Saturday, September 11, 2010

Using The Past To Predict The Future

¹²Using The Past To Predict The Future

By Bespoke Investment Group | 10 September 2010

How many times have you looked at a chart and agonized over which way the index or stock was going to go next? Well, many traders are doing that right now with the S&P 500. As shown in the chart below, after a sharp decline in late April and early May, the S&P 500 has essentially been range bound for the last three months. The $64K question now is, what's next?

Since most technical analysts believe that chart patterns tend to repeat themselves, what if there was a period where the S&P 500 exhibited a chart pattern nearly identical to the current one. Would the market's performance following that period provide a guide as to what to expect in the future? Using some quantitative analysis, we went back and compared the last six months in the S&P 500 to every other six month period since 1928.

After comparing all of the other periods, we found that the one stretch of time that most closely resembles the last six months is the period from November 1959 through May 1960. As shown in the chart, the two periods have very similar patterns.

So if history does continue to repeat itself, what does the future hold? Looking at the year following the 1959/60 example, the S&P 500 ultimately traded more than 20% higher in the 12 months from May 1960 through May 1961. However, this was only after the index drifted lower for an additional six percent over six months before reaching its ultimate bottom in the Fall of 1960. Now, this isn't meant to imply that the S&P 500 will continue to follow the pattern from the 1959 to 1960 period, but it is interesting to note some similarities.

Back then the S&P 500 had just emerged from a recession less than two years earlier (April 1958) and wasn't far from entering another one in April 1960. Today, we are just over one year removed from what most investors consider the end of the Great Recession (June 2009) and in what is at least a slowdown in economic activity. While the majority of investors still believe we will avoid the double dip recession this time around, the 1959 to 1960 example suggests that even if we do go back into a recession (as we did then), a new bear market is not necessarily a sure thing.

[[It also fits with the scenerio of a drop over the next month or so, then a steep rise into 2011 as the "Presidential Rally" kicks in.: normxxx]]


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