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The Speculator
Still bullish after the Crash of
'02
The
market's recent spin downward reminds us of the events of October
1987, when building panic led to a wreck. But remember, a rally
followed. So we're still bulls, though we're not rushing
in.
By Victor
Niederhoffer and Laurel Kenner
What a difference a week makes. On Friday, July
19, the S&P 500 Index ($INX)
futures took a 1.5% decline in the last hour of trading. The October
1987 crash was Topic A over the weekend. Monday opened with declines
of up to 3% in Europe. The U.S. market opened and promptly resumed
its slide.
One week later,
on Friday, July 26, the S&P futures rose 1.5% in the last hour
of trading. The weekend papers carried a few stories on veteran
investors jumping on stocks. European markets opened Monday with
3%-4% gains, and the Dow Industrials ($INDU)
closed at the day’s high, up 447 points.
These mirror-image
snapshots show the danger of forcing oneself into a position that
does not take account of changes in cycles.
Big debacles
The July 2002 crash bore a
striking and instructive similarity to the debacle of October 1987.
In both cases, the declines took place over five days encompassing a
Friday options expiration. Investors worldwide panicked over the
weekend.
Having had similar setups, the crashes played
themselves out in an almost identical manner.
- 1987: The market fell on Wednesday, Thursday, Friday
and Monday. The bottom came Tuesday morning, Oct. 20.
- 2002: The market fell on Thursday, Friday, Monday and
Tuesday. The bottom came Wednesday morning, July 24.
- 1987: The worst declines came Friday (-108 points) and
Monday (-508 points). Total loss: 616 points.
- 2002: The worst declines came Friday (-390 points) and
Monday (-234 points). Total loss: 624 points.
In both
cases, the bad week had been preceded by several weeks of declines.
- 1987: From Aug. 25 to the Oct. 20 low, the Dow lost
38%.
- 2002: From May 17 to the July 24 low, the Dow lost
27%.
| Tale of two crashes |
| 1987 |
Dow |
2002 |
Dow |
| Aug. 25 |
2722 |
May 17 |
10,353 |
| Oct. 13 |
2508 |
July 17 |
8542 |
| Oct. 20 low |
1677 |
July 24 low |
7532 |
| Loss |
38% |
Loss |
27% | |
True,
the drop in 1987 was steeper; the Dow tumbled 22.6% on Monday, Oct.
19, alone. But in one sense, the 2002 decline was worse, because it
followed two down years (6% in 2000 and 7% in 2001). The 1987 crash
came after two major up years (27% in 1985 and 22% in
1986).
The U.S. crashes echoed around the world, leaving
every market lower except for those in the farthest reaches. In
2002, only three of the 71 primary international markets rose over
the four days between July 18 and July 23: Mauritius, Panama and
Pakistan. For the comparable four days in 1987, the only gains were
in Korea and Mumbai (formerly Bombay).
Lastly, in both 1987
and 2002, there was a remarkable surge from the low.
- 1987: From Tuesday’s low to Wednesday’s close, the Dow
rose 16%.
- 2002: From Wednesday’s low to next Monday’s close, the
Dow rose 16%.
The general outline of events is quite
similar -- a weekend panic, a disastrous start to the week, a
morning retest of lows and a big rally. Our experiences in other
markets leads us to believe that the similarity between these
crashes may not be coincidental, and that it may reflect a general
tendency in the human psyche.
Bear-market rallies and other
balderdash
Devastating declines elicit much propaganda.
After the bears have feasted for a long time, they’re unwilling to
entertain the notion that bad times might be coming to an end. This
inflexibility will ultimately lead to their downfall.
Many
of the current bears, savoring their triumph after having been
pessimistic for 30 or 40 years, are looking for reasons to disparage
the possibility of a rise. A week ago, the day after the July 24
rally, a table making the rounds on the Internet made the point
nicely.
The table consisted of a list of percentage changes
in the Dow Jones Industrial Average. “Nine of the 10-biggest rallies
in U.S. stock market history occurred during the great 1929-1932
crash period,” the accompanying note read.
So many things
were wrong with this table that it is hard to know where to begin.
For starters, the list omitted the biggest rally of all, a 17% jump
on March 15, 1933, that just happened to be the start of a sustained
rise. Not many people recall that 1933 was a major bull market, up
67%. In fact, four years after that history-making 1933 rally, the
Dow had tripled.
Beyond that omission, the table was out of
context. The 1930s stock market was very different than today’s
highly liquid exchanges. Bid-asked spreads were much larger then,
and a very small number of transactions was enough to send the
market shooting up or down.
Moreover, indexes (and stocks)
are more volatile at low levels, as can be witnessed in the daily
action in penny stocks. There, thousands of stocks go on
roller-coaster rides that cause heart attacks in shareholders of
larger companies.
