Can History Show Us the Way Out of This Bear Market?

At the start of the year, there were reasons for optimism that stocks had put in an important low on November 20. Those hopes have been dashed in recent weeks amid unrelenting day-after-day declines. All but a handful of market indexes have plunged to new bear market lows. The central issue remains the banking system - specifically the fear that the large banks are insolvent (i.e. that they lack the capital to deal with the loan losses that may be coming).

Even allowing for the enormous scope and complexity of the task of repairing our broken financial system, further complicated by a change of power in Washington, surely this period will be remembered as an example of how not to manage a systemic banking crisis. With our financial system in flames, consuming asset values and risking a catastrophic debt deflation trap, it is utterly exasperating to witness policymaking bogged down by politics, populist confusion/outrage, and logistical details, and the attention of our financial officials diverted by less pressing matters such as the development of ten-year budgets.

One can’t help but be depressed by the partisan spectacle that has unfolded in Washington D.C. Democratic policies intended to lift confidence seem to be having more of the opposite effect, because they are seen by too many to involve more social engineering and pork barrel spending than legitimate and equitable stimulus. And the Republicans, who presided over the financial sector and real estate bubbles, have re-discovered their long lost virtue of fiscal responsibility at the worst possible time (if there was ever a need for government to run temporary deficits, surely it is now). As a result of the financial and economic meltdown, consumer confidence as measured by the Conference Board is the lowest in the history of the survey (going back to 1967). The last thing Americans need right now is for their political parties and their media mouthpieces to revert to tired, ideological battles, but that is the situation in which we find ourselves.

Historical Analogues
The closest historical analogues to the price pattern of the current bear market can be found in the bear markets of 1973-1974 and 1937-1938. The accompanying charts overlay the price movements of the S&P 500 in the current bear market (shown in orange) with the price movements from these two historical analogues. No two bear markets and recessions are alike, but these two potential “roadmaps” give us a sense of how this bear market could evolve.

The 1937-1938 scenario, which unfortunately has been tracking most closely, is the bleaker of the two scenarios in that it projects a further drop of approximately 15% in the weeks ahead. The “good news” is that such a drop, if it occurs, and the analogue continues, would be followed by a 50% rally over the ensuing four months.

Potential Roadmap: 1937-1938

Even for investors who are firmly in the “secular bear” camp, and wish to raise cash levels, this would be a rally worth waiting for to get more defensive.

According to the 1973-1974 scenario, stocks have already experienced a greater percentage decline in this bear market, but the bottoming process may extend for a few more months to match the duration of the 1973-1974 bear market. Again, the lesson from that experience is that patience is warranted at this advanced stage of the game. After stocks bottomed in 1974, they appreciated 80% over the subsequent 18 months.

Potential Roadmap: 1973-1974

We don’t want to overdo the comparisons with these historical bear markets. The differences in the economic environments, policy responses, monetary conditions, and political environments vastly outweigh the similarities. However, mass psychology, which is a dominant driver in epic bear markets such as these, does manifest itself through stock market price patterns. Moreover, the crises in the 1973-1974 and 1937-1938 periods were every bit as severe as the crisis we are in today. The 1973-1974 crisis featured soaring inflation, record high interest rates, gasoline shortages, a war in the Middle East, a recession, and forced resignations of both the President and Vice President. The 1937-1938 crisis was characterized by a looming world war with Japan and Germany and a relapse into a seemingly insurmountable economic depression.

Comments

[Dave Wrixon:]

Yes, but neither of these two where charachterised by the need to de-leverage such an over-whelming amount of debt. Furthermore in 1937 the US really was a safe haven, rather than being the root of the problem.

Mar 09 04:17 AM

[Steven Hansen:]

what a difference a few months makes. if you would have tossed this article out six months ago, you would have had very negative comments. i am looking at it now and i am thinking if could be optimistic.

Mar 09 04:38 AM

[Tradememe:]

It is pointless to look in the past for solutions for the current crisis. But the authorities seem to believe that we are at the beginning of Great Depression 2.0 and thus, all we need to do is print more money. In the long run this is supposed to correct the structural problem in the financial system.

Mar 09 04:43 AM

[currency x com:]

The problem with printing money is that there is not way to print trust, in order to back that money.
Would it not be great to eb able to just order some trust... ?!

Each crisis has particularities, so does this one, I don't think too much comparisson to the past will help much. History helps, but don't compare the hell of today to the hell of yesterday and look for custom solutions.

Mar 09 06:37 AM

[Moon Kil Woong:]

The historic differences between these two periods make comparisons a bit on the ridiculous save we don't have many more test cases to compare with. Needless to say, aside from the graphs looking similar, I can't say the graphic comparison should indicate a continuation of the trend.

