Market Bottom: Historical Norms May Not Apply

Last week, stock markets rallied vigorously and so far have avoided any major plunges like we have seen in previous weeks. Has the stock market bottomed?

The S&P 500 turns up 2 to 4 months before the end of the recession according to Northern Trust and the average length of the a U.S. recession in the post-war era has been 10 months according to Bespoke Investment Management. So if the recession began in early to mid-2008, we could be near the bottom going by historical norms.

We’ll know when the recession officially started when the National Bureau’s Business Cycle Dating Committee makes its call. A rule of thumb is two consecutive quarters of negative growth in GDP. What can make it tricky are ongoing revisions to GDP growth figures.

Another historical norm suggesting a bottom is the typical decline seen in bear markets. Nick Majendie, a portfolio strategist at Canaccord Adams says “…there have been 12 occasions since 1900 when the Dow Jones Industrial Average has been down more than 40%, and in 11 of those periods, the drop stopped somewhere between 40% and 50%.” That’s where markets were last week prior to the rally.

However, historical norms may not apply this time around considering the severity of the current financial crisis. Indeed, a recent IMF study concluded: “Recessions preceded by banking crises last twice as long on average as those not triggered by a financial crisis, and the loss of output was about four times as great.

Bert Dohmen editor of the Wellington Letter, is bearish too: “Most bear markets, after a major bubble has burst, decline 80%-90%, going back to where the bubble started. In the United States, that’s what happened after the 1929 Crash. During the 1973-74 bear market, the broad ValueLine Index was down over 80%. In 2000-02, the Nasdaq Composite was down over 80%.”

Comments

[prudentinve...:]

You're right. Seems to me that this recession is (a) just starting, and (b) will be long and deep. There are too many imbalances that will take time to correct, and the law of unintended consequences will rear its ugly head to haunt the ill-conceived bailouts.

2008 Nov 04 04:39 PM

[dshort:]

"Has the stock market bottomed?" you ask. Good question, but you confuse the issue by raising the topic of historical recessions. The recession call by the NBER will be based on GDP and related statistics that have evolved in methodology over the decades since the organization was founded in 1920.

Consider, for example, that the eight-month recession during the 2001-2002 bear market ended in November 2001, according to the NBER, with the S&P 500 at 1,084.10. The index didn't bottom out until the following October at 776.76. That's a further decline of 28%.

A more productive approach to the question of when the current bear market will end is to examine previous bottoming processes. The key word is "process". Rather than a sudden single event, the bottom is better understood as a process over a period of weeks or months. An overview of the eight completed S&P 500 bear markets since 1950 reveals this bottoming process that lasted anywhere from six weeks to eight months:

dshort.com/charts/bear...

In four of these bear markets, the first low in the process was the actual bottom. In three, it was the final low. In the triple bottom of the most recently competed bear, the trough came in the middle. The process ranged in length from six weeks to eight months. There is no clear correlation between the depth of the decline and the length of the bottoming process. Likewise, the overall length of the bear market doesn't reliably predict the amount of time spent bouncing around the bottom.

2008 Nov 04 05:15 PM

[lanaslinesd...:]

There are many imbalances in the economy that has to be corrected: the stablization of the housing market; the rising national deficit; rising unemployment rate; et al.

We're far from the end of this downturn, which is a good thing if you're trying to buy stocks from beaten good companies that are going to make it through this cycle like I am.

lanaslines.com

2008 Nov 04 05:38 PM

[Socialism c...:]

Agreed: it will be long and deep, particularly because the government took the wrong direction for a "solution!" Socialism and nationalization of banks and private companies NEVER ends up generating better returns than letting free-market economics work!! All we've done is try to credit-spend our way out of a *credit* problem!! And Neel K., "boy wonder", has his stated goal to grease the wheels for renewed lending at the banks!! Um...wasn't too much lending the problem?

We need to learn to live on income, not credit. That goes double for the government!! And by the way...the only viable long-term solution that will enable us to get the government back under control is an abolishment of the income tax and a Balanced Budget Amendment!! The former is necessary in order to return control to the people over their own property! As long as the government has a preemptive claim on your hard-earned money, there is no limit on its grabbing more. When (not if) we go to solely consumptive taxes, *you* are in control of how much tax you pay...by deciding whether and when you want to buy something!!

