1987 And Now

• Could it be 1987 deja-vu all over again?
• Why it’s not 1987
• Conclusion

A savvy subscriber to my monthly Intermarket Review sent me a copy of Chart 1 yesterday. Whenever he forwards me a relationship in chart format, it is usually pointing out a different conclusion than that set out in the publication. His charts, therefore, force me to re-think my position. This one compares the performance of the Dow between April of 1987 to the post-1987 crash price action.  Overlaid is this year’s performance for the same calendar period. The implication, of course, is that both paths are very similar. If that relationship is to continue we should expect to see a sharp drop in mid-October. I have always loved these overlay comparisons since I am a great believer in human nature repeating. The problem is that they work until they don’t, so to speak. Moreover, the “don’t” part usually materializes at the most critical point. I am not saying we won’t see a repeat of 1987 because you can never say never in this game. After all, central banks appear to have lost their effectiveness and several European banks seem to be in trouble. There is nothing like a banking crisis to trigger panic selling! However, it seems to me that while there may be similarities, there are far more differences.

Chart 1

Could it be 1987 deja-vu all over again?

For example, one of the most scary-looking charts at present is the series displayed in Chart 2. It represents the ratio between the current return on stocks (the Shiller P/E) versus that for Moody’s Corporate Baa bond yields. The arrows show when this series has reversed from an extended level and crossed below the red horizontal line prices have often suffered. Obviously, this method of valuation says that stocks are currently very overvalued relative to bonds. However, until the indicator reverses and moves back below the red line, we are probably ok. In other words, as long as confidence in equities holds, which is all this indicator is really measuring, so too will stock prices.  I can’t say that I can totally ignore this situation, indeed high valuations are the wall of worry for most investors in this bull market and that’s a good thing. However, returning to our 1987 analogy, let’s temporarily set it aside.

Chart 2

Why it’s not 1987

I think there are three major differences why it’s 2016 and not 1987. First, the 1987 crash was preceded by a tight money policy best expressed in a falling bond market and rising yields. This point is laid out in Charts 3 and 4. Chart 3 shows that the 10-year yield ($TNX) had been rising for several months prior to the crash.

Chart 3

Compare that to Chart 4, where you can see that the 10-year maturity has been in a falling trend for quite a while. Thus October 1987 was preceded by tight money, which is traditionally bearish for stocks, whereas October 2016 is being preceded by easy money, which has the opposite effect.

Chart 4

Charts 5 and 6 compare the long-term pictures in terms of momentum. In 1987 we see the PPO using the 3/24 parameters as being in an overbought condition. Indeed, at the time of the August 1987 peak, it was registering a record overbought condition. In September, the indicator actually began to turn down.

Chart 5

Compare that to today’s picture, where the long-term KST for the NYSE Composite has started to cross above its MA for a bullish signal. Of course, this is a tentative crossover and could reverse in October. However, I would much prefer to be in the current situation with a potential reversal to the upside rather than experiencing an unsustainable overbought reading with great vulnerability to the downside.

Chart 6

Finally, the current technical picture has been preceded by a 2-year consolidation, but under the surface,  the market has experienced a complete sector rotation. This can be appreciated from Chart 6, where the indicator in the bottom window calculates a basket of S&P sectors that are in the “winter” position. Winter is defined as when the long-term KST is below zero and falling. The inset diagram highlights this condition in red. The bad news is that Winter is about as bad as things can get momentum-wise for any security. The good news is that it’s always darkest before the dawn. Consequently, when some leading industry groups begin to experience a rising KST, i.e. are moving to the spring position, the Winter indicator peaks out. This sets in motion a kind of bullish reverse domino type of effect as more and more groups turn positive and push the market averages higher. The indicator recently peaked from a high level, effectively giving us a buy signal. Compare that to 1987, where virtually no groups were in the winter position. That was definitely a weak technical structure, quite the reverse from the current strong one.

Chart 7

Conclusion

As we approach the crisis-prone month of October, it seems that there is plenty to worry about. Some kind of dip may well be in the cards. However, if there is going to be a crash, it will be based on something entirely different than the conditions that prevailed in 1987. Personally, I am looking up rather than down and I am anticipating the bullish seasonal that begins in November and runs to May.

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.