Tuesday, October 25, 2011

Characteristics of Market Bottoms for Aussie All Ords

Since 1984 (based on the free data from Yahoo Finance), the Australian All Ordinaries has experienced 9 major market bottoms of 14% or more, 7 of which were 20% or more and 2 were 50% and 54%. So while no one rings a bell at a market bottom, we ought be able to observe some characteristics of market bottoms that may help inform decision making now and in the future.

The table below summarises some of the indicators I believe are relevant to determining whether a market bottom is likely to have occurred. This should be read in conjunction with market trends so that you don't pick a bottom while the market is still trending down. In the case of very large sudden falls you might try bottom picking on the basis that if you are a bit early it is likely not worse than you would have been being a bit late while you waited to be sure a sustained upswing was emerging.

The main indicators are growth/fall rates over various time periods, and the length of a rise and fall. From past major bottoms and these indicators are derived Average, Median, Maximum and Minimum of each indicator.

From the table below
Please note that the last normal row is as at today which can't be a major bottom, but including it lets us see it is not too dissimilar to 2 previous major bottoms so could still be good buying.

If it is more than 1.5 years since a prior bottom you are getting into the range where one has occurred previously. The range however extends out from 1.5 to 6 years so this measure alone is not sufficient.

Falls can be surprisingly rapid - 1987 was 50% in 50 days, so you may want to sell after a fall of 7 to 8% no matter how quick the fall. A smaller fall is unlikely to be part of a major fall and if you sell after a fall of 3 or 4 % you will be whipsawn frequently, much to your detriment.

Assuming the fall is at least 8% already, the bottom could be in at as little as 14% total fall but the median is 22% and the average is 28%. As a guesstimate, if you buy in after a 20% fall you may still do as well as if you waited for a 30% actual bottom and then a 12 to 15% recovery while you waited to be sure that any emerging uptrend was likely to be sustained.  If you buy at 20% down and the actual bottom is at 25% down you might have done better buying in at the 20% as it might recover to being only down 15% before you otherwise are convinced to buy. The chances of picking an absolute bottom are virtually nil.

Major bottoms have only occurred when there has been a fall over both 2 months and over 1 year. It is also not uncommon for there to have been falls over longer periods, but rarely for there to have been a fall over 5 years except in the very worst of falls. The very worst of falls normally occur after the very best of rises!

As in the last few columns on the right of the table, you can look at cumulative falls from the 2 or 3 shortest periods of growth I monitor as a further indication and look at the Average, Median, Minimum and Maximum for them also.

While it would have been misleading in the Japanese market since 1990 and I assume in any other crash of a huge bubble you can look at the rate of growth since say 3 bottoms ago compared to the median to see whether the rate of growth seems to be about the rate of growth in the economy over that extended period. It is highly unlikely that there will have been exceptional growth compared to the economy as a whole over the term of 3 bottoms.

From this exercise we can see that there was an almost median bottom of a fall of 22% on 26 Sept 2011. This is not to say that the market can't fall further, possibly resulting in whipsawing losses if you buy back in/increase exposure and the market falls.

Note of Caution
"Time in the market" and "Buy and Hold" have been disastrous for the Japanese since 1990. Given the global debt crises (public, private, external and FX denominated) it is possible that we may be in a Japanese situation and that should be kept in mind. In the Japanese post 1990 bubble the market has shown a further loss (and negative return over the last 3 bottoms) at each new, lower bottom until now (assuming September was a major bottom). the percentile amount of time in loss approached 50% compared to 30% in the Australian market since 1984 to date. our percentiles in loss could increase given the long, high growth we had from 2002 to 2007.

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