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Stock Market History - The Past Provides Clues To Today: Mike Swanson

Investors View Magazine - January 2010

Over the past few years a lot of people have compared the bear market collapse of 2008 and the economic recession with what occurred during the Great Depression. When you look back on stock market history there are a lot of similarities.

For example what we went through in this last bear market can only be compared to the stock market collapse of the 1930's when you look at the speed and the depth of the drop in stock prices in 2008.

2008 was indeed a complete stock market crash. It was even worse than the bear market that broke out in the middle of the 1970's.

And when it comes to the economy the speed of the deceleration in the GDP that accompanied the stock market drop also can only be compared with the 1930's or the time after World War II when the United States when military spending dropped off.

So huge things have been happening in the stock market and the economy.

However, things are not playing out exactly like they did then. This is not a Great Depression we are going through.

But it is a huge secular change in the trend of the stock market.

From the early 1980's till 2000 the stock market was in a secular bull market. But since then it has been in a secular bear market, very similar to what happened in the 1930's or the 1970's.

In both those periods the stock market entered a big bear market and then spent over a decade moving a wide sideways trading range.

Actually the time period from 2000 to 2010 was the worst overall decade from start to finish for the US stock market.

Many investors got into the market in the late 1980’s or 1990’s, which was the second best decade in the history of the US stock market with a 17.6% average annual return.  Well the last decade was the worst decade ever, even worse than the Depression years of the 1930’s that saw a 0.2% decline overall for stocks.

Investors who simply did buy and hold have done nothing.  Even bonds beat them.  However, some investors did well.  Those that invested in gold in 2002 did great and those that simply kept their pulse on the big trends of the market and engaged in a little market timing did even better.

The thing is it isn’t that hard to do.  All you need to do is recognize the large trend of the market by looking at the relation of the major market averages to their 150 and 200-day moving averages and the slope of those averages.  I’ve talked about this with you before and have a whole module about it in the Stock Market Mastery Course.

The key is doing this enables you to tell whether the market is in a bull market, bear market, or a transition period.  No it doesn’t tell you when the exact top and bottom occurs, but it tells you how to think about the big picture.   Going beyond that there are all sorts of indicators you can follow to get an idea of the smaller trends, but in the end recognizing the big trend and adapting when it changes is the key to making the big money.

This is what enabled me to making money shorting in 2008 when everyone else lost money and to believe that the market was going to go higher this past summer when most were calling tops and profit from that belief the rest of the year.

Right now the market averages are still above these moving averages so it doesn’t make sense to start to worry about a bear market.  However, right now isn’t a great entry point to start buying long-term positions in stocks blindly, because the market has indeed run up tremendously and there are important historical precedents that should play out in 2010 that you need to be aware of and can profit from.

We are in a cyclical bull market within a secular bear market.  That is an important distinction.  Most cyclical bull markets in secular bear markets only last one or two years.  You can look back at 200 years of historical data in the US stock market and look at other markets that got in a similar position to ours and see a similar pattern that is likely to play out this year.

Simply put after a major bottom in a secular bear market like we saw last year typically the stock market will rally back up and take back a good half to two-thirds of its losses and then stall out and go sideways for at least 6-8 months.  It then either breaks out and goes on another huge tear for a few months or rolls over and begins another bear market.

I’ll show you the examples in a minute, but I want you to realize first what this means is that the market is likely to put in a peak within the next few weeks (if it hasn’t already, it is possible) and then go sideways for at least the first two quarters of this year.  This sideways pattern will either mark a consolidation phase within this current cyclical bull market that will be a prelude to another huge rally or else will mark a stage three topping phase.

I have no interest in trying to predict which will occur, because I’m not going to delude myself or you into thinking I can predict the future of the economy so perfectly and it isn’t necessary to make such predictions at all to make money.  I’ve got some guesses about it as I’m sure you do too, but I know that trying to predict such things may be dangerous to do, because you might focus on them and the news that backs them up instead of real market trends and it isn’t how money is made anyway.

We have been in a powerful rally since March in which the market has had only one pullback of significance in last May through July.  The people who have made the most money are those that bought the dips and ignored the negative news and short-term pullbacks and have held on.  I’ve done that myself most of the time, but there is always a danger in investing that when you are making lots of money using a strategy that when the market changes and the strategy is no longer the way to go that you miss the turn.

That is the mistake I made in the beginning of 2009.  I made a huge amount of money in 2008 shorting the market and took profits in the middle of the Fall 2008 stock market crash on short positions and went to cash going into the end of that year.  I knew that the next big opportunity to make huge money in the market would be in 2009 when the stock market finally bottomed.  But as the year started I started to look at short-term trends in markets and individual stocks and got caught up trying to trade them.  I ended up making small losses, putting myself behind, and getting distracted from the big trends of the market.  This made it so I missed the bottom and didn’t fully adjust to what was happening until the summer.  Once I did though I made up my losses and got back to where I’ve always been in the stock market – making money when aligned with the broad market trend.

