1932 to find a rally that advanced faster than the rate of the current rally, and further look to the initial low in 1929 to find a rally of comparable speed. Not even during the "Irrational Exuberance" years of the 1990's did the S&P advance this rapidly. The difference this time around, is that the government is cheering on Hyper Exuberance instead of questioning it. Maybe it is their only hope of a "stimulus" that could bring the economy out of the current mess.

While the S&P drop from 2007 was only 57.69%, the rally in 1932 came after an 86% drop in 1929. That move retraced 51.96% of the loss from the 1929 top, over the course of 13.5 months. It advanced at a rate of .43% a day, and did have higher speeds of advancement within it. However, after it topped in July 1933; that high level was not seen again until February 1946. Further, the high in 1929 was not exceeded until October 1954. If the current rally were to retrace 51.96% of the loss from the October 2007 high, it would carry the S&P to 1139. If it then followed the same path as the 1930's, the market would not surpass the 1139 level until 2022; and not climb above the 2007 high until 2030. With a little better than 100 S&P points to 1139, there is not much reward to risk; judging from history. If you miss getting out at the high, a similar 13 year period is a long time to wait. When you look back and see a never before in history situation, you must ask the question: What is different this time?

Below I have posted a chart of historical moves in the S&P near 40% or better. The chart shows the dates, prices, highs, lows, % moves, lows after the move, and the rate of the advance. As you can see the average rate of advance for these great moves is .14% a day. Currently we are advancing at a rate of .32% a day which is very abnormal. There have only been 3 other times when the rate was above .19% a day, and only once when the rate was above the current rate as mentioned above. The 1932 rally advanced at a rate of .43%/ a day and was followed by a 33.93% decline. The second greatest speed is equal to the current rate of .32%/ a day. This was the Bear Market Rally that followed the initial drop in 1929. That move was followed by an 83.02% decline. The only other move that was anywhere close to the current move; was a rate of .28%/ a day in 1938, which was followed by a 45.83% decline. If you took the average decline after such great advancements, you would end up at a low in the S&P of 473.78 sometime within the next 884 days. Levels from least to worst case scenario would equate to 684, (just above 666), 561, (well below 666), and 175 (extremely below 666), using the declines that followed rallies of this magnitude. Looking to history, it also means that there is 2of 3 or a 66% chance that the S&P will hit a new low.

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Since the rally from the initial low in 1929 is the most comparable, it a rally that warrants further attention. We have already matched and exceeded the rally in terms of % gain and days of length. However, if you look to proportional levels comparing the initial decline then to the initial decline now; it yields some higher levels. Since the initial decline in 1929 was only 44.56% compared to 46.77% in 2009, it could equate to a level of 1070 using the October 2007 high, or 1042 using the secondary high in May 2008. The high Monday at 1035 is very close to the 1042 and already satisfies time requirements. With my proprietary Gurk Oscillator turning down August 25 for a sell signal, this could mark a high. In addition, if you look at the chart below, these levels are also near the 38.2% Fibonacci arc retracement level (highlighted with a circle) of the 1982 to 2007 Bull move. This move is proven to hold significance since it caught the 666 low with the 61.8% retracement (green circle). Coincidentally, if the next move down were to go towards the 473 level mentioned above, it is right near the 76.4% retracement level shown with the silver arc. (also highlighted with a circle)

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One of my best teachers, Alan Shaw, had a saying that always stuck in my head.

If a storm blows by and knocks a few shingles off your roof, then it's no big deal. If a wrecker and a crane bash your house in, it is going to be a long time before it is back to normal.

I think the decline from 2007 would qualify as a wrecker and a crane, since it was the worst decline since 1929. Alan would expand upon the quote and say "the bigger the drop the longer the need for time of repair". A foundation must be built if the market is to be sustained, and the current rate of advancement does not make for a well built foundation. To start with the knocked down wreckage has not even been cleaned up. The best thing that could have happened to the market is for it to have sat around flat on the low for many months, and then begin to rally. The market however, is energy in motion illustrated with charts. The current advance is a counter action that is following a primary action. The speed and magnitude of this counter action is indicating rough times ahead. In fact, the strength of the ascent will only further power the strength of the descent. I have been cautious all along, but with Hyper Exuberance running rampant, now is definitely the time to remember the old saying Buyer Beware.



Author: Christopher Gurkovic

Christopher Gurkovic, CMT

Christopher Gurkovic, CMT, writes as Chief Market Strategist for Deltatide.com where he posts daily market comments.

Copyright © 2009 Christopher Gurkovic

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