Can Next Year Be Better?

First of all thanks to the readers who sent me historical data on the "market" as requested.

I wanted to take a look to see how the market did (using S&P 500) in years following 'historically' bad years such as the one we are currently experiencing. In fact, this is tracking to be the worst year in history - worse than any of the Great Depression era. Now let me preface this by saying I am not big on the whole "every 3rd year of a Presidential cycle the stock market returns on average X percent" or "when the moon is in the fifth quadrant of blah blah, then the market returns X percent" or "if the NFC team wins the Super Bowl...." well you get the idea.

That said, I am a big reversion to mean person. For example as of Thursday's close, the S&P was 37% below its 200 day moving average - the worst ever. Doesn't mean a rally in the near future - but if you don't have probabilities and statistics you really have nothing. The market turns into a casino - which as we keep saying is why this market has become useless as an investment vehicle - no playbook is working, no historical precedent, no probability, etc.

So heading back to the reversion to mean theory, if the market returns X% over the really long run (50 year periods) and you have a period of extended gains as we did in the 80s/90s you should expect a period of substandard returns (Warren B warned of this actually at the beginning of the decade). You can do the same over shorter time frames. Effectively we've gone back to 1997 levels on many indexes so that's a reversion to mean if I ever saw one.

But just for historical reference I am listing the worst market years post 1926, and then the returns in the 1st and 2nd year after. It is listed in order of worst year to "least" worst - I pulled the 5 years that now trail 2008 as the "worst ever"

#1) 2008: -48.8%
'09: ?
'10: ?

#2) 1931: -43.3%
'32: -8.2%
'33: +54.0%

#3) 1937: -35.0%
'38: +31.1%
'39: -0.4%

#4) 1974: -26.5%
'75: +37.2%
'76: +23.8%

#5) 1930: -24.9%
'31: -43.3%
'32: -8.2%

#6) 2002: -22.1%
'03: +28.7%
'04: +10.9%

***************
Conclusions: There are no conclusions here as every set of historical conditions are different. There were no derivatives in the 1930s, but there was not an easy Central Bank flooding the world with capital either. In the end, basic economics are all that matters - price is the cross section of supply and demand; my main concerns at this time are demand for stocks.

This "Great Deleveraging" is problematic in that stock valuations were obviously being buoyed by some large degree by over-levered institutions - so we have multi years ahead where demand will be depressed from 2005-2007 levels. Further, I believe we've permanently lost a great many of the "retail" investors - many burnt twice in a decade now, and even longer term types from the 1990s who, using conventional investment vehicles (index ETFs), have made nothing for 12-13 years, while others buying the "bluest of blue chips" (GE, GM, Citigroup) have been destroyed. Of course supply of stock is never ending as insiders enrich themselves by issuing new stock and option grants to make sure they never lose but that's a discussion for another day.

What strikes me is just how bad this year has been; the variance between this year and even the 4th worst year in history (-26.5%) is gaping. We are almost double the 4th worst year in history at this moment.

If you do take any stock in this, you should be bullish or at least neutral for the intermediate term... aside from episode #5 which was the birth of the Great Depression, most other historically bad years were followed by a large rebound. And things were pretty good two years out as well. On the other hand, aside from 1973-1974, most people seem to be comparing this era as most similar to 1930-1931. So just some data for those numerically inclined as I am...

*Please note the 2002 number looks benign by today's standards but this is the S&P 500 and not the NASDAQ which was the epicenter of that bubble.

Comments

[Steve in TN:]

"...Further, I believe we've permanently lost a great many of the "retail" investors - many burnt twice in a decade now, and even longer term..."

I don't think this is a major concern. New investors, institutions, etc will take their place; they always seem to. When the bull starts anew it's amazing how greed takes over.

Great article!

2008 Nov 24 09:12 AM

[CrisisTheory:]

this comment is the best indicator yet that we are nowhere near bottom; bear market rallies notwithstanding.

delusional historical optimism that 'it will all be back to normal soon' is still at an unsustainable hight.

when intermediate and long term bears vastly outnumber bulls, then a bottom can begin.

2008 Nov 24 02:50 PM

[Urbane Gori...:]

I think you are overly concerned. Looks like it's forming a 'Dubya' bottom to me.

jegan

2008 Nov 25 06:43 PM