It Could Be Worse

Today’s economic reports, stock market decline and related news stories were all pretty ugly. But they were 1970s ugly rather than 1930s ugly, which is some consolation.

The Dow Jones Industrial Average is down, as of today’s close, 44 percent from its all-time high set a little over a year ago. The decline from the January 1973 high to the December 1974 low was 45 percent. The decline from the September 1929 high to the July 1932 low was almost exactly twice as much, 89 percent. An 89 percent decline from the October 2007 high would put the Dow at about 1558, so today’s much-discussed close slightly below 8000 may not look quite so bad.

Mathematically, stock market movements resemble earthquakes; that is, they’re fractal and scale according to a power law. In oversimplified English, which is the only way I can understand this kind of thing, what that means is that exponentially larger movements occur exponentially less often than small movements. This is why seismologists are unable to tell Californians exactly when “the Big One” will occur but insist that the more time passes without a big one, the more likely it becomes. So same thing with the stock market.

The current bear market is the second since 2000; the decline from the January 2000 high to the October 2002 low amounted to about 38 percent. From the seismological point of view, that might mean that we’re less likely to get a “big one” of near 90 percent, and instead must suffer through a series of less catastrophic but still thoroughly unpleasant medium-sized shocks.

From the standpoint of technical market analysis, 8000 on the Dow isn’t very interesting anyway. The really interesting number is the October 2002 low at about 7286, which we could stretch a bit down to the 7000 level as an idealized 50 percent decline. If that range doesn’t hold, then we’re potentially looking at a decline to 1.) the 5300-5700 area, representing the trading range of a 1996 pause, for a possible 62 percent drop; the 3600-4000 range, which is the level of a somewhat significant sideways move in 1994 and would amount to a roughly 75 percent decline; or the aforementioned near-90 percent decline to the 1500 range. And of course there's always the possibility that the world could come to an end and the Dow would fall to zero, but personally I give that pretty low odds.

Those are, of course, the worst-case scenarios. The most optimistic case would be that the market is “base-building” right around where it is now and will launch a new, multi-year uptrend from here that will replenish all the 401(k) accounts and other investments that have been stripped in the past year. I’d feel a lot more confident about that scenario if it didn’t depend so much on believing that the same people who contributed so much to the current problems - and who are still apparently more interested in self-justification and self-aggrandizement than in doing anything for their society or their world - will somehow suddenly start making all the right decisions.

No Bull

Observers have been comparing stock market dynamics with Taoist concepts for many years now; Bennett W. Goodspeed’s book, “The Tao Jones Averages,” was published in 1984, for example. It’s a reasonable idea; the longstanding bull and bear symbolism lends itself readily to analogy with the yin and yang of Chinese philosophy.

In the Wall Street mainstream, unfortunately, the current understanding of what constitutes a bull or bear market is pretty superficial. Many analysts and financial journalists insist that a bear market is a decline of 20 percent or more, which is an arbitrary, meaningless and ultimately useless way of looking at the market.

If bull/bear really is equivalent to yin/yang, then there must be fundamental qualitative differences between bull and bear markets; it isn’t just a matter of whether the market is going up or going down. And there are a number of technical analysts who have said just that for many years, arguing that bull markets are structurally different from bear markets, and noting that, for example, a rally can occur within an ongoing bear market without reversing the overall trend.

One example that has been noted fairly widely: Bear markets tend to move faster than bull markets; that is, the market falls by larger increments and in less time than it rises in bull markets. And even a fairly superficial look at the data supplies some confirmation of this view. Using a database of daily closing prices for the Dow Jones Industrial Average from 1896 to the present, the average percentage change on up days has been 0.750 percent, while the average change on down days has been 0.774 percent. On the other hand, 52 percent of all trading days have seen advances, while 47 percent have seen declines, with about a half-percent showing no change.

It occurred to me that there might be a way to use this information as a sort of trend indicator. What I did was compare the 20-day median percent change in the index with the overall average of up days (i.e., 0.750 percent) and the equivalent average for all down days (0.774 percent). Then I plotted all days when the current 20-day median was above the up average or below the down average. Here’s the result, along with the Dow for comparison:



I'm sorry the dates aren't clearer; I'm just learning to use the image upload on this site. But two things jump out from this chart. First, periods when the 20-day average change is above or below the long-term up or down average are fairly rare. Second, we’re in one of those periods right now.

That’s right: Starting on Oct. 10, the 20-day median percent change in the Dow fell below the 118-year average for down days, and it has continued to fall further below it, as of Monday’s close. It’s now about a full percentage point below the long-term average and is at the lowest level since early 1932, during the worst of the fierce 1929-32 bear market.

I don’t know whether this bull/bear indicator has any predictive value, but there is one thing that might be worth noting: In general, the lowest readings on this indicator have coincided with the steepest phases of bear-market declines – NOT with the end of the decline. So even if we were to take an optimistic view that this indicator has reached its lowest point, it still wouldn’t preclude the Dow from falling significantly lower.

Update 4:35 p.m.:

Today's 889-point jump in the Dow had no effect on the bull/bear indicator described above. In general, all it did was carry it back toward the upper end of the downward-tending trading range it has been in for the past three weeks.

Also, a little more explanation about the chart above: Ostensibly bullish moves are those above the zero line, shown in red to represent "fiery yang energy," as they say; bearish moves are those below the zero line and are shown in blue, representing "cool, watery yin energy."