But the key is no one is perfect.  And along with ignoring the big trends of the market – which is the mistake the typical investor makes – the professional investor or the trader often makes the mistake of getting caught up watching the market too carefully.  A key to following the big trends is patience and it is impatience that costs the professional investor or trader more money than anything else.

Everything outside of you is geared to make you impatient and want to trade.  When you are a broker or money manager or running a service like mine you feel like you need to make money all of the time for people and that can make you look for opportunities when it is best to just sit back.  And the professional trader more often than not cannot stop trading.

The most dangerous time for the professional trader is after he or she has made a lot of money in the stock market using the same strategy over and over again.  The strategy is working that well, because it is aligned with the market, but that very fact can lead to the mistake of ignoring the market trend when it changes or taking bigger risks. 

I suspect the next few weeks will be a danger point in the markets for most people.  The market has been going up and rewarding people, but at some point the trend in the market will change and it will be at that time that most people will be unprepared.

No one can sell at a top.  You always either do so too soon or too late and one reason I decided to take my profits at the end of the year was to insure that I would adapt to changing market conditions in 2010.  It is very important to start the year off as best as you can, because you do not want to make some critical mistakes in the beginning of the year and then spend the rest of the year trying to fix them.

During the past two months we have seen the market spend most of its time trading in a very narrow range.  During this time every time the market got near the top of the range the bulls would get excited and think the market was going to break out and go on a tear and every time the market has fallen down to support or bad news has gotten out the bears have come out with predictions of doom and the short sellers have gotten excited and then disappointed as the market held up and bounced back up.  This cycle has repeated over and over again during this time and I’ve sure you’ve gotten caught up in some of these emotions too.

I want you to think back on these weeks and picture them as a microcosm for the first half of 2010.  I suspect the market will trade in a wide 15-20% range for most of 2010 during which people will get overly bearish on the pullbacks and too excited on the rallies.  The problem is most people will either be too bullish or bearish during this time and will end up getting shaken out of their positions or trying to trade too much.  The bulls will try to hold on too long while the bears will make the mistake of thinking every temporary dip is a new crash.  They didn’t realize that the market environment had changed, because they focused on their own hopes and the news instead of real market trends.

But money can be made by buying on the bottoms of this trading range and then being willing to take profits once the market goes up.  Then simply sitting and waiting for the next bottom.  If the trading range marks a consolidation phase then at some point towards the end of the phase it will be time to buy and hold into the sectors that will lead on the next bull run, but until that time (and yes I believe it can be identified) it will make more sense to have a trading mentality in which you are willing to set profit targets and just take them then to try to buy and hold. 

And if the market is really going into a bear market then it will still spend the first 3-6 months of next 2010 going sideways in a range, but instead of consolidating it will be making a top.  There will be warning signs that a top is being put in place, such as deterioration in the advance/decline line, growing bullish sentiment in a market just going sideways, and negative action in the commodity markets.  But even if a bear market hits in the second half of 2010 most bears will be too early to the game.

I doubt we are going to see a huge bear attack in 2010, but I know that a bearish scenario is possible and I’ll have my eyes on watch for that possibility.  I really cannot look that far ahead into the future though.  I don’t want to give you my guesses, but only keep you informed on what the stock market is really doing and when it comes to the stock market the most likely thing it is going to do is go sideways in the first half of 2010 and then make a big move one way or the other towards the end of the year.  And that is enough to know to make big money.

Again the reason why I think we are likely to see a wide sideways range in the first half of 2010 is because if you look back at past market history after the market has had a major collapse and then came back within a secular bear market it has entered a sideways pattern for at least six months before making another big move.  I’m starting to get worried that we are near the end of the current move.  Towards the end of December the market did manage to go to a new high, but it do so in a much less explosive manner than it has in past rallies.  It may still go higher from here, but I think when you ask what is the next big trend of the market it is going to be a sideways range once the current move ends.



The current market environment is incredibly similar to what happened during the last cyclical bull market, which began after the March 2003 stock market bottom.  After that bottom the market rallied sharply and then peaked in January 2004.  After that peak it then traded in a range until the Fall of 2004 after which it broke out and resumed its march upwards, but that trading range lasted a little over eight months and shook both bears and bulls out of the market.

A few sectors did well and bucked the overall sideways trend and were easy places to make money – and that is another thing we will be on the lookout for in 2010 – but the overall market was a difficult place to buy and hold or to try to short in the belief that every dip was the start of a crash. 

Once the current end of the year move ends I expect that 2010 is going to be dominated by a similar trading range as what we saw in 2004.  What causes these ranges is the simple fact that after huge moves one way or the other the market almost always spends a period of time digesting the move, before making another big one. 



In fact the 2010 trading range may last all year – much longer than the one in 2004.  The reason why is that the stock market has had a period of EXTREME and historically ABNORMAL volatility in the past two years – in fact the market moves have been so extreme that it is difficult to find anything that compares.  It has been extreme on the downside and on the upside. 

