Commentary for February 27, 2009

| February 27, 2009

We are living through historic times. The type of market crash that stocks are currently experiencing comes along, at most, once every generation. The S&P 500 index is now down about 53% from the peak in October, 2007; that’s over half of its value lost in a span of about 16 months. If you’re having trouble appreciating the extreme nature of this type of move, it always helps to review the long-term chart:

Again, what you are seeing here is exceedingly rare. The last time a crash like this occurred was during the secular bear market of the 1970s when stocks dropped about 48% from January 1973 to October 1974. A normal cyclical bear market within a secular bear looks more like the move that took place from the peak in 2000 down to the 2002 bottom: a well-defined, measured downtrend that is periodically interrupted by short-term reactions. A true market crash, however, does not obey the “speed limits” of normal long-term market movements; it goes much too far, much too fast. Emotion grips the majority of market participants and fear feeds on itself, accelerating the pace of the sell-off to an unsustainable level. It can be a dangerous time for the uninitiated and unprepared. However, whenever this type of extreme move occurs, a highly profitable opportunity inevitably follows close behind.

Markets have their own laws of motion, their own physics that govern price movements. Whenever an extreme rally or sell-off like this one occurs, Newton’s Third Law of Motion comes into play: for every action there is an equal and opposite reaction. Think of stock market volatility as a massive pendulum that is continually swinging back and forth–or, rather, up and down–as the long-term trend gradually moves prices higher over decades and centuries. Most of the time, the pendulum swings gradually in either direction with relative regularity in a predictable fashion. But when a crash (or parabolic rally in the case of an uptrend) occurs, the pendulum swings very far, very quickly, and when it moves back in the other direction, Newton’s Third Law dictates that the move will be equally severe. For example, after stocks bottomed in November 1974 they promptly rallied about 53% over the next 9 months.

Will the current crash produce a violent rally as well? The answer is invariably yes! However, as always, timing is everything. The market is already incredibly oversold and it “wants” to rally. All it needs is a catalyst. Of course, it is impossible to predict what that catalyst will be and when it will occur, but it is coming, and whether the rally starts tomorrow or in a month, we will be there to identify it. Stay tuned.

Category: Commentary, Market Update, Video

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