Lighthouse Investment Management

How the market works

"Time dependency of bull markets"

Contents
Summary ....................................................................................................................................................... 2 Bull market duration ..................................................................................................................................... 3 Bear market duration.................................................................................................................................... 6 Conclusions ................................................................................................................................................... 8

How the market works - Time dependency of bull markets - January 17, 2013

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Summary Stock market performance during bull markets is mainly (89%) explained by the duration of the bull market (defined as an uptrend without any pull-backs of 20% or more).

How the market works - Time dependency of bull markets - January 17, 2013

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Bull market duration
I came across this chart via Barry Ritholtz ("The Big Picture"-blog, FusionIQ):

Nice, but what about performance?

So I looked at the duration of bull markets, defined as not interrupted by a 20%+ decline (which would be a bear market) and the corresponding performance:

How the market works - Time dependency of bull markets - January 17, 2013

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To better visualize the data, I used bubbles, where the size of the bubble is proportional to performance:

And I thought "that looks pretty well correlated". So let's run a regression analysis, with performance the dependent and duration the independent variable:

How the market works - Time dependency of bull markets - January 17, 2013

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The result? Bull market performance is almost 90% explained (R2)by the duration of the bull market. That is unbelievable! If you exclude the mega-bull run 1987-2000, the result is still a 54% correlation (and interception with x axis is at zero, which is comforting, since days cant be negative). The mega-bull run got very close to being interrupted by a bear-market in 1990/91 (Iraq invasion), but missed that condition by 3 points or 1%. Does the apparent time dependency mean fundamentals do not play a role? No, since you might not get a long bull run if initial conditions (like low P/E, high interest rates) and end conditions (high P/E, dot com bubble) are not right. Still interesting that performance seems to be mainly a function of time. The current bull market (1,408 days) will get to median age in October 2013 and reach an average age in April 2014. The current bull market (+117%) is a tad ahead of the expected performance (which would be +95% or 1,324 points for the S&P 500). You can use the formula [y = 0.0014 x duration 1.0146] to extrapolate your own value. Excluding the mega-bull run the expected performance as of today would be +103% or S&P 1,375.

CONCLUSION: As long as no shock rocks the boat, the expected market return is +22% per annum. How the market works - Time dependency of bull markets - January 17, 2013 Page 5

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Bear market duration
What about bear markets?

What would we expect if performance during bear markets was correlated with the duration of the bear market? You should see the regression line declining from upper left (short bear markets, small drop) to lower right (long bear markets, large drop):

How the market works - Time dependency of bull markets - January 17, 2013

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How the market works - Time dependency of bull markets - January 17, 2013

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Bear market performance is only slightly correlated with duration (R2 = 29%). Further, inception with the x axis is not at zero. A one-day bear market would have an expected performance of -23% (wait - maybe that's a sign of how the next flash crash will pan out?). If you exclude the 1987 crash, which was short but sharp, correlation increases slightly to 35%.

Conclusions
Time-dependency matters more in bull markets. In bear markets, fundamentals (or initial conditions) matter most. What does this mean for current market environment? Valuation is, depending on what you look at, either cheap (P/E ratio) or expensive (P/E 10,Tobin's Q, regression etc). Hence all eyes have to be on the look-out for any external shocks. In general, as leverage increases, swings should get amplified (the value of equity, as the residual of assets minus liabilities, gets more stretched and compressed).

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How the market works - Time dependency of bull markets - January 17, 2013

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