March 1, 2007

First, what triggered the sell-off in domestic markets?  China’s major market indices plunged 9% prior to the NYSE opening.  That drop was based on an announcement that (drum roll please) China would be going after perpetrators of illegal share offerings and other acts of dubious distinction that had helped push shares higher.  I asked for the “wise guy drum roll” because China-bears have continued to argue (rightly or wrongly) that there is not enough transparency or regulation on the Chinese stock exchange.  Then, ironically, once meaningful conversation about that process begins there is a negative market reaction.

Then, from high-to-low, the Dow dropped over 4.3%.  I’ve been saying for a long time that, domestically, this is a cyclical bull market operating within the context of a secular bear market.  The question becomes, was this sell-off the beginning of the next cyclical bear market? 

To answer that question, let’s put the sell off into perspective.  From its recent February 20th closing peak, the Dow has had a relatively severe 4.5% five days; at least it would be considered relatively severe if it were indeed the beginning of a bear market.  The historical median five-day beginning to a bear market has been 2.3% (an average of 3.0%).  Since the Great Depression, the only bear market that has started with a worse slide than this most recent one was the one that started in January 2000.

In my February 10th report (Charts & Graphs – Indicators and Interpretations for 2007), I pointed out that we had gone a long time without a meaningful correction and that, quite frankly, investors might have forgot what it feels like to go through  a correction.  And I think that a lot of investors had already forgotten the market’s propensity to sell off (which is why I had posted the “History of DJIA Declines” table).

To be blunt, a five-day drop of more than 4% from the February high is nothing unusual for the stock market during a cyclical bull market rally.  (And I focus on five days for a couple reasons.  First, that’s the amount of time it took to go from recent peak to recent trough.  Second, a 1-day US market reaction to a 1-day Chinese market reaction is empty data in terms of any meaningful interpretation). 

Here is what to consider in terms of how normal market activity has been:

• Since the bull market started in 2002 there have been eight 4% declines over a five-day period.

• Over the course of a calendar year, the historical median for 4% decline over a five-day period has been four declines per year (the average has been 5.1 such declines per calendar year).

In conclusion, it is too early to conclude that a bear market has started.  I certainly am not dismissing the last week, after all twenty percent crashes start off as four percent declines. But based solely on one week’s worth of trading activity, there is no rational extrapolation to make regarding the direction of any markets.  But come back to this site soon.  Shortly I’ll have more to say about additional indicators.