Ian Woodward's Investing Blog

At this time of the year, let me start  with Season’s Greetings to wish you and yours a Happy Thanksgiving.  Consider this particular Blog Note as my Thanksgiving Gift to all of you.  It is a trifle long, but it lays out the entire assessment and a new game plan of what to expect against which we can measure where the market takes us.

As the Woodward Family sits down to enjoy a get together of 17 people, there will be sobering discussions about what is ahead, especially as my two elder grandsons are just two or three years away from heading off to college.  The nest eggs have shrunk all around us and now the Auto Industry is the latest to be with tin cups  in hand while flying in to Washington in private jets to ask for a $25 Billion handout.  Where will it end?

At least the announcement of Tim Geithner late on Friday afternoon as Treasury Secretary for President Elect Barack Obama buoyed the Stock Market by a whopping 1-Day Change of 6.3% for the S&P 500.  Earlier we were headed down once more and did indeed set a New Low of 741 on the S&P 500, but drove up nearly 60 points at the close to finish at 800.03.  If you have followed this blog over time, you will know that I am a firm believer in watching the Stock Market’s reaction to FOMC and Treasury actions, and now as we have a changing of the guard at the White House, the new appointments in key positions of the Administration.  So far, so good…let’s hope that reaction continues as these unfold and more importantly that the decisions are pragmatic to restore consumer confidence and stability for the ordinary person in the street…usuns:

This latest free fall has produced the worst market conditions since 1937, surpassing 2002 as shown by our latest barometer which we have watched these past six weeks:

One of my staunch supporters put up an interesting chart showing the Stock Market Corrections on the DOW since 1900, and it gives a good perspective of how serious a fall we have had, especially since the Bail Out Plan was passed:

This Crash now leaves us with impossible odds for any near term recovery, since the return paths all require huge Market Rallies to get anywhere near the down-trend-lines which I call the 405 Freeway.  Just to get back to a double top of the recent Bounce Play we had to 1014 requires a 41% Rally.  The numbers are on the chart:

Let me give you one more chart of the hurdles we must surmount on the way back to set the stage for what it will take to recover from the free fall.  I have spoken often about using the High Jump and Limbo Bar Indicators as valuable tools I developed over 15 years ago at Market Peaks and Market Bottoms, respectively.  The High Jump measures the % difference of the 200-dma and 50-dma from the Index High, while the Limbo Bar reverses the process and measures the % difference of the 200-dma and 50-dma from the Low of the Index.  When done this way, it gives a feel for the magnitude of the problem we face as we try to retrace our steps up to what we would consider normalcy.  That can only be attained by rapid Bounce Plays, Bear Market Rallies and then Bull Market Rallies in quick succession.  As the chart below shows the challenge is huge:

All right, you have heard all of that gloom and doom enough now to last us until the New Year.   I had to lay out the perspective of the size of the problem to begin to give you a feel for what it could take for the Market to restore itself out of this insane hole that we have dug for ourselves.  You will have to bear with me as when problems get this tough, I resort to Stakes in the Ground and Measuring Rods.  Understand that now that we have undercut all previous numbers, we have to innovate and start afresh with what history has given us but then address tests-of-reasonableness to see whether the scenarios I offer you are achievable or beyond the probabilities of achievement.

Since I introduced you once again to the value of the Limbo Bar and the fact that the most recent set of deep hole statistics was back in 2000 to 2003 and within our comprehension, what better way than to start with the Low back on 10/10/08 and 7/24/02 as the initial starting points, come forward from these since then to the current date of 11/21/2008 and assess the Actual situation of the Limbo Bar readings (200-dma and 50-dma to the Lows).  Then superimpose the 2002 and beyond statistics on the current situation and see what it gives us for things to come as shown by the data below the blue line:

The conclusion is at the top of the chart…this recent free fall is too steep compared to 2002 when we focus on the difference in the numbers for the 200-dma and 50-dma, i.e., the Limbo Bar numbers for the two cases.  We are almost 2:1 lower for the 200-dma and over 2:1 for the 50-dma (blue circles).  If we now experience a Bounce Play from this low of 741 comparable to the 24.2% jump we had back in 2002, this leaves us with big shortfalls thereafter as shown when you compare the numbers shown by the Red  and Green  circles, respectively.

