How deep will the S&P 500 fall?

Several days ago we predicted the current fall in the S&P 500 index. For this reason, we did not enter the stock market and instead invested in a defensive portfolio. We are waiting the level of 1350.  The reason is explained below.

Figure 1 shows the evolution of the S&P 500 index since 1980. After 1995, the index behavior reveals some saw teeth with peaks in 2000 and 2007. The current growth resembles those between 1997 and 2000 and from 2003 and 2007.  There are two deep troughs in 2002 and 2009 which are marked by red and green lines, respectively.  For the current analysis we assume that the repeated shape of the teeth is likely induced by a degree of similarity in the evolution of macroeconomic variables. The intuition behind such an assumption is obvious – in the long run the market depends on the overall economic growth.
Having two peaks and troughs between 1995 and 2009, what can we say about the current growth in the S&P 500? Before making any statistical estimates, in Figure 2 we have shifted forward the original curve in Figure 1 in order to match the 2009 trough (blue line).  When the 2002 and 2009 troughs are matched, one can see that the current growth path closely repeats that after 2002. The first big deviation from the blues curve in Figure 2 started in 2011 and had amplitude of 150 units (from 1210 to 1360).  The black curve returned to the blue one in August/September 2011. A month ago, we observed a middle-size deviation of about 100 units and predicted that the index will have a negative correction down to the level of 1300 any time soon.  If the index will repeat the path of the previous rally one-to-one, one may expect the peak level of 1500 in the end of 2013.  In two to four weeks it might be a good time to invest for a 15% return cumulated to October 2013 (but not more than two months), when the negative correction is over. 

With the S&P 500 falling down to 1350, the prediction does not seem inappropriate. The next several weeks should decide on the new level. In Figure 2, we have drawn the fall we expect by the end of May 2012. We would wait by the end of April to decide on the following move in the S&P 500. If the current fall will reach 1300, it’s likely a good time to buy. Otherwise, the end of May is the horizon to wait the bottom.

Figure 1. The evolution of the S&P 500 market index between 1980 and 2012.

Figure 2. The curve in Figure 1 peak is shifted forward to match the 2009 trough (blue line). Red line – expected fall in the S&P 500: from 1400 in Mach to 1300 in May.

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