The Great Recovery


This rally has gone beyond what one would normally call a dead cat bounce. . .it is what we have previously called a "really big sucker rally."

Around the time of the anniversary of the lows of March 2009 (March 9 saw the low close) there were a number of articles referring to the rally that got underway at the time as the "Great Recovery." More often than not it was the "great recovery" following the "great recession" or "great crash." ("The great recovery after the great crash" in the Toronto Star of March 9, 2010 was but one of the articles and blogs noted).

The temptation is to ask, "So what?" A recovery following a crash is not unusual, whether it is called a dead cat bounce (a temporary recovery following a prolonged decline or bear market) or a bear market rally (sometimes called a sucker rally). The stock market is often a leading indicator for the economy when it is improving but can lag when it is regressing, thus giving rise to crashes.

This rally has gone beyond what one would normally call a dead cat bounce or bear market rally or sucker rally. It is what we have previously called a "really big sucker rally." The Technical Scoop of April 9, 2009 provided definitions of four types of sucker rallies:
  • Failed Suckers: these are usually short-lived, lasting at most a week or two and lifting the market less than 10% from any low.

  • Mini-Suckers: usually rallies of 10 to maybe 20% from any low, lasting up to a month or so.

  • Big Suckers: usually more than 20% and could even rise as much as 50% from any low. Duration usually no more than a couple of months or so.

  • Really big suckers can last for months and even years and gain 50% to 100%+ from the lows. It is usually during really big suckers that the pundits declare the bear is dead and that we have entered a new great bull market that will go on for many years.
Failed suckers and mini-suckers actually describe quite well the "dead cat bounce" and "bear market rally" or "sucker rally." The latter two are bear market rallies as well but often look like the start of new bull markets. And that is where the confusion comes in, resulting in articles touting the "great recovery."

The current rally has now lasted a year and, as measured by the S&P 500, has gained 73%. Impressive, but in order for the S&P 500 to regain its 2007 highs it must rise 133%, or go up a further 34% from current levels. It is not impossible. The S&P 500 regained and even surpassed its 2000 highs during the 2002-07 rally, gaining 101%, but took five years to do it. One year after the October 2002 low the S&P 500 had gained only 34%.

The reality is that since the highs of 2000 the markets have been in a secular bear market. In a secular bear market the primary trend is down, or bearish. Secular trends last for years. The last secular bull market got underway in August 1982 and lasted until the highs of March 2000, a period of almost 18 years. The current secular bear market is now in its eleventh year and probably has many years to run. The S&P 500 is down 24% from its high of March 23, 2000. Instead of calling this the "great recovery" it is more appropriately the "lost decade."

However, those who have been in metals, precious metals (gold and silver) and energy since 2000 are not calling this a lost decade. The TSX Gold Index is up 211% and the TSX Energy Index is up 283% in the same period that the S&P 500 has lost 24%. The big winner has been the TSX Metals & Mining Index, up a huge 869%. The S&P TSX Composite is up a modest 20% during that period but without the performance of the aforementioned three it would probably be down.

A reminder: the NASDAQ lost 78% as a result of the high tech/internet collapse of 2000–02. The NASDAQ remains down almost 50% from the highs of 2000. To put this further in perspective, a chart on bull recoveries following financial panics is repeated. This chart appeared in Technical Scoop of January 8, 2010 (A Recovery Year—But Now What?)

Dow Jones Industrials Financial Panics since 1900

Thus far the rally has been more in line with the rebounds seen after the 1937 financial panic or the 1974 collapse. When those rallies ended the market fell once again, not making a final bottom until 1942 in the case of the period following 1937–38, while the remainder of the 1970s and early 1980s witnessed a see-saw market that saw the Dow Jones Industrial continually fall back from the 1,000 level towards its 1974 lows before making the final low in August 1982.

On the basis of the past bear markets, we could have anywhere from two to six years more of seesawing before the final low is made. Whether new lows are made is not important. The point is that investors who are in a stay-the-course mode (buy and hold) will not make any money for years to come unless they are invested in secular bull markets or they adopt a more active investment strategy.

Here are two charts that are worth looking at. The first shows the Dow Jones Industrials, S&P 500 and NASDAQ. The second shows the TSX Metals & Mining Index, TSX Gold Index and the TSX Energy Index. The former are in a secular bear market but the latter are in a secular bull market. Monthly charts are used to show the secular trend.

