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. 

 

Interpretations/Explanations
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.

Market Cycles in the Australian All Ordinaries

What have the market cycles in the Australian All Ordinaries looked like in the modern era (post 1984)?

While I have previously posted on market Tops and Bottoms as separate entities, this post shows the cycles of tops and bottoms in one table in chronological order.

Explanation of the use of the lengths of cycles and rates of growth over different time periods have been given in the last post about the Characteristics of Market Bottoms and very similar principles apply to market tops.

The only additional word of caution is regarding the possibility that we are in a long term secular bear market and so falls might be longer lasting and bigger and bull rallies shorter and lesser, but this is just a caution about a real possibility, not a prediction.

The last line is today's results and it will not be a major turning point (famous last words?) unless Europe falls apart over the next few days.

The greens and blues are buys, the pink, yellow and orange are sells. you will see from the last two columns that tops are all large rises (because we are adding together the growth for 2 or 3 periods) and the bottoms are all large falls (for the same reason).

You will see that all bottoms have falls for 2 months and 1 year and generally for 2 years also, while almost all tops have positive growth for all periodicities with only a few exceptions, including in April 2011. Only 2 tops out of 7 have any negative growth period. It is uncommon to see a top without all periodicities showing positive growth.

The median lengths of complete cycles, rises and falls are at the bottom of the table as are the median results of adding each of :
a) 2 month and 1 year, and
b) 2 months and 1 and 2 years growth
for tops and separately for bottoms.

Median cycle is 3.2 years, median rise is 2.1 years, median fall is 1.0 years.

In about 1974 Austin Donnelly's book on Charting for Profit indicated that cycles averaged about 4 years, so things haven't changed that much, particularly if my 2 sub 20% fall bottoms were excluded, as most people would do in an article on market cycles.

Because of the occasional fast dramatic fall like 1987's 50% in 50 days with some trend indicating strategies failing to initiate a SELL until most of the loss was over, you may wish to have a stop loss at say 7 to 8% fall from the current bull market high. A tighter loss will result in more whipsawing and resultant losses over the round trip (Sell/Buy)

 When looking at market bottoms, you may also like to consider the likely maximum fall in terms of the previous 1 or two rises. The largest falls often occur after the most extraordinary rises like the 1987 and 2007 tops.

Should I "pick the bottom"?
You may choose to to invest at a time when the market:
a) is grossly oversold compared to eg its 200 SMA,
b) has had a fall of say 9% over the last 2 months (all bottoms except 1995 met this criteria), and
c) has fallen more than say 114%
on the basis that you will lose recovery of say 10% of the value at the top when the market turns up while you await the emergence of an apparently sustainable uptrend and so will get in closer to the bottom with this bottom picking strategy than by waiting for the uptrend to establish. You would likely be more cautious and adjust the above parameters if the preceding bull market was longer than usual, had a higher percentage rise than most bull markets and a higher rise in percent per annum terms.

For those interested in avoiding major falls but participating in major rises, this information should be helpful.

I add my usual cautions about the Japanese possibility which would change all these things and also of the dangers and costs of being whipsawn.

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.

All Ords Dashboard Update - 25 Oct 2011

(See earlier article for a detailed explanation of this Dashboard. Essentially the top section is about timing signals and the bottom section about whether it is a likely top  or bottom in the market)

From the Dashboard it appears that a possibly sustained up trend is emerging from an approximately median market bottom on 26 Sept 2011. (See recent post on characteristics of market tops and bottoms.)

While the market is up 9% from the low it is still 15% below the April 2011 high and a sustained up trend could be reasonably expected to have a total rise of 20 to 50% or more.

From the short term chart included in the Dashboard below you can see a possible trading range of 3900 to 4400 and a longer term chart shows strong resistance at 5100. (I use Incredible Charts free version and the free data since 1984 from Yahoo Finance.)

From the Dashboard
The market is presently above its 10, 30 and 50 day simple moving averages, but below the 100 and 200 SMA's.

The 10, 30 and 50 day SMA's (as I calculate them which uses two lots of 3 days with a 2 day delay) have all turned up, but the 100 and 200 are still trending down.

