Is History Repeating Itself? - John Rothe | Portfolio Manager, Quant, Tech Geek, And Sometime Superhero To My Kids

Is History Repeating Itself?

The US stock market is still stuck in its sideways trading pattern as investors are waiting to see what the outcome of the European banking crisis will be:

I have been researching the similarities in market patterns between the current market and 2008, when the US went through its own banking crisis — and I found many similarities.

The Wall Street Journal reports Euro-zone banks’ overnight deposits at the ECB increased again last week, “reflecting deepening distrust in interbank lending markets.” During times of crisis banks typically will deposit money overnight at the ECB as become worried about current liquidity conditions among other banks.

From the Wall Street Journal:

Overnight deposits Friday rose to €255.57 billion ($341.88 billion), surpassing Thursday’s 2011 high of more than €229 billion.

The focus of the sovereign crisis in recent days and weeks has shifted to concerns about the health of the euro zone’s banks, reflected in large part by the poorly functioning funding markets…

Aside from market tensions, overnight deposits tend to rise towards the end of the ECB’s reserve period, which is Tuesday, as banks store excess liquidity in the facility after meeting their own reserve requirements for the month.

The ECB’s all-time overnight deposit high of €384.3 billion was reached in June 2010, driven by uncertainty about the then nascent debt crisis and an abundance of liquidity in the market as banks prepared to repay a 12-month ECB refinancing operation.

 

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In addition to the way European banks are acting, investors here in the US are acting in a similar way to 2008:

top money managerCurrent S&P 500 vs 2008 (chart via Macrostory.com) – click to enlarge

The above chart is showing a similar pattern of the current S&P 500 vs the S&P 500 in 2008. Why is this important? Studies in behavioral finance and technical theories, such as the Elliot Wave Theory and Fibbanci Sequence, show that investors act in similar patterns during similar economic conditions. For example, we can predict that traffic flow will slow down on the interstate if there is a car accident ahead. Human nature is to slow down and look at the accident. The same concept applies to investor behavior in the stock market — investors as a whole get scared when a historically similar economic crisis appears.

Not only are the current price levels almost identical between now and 2008, we are starting to see a similar “rounding” pattern in the market. The 2008 pattern, of course, occurred right before the significant decline in the stock market.

To further prove the point that investors behave in similar patterns, let’s take a look at some analog charts:

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artais fund, john_rothejohn rothe

 

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