Has a market meltdown begun? from 28/2/2007 http://articles.moneycentral.msn.com/Investing/SuperModels/IsThisAMarketMeltdown.aspx
Investors have been trading stocks at Wall and Broad streets in New York for a very long time -- more than 200 years. There's been trading through wars, depressions, recessions, booms, busts, floods and riots.
And human reaction to changes in buying and selling pressure has never changed much. That is why it's useful to study history as a guide to future market behavior. History shows how investors in the past have reacted to events we're witnessing in the present. The market is as much an emotional feedback loop as it is a weighing of the economic prospects for companies and countries.
So what does history tell us about what to expect in the aftermath of a 416-point plunge in the Dow Jones industrials ($INDU) on Feb. 27, one of the 20 largest one-day percentage declines on record?
Well, let's see what caused the collapse first.
It was kicked off by a sell-off of stocks in China, but that was hardly the only cause. Former Federal Reserve Chairman Alan Greenspan actually started it all when he said a recession could hit the U.S. later this year. Then on the morning of Feb. 27 in the U.S., the Commerce Department reported that durable goods orders fell 8% in January, which was a much worse-than-expected number. And although reports on housing starts and consumer confidence showed strength in the economy Feb. 27, there is still a lingering feeling that the residential real estate market is on shaky ground.
Yet wait a minute. Didn't current Fed Chairman Ben Bernanke tell Congress last week that everything is hunky-dory in the economy? And didn't he essentially tell Congress the same thing today, helping to spark a small rebound?
Yeah, he did. And there's the rub. We have a market that was up a lot since summer without a major decline -- ripe for serious profit-taking -- and a few little catalysts to get the ball rolling downhill. But at the end of the day, when you look soberly around the world, things are just not bad enough to merit the start of a long-term decline.
OK, so this is where history comes in.
There have actually been 14 occasions in the past when the market has fallen 3% on a single day in February since the 1880s, according to research by Logical Information Machines in Chicago. In all but two of those occasions -- 1898 and 1933 -- the Dow Jones industrials were higher a month later. In the most recent two instances, which occurred in 1938 and 1946, the Dow was 8.2% and 7.1% higher a month later.
So most of the time, big declines do tend to bring in buyers who were waiting for lower prices to begin or add to their investment positions.
Lots of losers Another way to look at the Feb. 27 decline is through the prism of the New York Stock Exchange advance-decline line. This is a ratio of all the NYSE stocks that finished up in a single day to the number of stocks that finished down.
Feb. 27 was off the charts in this category, the worst reading in 10 years. To make the concept more concrete, consider that only two of the 500 stocks in the S&P 500 ($INX) were up: retailer RadioShack (RSH, news, msgs) and natural gas utility Questar (STR, news, msgs).
Analysts at Birinyi Associates looked at similar advance-decline line plunges in the past 10 years to see how the market reacted the next day. The answer: The S&P 500 has risen three-quarters of the time for an average gain of 1.2%. But Birinyi observes that the advances do not tend to start right away. On average, the market starts the next day with a sell-off as margin calls go out and people sell stocks to raise money, and the rally begins around 12:10 PM ET.
Birinyi analysts further noted that in the two cases where the advance-decline debacle occurred as a result of Asian market fears, the S&P 500 ultimately rose 5.1% and 1.2% the next day.
Just a correction So what happens next? According to technical indicators that compare stock indexes to their average values of the recent past, the bull market will not be considered to have been broken until the S&P 500 falls below the 1,342-to-1,328 area and remains there for at least two days. For now, we can only say that we're observing a market correction within an uptrend. It's the first big drop since the summer, but for now that's all it is.
Can it go farther? Yes, of course. I'm on alert for signs that Feb. 27 signaled the start of a major bearish break. But when you consider that down volume exceeded up volume on the New York Stock Exchange by around 70-to-1, you just have to figure that a lot of people panicked and sold into the decline.
Generally that kind of down volume leaves a vacuum into which buyers will rush -- particularly when it happens at the end of a month, as mutual-fund and hedge-fund managers dress up their portfolios for clients to see in their statements.
So my guess is that the plunge was more like a natural blow-off in an uptrend than the start of a much bigger decline. In the next couple of days I would expect a snapback to higher levels, perhaps back to where we started this week.
Fine print Two weeks ago I warned readers of my stock-picking newsletter of a possible market disturbance in the last week of February. I didn't want to panic people by giving an exact date because, frankly, I wasn't sure that it would occur. But the warning stemmed from my study of the work of economist Martin Armstrong (currently in prison on a civil contempt charge), who developed a theory on market cycles in the 1970s called the Economic Confidence Model, or ECM, when head of an organization called Princeton Economics International.
The ECM is fascinating and complicated but the bottom line is that Armstrong believed it provided dates in the future that would represent turning points for markets around the globe.
There's no point in debating now whether his theory on eccentric cycles of 8.6 years was any good. The point I need to make is that his work was very popular in Asia, and also had many fans among big "macro" hedge funds here in the United States.
The last "ECM date," as these cycle turning points are called, was Jan. 1, 2005. And, in fact, that date did witness a huge decline that came out of the blue after a buoyant December.
The most recent ECM date was Feb. 27, 2007. Yeah, Feb. 27.
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