Last Wednesday we wrote a blog here (http://www.spreadbetmagazine.com/blog/as-january-goes-so-goes-the-year.html) detailing some of the factors that help you understand market sentiment and hence serve as a potential barometer or warning signal for investors, in particular regarding the so called “January effect”.
Even though the January effect has been long discussed inside academia and within the investor community, truth is that under the traditional so called “efficient markets hypothesis” that investors are deemed to be “rational” and that markets are efficient (for the record we categorically do not subscribe to this theory). Consequently any patterned profit opportunity based upon history would be quickly arbitraged away. In contrast, even if efficiency did not hold, it would be also difficult to explain repeated profit opportunities over time for the very reasons detailed referred to in the prior blog (note – read blog!).
So if such events as the January effect aren’t particularly helpful for a quick profit, they at least can guide our actions.
So if January isn’t a profit opportunity, it is still a potential barometer for the rest of the year as investors reposition their portfolios at the beginning of the year, analysing past year’s performance and taking into consideration next year’s prospects. This kind of revaluation and reallocation occurs more often at the beginning of each quarter, with a special emphasis in the first quarter. Given that this January has been negative (at the time of writing) it is a fool that does not pay heed of the signals this may be giving us based on history…
One very negative signal brought to our attention this week is what is called a 90/90 Downside Day – something which was identified by Paul Desmond from Lowry’s Reports Inc (http://go.bloomberg.com/assets/files/2014/01/Desmond-report.pdf). In his work, Desmond looks at past market performance looking for single trading sessions where downside volume equalled 90% or more of upside volume and 90% of shares declined (9 out of each 10 shares). He states that when such a day occurs, we are in the presence of a reversal from a positive to a negative stance, a transition from bull to bear essentially. The idea behind this stance is that under such a decline where the ratio of declines to advances (nine to one in this case) is so high and where down volume (supply) grows too much, negative sentiment dominates the market and the only way to negate this for an equal and opposing reversal session to occur. That is a 90/90 Upside Day, and which is simply the opposite to the Downside Day.
After a 90/90 Downside Day, the market usually recovers a little as the declines turn the market into an oversold condition but such recovery is usually short-lived over the ensuing days as the new downtrend becomes entrenched. This very situation happened in 2000 where, after recording a 90/90 Day, the market initially bounced back but then entered into a strong downtrend period.
The concept is not new, first being reported upon in 1982 but it was further investigated by Desmond who added 30 years of data into it to verify its value. According to his work, this indicator proves to be very strong signal to help identify market turns.
Last Friday was one of those negative 90/90 Downside Days. The S&P 500 closed 2.1% down with downside volume representing 94% of upside volume and at least 9 shares for each 10 were down. Since Friday shares recovered a little, as predicted by Desmond, but if he is right, as we have not seen a 90/90 up day, then we are likely to experience further weakness.
With both a negative January and a 90/90 Downside Day – the technical stats are beginning to stack up on the bear side aswell as the valuation excess story. It is a signal we intend to listen to…