A third chart, of the Tokyo Nikkei Dow (TND), illustrates the nightmare of a long secular bear market. The TND is still down 72% from its peak in 1990. Note that it is also well down from its level in 2000. Interestingly, the TND had important lows in 1992 and 1998. These correspond well with the lows seen in the DJI in 2002 and 2008. The rally out of the 1998 low topped in March 2000, exactly 10 years ago. What followed was a devastating collapse to new lows. At the time many were calling for an emerging new bull market for the TND.

Dow Jones Industrials

TSX Metals and Mining

Tokyo Nikkei DOW

Secular bear and bull markets can and do have bull and bear markets within the larger trend. The bull markets for the broad indices are no different than the bull markets seen during the Great Depression bull markets. During the Great Depression there was a long bull market from 1932 to 1937; this past decade saw a bull market from 2002 to 2007. Conversely, bull markets can have nasty mini bear markets. In that respect the 2008 collapse for the metals & mining, gold and energy indices can be compared to the 1987 stock market crash or the 1998 Asian/Russian crisis—sharp, scary corrections within the context of a bull market.

Secular bear and bull markets can last many years. What is currently being seen is a secular bear market in stocks that could last upwards of 20 years. Only 10 years has passed. Cycles suggest that there is some evidence of long-term cycles of debt collapse and depression of roughly 72–75 years.

The current crisis is just the latest manifestation of this phenomenon. The last one was the Great Depression and war lasting from 1930 to 1949; prior to that it was the Long Depression from 1873 to 1896: periods of 19 and 23 years respectively. Yet there were periods of growth and stock market rallies throughout. The Long Depression was in fact more like a series of severe recessions whereas the Great Depression went deeper. Thus far the current crisis resembles the Long Depression more than it does the Great Depression. Going back 72 years from 1873 takes us to 1801 and as the 200-year chart below shows, stocks were quite depressed during that period. The end of the 18th century and the early 19th century was a period of economic depression.

What is fascinating about these depressions is that history really does repeat itself although never exactly in the same manner. The Long Depression was a global economic crisis (although global then meant primarily Europe and North America (United States). Causes included war reparations in Europe and the United States, speculation in railroads that resulted in a bubble and collapse, easy credit, the use and creation of complicated financial instruments that few understood, leading to their collapse, and even a housing bubble.

The result was at least two severe stock market panics, in 1873 and 1893, severe recessions lasting several years, banking failures, record bankruptcies, debt collapse, trade wars (protectionism), financial scandals and high unemployment.

The Great Depression and WW2 had its roots in the huge reparations placed on Germany following WW1, easy credit resulting in a stock market bubble, new technology such as radio, a housing bubble, and the creation of complicated financial instruments that few understood and which eventually collapsed. The Great Depression and War was global in nature but primarily impacted Europe and especially North America (United States).

The result was at least two severe stock market panics in 1929–1932 and 1937, followed by a severe depression and/or recessions that lasted several years, banking failures, bankruptcies, debt collapse, trade wars (protectionism), financial scandals and high unemployment.

So what is different this time? Very little. The current crisis had its roots in stock market speculation (new technology and internet), easy credit that resulted in bubbles in housing and leveraged buyouts, and the creation of financial instruments that few understood and which eventually collapsed. The crisis is global in nature but is having its deepest impact in Europe and North America (United States).

Thus far there have been at least two severe stock market panics in 2000–02 and 2007–08. There has been two recessions that could have or maybe should have been worse but for an unprecedented flooding of the financial system with money and sharply lower interest rates. There have been thousands of bankruptcies, bank failures, threats of trade wars (protectionism), financial scandals and high unemployment.

Periods of severe economic dislocation are normally accompanied by war. While no major war was seen during the period of the Long Depression, the seeds were sown for WW1. WW2 came on the heels of the Great Depression. The economic depression at the end of the 18th century and beginning of the 19th century was the period of the American and French revolutions and also set the scene for the war of 1812 and the conflict in Europe that culminated in the Battle of Waterloo. The current period has seen the war on terror, the invasions of Afghanistan and Iraq, the continuing conflict in Israel/Palestine and threats of war with Iran. Any one of these areas has the potential to become a wider conflict.