The 10 has crossed above the 30 and 50 but there are no other crosses (30/50, 30/100, 50/100 and 50/200).

The market is still heavily oversold against the 200 SMA being in the 13th worst percentile since 1984. The 2 month rate of growth is not at either extreme. The market remains extremely volatile based on my calculations, being in the 95th percentile of most volatile periods.

The 1, 2, 4 and 5 year growths are all in the bottom 20 percentiles. Over 80% of the time the market shows better growth for these periods than currently.

While Japan is a cautionary tale for many of these indicators, the market has since 1984 been closer to its then all time high 92 per cent of the days. I am not very persuaded by this as the 2007 top was quite and extreme and we could be in a secular bear market with another 10 or 15 years to run so medium term cycles might be more helpful indicators than relativity to the 2007 high.

Conclusion
My overall conclusion is that on a break above the 4400 mark or perhaps on earlier favourable crosses of moving averages I will increase exposure to stock markets, probably in Australia.

Macro Analysis
Uncertainty in Europe looks like being resolved, at least in the short to medium term, later this week. (In the absence of full union or individual currencies it is impossible to expect that trade and performance imbalances can be resolved - Europe is on a "gold like" standard which means all adjustments are internalised, not through a floating exchange rate and/or inflation.). Even temporary resolution will likely assist market confidence globally. A Euro breakdown would be a Lehman like event, while a time delay would be a likely negative.

The US has some indicators showing that the recession forecast by ECRI and John Hussman might be avoided, although others claim that the favourable indicators are lagging or their positive performance is statistically insignificant noise.

China continues to be of some concern and this is not positive for Australia, but falls in commodity prices and the mining sector may ease the AUD and assist local manufacturers and tourism operators and any interest rate cut would provide cash to most mortgaged households and could lead to increased spending and profits.

A fall in interest rates because of slowing construction approvals (12 month average), falling house prices in some mainly regional markets and core inflation probably moving back into target range is now regarded as quite possible/likely, particularly after recent IMF growth warnings.

All Ords Dashboard Update

The Dashboard says:
1. Should have been in 100% cash or 100% short by now (if you short), (but it may be too late to start selling now - see below).
2. There is no uptrend to buy into so don't buy now.
3. Various percentiles of growth and volatility are at about the types of levels for an average/median bottom (based on performance since 1987), so look for a change to an uptrend to buy into.
4. It could still get markedly worse as 2 month, 1 and 2 year percentiles are only at moderately, not extremely low levels.

 

The macro fundamentals remain negative as Greek interest rates indicate the market thinks default highly likely within 6 months.

The Japanese post bubble experience would treat the All Ord's current  negative growth levels as only around or slightly below median performance (other than for 3 month) and the expectation would be that a bottom was not really likely until negative growth was more extreme (say around 15th percentile) at at least 2 of  1, 2 and 3 years.

Given Zombie Consumers in US and Zombie Sovereigns and Banks in Europe it is quite possible our next ten years will be much more like the Japanese experience than our last 10 years.

David Murray, CEO of Australia's Future Fund is reported (21 Sept 2011- ABC On Line) as saying we likely have 20 years of deleveraging and low growth from major developed countries in front of us.

A Statistical Approach to the Australian All Ordinaries

Buy low, sell high - like motherhood and apple pie, but what is high and what is low?

The answer to this question can be narrowed down by taking a statistical approach to analysis of the recent history of the Australian All Ordinaries.

Excel has a function which allows you to create a percentile analysis of a series of data. This can be applied to a series like the results of calculation of the percentage difference between the All Ords today compared to say 2 months, 1 year and any other number of periods ago. It can also be applied to a series of the volatility, or degree of overbought/sold compared to a benchmark such as the 200 day simple moving average.

The results of that percentile function can then be graphed using Excel's built in graphing functions.

You can then read any piece of data against the chart to determine where in the historical context the point lies. What percentile does it fall within? What percentage of historical results were higher or lower?


Here is the result of percentile analysis of the All Ordinaries growth performance for various rolling periods using index data starting from 1984.

