Wednesday, November 01, 2006

That's a mighty mean reversion you're packin' there Mister

Economonitor carried a post about how the bears are being skewered by expectations of the markets reverting to the mean. He asks, "Does anything revert to mean any more?"

A similar observation might be had about those people who count the number of days in bull and bear markets and judge whether one is "too" long in the tooth by reference merely to the length of past cycles. Bloomberg has this:

History, Profit Outlook Threaten to End U.S. Stocks Bull Market
By Daniel Hauck

The rally that began in October 2002 is now the second- lengthiest since World War II and has lasted 89 percent longer than average, according to Ned Davis Research Inc.

Last month's highs for the Dow industrials and the S&P 500 occurred 1,478 days after the bear-market low set on Oct. 9, 2002. Since 1945, there have been 18 previous bull markets, lasting 781 days on average, according to Venice, Florida-based Ned Davis Research.

The firm, whose more than 1,000 clients include investment firms such as Morgan Stanley, defines a bull market as a gain of 13 percent or more in the Dow average that lasts more than 155 days, or a 30 percent rise after 50 days. A bear market consists of a 30 percent drop in 50 days, or a 13 percent drop after 145 days.

The longest bull market occurred from October 1990 to July 1998, a period of 2,836 days. Markets then plunged as Russia devalued its currency and defaulted on its debt, and hedge fund Long-Term Capital Management LP began to collapse.

Both the Dow and the S&P 500 have added 13 percent since June 13, when the S&P 500 reached its 2006 low. Those gains are consistent with what Ned Davis describes as the "blow-off" rallies that often occur in the last phase of bull markets.

The median gain in 21 "blow-offs" since 1901 was 14 percent, usually over three to four months. They typically featured "divergences" such as the ratio of advancing stocks to declining shares failing to make a new high, or "excessive" optimism. Divergences exist in the current rally, while the second condition doesn't, according to Ned Davis.

Still, any decline may wait until the new year. The S&P 500 has posted fourth-quarter gains in 10 of the past 11 years, with the exception being 2000.

That seasonal tendency may help support stocks in the rest of 2006, according to Jeffrey Hirsch, editor in chief of the Stock Trader's Almanac.

"I'm not sure that the length of this bull market is the driving force of what's going on right now," said Hirsch, president of the Hirsch Organization in Nyack, New York.

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