Does the Dow's History Offer Hope?

After the horrid US data released Wednesday morning, there are plenty of reasons to believe that the equity markets including the Dow Jones Industrial Average are headed lower. We have argued that the next string of GDP reports will finally reflect the recessionary conditions that Americans are already feeling. However in every battle there are signs of hope. Here is a very interesting chart published by Barclays Capital this morning. They compare the current equity market movements to that of the “Panic of 1907.”

The similarities are striking. In 1907, the last leg lower in the Dow was the 37% decline that lasted from the second quarter to the fourth quarter. So far this year we have only seen a 34% decline from the August high of 11867 to the October low of 7882. Another 3 percent decline would bring the Dow down to 7475.

Click to Enlarge

Barclays Capital

The price action in the Dow in 1907 suggests that there could be one final push lower in equities before a long term bottom and when a rally does happen, it could be as much as 20 percent. Afterward, expect a long phase of consolidation. Back in 1907, there was a 15 year consolidation before the stock market picked up once again and we entered the Roaring 20s.

Here’s a chart of the Dow from 1900-2004 (click to enlarge)

Comments

[JCCIII:]

Pretty scary. Do you think the facts that we are now in the information age where many investors are do-it-yourselfers via internet accounts will make the current consolidation period end sooner than previous consolidation periods?

2008 Oct 15 03:23 PM

[Smarty_Pants:]

One difference though was that in 1907 the banks actually had reserves and didn't have to borrow them from the FED.

Apparently definitions change over time. Back in 1907 bankers had enough sense to not obligate their reserves so they were available for 'emergency use during the panic.

Today reserves are something you leverage 40:1 for use in speculation on products that nobody can accurately price.

Perhaps this small difference will translate into some sort of difference in the performance of the economy as things move forward.

2008 Oct 15 03:27 PM

[Smarty_Pants:]

In 5 trading days the Dow went from 9400 to below 8000 (-15%), back to 9700 (+21%), then back below 8600 (-11.4%)

A couple more weeks of this and the FED won't have to worry about stabilizing the market. Everyone will be so stressed out that they won't care any more.

2008 Oct 15 04:13 PM

[Crudeman:]

Well back in '29 you could buy stocks for 5-10% down. Now you could buy houses for 5-10% down...Hmmm, when are we gonna learn there ain't no free lunch?!?

2008 Oct 15 05:05 PM

[Alex Trias:]

Technical analysis seems to have really caught on like wild fire during this bear market. What seems to drive most readers attention is the question: when will the market bottom? Everybody knows that, in fact, nobody knows, but it is fair to respond: "here is when it COULD bottom - look at this historical chart". That's sort of the point of this article.

I like charts. But for what it is worth, here's my response to the question: "when will the market bottom?" My response is, wrong question, guys.

Question: you mean, don't care about avoiding losses? Don't care about making money?

Answer: nope. That's not the point of investing. Investing is, contrary to popular belief, no different from spending. You like a particular car, you have the money, you buy it, accepting it will depreciate. Or you like a nice meal at a restaurant. So, if you can afford it, you go, spend the money and enjoy a good dinner. Sure, the money is gone, but you enjoyed the meal. Or, maybe instead of buying the car, or eating at the restaurant, you decide you really enjoy the thrill of playing Warren Buffet, or you think GE has a good business model, or whatever, and so you buy the stock. Sometimes it goes up. Sometimes not. You cannot know, and thus, should not care.

Now, its fair to say that GE probably tends to increase in value more than a prime rib steak, so, if that makes you happier to buy GE than the steak, great. But what actually happens to the value of GE after you buy it is just unknown unknowables. Ignore it. And if buying GE doesn't make you happy, don't do it. Spend the money on shoes, or whatever you're into. Or put it into a checking acount if you like those. No right or wrong thing to do.

What about selling? Well, I used to own some Starbucks stock. I drink coffee there, and like the product. Then they switched to Pikes Place. I can't stand that swill. I have to order an Americano now, or go elsewhere for my coffee. That got me mad, so I dumped my SBUX stock. No idea whether I took a loss or not, actually. But making money is not why I bought SBUX, held it, or sold it. I simply LIKED it at first, and when I stopped liking it, I dumped it like an out-of-fashion sweater.

I have a pretty good idea that I have taken some big losses this year, and figure it could get much worse from here. I mean, I am pretty rich, and I owned a lot of stocks, so it stands to reason I probably have taken a hit. I don't know how big this hit is, and the reason why is that I don't care. I hold enough cash to get by for a while - in case I get fired, which is fairly plausible. I started to get sick to my stomach with the credit crisis back in January last year, and decided that to not be sick to my stomach, I needed to dump US stocks for international stocks which, I figured, were safer. I felt pretty good after doing that, and smart to boot.

Ooops.

Once I realized all equities indexes are correlated to a larger degree than I thought, I began to get sick to my stomach again. So, in March, I bailed out and slept pretty well.

Now I feel sick to my stomach because I might miss out on a rally. Also sick to my stomach at the thought of how lousy the economy will get, how bad earnings will be. It's like being bi-polar. No matter what I do, I will be nauseated. That's not what I want.

Decision? Split the baby. 50% into stocks, 50% into bonds and cash. Why 50/50? Because then I really shouldn't feel like tossing my cookies at the prospect of a sharp rally or a stunning 1929 decline. I'm not even trying to guess which outcome is likely. My allocation is based purely on my best guess about what it will take for me to feel happy. I probably won't even know what my losses or gains will be because I might not even look at the markets for months unless I start to feel sick to my tummy again. If and when I do, I will buy or sell whatever it takes to feel happy, and be done with it.

Cars, restaurants, stocks, new pair of shoes, some bonds. When you get down to it, what's the difference? Why let losses in the value of your loafers keep you awake at night, trying to guess whether the coin will come up heads or tails this month, or hour, or ten years from now?

It all ties back in to charts. If you feel happy looking at 1907, by all means. Look. If this chart fills you with doubt because in looking at it, you find you are trying to guess the future, and you just can't crack the nut, you know, that sounds like you are not making yourself happy. If so, don't do it.

2008 Oct 15 07:28 PM

[Moon Kil Woong:]

Ummm, forget about notions of making money off nothing. That's why everyone is moving to cash. The charts show that I think you should be thinking about your job or lack thereof about now. Where the market goes well... all we know is there is still huge volatility and it may be all down (huge volatility is almost always downside vs. upside).

2008 Oct 15 10:53 PM