If we know the 1 year growth as at today we can compare to a chart to determine the percentile within which that level of1 year growth would lie. Excel will, for each point on the chart, tell you the percentile number and the level of 1 year growth. For 12 September 2011 the 1 year growth rate was determined from the my table of calculations to be negative 11.9%. From a similar chart to that above that was determined to be in the 13th percentile of 1 year growth. In other words, from 1984 to 2010 the 1 year growth rate was higher 88.1% of the time. But 11.9% of the time it was worse and that can mean a lot worse, but generally not lasting for more than a year.

From the chart above we can see that about 75% of the time there is positive growth in the stock market. Compare that to the chart near the bottom of the Japanese Nikkei over a similar period. It has had positive growth only about 35% of the time.

You can also look at the results for a day that was a historical high or low to determine whether the results for today look like previous highs or lows compared to medians and averages (two other Excel functions) of the available past results.

What do market bottoms look like?

Here is the result of my analysis of major falls in the market since 1984.

This chart is quite straight forward other than that I have assumed at present that we had a bottom on 9 August 2011. This is on the verge of being proven wrong as I write on 12 September.

The top section of the table shows the Average, Median, Minimum and Maximum of the results shown in the bottom half of the table.

The bottom half of the table shows the characteristics of a number of market bottoms. It can be seen that the market on 9 August 2011 was within the ranges of results that in the past have been a market bottom, but not at the extreme bottom of those ranges for the one and two year growth rates in particular.

Summarising the Outcomes.

The results of the various periods of growth (and moving averages) that I monitor can be summarised into a "dashboard" which shows both the percentages and the percentile of historical growth within which that percentage falls.

From the top half of the above Dashboard we can see that the market has virtually no evidence of an uptrend at present. All of the moving averages I monitor are pointing down (last 3 days total is less than previous 3 days total) and for all but 10/30 all moving average pairs/crosses indicate that the market is falling.

However from the middle of the dashboard we can see that the market is in the worst 20 percentiles of being:
1. Most oversold against 200 day sma
2 Having most negative growth in 2 months and
3. being most volatile (as it is during bear markets including around market bottoms).


Towards the bottom of the dashboard we can see the actual levels of growth over the periods I monitor, compare them to the median and see the percentiles within which todays results fall.

This analysis is subject to the usual caveat of the past not predicting the future. Also, given the size of the stock market boom to October 2007 and fall to March 2009 there is a chance that in future these curves will shift so that the types of negative growth now will be more common (ie in higher percentiles) as they are now in the Japanese market (which I have also analysed) because of the falls from the undoubted bubble top in 1990. Having said that, the odds of the market showing higher rates of growth in future would normally be regarded as quite strong, while the chances of significant further falls would be regarded as real but significantly less than the chances of rises.

If we look at a chart of 1 year growth from 1985 to 2010 we will see that more negative growth is quite rare and has not lasted all that long in the past.

Could this be a top?

We know that we are below April 2011 levels so it is not a top, but lets look at what markets tops look like in terms of growth. As you will see is that the current market does not look anything like any of our past market tops in terns of historical growth.

Since 1984 the market has never had a top without 2 Month and 1, 2 and 5 year growth being positive. Generally all periods show positive growth. At the present time, no period of growth is positive and all periods of growth are substantially below the median levels of past market tops. It doesn't look anything like a top.

What Strategy To Follow?

There is little point in buying when there is virtually no evidence of any sustained market upturn, even if the market is within a range often associated with market bottoms and with various growth periods being at relatively low percentiles.

My strategy is that now and lower provides a time of probable buying opportunity but there is no point buying a falling market. Work out what you will accept as signalling a likely/possible market uptrend and how to stage your commitment to that uptrend, but be prepared to cut positions in the case of any emerging uptrend being a bear market rally.

Two bits of folklore to remember in this regard are:
1. first loss is best loss
2. the (up)trend is your friend (until it ends).

This strategy is informed by the analysis and results of John Hussman. He was guided mainly by economic fundamentals and value compared to historical outcomes. This helped him identify the unsustainable high of the market in 2007. However he missed virtually all the 2009/early 2010 rally because he was unwilling to look at price trends and how low the growth percentiles were in historical terms.

A note about the Japanese experience.

