Forget the News. Investor Behaviour will Likely Signal the End of this Bear Market
Most people tend to analyze the current situation to see if stocks are near a
low. However, I have found that using our logic to try to figure out what stock
markets might do in the future does not produce very good results.
CXO Advisory Group did a study on the accuracy of forecasts made by 60
investment experts in 2011. They looked at the least famous, medium famous and
the most famous of them. As you can see below, the results were all below 50%.
The 20 most famous experts had a lower accuracy of 48% compared to the 20
least famous who were accurate 49% of the time. This proves if you are looking to
some of the most well-known or popular investment experts to get an accurate
perspective of what might happen in the future, you are likely to be disappointed.
You might as well just flip a coin.
I realized this more than 20 years ago so I began a quest to see if I could
improve on this accuracy rate. I found that it was better to study how investors are
behaving in the markets than to focus on factors like the economy, interest rates
and current events. While the situation around us is always different, the human
reaction to certain events in the stock market is often very similar. This is because
human nature has not changed in thousands of years.
Human behaviour in the market place has often produced a pattern of two lows
approximately 1 to 3 months apart at the end of a bear market. (A bear market is a
decline of 20% or more.) To end a bear market and start a new uptrend, the
second low is often within 4% of the previous low. Please see my illustration of
this below.
Please see examples of actual double bottoms that ended bear markets in the
past below. These are taken from Chapter 24 of my book, Mind,
Money & Markets.
This illustration shows the double bottom only 4 weeks apart in 1980 and the
double bottom that marked the end of the dreadful bear market and recession in
1982. It took many months after the final low on August 13, 1982 for investors to
believe that this bear market and very severe recession could actually come to an
end. The double bottom revealed it instantly.
U.S. stocks fell 20% from record highs in August 1987 to October 16, 1987.
Then, on Monday, October 19th, U.S. stock prices fell another 20% in one day!
Everyone knew that the only other time U.S. stocks had collapsed by 20% in one
day was in October 1929 before prices fell much further. This was followed not
by a recession but by an economic depression that would leave a scar on an entire
generation. Some people cancelled the purchases of real estate and businesses,
fearing the worst. However, U.S. stocks recorded another classic double bottom
close to six weeks apart, enabling the S&P 500 to move close to record highs two
years later. The October 1987 lows have never been revisited again and there was
not even an economic recession. This pattern of human behaviour provided a far
more accurate forecast of what was to happen compared to the logic at that time!
U.S. stocks had one of the longest declines in a generation after the technology
bubble burst in 2000. The red arrows show how markets reached a low in July
2002, October 2002 and then in March 2003. The second bottom in October was
the lowest low. The U.S. invaded Iraq in March 2003 and the SARS virus was
sweeping over the world. After a severe bear market and recession, these lows
showed that everyone who wanted to sell had sold.
Remember my saying that it does not matter how bad or how good the news
is. What really matters is how much bad news or good news is already
reflected in current prices. I have found that many investors cannot bring
themselves to accept that this is how markets function.
Some investors sell or are close to selling when the first low is made. There is
some relief after prices rally off of the first low. However, when stocks drop within
the range of the previous lows once more, some investors just cannot resist the
urge to sell to get some relief from the stress and anxiety that a bear market can
produce. After these last investors sell at attractive prices, there are more buyers
than sellers so stock prices can go up again. This is just how investors often behave
whenever there is a serious selloff.
However, there have been some exceptions recently. There was only a single
bottom after U.S. stocks fell 20% in December 2018. There was also only a single
bottom in March 2020 when stocks sold off due to Covid-19. The main reason for
these exceptions is that Fed Chairperson Jerome Powell intervened much faster
after each of these selloffs than most other Fed Chairpersons have done in the
past.
This chart, from Yahoo Finance, shows that, as of today, investors may be in
the process of creating double bottom pattern once again. The S&P 500 reached a
low of 3,666 on June 16th. After a multi-week recovery, the S&P 500 fell to a low
of 3,623 yesterday and then rose 1.97% today to close at 3,719. Bear markets
usually end on a Tuesday. The next most common day to end is a Thursday.
Yesterday was a Tuesday.
Many bear markets have ended with an announcement from the Federal
Reserve in the U.S. However, today, the Bank of England announced that it will
suspend the start of planned selling of U.K. bonds and will instead begin temporary
purchases of U.K. bonds in order to “restore orderly market conditions.” These
purchases will be carried out “on whatever scale is necessary” to soothe markets.
U.K. bonds had suffered the biggest monthly price decline since 1957.
This action by the Bank of England is the type of pivotal announcement and
intervention that has usually ended bear markets in the past. With very high levels
of pessimism and an extreme oversold condition, stocks were poised for a short term
bounce. Whether this is the bounce that starts a new, powerful, long-term
uptrend remains to be seen in the days and weeks ahead.
As of today, most of the characteristics of recent stock market action are
following the classic pattern of forming a double bottom. If they are, market
averages should stay within 4% of the low in June so that is what I will be
watching for. Confirmation of strong buying power over a period of a week or
two is required to provide more confirmation that a new longer-term uptrend has
started. Therefore, I will be watching the daily market statistics to see if investors
will continue to behave as they have at other market bottoms. I will pay almost no
attention to news of current events and the logic of experts, since I have found that
to be of little value at a time like this. It is more important to observe how
investors all over the world are actually reacting to the current state of affairs than
how I think they should react. Please make sure you are looking at useful
information too.
Long time RBC Technical Analyst, Robert Sluymer, wrote an endorsement for
my book. He wrote, “Over the past two decades, I’ve watched Dave Harder make
a number of impressive calls at long-term inflection points.” This Update shows
you the process I have used to make calls at long-term inflection points since I
completed my quest to produce more accurate market forecasts in 2001. I am
using all of my knowledge and experience to try to make another useful call at the
next major turning point when this bear market ends. I will keep you informed
with these Updates. Thank you for your continued trust and confidence during this
volatile year.
Please feel free to pass this Update on to others who may not have access to
information like this. Thank you kindly!
Enjoying an endless summer after an endless winter. It does not get any better
than this at this time of year. Have a great weekend my friend!