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Another October Bottom
By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 20, No. 20 on October 28, 2011. 

Once again, it appears that October has become the “bear killer.” Yes, volatility is still high and put volume is still heavy, so there are clearly worries out there. But it’s normal for there to be plenty of worries at the beginning of a new bullish phase. In this article, we’re going to look a very similar October bottom in the past (1998) to see how the market unfolded at that time. All of this would become academic, of course, if sell signals unfolded; we would never stubbornly stick to some thesis at the expense of ignoring trusted indicators. But with the October lows clearly in place and the majority of the indicators positive, we would like to compare this October to 1998, for the similarities to date are quite striking.

As this bearish market phase unfolded, we had identified three past years that were somewhat similar: severe market declines in August, with a retest and eventual market low in October, but 1998 is the closest pattern.


The similarities between 1998 and 2011 have been evident for some time. Even at the beginning of the August declines, we postulated that this year might bear a great resemblance to 1998. That is not to say they are exactly alike – no two markets ever really are – but they are similar. Let’s start by examining the movements in $SPX itself; later we’ll look at other indicators such as put-call ratios and volatility.

The chart of 1998 is shown in Figure 1. At that time, the market was making new all-time highs for most of the year, culminating with the peak in July 1998, at approximately SPX 1190.

Then a 21% decline set it, bottoming on September 1st, 1998. The “cause” of that decline was the Russian debit crisis, but that isn’t particularly relevant.

The selling was exhausted by September 1st, 1998, and a decent reflex rally took place, carrying $SPX about 130 points higher before another bout of severe selling took place. This second selling wave briefly made new lows, and was “caused” by the Long-Term Capital hedge fund crisis (an aftershock of the Russian debt crisis). This second wave was swift and severe, but suddenly bottomed with a strong positive intraday reversal on October 8th, 1998.

From there, $SPX went on an absolute tear for the remainder of October 1998 – eventually reaching 1100 by month’s end, a gain of 19.5% from the October 8th lows. For all the talk on CNBC recently about how the current October is setting records, it hasn’t rallied as much from the lows as 1998 did.

There was a bit of a pause during the October 1998 rally, when $SPX encountered the 200-day moving average, but after bouncing around it for a couple of weeks, it then broke on through to higher highs.

A topic one hears all the time now is how can the market continue to rally after the strong move it’s already had? In fact, in 1998, the market did continue to rally. There was a pause just after Thanksgiving, but by early January an additional gain of 15.9% was posted after the end of October. So it’s obvious that the market can rally after a strong October.


Figure 2 shows the chart of $SPX in 2011. So far, the similarities are strong. Although the market was not at new all-time highs in 2011, it was making new recovery highs from the last bear market. Technically, the highs were recorded in May on the day that Bin Laden was killed, but the secondary highs in July marked the beginning of the severe selling that took place in July and August. $SPX fell 19.2% during that time, bottoming on August 8th – a decline of similar magnitude to 1998's.

After some back and forth action for over a month, new lows were finally made on a single-day probe downward on October 3, 2011. The next day $SPX made new intraday lows, but followed with a strong positive intraday reversal, much as happened back in the October lows of 1998.

It is unclear what the main cause of the decline was – some will say the European debt crisis; others will say it was the possibility of a global recession. Again, it doesn’t matter why.

From the 2011 October lows, $SPX has rallied strongly, and with today’s close at 1284, it has eerily exactly matched the gain of 1998, having rallied exactly 19.5% from the October 4th intraday lows.

So far, at least, the down and up movements in $SPX in 1998 are quite similar to those of 2011.

Today’s move higher has also exceeded the 200- day moving average, moving above 1270. As we see in Figure 1, the 1998 advance stalled there for a couple of weeks, but eventually pushed onward.

If the market were to advance as much between the end of October 2011 and the first week of January 2012 as it did in 1998, it would climb another 15.9% – to 1487!! I don’t think even the most ardent bulls are citing targets like that, but as we see, it’s been done before.

$VIX Comparisons

Comparing $VIX movements in different bear markets and subsequent recoveries isn’t necessarily anything too enlightening. It isn’t just typical – it’s literally mandatory – for $VIX to spike up, retest, and then collapse. Figure 3 shows the path of $VIX in 1998, while today’s $VIX is shown on page 11.

Perhaps the most interesting thing in this chart is the seasonal factor of $VIX declining during the last part of the year. $VIX dropped sharply through Thanksgiving in 1998, then rallied while the market had a modest correction, and then made new lows with new market highs in December.

This is fairly typical action, as well. Perhaps the noteworthy thing is how quickly $VIX bounced back to the 29-30 level in November and December, at the slightest sign of a slowdown in the rally that was taking place at the time. In some sense, there seems to be a “memory” in $VIX – in reality, traders are still fearful of what a market correction might lead to – long after the time for fear has passed.

Such fears can sometimes be justified, of course, for in true bear markets, there can be swift returns to the “risk off” trade (2008 was an example of this, as several severe oversold readings led only to modest, intermediateterm rallies which eventually gave way to lower prices). But probably more often than not (and I have no hard statistics to verify this) the residual fears are unjustified.

Equity-Only Put-Call Ratios

Figure 4 is the standard equity-only put-call ratio chart, as copied from Volume 8, No. 1 (January 1999). At that time, we were not yet using weighted ratios. Also, apparently, we were not overlaying the unscaled $SPX or $OEX chart on the graph. Compare this chart with the standard put-call ratio chart at the top of page 7.

In Figure 4, it is clear that the put-call ratio rose to lofty heights in September and October, giving two buy signals near the highs of the chart. As an aside, note that those highs were just above 60 (i.e., 60 puts traded for every 100 calls). This year, the highs were in the 75-80 area. The difference reflects how many more puts are routinely traded these days than there were 12 years ago (institutional traders are more routinely buying puts for protection). In 1998, from the October buy signal, the ratio continued on down to an eventual low in mid- December, which was a sell signal that was premature, as noted on the chart. But the pertinent observation is that eventually the put-call ratio declines to the lower regions of the chart before the bull phase ends.

We would expect that same sort of thing currently. There has been very heavy put buying, even during the rally since the October 2011 lows. But as confidence builds, speculators will buy fewer puts, allowing the putcall ratios to begin to drop at a swifter rate and for a relatively long period of time.

Market Breadth

Like $VIX, market breadth patterns are very similar at all major lows, so the comparison between 2011 and any other bottom would look similar. But, for the record, we were keeping the breadth oscillators in 1998. The “stocks only” oscillator was in negative territory from July 21st through October 15th. At its worst it reached –823 in September 1998 and –540 in October 1998.

This year, the breadth oscillator went negative on July 25, 2011, and remained negative until October 6th – with two 3-day exceptions in some of the interim rallies. The worst reading was –1264 in early August, which in my opinion reflects the uniformity of market action that we see these days; all the hedge funds do the same thing at the same time.


The similarities between 1998 and 2011 are strong. The action this year maps more closely to 1998 than to any other October decline in my memory. Whether the final part – a rally to 1450 or higher – takes place or not is just conjecture at this point. But bears should make sure that sell signals are in place before shorting this market; merely selling it because it seems to have advanced too quickly is a poor reason and could prove very costly.


This article was originally published in The Option Strategist Newsletter Volume 20, No. 20 on October 28, 2011.