Saturday, October 29, 2011

All Ords - A Below Average Recovery

The Australian All Ords recovery since the 6 March 2009 bottom is below average, but in the recovery from the 1987 crash it got a lot worse from here.

See the bottom of the page for methodology and disclaimers.

Recent Position
As can be seen from the chart below, the current recovery from the 2009 bottom after the 2007 peak was the lowest percentage recovery of all since 1984 for a few days around mid September this year, 2011, or about days 645 to 648 on the graph which is about 2.5 years after the bottom. It was significantly below Average and below Average - 2003.

Currently (Friday 28 October 2011) after 671 trading days, or about 2.5 years since the 2009 bottom, we are at a 41.6% recovery, compared to an average of 54.9% or an average not including 2003 of 52.3%.

This does not mean that the recovery will automatically revert to the mean/average or that any reversion that does occur will be before any further significant falls. I am not pretending to forecast the market close at some point in the future.

In the chart below, which only covers trading days 471 to 810 since the bottoms, bold bright blue is the current recovery, the average is the orange line around the middle of the chart and 1987 is the pink line dipping towards trading day 800. 


There are several possible explanations for this position.
1. The European debt crisis caused a secondary crash - the fall from the April highs to September lows was a median major fall of the Australian All Ords.
2. Austerity to reduce government debt resulting from stimulus and bank bailouts is reducing GDP/GDP growth whereas there was no Western debt crisis other than for highly geared corporates in most previous recoveries.
3. The imbalances that grew during the artificially induced "Great Moderation" of 2003 to 2007 and the size of the 2007/8/9 crash were of such magnitude that they will continue to work through the global economy for some years, much as was the case after the 1987 crash and so 1987 is as likely a guide to the future as the average of past recoveries.

The Megaphone of Likely Possible Futures
 We can think of the chart from Day 671 forward as a megaphone (or sideways cone if you like) of  likely future possibilities - it might not be correct, there could be worse outcomes eg Japan from 1990 to 2011, or maybe even better outcomes than the recovery from 2003, although personally I don't give that a snowballs chance in hell. I regard these latter outcomes as very remote, highly unlikely possibilities.

Our Attitude And Approach From Here - Invested but respecting the possibility of 1987/1991.
While we might hope for reversion to the mean and possibly above from time to time, we should not lose sight of the 1987 possibility (I heavily discount a Japanese possibility because of the resource demand from China and India and our better demographics), which is that we could fall from being a 41.5% recovery now to being only a 4.6% recovery over the next say 130 trading days, just like what happened to the recovery from the 1987 crash in 1991.

So while we might be heavily invested now after the September bottom, we should set our stop loss limits now (one off  "risk off" disinvestment or staggered risk/investment reductions to avoid the possibility of being totally whips sawn). Personally I will reconsider what will, after this Monday, be my almost fully invested position if there is a drop of 5% from my buy price on Monday.

Methodology and Disclaimers
I keep a number of charts of recoveries, all with the bottom as zero and measuring the percent improvement since the bottom for all crashes from 1987. I follow each recovery for 1100 trading days which allows us to see how this recovery compares to others. That period of time normally includes at least 1 other fall of more than 20%, but not in the case of 2003 to 2007. I include 2 averages, one of all recoveries and one of all recoveries other than from 2003 given it seems unlikely to be repeated any time soon given the various private, public, foreign and foreign currency debt crises that still exist.

As always this is not financial advice or a forecast and the past does not foretell the future. Ask any Japanese stock market investor about time in the market and the possibility of markets being lower even after 20 years after a bubble peak. Read widely and make your own decision after getting whatever specific advice you might need.

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