So the next step is to see what it would take to make the numbers more reasonable by increasing the Rally from what I term a “Bounce” to a full blooded Bear Market Rally.  It’s sad to say that it will require a move of twice the 2002 move of 24.2% to produce the desired results.  The net Target is a 48.4% rise from the low of 741 to 1100 on the S&P 500, virtually an impossible task, though such rebounds were achieved back in the 2001 timeframe.

Of course, one can do anything with numbers…that is not the point of this exercise.  It is to show you the magnitude of the challenge.  Others would say it doesn’t have to be achieved in one step and that is correct.  In that case the Retest Low #2 would have to be less than shown…I’m sure you get the point.

Many people are not left brain types and prefer a picture to a bunch of numbers.  So let me turn the tables around and immediately give the right brain types their wish with two obvious pictures.  I turn to superimposing the history from October 2002 implying we expect a Double Bottom scenario to play out, and then try the obvious Triple Bottom, or Head and Shoulders Bottom as I have shown starting with History from  July 2002.  The next two charts show those two conditions.

This chart shows the best of conditions with regard to a strong rally, but will still not show a Golden Cross of the 50-dma coming up through the 200-dma before mid year 2009.  Note it would take the best part of a 3000 point rally for the DOW to pull it up by the boot straps in the next couple of months to give any assurance of withstanding a re-test of the lows that form the Double Bottom.

The Triple Bottom Case sets the overlay back a stage to July 2002 and does not have as ambitious a rise in this next Rally.  Note that the expectation is that we will have a re-test of the lows undercutting the current level to a lower low of around 7000 or let’s say 700 on the S&P 500, and then drives up sharply.  The final leg would produce the Right Shoulder as shown and with all the to and fro, the Golden Cross would occur later by around September of 2009 and at a lower level of around 8000.

All of the above is Modeling and Game Playing, but is based on logic surrounding the depth of the Limbo Bar numbers, and more especially demonstrates the havoc that has befallen the internals of the market with the steep drop of the 50-dma well below the 200-dma.  The bottom line message is “The recovery will not happen any time soon and we are in for a long winter in the Stock Market”.   At least we now have a Game Plan and Targets to measure against.  We will amend these as the Market tells us where it is headed.  It goes without saying that if we head down again immediately below Friday’s Lows, all bets are off and we will have to re-adjust the Game Plan.

Best Regards, Ian.

During the past several months I have tried to steer you through the mine fields and give you ample warning of the Lines in the Sand at critical points in time.  Past Blogs have featured key skirmishes between the Bulls and Bears at the O.K. Corral and we have just finished Round #4 which the Bears have once again won.

In recent blogs I have shown you the boundaries in which the “Ball Game” was being played to keep the picture down to its simplest form.  The chart below needs little explanation as you have seen this from time to time in the past.  What is important is that the Last Line in the Sand is broken and it will take a Thanksgiving Gift, A Santa Claus Rally and a “Hail Mary” Pass to head back into the Zone again as shown above and below:

Worse yet, given past statistics of Bear Market Swings Down, Rallies Up and Re-Test Statistics we find ourselves in the dubious spot of having beaten all of them to the downside except the one of 1937, and heaven forbid we head on down that low:

At the recent High Growth Stock Seminar completed in late October just four weeks ago, I presented the following chart as evidence that Wall Street had now impacted and spilled over into Main Street by describing the effect of the downgrading in Earnings Estimates as we go forward into 2009.  The chart below is a picture I put together to show the effect of both EPS estimates (past and future) on one axis with P-E on the other to show the net effect of what the S&P 500 can support as an Index Price.   Sad to say we have wallowed around in the Red Zone of late in these past five weeks and have now broken down into the Brown Zone as shown on the chart below.   I suggest we are now headed for 770 (between friends) on the downside, unless we get a humongous Bear Market Rally:

