Range Should Continue
Tuesday, March 2nd, 2004 10:00pm EST
How Now, Dow?
Bottom Line: Extending the scope of a previous study, the price persistency seen recently in the Dow suggests further gains ahead.
Last October, I showed the results of a study that looked at past instances of the S&P 500 being more than 5% above its 200-day average for 100 or more consecutive days. You can read the results here, so I won’t repeat all of them again, but essentially the conclusions were that it was very likely that we would see at least 130 days in the streak, and it would not be unusual to see up to 230 days. The S&P was higher 120 days later 17 out of 20 times, suggesting that that type of trend persistency tends to keep going. That certainly has been the case this time too, as we are still marking days in the streak (we’re currently up to 196 consecutive days).
I thought it might be more instructive to look back a bit more, and the best way to do that is to use the Dow Jones Industrial Average. Looking at that index back to 1897, I show that there were 15 instances of the index being at least 5% above its 200-day moving average for 190 or more consecutive days. The average streak lasted an impressive 264 days – just over one full trading year. The standard deviation was 60 days, meaning that most of the streaks should have lasted between 204 and 324 days, which is indeed the case. The shortest streak ended up being 195 days, while the longest was 435 days in 1955.
Also notable is that after the streaks ended, meaning the Dow dropped to within 5% above its 200-day average, it didn’t actually drop below the 200-day average for another 84 days (about 4 months later). There was a relatively wide variation here, as it happened as soon as 3 days later (a quick, sharp decline in 1926) and as long as 285 days later (in 1905, with 1986 a close runner-up at 277 days later).
Perhaps the most instructive way to look at this is to see how the Dow did in the past when the streak had reached the point it is at right now – 191 consecutive trading days at least 5% above the 200-day average. The returns over the next 30, 60, 90, 120 and 250 trading days were positive, and the Dow was higher a majority of the time. Looking out 120 days, the average return was +3.6%, with 11 out of the 15 instances being positive. After 250 days, the average return jumped to 10.3%, with 12 of them being positive. One very notable exception to these averages was 1987, when the very long streak beginning in 1985 was abruptly halted by the crash that year.
The chart below shows a composite of all 15 occurrences, beginning with the day that the Dow first moved at least 5% above its 200-day average, and ending one year after the streak reached 191 days (allowing us to see how the Dow performed on average over the next year from the point we’re at now). The red vertical line highlights day 191, which is where we are at today.
One interesting aspect of the chart is that the market tended to begin something of a plateau about 178 days into the streak. This year, we began to plateau in late January, equating to day 166 – pretty close to average. The market then formed a tight trading range for the next 60 days before beginning to ascend again in earnest. Again, we’re dealing with rough averages here, but this would suggest we would continue our current trading range for about another month before resuming the uptrend. According to the stats, we would expect the Dow to be about 10% higher than today one year from now.
Personally, I always like to see the instances together on one graph in addition to just an average of them all so that I can see what kind of outliers there were. The chart below shows this.
You will notice that all the occurrences conformed to a fairly steady uptrend, both before and after day 191. There were two distinct exceptions, however, which as I mentioned above was due to the crash in 1987. Otherwise, most of the streaks followed the same general pattern - up or sideways, but rarely down by any significant amount.
Conclusion
In late January, my thoughts were that we were about to see an extended sideways market, taking strong positions on either side of the coin would be “more an exercise in bravado than prudence”, and the highest probability course of action would be to concentrate on oscillator-type indicators to trade the extremes of whatever trading range we may carve out. So far, the market has held true to a trading-range environment by struggling after reaching short-term overbought conditions and rallying (or at least stopping the decline) after seeing short-term oversold ones. My preference is to continue to trade these oscillations, assuming we are going to continue in a range for awhile. We may make marginal new highs, or marginal new lows, but we shouldn’t travel too far outside of where we have been for the past month.
Short-term, the overbought condition we reached yesterday has dissipated to a great degree and we’re back to mostly lukewarm readings. I currently have no preference for either side of the coin.
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
Disclosure: no positions
This disclosure is not intended as trading advice in any form. It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary. Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook. Positions can and do change at any time, without notice to the reader.
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