The scenario analysis finalized last week focuses on typical results with a bias on bearish results for 2012. This is due to my belief that we remain in a secular bear and have had three consecutive bullish years from 2009-2011. The results were marginally bullish in 2011, but positive nonetheless. A couple of technical tools were also calculated using Hubb Organisation Ltd’s ProfitSource software to project alternate bearish outcomes and given smaller weights.
Table 1 provides a finalized view of the 2012 Scenario Analysis. The process is aimed at assessing the current market environment and assigning weights to different potential outcomes. For the most part, it is grounded in average returns.
|
2012 Scenario Analysis
|
Probability
|
Return
|
Impact
|
|
|
|
|
|
|
Positive Returns: 0.24
|
|
|
|
|
Typical +Year: Secular Bear
|
0.12
|
+21%
|
+0.025
|
|
Presidential Cycle: All Years
|
0.06
|
+5%
|
+0.003
|
|
Decennial Cycle: All Years
|
0.04
|
+10%
|
+0.004
|
|
Best Year: Secular Bear1
|
0.02
|
+82%
|
+0.016
|
|
|
0.24
|
Sub-Total
|
+4.8%
|
|
|
|
|
|
|
Negative Returns: 0.76
|
|
|
|
|
Typical –Year: Secular Bear
|
0.38
|
-18%
|
-0.068
|
|
Presidential Cycle: Secular Bear
|
0.12
|
-5%
|
-0.006
|
|
Returns to Bearish Channel
|
0.10
|
-49%
|
-0.049
|
|
Elliott Wave Decline
|
0.08
|
-57%
|
-0.046
|
|
Decennial Cycle: Secular Bear
|
0.06
|
-15%
|
-0.009
|
|
Worst Year: Secular Bear1
|
0.02
|
-53%
|
-0.011
|
|
|
0.76
|
Sub-Total
|
–18.9%
|
|
|
1.00
|
Total
|
–14.1%
|
Table 1 2012 Scenario Analysis Final
Additional detail regarding how these potential outcomes and the weights given to them is provided in Scenario Analysis, Part 2 from last week.
Secular Markets
Two issues pose problems for the typical year, bearish bias approach:
- When using historic data and a look back, it’s possible to miss the early portion of the secular bull,
- Secular bears display increased volatility and the downside risk in outlier years may be underestimated.
To address these two issues, this week’s analysis includes secular bull outcomes while also more heavily weighting those negative years in a secular bear. To some extent this will off-set the impact to the end result; however, it keeps potential outcomes in focus rather than an estimate that is not expected to be realized.
Secular Bull & Bearish Outliers
The Alternate Scenario Analysis assumes a transition to a secular bull and updates the data accordingly. Please see last week’s article for cycle, channel and Elliott Wave data.
|
Alternate Scenario Analysis
|
Probability
|
Return
|
Impact
|
|
|
|
|
|
|
Positive Returns: 0.46
|
|
|
|
|
Typical +Year: Secular Bull1
|
0.23
|
+19%
|
+0.044
|
|
Prez Cycle: Secular Bull, Avg
|
0.09
|
+13%
|
+0.012
|
|
10-Yr Cycle: Secular Bull, Avg
|
0.08
|
+6%
|
+0.005
|
|
Best Year: Secular Bull1
|
0.06
|
+67%
|
+0.040
|
|
|
0.46
|
Sub-Total
|
+10.1%
|
|
|
|
|
|
|
Negative Returns: 0.54
|
|
|
|
|
Returns to Bearish Channel
|
0.12
|
-49%
|
-0.059
|
|
Elliott Wave Decline
|
0.10
|
-57%
|
-0.057
|
|
Typical –Year: Secular Bull1
|
0.10
|
-5%
|
-0.005
|
|
Prez Cycle: Secular Bull, Worst
|
0.09
|
-9%
|
-0.008
|
|
10-Yr Cycle: Secular Bull, Worst
|
0.08
|
-10%
|
-0.008
|
|
Worst Year: Secular Bull1
|
0.05
|
-13%
|
-0.007
|
|
|
0.54
|
Sub-Total
|
–14.4%
|
|
|
1.00
|
Total
|
–4.3%
|
Table 2 Alternate Scenario Analysis: Secular Bull?
Returns for All Years
Figure 1 provides return data for all years from 1915 – 2010 with a regression line added. Data for the Dow Jones Industrial AverageSM [DJ-30] was downloaded from Worden Brothers Inc.’s Telechart® service.
Figure 1 Returns for DJIA: 1915-2010
1 Easterling, E. (2005). Unexpected Returns: Understanding Secular Stock Market Cycles. Fort Bragg, CA: Cypress House (p 80)
Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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