I wish I could be the bearer of glad tidings at this festive season, but it is better to know the plain facts and the logic that supports them than for me to pull the wool over your eyes.  It goes without saying that we start the entire process again of Capitulation, Reversal Day and Follow Through Day(s) with Eurekas and Kahunas to support the Bull enthusiasm and that can take another six to nine weeks.  In addition we need New Highs on the NYSE to come out of the woodwork and New Lows to dampen below 50 before we have a glimmer of a proper Bear Market Rally.   When Base Low Stakes are uprooted, we now wait to see the above before we can even begin to suggest we have found “A Bottom”, leave alone “The Bottom”.

Best Regards, Ian.

My good friends are in the swing of things and send me pictures I might use for the blog, which keeps me on my toes.  Please keep them coming.  Here’s one that fits very well with the times.  Can you imagine giving up all that gain we had yesterday with another down day of over 350 points on the DOW today?

The chart shows we have been in a trading range of 1000 points or so for the past five weeks.  The Market is trying to put in a bottom, but every half hour or so there are alternately both Bull and Bear traps and of course it gets a trifle tedious.  I haven’t drawn the downside target, but the symmetry suggests 1000 points down from 8200 which would take us down to 7200 in a jiffy…maybe two days of heavy selling.

The upside moves are more constrained and it will take a Santa Claus Rally to get some steam going to get past 9200.   As I showed the other day we are in such oversold territory that all Technical Signals call for a Bounce Play, but essentially the extent of the bounce is little more than short covering, only to start the same process all over again. 

The mood is obvious in that there is so much Uncertainty that there is no Conviction by the Bulls other than to snap up a few bottom fishes when they feel the stops for the shorts a few points below the previous low will give a snap back until the so called rally if any runs out of steam within a day.  Meanwhile the nimble can switch back and forth between the likes of the QID/QLD and are happy campers as they are nimble and stay glued to their screens.

However, although the Darvas Box is over 1200 points around the NYSE high and Low these past five weeks, there are a few “Sherlock Holmes like” glimmer’s of clues that we may be gradually trying to repair at this level.  I come back to my trusty chart of the 20-dma 1, 2, and 3-std deviations on the Bollinger Bands to show you what I mean:

Best Regards, Ian.

Question: Mike Orlyk Says:

Ian – I am trying to understand your statement “seeing 300 to 600 point swings a day as commonplace on the DOW, 50 to 80 on the Nasdaq and 25 to 40 on the S&P 500″ in context with the remainder of the blog.  Are you saying to expect such swings until a bear rally finally manifests itself?

Also, within the past swing down/rally up/re-test shown in your spread sheet was the volatility, at least on a percentage wise basis, equivalent to what we are seeing today?

Thanks,  Mike

Reply:  I am saying that the Days of Wine and Roses regarding Volatility are long since gone and we will not calm down for a long while to come.   I doubt if the wild swings will change when we start a Bear Market Rally.   It is far more likely that it won’t calm down until we see a NEW BULL MARKET Rally, which to my mind is at least 6 to 9 months or even a year away.

The only Measuring Rods I can offer to answer your other question is to take you back in time to May through July 2006, when we first noticed a string of six Eurekas in a row which we ultimately found in hindsight was due to excessive volatility and no fault of
the Eureka Indicator.  After a long hiatus, So far we have had three Eurekas in quick succession, so you can immediately see a similar pattern.

The second Yardstick I can offer you was in the March Seminar where I showed a chart of a Day in the Life of a Day Trader and at that time the swings were 150 points a day:

It goes without saying that was chicken feed to what we have now where the Volatility had increased four times at the time of the precipitous drop we had a month ago. It is half that now in terms of daily swings, but at the next sign of a crisis we can experience
going back to 600 to 1000 points a day or two days at most.

