Paul Tudor Jones made his most famous trade based partially on his realization that the chart of the Dow Jones Industrials in 1987 looked remarkably similar to the chart of the Dow Jones Industrials in 1929. In "The Trader," a 1987 PBS show that chronicled several weeks of his career, Paul Tudor Jones overlaid a chart of the two time periods and drew the following startling picture.
With the help of Yahoo Finance and an Excel spreadsheet anyone (namely me) can do today what took Jones weeks to do in 1987. Overlaying market charts can provide traders and investors an historical context to help generate ideas. However, traders need to be very careful to not automatically infer that markets that look similar in the present will behave similarly in the future. Unless market participants are in a highly emotional state of mania or crash, they won’t trade alike.
Many analysts have overlaid the 1929 Dow onto the 2000 NASDAQ to highlight the bearish parallels. However, what most fail to mention is that investors who bought stock in 1932 did well over the next five years as the Dow went from 40 back to 190 in 1937. In fact, the Dow from 1932-1935 and the NDX from 2002-2005 reveal a rough similarity.
In the following chart, the red line and dates represent the current NASDAQ 100 (NDX) through August 5th and the black line represents the is the Dow Jones Industrials from 1932 through April 1935.
If the relationship holds, the NDX could power higher through the rest of the year, much like the Dow did from April, 1935 onward.
On the other hand, a parallel between today’s market and the 1990s draws a more bearish short term picture. The strong market rebound out of a recession, the advance by small capitalization stocks, and the Federal Reserve’s monetary policy are all similar to to the early 1990s. Interestingly enough the S&P 500 today looks like the period from 1992 and 1993.
This 1990s overlay presents a more bearish interpretation than the 1930s overlay since the S&P 500 topped out shortly thereafter, declined sharply and traded sideways in a 20% range for the remainder of 1994.
Currently, I’m leaning toward the bullish 1935 overlay as having the higher probability of coming to fruition. However, investors and traders need to keep in mind that if the Federal Reserve continues raising interest rates, the fundamental backdrop will be more similar to 1994.