Monthly Archives: April 2013

Pattern Schmattern

 

 

Now that most major indices have breached their old highs (sorry, gold), the negative chatter immediately appears with many “experts” calling for a major decline in stock prices.  This chatter is as predictable as it is likely to be wrong.  Just because the market reaches a new high is no reason, by itself to become negative.  There may be reasons to be negative (I don’t see a lot right now), but the pattern of a stock or market chart rarely compels me to action.

I can only presume that the intent of its creator was to show that the S&P 500 only moves in this “no win” saw-tooth pattern and that the next direction must be downward, perhaps all the way to the old 2009 lows.  In my view, this is the lowest form of stock market “prediction” – one that uses a simple chart pattern to scare people into doing something that is probably not in their best interest.  When I first looked at this, I was surprised that its creator included the P/E values at each peak and through.  My first impression was “Wow, look how cheap the S&P 500 is now compared to past peaks!”  If it could trade at 2000’s valuation (*not a prediction*), we could see the S&P 500 move to 3,000, or up 100% (* not a forecast*).  Yes, valuation does matter, as do earnings, as do interest rates, as do many other things beside the chart pattern.

Allow me to show you a long-term chart for the S&P 500 to illustrate another major problem with the “saw-tooth” pattern chart.

It’s not exactly easy to see, but if you can find 1997 on this chart, you can see that it was not a trough of any kind, but simply a point on the huge upward trek the market experienced in the 1990s.  I suppose that some people in 1997 were wondering if the market was overvalued and overbought – it was reaching new highs, after all.  The market continued rising for another three years after 1997.

I am not trying to say that charts are “bad” or that patterns are not useful – I use technical analysis in all my investment research/management.  No, what is useless and potentially dangerous is cherry picking a chart pattern to support one’s opinion about the market or a stock.  In my experience, the chart pattern alone is rarely a reason to make a big decision about investing.  Most charts only “prove” their point well after the fact.  “See, the chart told you that you should have bought/sold back there!” Thanks a lot, Sherlock…

Taking a look at the long-term chart for the S&P 500, I did see one interesting pattern way back in the 1960s and 1970s.  The 1960s was a great time to invest in stocks.  The market was strong and valuations rose steadily until 1968 when both peaked.  This was the era of the so-called “Nifty Fifty,” where the 50 largest stocks commanded huge valuation premiums.  After 1968, everything fell apart and the market didn’t find its bottom until 1970.  The rally was short lived, however, as economic stagnation, oil shocks and government policy missteps pushed the market down again.  Even after 1975 when the market bottomed again, it struggled to surpass its old mid1970s high.  It wasn’t until early 1980 that the market reached its old high.  I suspect that some joker out there at that time probably produced a saw-tooth pattern chart showing that the market only moves sideways (after all, that is what it did for 12 years), and was predicting another big decline.

The rest as they say is history.  Those who might have sold stock in 1980 fearing a decline could have missed the greatest twenty-year bull-run of the century.  Now I’m not saying we are the cusp of another great bull market (we could be), but the chart pattern of 1968-1980 looks suspiciously like the chart pattern of 2000-2013.