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technical analysis

King Bull to abdicate and hand crown to Bear

Extract from The World of ABC Economics, February 2016 issue

FEDERICO IZZI The new year has charged investors a deadly bill, sweeping in just three weeks  last semester’s gains.

The first fortnight of 2016 was the worst start of a year in history, with markets eventually making up some ground in the closing stages of January.

Nonetheless, “the times they are a changin’.”  After seven years, the third longest streak, King “Bull” abdicates, handing the crown to Prince “Bear”.

The Wall Street Journal Almanac defines a “bear market” in stocks to occur when any of following two conditions are satisfied:

Condition No. 1: The Dow Jones drops 13% after 155 calendar  days

Condition No. 2: the Dow Jones drops 30% after 50 days.

The Dow Jones currently meets the first condition, hitting the low point on 20 January, 13.9% down from the high point reached on May 19, 2015.

Looking carefully at the time series, the current bear phase is affecting the Dow Jones for the eighteenth time since 1945 (the graph on the left hand side does not take into account the the1987, 1990 and 1998 slumps which satisfy the second condition). In the months to follow, 16 out of 17 times the markets recorded new lows before turning around. 11 times the lows were reached in less than two months whereas other 6 times it took six months or longer to recover.

Excluding the crash of 1998 when markets lost 19% over a month, in the last 20 years the most painful and deep slumps were those recorded in September 2011 (-30%), October 2002 (-31 %) and September 2009 (-54%). Two slumps, in 2001 and 2009, lasted longer than others, with the low points being reached after 11 and 12 months, respectively.

However, it is usually the second ‘bearish leg’ that leaves deeper wounds. The lowest points of March 2009 and September 2011 were 47% and 18% below the previous minimums recorded.

Over a century ago Charles Dow (1851-1902), a financial journalist, founder of the Wall Street Journal, a precursor and inventor of modern technical analysis, devised “the rule of five”: “It is inevitable that with every five years of increases will be followed by another markdowns, even partial.




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