The Big Picture for the Week of October 9, 2011

A reader left a question a couple of days ago asking my opinion on how to determine a market bottom. My thought process here will probably seem a little Hussmanesque.

I tend to think of this in terms of probabilities and whether or not the market gets the benefit of the doubt at a given moment. A contributing factor here is duration. Earlier in the week I saw a stat about bear markets lasting four hundred and something days and we were only 150 days in (by some measure). The exact numbers cited don't matter to me so much is the general understanding that bear markets last well over a year on average and we are only a few months in.

That assumes of course that we actually left the 2008 bear market and then had a bull market. My thought there has been that this will all be looked back upon as one big financial event and in late 2011 we are still in the middle of it. If I am wrong and we are in a normal bull bear cycle then based on averages there is still more time to go.

Either way I think we are still early in this bear phase. I would then look at two things to think a bottom is in; one related to time and one related to price. Five or six months from now I would be more inclined to give the market the benefit of the doubt than I would now. Among other things that might give the SPX' 200 DMA time to flatten out or turn higher or for the 50 DMA to cross back above the 200 DMA.

In terms of price, if there were a panic this month or next to something like SPX 800 (or some other level that might be relevant when we got there) would at least be a reason to deploy at least a little cash. A real panic is better to buy, although it is difficult to do. We bought a little into the Lehman panic in 2008 and a little in early 2009, before the low, but in hindsight we should have bought more.

The perspective here is more in line with my thoughts about targeting a result over the entire cycle as opposed to short term trades. Before the open on Tuesday with the SPX at about 1100 I commented that it would not be a shock if the SPX closed the week at 1200, and while it did not get that close it went up a lot, 1170 early in the day on Friday. That is still a pretty good lift for such a short period of time but unfortunately is not a sign of a healthy market hence I am not inclined to give the market the benefit of the doubt here.

The idea of the biggest up days occurring during bear markets is not something I came up with of course but something I have referred to often in this context because it seems to be pretty reliable.

I said I have been influenced by John Hussman on this subject but am generally willing to look more like the market than he is. I mention this as an example of taking bits of process from various sources to create your own process.