Dow Jones Industrials Remain in Over Reaction, Mean Regressive State

The Bifurcation Parameter (BP) for the Dow Jones Industrial Average (DJIA) remains in negative territory at -38%. This market has been in an over reaction, mean regressive state that has often accompanied crisis markets. The BP is defined here.

Figure 1 summarizes the DJIA BP dating back to the Crash of 1929. For most of this period the BP has been indicating a bifurcated market in which investor sentiment is prone to under react and price is trend persistent. However, with the advent of computerized trading and negotiated commissions in 1975 the markets have become more efficient. An efficient market is defined here as one in which there is neither trend persistence nor mean regression is large enough to provide significant trading opportunities.


Figure 1. The Dow Jones Industrial Average Bifurcation Parameter suggests that the market has become more efficient since 1975. (Click on chart to enlarge).

The average return for the DJIA as a function of the average value of the BP for each market state is summarized in Figure 2. The t-test for each state provides the probability that the returns for a given state are equivalent to those from the efficient market state (when -10% < BP < +10%). Note that the crisis state (BP < -10%) is not statistically significant at the 95% level due to the limited amount of data, the recent market rally and the high volatility of this state. In contrast, the bifurcated bull state (BP >= +10% and R(0) >= 0) is statistically highly significant (p = 1.6E-9). Likewise the bear state (BP < -10% and R(0) < 0) is highly significant (p = 1.5E-5). However, if the markets have become more efficient, then these trend persistent states will be evident less frequently.


Figure 2. The Dow Jones Industrial Average market returns for the bull and bear state have been highly statistically significant. (Click on chart to enlarge).