Japan has three lessons for us. First, money can be made in a market post the bursting of a bubble if timing is good, which is why looking at the trends is important. Second, what appear to be lowish percentiles in a market characterised as a sustained bull market will be average percentiles in a post bubble market with tough demographics, which is why not getting too carried away based only on the percentiles is also important - wait for the emergence of a trend. Third, time in the market is not a guarantee of a positive return if you buy at an extreme market top, which October 2007 may have been.

We see from this chart both that the top growth percentiles are literally off the chart because of the extreme bubble of 1990 and that about 65% of the time each period of growth monitored had negative growth as a result of the protracted readjustment of the market from the 1990 bubble during which the Nikkei has fallen about 80% from its all time high.

Conclusion.

By looking at the percentiles resulting from a statistical analysis we can know whether we are buying near a possible top or bottom and tailor our risk management accordingly.

By looking at indicators of existing trends such as the direction or crosses/pairs of moving averages we can judge whether we would be buying/selling into an up/downtrend.

The goal of course is to buy near a bottom but only into what is likely to be an uptrend but to accept the possibility of whipsawing and losses through reversal of the trend.

We can reduce the risks of whipsawing by staging our commitment to a new up or down trend or, having bought near a very likely low based on our percentile analysis, we can choose to ride it out in the hope and with the likelihood that our losses will be smaller than most other investors and eliminated during the next uptrend.

Building Approvals Show the Coming Slow Down.

Building Approvals by Value are, obviously, a good indicator of likely levels of future construction activity.

New buildings leads to new furnishings, plant & equipment, and technology sales so provide opportunities in those other areas including retail. 

During the GFC the Federal Government supported the building industry and construction workers through the insulation and school building programmes. Most of those jobs are now finished or soon will be. So what does the future hold?

The Australian Bureau of Statistics (ABS) series 8731, table 39, Value of Building Approvals by State/Territory as of June shows that building approvals by value across Australia are in a major downtrend. That can be shown in both semi-logarithmic and linear axis charts. The semi-log chart allows a more meaningful evaluation of changes over time.

There are a number of noticeable events in this chart:
1. The slump before the 1974 stock market crash
2. The slump before the 1982 bear market
3. The major boom in approvals between 1987 and 1991, and the slump prior to the 1992/3 recession
4. The slump in approvals prior to the 1992 recession
5. The double dip now occurring, reflecting the pre GFC slowdown, government stimulus and the run-off of that stimulus.

By clicking on the chart to see the larger version the dimension of the slowdown in approvals compared to previous periods is quite evident (directly comparable in nominal terms as a result of the use of a semi-log scale). It is not as severe as the 1989/91 downturn, but is comparable to each other slump. If adjusted for inflation, it may well be more severe than many of the seemingly similar slumps that happened in times of higher inflation.

So what does the next 12 months hold?

There is a lag of, in the main, 3 to 12 months in building starts compared to approvals. The slump in approvals is a harbinger of substantially reduced activity and employment in the construction industry and those that benefit from the spending decisions correlated with construction and its completion.

While the NBN roll out may absorb some employment as the insulation program did, there will be reduced employment in the construction industry most of which will not be taken up in the resources industry.

Reduced employment will result in falling retail sales as consumers see an increased risk of personal unemployment and defer purchase of durables and forgo discretionary expenditure, initially by moving purchases down market and reducing frequency of things like restaurant meals. Construction and Retail were two of the major areas of reduced employment in the US as a result of the mortgage crisis, busting of the home building and value bubble and GFC, but the scale will likely be smaller in Australia.

The chances of a slump of the current magnitude not having an adverse effect on GDP and employment are very low.

The likely consequences are:
1. fall in profitability of retail, construction and discretionary services
2. increased unemployment
3. a lower stock market in Australia

The likely timing is 4 to 8 months based on the lag between current jobs finishing and the reduced activity from the reduced level of new jobs becoming more obvious to the general community.

Now is the time for government to plan the infrastructure renewal and its tendering, costing and execution (to avoid the problems of the insulation and school building programmes)  so as to be able to take advantage of the opportunities that arise and to ameliorate the downturn.

The nominal axis chart below provides a better view of thevolatility of the swings in approvals of the last 5 to 7 years.

Please note the trend lines and 12 month simle moving average are different between the two charts as a result of the different scales used for the vertical axis.