One other thing: It should be noted that
half of the 10-biggest declines also took place from
1929-1932.
| Top 10 % Declines in DJIA
1900-Present |
|
Date |
% Loss |
| 1 |
12/12/1914 |
23.52% |
| 2 |
10/19/1987 |
22.61% |
| 3 |
10/28/1929 |
12.82% |
| 4 |
10/29/1929 |
11.73% |
| 5 |
11/6/1929 |
9.92% |
| 6 |
8/12/1932 |
8.40% |
| 7 |
3/14/1907 |
8.29% |
| 8 |
10/26/1987 |
8.04% |
| 9 |
7/21/1933 |
7.84% |
| 10 |
10/18/1937 |
7.75% | |
For
the record, here is the correct list of the Dow’s 10 biggest
rises:
| 10 Biggest % Rises in DJIA
1900-Present |
|
Date |
% Gain |
| 1 |
3/15/1933 |
16.83% |
| 2 |
10/6/1931 |
14.87% |
| 3 |
10/30/1929 |
12.34% |
| 4 |
9/21/1932 |
11.36% |
| 5 |
10/21/1987 |
10.15% |
| 6 |
8/3/1932 |
9.52% |
| 7 |
2/11/1932 |
9.47% |
| 8 |
11/14/1929 |
9.36% |
| 9 |
12/18/1931 |
9.35% |
| 10 |
2/13/1932 |
9.19% | |
Who
circulated the “10 Biggest Rises” table, and why?
In the old
days, hit-‘em-over-the-head propaganda techniques such as “plain
folks,” “get on the bandwagon,” name-calling and testimonials were
effective. Today’s methods are more subtle. Modern propaganda
doesn’t show the enemy in a ridiculous pose; rather, seemingly
objective data is presented with terse or no comment. (The data are
probably tainted, or taken out of context, as was the case with the
above table.) But it’s up to the reader to make the leap: “If 9 of
the 10 largest rallies occurred in bear markets, better disregard
this rally, as we’re surely still in a bear market.”
What
hasn’t changed is whom the originator of propaganda wishes to
benefit. It’s never the target.
But . . . what comes
next?
Devastating declines are much easier to describe than
to predict. As we fell prey to this unfortunate tendency of stock
market scribes at the start of today’s column, we’ll attempt to
rectify it now by counting what has happened in the days after very
big gains.
We have now had two rises of 40 or more S&P
500 futures points in the past week. On July 24, the contract rose
47 points; on Monday, July 29, it rose 40.
Over the past six
years, there have been 21 occasions when S&P 500 futures rose 40
or more points in a day. We looked 1, 2, 3, 4, 5 and 7 days in the
future and found:
| Changes After 40-Point Rises in S&P
Futures |
| Days after |
1 |
2 |
3 |
4 |
5 |
7 |
| % up |
42% |
42% |
42% |
66% |
71% |
71% |
| % chg |
unch |
-2% |
-1% |
0.75% |
2% |
1% | |
Although
Monday’s 447-point rally was encouraging, coming on the third day
after Wednesday’s 489-point rise, jumping in to buy immediately
after a big rally in hopes of a quick repeat doesn’t seem like a
high-percentage shot, given the record.
Bye-bye?
For more than 30 years, a
certain columnist at a leading financial weekly has been
relentlessly bearish on the stock market. In the 1990s, the joke
among investors was that the bull market would only be over when
this particular commentator turned bullish.
Recently, the
jokes have been at our expense. As our long-suffering readers know,
we turned bullish several weeks ago, only to see the market sink.
And, we admit, we generally have a sunny outlook on the market,
having been mightily encouraged by the 1.5 million percent return in
the U.S. and European indexes during the last century. We still see
no evidence that things will be worse in this century.
Lately, many of our correspondents have written to advise us
that they’ll know when the bear market is over when we turn bearish.
Such comments are often accompanied by suggestions or pleas that we
retire soon.
To those readers, we say that our bullishness
is undiminished -- and that it is much more likely, bosses willing,
that we will retire at Dow 12,000 than Dow 7,000.
Final note
In our last column, we ran
the results of a test of one of the patterns used by technical
analysts, the head-and-shoulders. As our previous columns on
technical analysis have been roundly attacked, we were surprised to
received mostly positive mail. (Perhaps our critics were busy
covering their shorts, or perhaps they have given up on us.)
In any case, the negative commentary was mostly along the
lines of, “Technical analysis is an art, not a science,” and that no
one could possibly refute the validity of it.
We agree.
Technical analysis is a multi-headed hydra, and it can only
be approached one step at a time, with the expectation that more
heads will always appear. Our test of the head-and-shoulders pattern
was merely a preliminary step. We’re always open to the
quantification and testing of any such rules.
And one last
word: We use the S&P futures contract as a proxy for the
market because it is one of the most liquid in the world, with some
$100 billion traded daily. One contract is worth $250 per S&P
500 point, or roughly $225,000 at current levels. Equivalent
securities called Standard & Poor's Depositary Receipts, or
"Spyders," are traded on the Amex, where they closed today at about
$91.50 a share. Investors wishing to participate in market moves
without trading futures might consider SPDR
Trust (SPY,
news,
msgs),
broad-based mutual funds or a group of individual
stocks.
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