Weekend reading: Scare bear markets

by The Investor on October 24, 2009

My regular Saturday comment followed by this week’s blog and financial site links.

I admit there are worrying signs in the market. I don’t mean how the main indexes seem to have stalled — it’s always very hard to tell signals from noise, and anyway Australian academics just proved that technical analysis doesn’t work:

Technical analysis is not consistently profitable in the 49 countries that comprise the Morgan Stanley Capital Index once data snooping bias is accounted for.

There is some evidence that technical trading rules perform better in emerging markets than developed markets, which is consistent with the finding of previous studies that these markets are less efficient, but this result is not strong.

While we cannot rule out the possibility that technical analysis compliments other market timing techniques or that trading rules we do not test are profitable, we do show that over 5,000 trading rules do not add value beyond what may be expected by chance when used in isolation.

No, what’s slightly concerned me are reports that traders are making out like bandits on the City desks, oblivious to risk.

On the one hand, this explains why bankers are making a fortune.

On the other, I don’t think bankers are demonstrably cleverer than more cautious souls, what with them bringing the world to its knees 12 months ago.

Bull markets are always manic, but I wonder if the 22-year olds on these trading desks are getting carried away again?

Gutting the bears

One group of 20-somethings who don’t worry me are the analysts whose stock market graphs don’t go back beyond 2007.

(Actually, most are well into their 40s and 50s — I’m just making excuses!)

This week saw a rush of articles warning the so-called ‘bear market rally’ is almost over because of a vague similarity between graphs of other major historical declines and their subsequent false rallies.

The gist is we’re going to have a second leg down that will retest the March lows.

For instance, here’s a chart from zippy insider blog, The Big Picture:

(Click to enlarge).

And here’s one of my favourite commentators, John Authers in the Financial Times, also commentating on the same pattern:

What should we make of the landmark? […] Rebounds after big bear markets tend to be about 70 per cent. This one is closing in on that. But the speed with which this rebound has made good the losses is historically unusual – perhaps because this rebound is being deliberately aided by governments.

Also the historic pattern is for the rebound rally to give way to a new bear market.

There’s plenty more in the less respectable corners of the Internet, too.

Now, given those academics proved 5,000 technical signals don’t work, what, to paraphrase John Authers’ question, should we make of news that one squiggly line from 2009 looks a little bit like another from the 1930s?

I say: Absolutely nothing!

The market will go down a bit at some point, because it can’t go up forever.

But if it does so at the same percentage point as with the bear market of the 1930s, it’ll surely be a coincidence.

There’s not a Bear Market Rally God with a Google Alert to SMS him when the Dow hits 11,000.

Furthermore, these graph watchers all believe the slump began in 2007.

I’d argue it makes more sense to think of it starting in 2000. It was then that equities were super expensive. In 2007, most of them looked pricey but not at 1999/1929 levels.

In short, we’ve already been through a ten-year bear market. If you want to see a second slump, look for it in 2007-2008, not in 2010.

Here’s a FTSE 100 graph from 1999 to 2009 that I nabbed off a bulletin board this week (sorry, no source, but standard with some red lines added):