Friday, August 19, 2011

The Recession Line

As it appears that the markets are not at all in the mood to head higher and, in fact, looking at where futures are playing out right now, will likely be headed lower in the near term, I began tracking back to see where we could find some level of support.

When markets have gone through the multi-year rally that we have all lived through over the past 2 1/2 years, it's important to recognize our own biases. We will all be tempted to jump in sooner rather than later on any minor selloff in the equity markets, hoping to continue riding the powerful 100% rally in the S&P 500 that we saw unfold between March 2009 and April 2011 (hope you caught our call for a generational bottom). In fact, it is this tendency that often keeps bull markets running far longer than many expect them to.

Thus longer-term trendlines, if they can provide some historical support as relevant, are critical to monitor and effective deterrents from reacting too quickly and too soon. In a bear market (as we are in now), the speed of the decline will ruthlessly punish overly anxious investors.

To generate a sense of where we might find support, I looked back to the selloff last July (the one that sent Barton Biggs into a tailspin and put him through his now-famous 3-week reversal) and drew a trendline where we found support at that time. The level is at S&P ~1027.

This is not incredibly exciting as it is only one data point of support...what is interesting is what happened when I extended the trendline back 20 years and looked at the S&P on a monthly basis.

Notice that the 1027 line was not only a support level in the July 2010 timeframe, but was tested over 3 months in late 2009 as market participants looked to see if the bounce off the May lows was sustainable.

The 1027 S&P level was also tested in late 2008 shortly after the Lehman collapse and the break below 1027 resulted in the largest 1 month selloff in the S&P over the last 20 years (and probably ever). Even further back, it was in October 2003, when the market broke above this level that industry experts began calling for the end of the recession. It was also a test of this level over 3 months in late 2001 (Sep - Nov) and a subsequent test and failure in June 2002 that sent us into our dotcom recession. Finally, it was this same level that was tested and held in the 25% correction in late 1998 (who remembers this?) that preceded the 60% market run through March 2000. With the amount of historical support for the 1027 S&P level, I would argue that this trendline represents the Recession Line...a break below means we are heading into our 3rd recession in the last 12 years, a real possibility given economic conditions.

Now, not to be too exact, one could also argue that a similar trendline, at S&P 1100, found similar support over the last 20 years and this level may hold again as it did last week (we can only hope...). The only difference is that this will not signal a clear bottom.

It appears that the Relative Strength Index of the S&P (on a monthly basis) approached the 25 level at both the 2002 and 2009 bottoms. With the monthly RSI currently at around 45, I am afraid that the historic Recession Line may not hold this time.

As the old adage goes, only fools (and bullish investors) try to catch a falling knife.

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