Since the world came off the gold standard in August 1971 there have been a series of financial crises. The first was the panic of 1973 that lasted two years and was caused by sharply rising oil prices. As well there was war (Vietnam), political scandals (Watergate), and resulting bankruptcies and bank failures (Franklin National). The next panic was the stock market crash of 1987 but that was largely over within a year. The period of the late 1980's also saw a number of financial scandals. The panic of 1990–91 lasted longer and was highlighted by recession and a real estate collapse and was triggered by an oil crisis with the Iraq invasion of Kuwait. 1998 saw the panic related to the collapse of the Russian rouble and LTCM. But like the earlier panics it was short-lived. The bursting of the high-tech dot-com bubble brought the panic of 2001 and was also highlighted by September 11 and the subsequent invasions of Afghanistan and Iraq. There were numerous financial scandals in high tech companies. The financial panic of 2007–08 is but the latest in a line of financial panics, and scandals that have rocked the world.

There have also been numerous currency crises in the past 40 years, including the Latin American crisis of the late 1970s and early 1980s; the European exchange rate crisis in the early 1990s following the reunification of Germany and later the massive run on the British pound; the Mexican currency crisis in 1994; the East Asian currency crisis that started with the collapse of the Thai baht in 1997 and continued into 1998 with the Russian rouble. The past decade has seen the Argentine peso crisis and currently a crisis over the Euro due to the financial collapse of Greece and the downgrading of Portugal.

The chart below highlights market panics over the past 200 years of the Dow Jones Industrials. While the recessions or depressions don't last as long or go as deep as they used to, there has been an increase in the frequency of financial crises. These ongoing financial crisis and panics are a characteristic of a financially unstable world.

DJIA vs. Market Panics

This "great recovery" appears to be anything but. Danger lurks behind the scenes with pension funds that cannot meet their commitments; U.S. states that are technically bankrupt (California, Illinois, Michigan, Florida and many more); a housing crisis that is not over; millions of homes with negative equity and many more that will likely fall into foreclosure over the next year; a housing bubble in Canada that will get pricked as interest rates rise; a crisis in Europe centred around Greece; unsustainable debt levels of major G8 countries with warnings from the rating agencies that their debt could be downgraded (Japan, Great Britain and the USA); the printing of money in a vain attempt to bail out the G8 economies, and which could result in hyperinflation; warnings from the IMF concerning the debt levels of the G8 countries (Canada and Germany excepted); and, instability in the Middle East and Near East which could result in a global war.

The clue that all is not right in the market is seen in the charts. Technical analysts often cite volume as a key indicator. Volume should rise with the dominant trend. Falling volume is a warning sign that all is not well. The chart below is the Dow Jones Industrials over the past decade.

A couple of volume indicators have been added. First, "on balance volume" or OBV. OBV is used to detect momentum in the market. It should move in the direction of the market and that was confirmed with the huge rally from 2003 to 2007 and also with the downtrend in 2007–08. OBV is also confirming the uptrend since March 2009, but note that while volume was rising sharply in the financial collapse of 2007–08 it has fallen in the rally of 2009–10. This is a potentially negative sign indicting that this is a bear market rally only.

The second indicator at the bottom is a volume oscillator. A volume oscillator is another momentum indicator, using a fast and a slow moving average and then taking the difference between the two. The resulting histogram fluctuates above and below a zero line. A positive value confirms the price movement while a negative value suggests a lack of support for the price trend.

DJ Industrials

The chart notes points of confirmation (C) and non-confirmation (NC). It was no surprise that the volume oscillator was confirming the financial collapse of 2008, for example, but the highs in 2007 were not confirmed. Nor for that matter were a number of the tops in the early part of the decade. A key non-confirmation was seen in March 2003 prior to the up move in the market that resulted in the long rally from 2003 to 2007. Currently the volume oscillator is not confirming the price rally. It is a warning sign that the "Great Recovery" could turn into the "Great Bust."

David Chapman is a director of Bullion Management Group Inc., and manager of the BMG BullionFund and the BMG Gold BullionFund

Note: Charts created using Omega TradeStation. Chart data supplied by Dial Data.

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