Wake up, people!! Obama isn't going to go this route -- he is FINE with the tax & spend paradigm -- and will not only retain it at all costs, but EXPAND it...in order to redistribute to the entitlement bunch!! Sigh. We will learn the hard way, it appears. Let's hope we have a country to vote for in 4 years. :(

2008 Nov 04 05:42 PM

[investor88:]

A good wake up call from Larry here.

We have a nice rally of some 20% or 1500 pts on the Dow [8k to 9.5k]. Some are talking of Dow 11k before any weakness.

Larry's article should make us cautious at least whilst playing the rally.

2008 Nov 04 06:23 PM

[aarc:]

This is a "Once in a Century" global crisis that has never happened before.

No amount of recession statistics will apply since this "correction" has never happened in the past 100 years at least since the recorded stock market history.

Elliott Wave Analysis do apply since it is not dependent on linear cycles like currencies or commodities nor statistical analysis of previous recessions but rather the progression of rallies and corrections as they occur in any given time frame. Thus it is applicable even to short term as well as long-term analysis since it is more pattern dependent with varying degrees of corrections as the patterns unfold.

Young stock markets do tend to be immature at best. Examples are Dow Jones of 1929-32, Nasdaq of 2000-2003, Hangseng and Sensex of this last 2 years.

Young companies usually correct 80% and much less as they mature. But they also go thru excesses that "resets" them back significantly. Example is Google on the monthly chart (3 rallies and 2 major corrections before 2007 top followed by a massive correction now in progress that is threatening to reset its progress from early 2005 to late 2007). Google, however, has no discernible weakness and less likely to correct the usual 80% of a young company. SBUX has a significant structural weakness and is suffering mightily with just the initial run down. It is going to make a corrective rally only to go lower again or even go bankcrupt at the rate it is correcting much like AIG.

Being young and aggressive Dow Jones rallied from $42 of 1932 to $1000 or 1965. However, 43 years of rally gave DJ enough time to mature and become less prone to panics thus the consolidation of 700 to 1000 from 1965 to 1980 with 1000 thought to be the unbreakable resistance at that time.

1000 got broken anyway in 1980 and Dow Jones found new confidence that propelled it to 12000 of year 2000.

However, the rally from 1980 to 2000 was simply too massive and have occured in a very short period of time.

Excess was committed and have been partially paid but not fully corrected. With the "mistake" of investing in housing from 2001 to 2006 the penultimate error of investing. Housing is an expense generating asset and the economy cannot sustain growth by turning it's back to business (most business investments of 2002 to 2007 were diverted to China, India and other developing countries).

Now we have the biggest crises america has ever experienced compounded by the tech bubble and the housing bubble.

5000 (4750 using equal move fibo projection) is the estimated target for Dow Jones by Q2 to Q3 of 2009 using EW analysis - the technical side of EW they call the expanding flat correction which is a common occurence in shorter time frame charts such as intraday, daily and weekly charts and used in the quarterly chart of DJ.

The unfolding Dow Jones chart is also similar to MER quarterly chart with MER well ahead of DJ since MER went down well ahead of DJ. Japan yearly is similar to MS quarterly chart.

There is 20 to 30% chance DJ will fail to reach 5000. A terribly not so confidence builder probability. A rally above 11,000 is needed without breaking the 7,200 bottom of year 2002. That will be enough to provide the psychological boost to investors and give them new insight into the future with 16,000 the next target before the next run down.

At any rate; the current crises points to another potential rally of 100 years or more with another 2 major corrections/recessions and 4 to 12 garden variety corrections/recessions similar but shallower than of the past since DJ is in the process of becoming more mature as time progresses.

However, SnP500 is going to be more relied upon in the future since it represents the US stock market better than the DJ or Nasdaq. SnP500 has the common double top pattern on the quarterly chart that everybody can recognize but not be able to predict accurately since double tops have only about 60% chance of producing higher lows rather than lower lows.

Likewise, China and Nasdaq will more likely mimic the Dow Jones of 1932 to 2000 in the Technological Revolution of the future replacing the Industrial Revolution of the past. China should be more Industrial Revolution rather than TR in the early stages of the next global boom.

2008 Nov 04 08:03 PM