Saturday, May 8, 2010

The "Right Math" vs. "Fuzzy Math" of Market Declines

Last week produced a day with a particularly wide swing from low to high on the Dow Jones Industrial Average. What one needs to take into consideration is that although it was a very large swing, the "perceptional impact" of the swing gets distorted.

What I mean is that a 1000-point swing when the Dow was at 5000 would actually be a much worse swing than a 1000-point swing with the Dow at 10,000.

It is kind of like the math of downturns: To make up for a 50% loss,requires a 100% gain, not a 50% gain.

Last week's “bad day” was the 3rd largest in "point drop terms" since 1987. That is certainly attention getting. However, ironically, last week's bad “point swing” day represented only a 9th place finish for bad days in "percentage drop terms" since 1987.

It is this "point drop" effect that tricks the brain into thinking it may have been the worst you may have ever witnessed. When the dust settles, I would take the 9th place worst intraday swing in “percentage terms” on 5/5/10 of -10.2% vs. the -29% swing on 10/19/87.

The following commentary is from Bespoke Investment Group:
For anyone actively involved in the market, we all remember where we were when the market had some of its biggest moves. The crash of '87 and the day Congress voted down the TARP are just two of many that come to mind. Strangely enough, even though Thursday was the third largest intraday point swing in the history of the DJIA and the ninth largest in percentage terms since 1980, it didn't seem to be one of "those days."

Even as the market was falling, there seemed to be a sense of calm in the market. Perhaps, we've all been anesthetized from the declines during the last bear market. Whatever it is, most people will probably be happy to forget it.

INVESTING WISDOM

WFG balanced portfolios are well positioned if the declines this week become a harbinger of things to come. If not, we will wait for our selection to the "all defensive team," at which point in the future the current market cycle has gone full circle.