2014: Deja Vu All Over Again?
If the stock market action thus far in 2014 has made you a little uneasy, you are not alone. If you find yourself wanting to beat your head against the door, don't fret, you've got company. And if you are spending an inordinate amount of time yelling at your screens, don't despair - the guy next to you is probably doing the exact same thing.
Sandwiched in between the Jan/Feb's -5.76 percent decline in the S&P 500 and the more recent thrashing of the momentum stocks (which produced a decline of -8.22 percent in the NASDAQ and -8.07 percent on the Russell 2000), has been a great deal of frustrating, range-bound, sideways movement this year.
In fact, of the 16 weeks that will have been completed in 2014 when the closing bell rings today, at least 10 have been largely east-west affairs. But mind you, these are not simply sideways markets. No, this is sideways with a dash of volatility mixed in - so as to drive everyone completely batty!
The overly simplistic chart of the S&P 500 below makes the point quite clear.
2013 Gains Being Digested
Some analysts suggest that the strong move up in 2013 wound up "pulling forward" some gains that rightfully belonged to the current calendar year. The thinking iss that with everyone looking to better days ahead - especially near the end of last year - the buying simply got out of hand. As a consequence, the action in 2014 can be considered a digestion or consolidation phase.
Ok, that certainly makes some sense. Then when one considers that we've already been exposed to at least two possible "crises" (the emerging market currency crisis and the Russia/Ukraine geopolitical crisis) and a rather severe correction in the mo-mo names, well, it's a wonder that the S&P 500 isn't in the tank at this stage of the game.
Haven't We Seen This Movie Before?
Many analysts (including yours truly) have expressed a nagging feeling that we've seen this movie before. And unfortunately, the ending, while not horrific, wasn't much fun to watch.
Michael Santoli, formely of Barron's and now with Yahoo! Finance, recently penned a piece entitled Last Year Wall Street Cheerily Recalled 1995; What Year Is Replaying Now? Cutting to the chase, Mr. Santoli - like many of my colleagues - believe that we may be seeing a replay of 2005 unfolding in 2014.
Consider, for 2014, several familiar elements of the 2005 tape:
The market spent 2005 digesting a rapid advance that began more than two years earlier, at the bottom of the tech-bust bear market. By year-end 2004, the S&P had gained 52% over the prior 28 months. The index finished 2013 at the 1,848 level, having risen 63% over 28 months, dating back to the time of its last double-digit drop (of about 19%) in mid-2011.
Having finished last year at a record high, the S&P 500 has seen some stumbles and has struggled to stay even for 2014, even as it threatens this week to return to record levels set in March.
It has been a less-inclusive, two-way market so far, with a bit more day-to-day choppiness, and a perceived lack of clarity about the interplay among economic data, corporate results and monetary policy. That’s how 2005 played out; the market fell no more than 6% from where it started, reaching that low in April. At its high print that year, in December, the index was up just 5%.
Remembering 2005: A Not-So Fond Affair
Although 2005 is now nearly 9 years removed, the action is still fresh in many investors' minds.
The year began with a dive lower after a big finish to the prior year. The indices then "V" bottomed and moved to new highs in Feb/Mar. Then there was another dive, which was followed by another move up into the fall. Another correction then ensued until the traditional year-end rally showed up to save the day.
The bottom line is the highs seen in December 2004 were not eclipsed for good until nearly a year later. And in between, there was a lot of up-and-down, volatile action.
This is the type of market that can drive traders to drink. One minute the trend is down hard and the internal indicators are bad enough to cause anyone trying to stay in tune with the environment to cut back or move to cash. But before long, the decline ends and the indices are right back to where they began. And as you might guess, the move up was just strong enough to suggest that a new uptrend was beginning.
Trend Following Didn't Work
Getting straight to the point, trend-following did NOT work all that well in 2005. There was an abundance of whipsaws in both directions and then the trends that did develop didn't last long enough for traders to make any real progress. So, it was a tough year.
Market Modeling Didn't Work
Another approach to managing the risk of the market is to follow the lead of various market models. The idea is to try to stay in line with the overall mood of the market by taking your cues from momentum models and the like. However, this didn't work very well either in 2005. Again, the moves were fairly short and yet strong enough to trick the models into signaling that a meaningful move was developing.
But Mean Reversion DID Work in 2005. So...
However, it is important to recognize that although momentum didn't work in 2005 and trend-following didn't work in 2005, there were strategies that DID work in 2005. Namely "mean reversion" strategies.
Sometimes this strategy is referred to as swing trading. Others like to call it "riding the range." But the key is to understand that when there is little risk of a recession (which is traditionally the primary cause of the really big, really bad bear markets) utilizing a strategy of "buying the dips and selling the rips" has merit.
So, if this market is giving you that "deja vu all over again" vibe, it might be time to utilize a tactical trading approach. When things get ugly and oversold, you can start adding long positions. And then when it feels like traders have collectively exhaled in relief and starting to feel good about things again (like now, for instance), it is time to start "selling the rips."
Is this a perfect strategy? Uh no. To be sure, nobody knows when the trading range that you've been "riding" will break and a meaningful move will begin. But given that the historical cycles suggest that it could be a while before the bulls return in earnest, playing a tactical game for a while might make sense.
Positions in stocks mentioned: none
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