Thursday, May 1, 2014

The 1996 Analogy

RUT has now closed above its 200-dma 361 days in a row. The all-time record is 364 days from 1996.

SPX has also closed above its 200-dma for longer than any time in the past 30 years, except 1996.

SPX has not touched its lower weekly Bollinger in 17 months, longer than any time, except 1996.

And SPX is up 5 quarters in a row. In the five previous times this has occurred in the past 40 years, it has only closed up for a 6th quarter once. The year: 1996.

Apparently the current period resembles 1996.

The current rally started in October 2012 and ran up some 40% to January of this year. It swooned for two weeks, then rallied 8% in February. Since then it has chopped in a range for 9 weeks and counting.

The rally into 1996 started in December 1994. From then until January 1996, SPX also rose some 40%. It swooned for two weeks, then rallied 10% in February.  It then chopped in a range for 12 weeks. Sound familiar?

OK, these periods are not identical. 2012 was a much stronger year than 1994. NDX and RUT have been much weaker in 2014 than they were in 1996. The January fall and February rally in 1996 were weaker and stronger, respectively, than in 2014. But the similarities are more significant than the differences.

What happened next? Both periods made a low in the middle of the chop period right near Tax Day. In 1996, early May weakness cut 4% off SPX. It then rallied 8% and then stalled, chopping sideways another 5 weeks. In early July, it finally ended all those streaks: it went below its 200-dma and its weekly Bollinger. It just missed having a 10% correction on a closing basis. 

The 1996 summer low, like many, set up a nice rally into year end. Good enough to prompt Alan Greenspan to make his 'irrational exuberance' remark in December 1996.

The economic climate was different in the 1990s than it is today, and this analogy is not meant to imply that SPX will rally hard another 3 years. The current rally will end differently. This is one example of how it might end.

If nothing else, take away that the risk/reward from the end of April to August 1996 was about 2:1 negative. That's probably very similar to the risk/reward right now.

Also take away that the 1995 rally is the benchmark for hot streaks. The current rally is now its only competitor. This is in an exceptional period that won't likely be repeated for another 20 years. The 1990s are remembered for the big gains, but 1996, 1997 and 1998 all included 5-7 month periods where the markets chopped and swooned, completely unlike 2013 and 1995.

By July 1996, AAII bears were up to 40% (29% today); Investors Intelligence bull/bear ratio was down to just 0.94 (2.7 today); the weekly RSI(5) was only 23 (65 today). These are likely to be useful markers for a washout this summer.
Our thanks to Ryan Detrick and Jonathan Krinsky for the data on RUT and SPX win streaks (paragraphs 1-4)