Of course the VIX pundits know all of this only too well and point to the VIX chart as a quick confirmation that times have changed and that is the quickest way to get a feel for the picture over time.  To my beady eyes it suggests at least a “twofer” compared to the
2000 to 2003 timeframe: 

So what has caused all of this?  I think I mentioned at least three items, one of which is the rage in playing double and now triple ETF’s and the second is the “No Uptick” rule for shorting.  The third is the natural jittery market conditions due to Uncertainty.  That
item is always the killer.  Bears romp around while the Bulls stay in hiding.

I’m sure the pundits of 1987 can wax eloquently on volatility of the crash, but I was still working for a living back then and was not into such esoteric items when my 401K took a dive that set me back a couple of years at least in one week flat.   Fortunately my sons are in better shape this time around with the “ole man” to guide them.

My point is don’t expect calm waters until 2010 if past history is anything to go by.  Therefore it plays into the hands of the Type 1 and 2 Moment and Day Traders for a long while to come.  Type 3 Swing Traders will look for the key signs covered in the Newsletter by Ron and I for a Bear Market Rally.  Type 4 Long Term Buy and Hold types can hibernate for a while until we see a Golden Cross of the 50-dma coming up through the 200-dma.

Best Regards, Ian.

With apologies to George Gershwin  and an old favorite tune many moons ago which Gene Kelly danced with Leslie Caron on the banks of the Seine, I’m afraid our Volatility is here to stay forever and a day!  Times have changed and we will need to get used to seeing 300 to 600 point swings a day as commonplace on the DOW, 50 to 80 on the Nasdaq and 25 to 40 on the S&P 500.  Likewise, 20% knee jerk moves within a few days both up and down should also be expected to be commonplace.   It will be a while before this volatility subsides. 

The following is a spreadsheet of the nine other Bear Market occasions where the “Swing Down” has been greater than 20%, followed by a Rally Up and then a re-test of the Lows .  The picture below is worth a thousand words and confirms the expected odds:

I have shown the % Gain/(Loss) and the calendar days for each step down, up and down again.   As you can see on the left hand side, the average and median numbers are so close to each other that the probabilities of these numbers occurring are high.  On the right hand side, the days are all over the place, but if you look at them carefully they fall into two camps, short and long term. 

Another point to notice is that the re-test is invariably less than the Rally Up, which suggests that we have probably found a bottom, unless there is some other major global surprise that raises its ugly head.  The Bounce Play occurred in two days flat and the re-test started on October 14, 2008.  It is now a month since that high, so we are on track to seeking a bottom soon.

The above statistics are for the S&P 500.  Note I am using 17% down based on the above for the re-test of the Lows; anything worse than that suggests 2002 like numbers of >-20%:

The Key Lines in the Sand to the Downside are:

We can see that we are just 6 points away from being 17% down on the Nasdaq, and no more than one day’s worth for the DOW and S&P 500.  As we can see, the DOW has behaved the strongest in this past month with the Nasdaq the weakest.  It has been 29 days since the re-test started and as one can see from the table, three of the readings are 33 or 34 days for previous re-tests, so we are on track!   We must hope that this will not end up with another crater to the downside, and that we will see no worse than a Double Bottom for now before we head back up. 

The $64 question is “Are we close to the end of the gloom and doom or do we head down further with more misery in store before this market can recover into a Bear Market Rally?”

The market started to drive up last week where two Eureka’s accompanied by Kahuna’s showed some signs of recovery underway.  Once that trend upwards was broken to the downside as we witnessed these past three days, the whole process must start again, so we must look for a Reversal Day as the first step in the recovery process.  We first look to Capitulation with a Spike in New Lows which is currently at 324, but could get as high as >1000, then look for a Reversal Day, and a Follow Through Day thereafter.  The short answer is to take it a day at a time for the moment as the market is still too jittery to give a clear indication of the start of a bear market rally.

Best Regards, Ian.