This has caused the 200-day Bollinger bands, which measure market volatility drawn on green on the above charts to widen at a point way past what was seen 2003 bottom last year.    Normally periods of extreme volatility are followed by periods in which the volatility shrinks – that’s what causes a trading range and paves the way for another big move.  

In secular bull markets the market tends to rally up sharply in spurts and then pause long enough for the 200-day Bollinger bands to come back together before spurting up again.  You can see how this happened several times in the last cyclical bull market – once in 2004, then again in 2005, 2006, and finally in 2007.  It would probably take a year for the Bollinger bands to get that close together again and would mean the market would likely spend 2010 in a range between the 1175 area of the S&P 500 at the top and 950-1000 on the bottom.

That best comparison to now may be the 1970’s during the last secular bear market for the US stock market.  The ultimate bottom of that bear market was in December 1974, just as last March was likely the true bottom of this secular bear. 



After the market bottomed in 1974 it went up huge in 1975 and then spent the next year basically doing nothing.



Some people like to compare the current market environment and even the economy to that of the Great Depression.  Well after the market rallied off of the Depression lows in 1933 it then spent all of 1934 going sideways.  The market more almost more than doubled from the low of 1933 to the top of 1934 in less than six months.  Well extreme moves that create huge volatility are followed by periods in which the volatility shrinks.  That’s why the market went sideways for almost two years after that 1933 peak.

The point of all of this is that there is no way I can predict where the stock market is going to close at in 2010.  But what I can tell you for sure is this – we have gone through a period of extreme market volatility in the past two years and historically such periods of extreme volatility are followed by the opposite – a long period in which the market simply trades sideways.

We have seen action the past two years in the S&P 500, Nasdaq, and DOW that truly are very unusual.  That has caused most people to lose money and suffer, but when you have been positioned correctly with the market averages you have been able to make a huge amount of money.  For example, I made 50% by shorting the market a couple of times in 2008 for example and made a nice 20%+ gain in the last few months of 2009.

To make big gains like that playing the market averages requires a high degree of market volatility – it requires big swings either way in the market.  What I’m asserting to you is that these huge swings have been historically ANBORMAL in the stock market and we have simply become so accustomed to them that we expect them to continue.  In reality they probably won’t.
Most people are not really prepared for that.  They are caught up expecting a huge rally in the stock market or for a big market crash in 2009, when neither are likely to occur.  And even if the bears are right about them market it will take months for the market to truly get bearish again and even then the downside what would be limited.

What this will make for is a market environment that will cause most people to lose money through over trading.  People who have been accustomed to huge market moves will try to repeat the strategies they used to make money in the past few years in 2010 only to be disappointed or shaken out over and over again.  Instead of stepping back and being patient for things to line up for them or getting into better sectors and markets they’ll get sucked into one sub-par trade after another.

It is simply going to be tough to make money trading the broad market averages.  Money will be made by looking away from the Nasdaq, S&P 500, and DOW into other foreign markets that haven’t been quite as volatile than the US markets and are in a better position to go up and in individual sectors that can go into bull markets over their own.

In the stagflationary 1970’s during the decade of dead stock returns gold and energy stocks went up as a result of the inflationary trend.  Despite the recessionary environment pockets of economic growth and innovation still occurred.  Casino stocks for instance were very hot thanks to the opening of new casinos in Atlantic City and Las Vegas.  People who invested in the right places made money while those that didn’t – well they didn’t.  And in 2004 when the market went sideways all year gold and oil stocks went up then too.

Even though the typical buy and hold investor has had a tough time this past decade it has been a great decade for traders who have benefited from the huge swings in the market.  In the final analysis the recent years though have been a period of ABNORMAL swings in the overall market averages and this behavior is likely to come to an end this year.  That means it is going to start to be tough for the typical market timer to make money too.

We will have to focus more and more next year and in the years to come on sectors – may they be in other world markets or select ones in the US – that are in positions of their own to go up in order to make money.  The same tools and methods always work in the investment world to make money, the key is to apply them to the places that are most profitable.  Paying attention to the economic news on TV is going to be of even less use than it has been.  Only the true contrarians will win.  Making money will require doing more work to find the pockets of bullish strength in a few select US sectors and in the best foreign markets.  That will be the only way to find the winning stocks.

My whole goal in 2010 is to find these stocks for you using The Two Fold Formula which combines both technical and fundamental analysis to invest in the stocks that have the best chart characteristics and are truly cheaply valued and have high earnings growth.  Over the years I have found that these are the stocks that go up the most every year and I think it will be more important than ever to invest in these stocks next year, because I think the market as a whole is simply going to go sideways and provide you with very little return.

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Hello. My name is Mike Swanson. I’m the best-selling author of the book Strategic Stock Trading. In a former life I used to run a hedge fund from 2003 to 2006 that generated a return of over 78% during that time frame. In fact it was ranked in the top 35 out of 5,000 hedge funds in 2005.

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