As they say, another month another graph. If it falls further you'll plot it with the great depression. If it rebounds you'll plot it to the 1980's recession. What value is this asides from having a lot of fun? Seriously, would you make a stock market bet with your own money on these?

Constructe now known as Moon Kil Woong.

Mar 09 06:45 AM

[User 294807:]

Well said Sir. What never ceases to amaze me is why technical analysts do not rank amongst the wealthiest men in the world, instead most are peddling monthly newsletters for a modest fee. They should all have retired after falls like these, they saw them coming based on head and shoulder formations, broken triangles and the like. Sadly in a world devoid of common sense these predictions have a self fulfilling air about them. People thought the last US administration were clueless, and rightly so, heaven help how history will judge the current incumbents given their track record to date. Why FASB157 has not been repealed, the uptick rule brought back and scrip lending abolished is beyond me. Instead the government and congress fiddle whilst the US burns. Currently the top four South African banks, YES SOUTH AFRICAN, have market caps that approximate Citi. That tells me that either the leading US financials are ridiculously cheap, SA banks are overvalued, unlikely seeing they are close to book, or the Rand very undervalued ! If what we are witnessing is the collective intellect of the US leadership, then the USD must also rank as a short at these levels. Oh for a dose of common sense to return to markets and mankind, because until it does we are creating a deeper and deeper hole to get out of !


On Mar 09 06:45 AM Moon Kil Woon wrote:

> The historic differences between these two periods make comparisons
> a bit on the ridiculous save we don't have many more test cases to
> compare with. Needless to say, aside from the graphs looking similar,
> I can't say the graphic comparison should indicate a continuation
> of the trend.
>
> As they say, another month another graph. If it falls further you'll
> plot it with the great depression. If it rebounds you'll plot it
> to the 1980's recession. What value is this asides from having a
> lot of fun? Seriously, would you make a stock market bet with your
> own money on these?
>
> Constructe now known as Moon Kil Woong.

Mar 09 07:38 AM

[MJJP:]

What got us out of the great depression was the great stimulus package called World War 2. Whats different now than then is that WE produced the goods to make the difference. Giving the average guy on the street more money in his pocket to buy goods from Walmart made in China only helps China. Studies have shown that every job in durable goods supported another 300+ jobs in the economy. Our now overweight service sector only supports about 150 and at wages far less than manufacturing. The government needs to create a stimulus but one which forces people to actually work. Put money in new rail, energy projects, tax breaks for homeowners to redo homes for insulation, tax breaks for new efficient heating systems, tax breaks for getting rid of 10 year old gas guzzlers etc. We need to take back some labor intensive industries and protect that market (shoes clothing electronics etc) If others countries cry foul tell them to build their infrastructure if they need jobs for their population. They are only successful while standing on our backs.

Mar 09 08:14 AM

[pacman1947:]

J.D. --
Great article with sound observations. You clearly point out that our politicians do what they do -- produce chaos in the vacuum of leadership.

We certainly could use some enthusiasm and positive thinking. It wasn't very long ago that one politician said that the US economy was solid and in good shape. Unemployment was under 5%. The market was peaking at 14000 on the Dow. SUVs were selling like hotcakes at Denny's.

Sounds like a different planet today? Yup. Getting back to the good old days may take some imagination.

Look up. There has to be a break in the clouds somewhere.

Just don't look inside the Circuit City. It's closed for good.

Mar 09 08:53 AM

[pockyclips ...:]

I tend to agree with your analysis, but I think the "bottom" won't occur until after the Second Quarter 09
reports are in.

Mar 09 09:08 AM

[Jet:]

The '09 Depression has no historical precedent. Oil prices spiked to $150 in July 2008 which instantly crashed everything. The resulting chain reaction is what we are now watching. If they do manage to stop the fall and we see any world economic recovery and growth, oil prices will just spike again and cause the next Oil Crash. This is not a banking or paper problem. The world ran out of oil plain and simple. The only fix is to replace oil with solar energy. We must turn the US into a massive solar collector. The Cost of doing this will be 100% of GDP for 25 years. The cost of not doing it is the end of civilization. Don't get it? Stock markets are not just headed down they are headed for zero...........

Mar 09 09:21 AM

[User 294807:]

Sure thing Jet, very helpful well thought through comment .........


On Mar 09 09:21 AM Jet wrote:

> The '09 Depression has no historical precedent. Oil prices spiked
> to $150 in July 2008 which instantly crashed everything. The resulting
> chain reaction is what we are now watching. If they do manage to
> stop the fall and we see any world economic recovery and growth,
> oil prices will just spike again and cause the next Oil Crash. This
> is not a banking or paper problem. The world ran out of oil plain
> and simple. The only fix is to replace oil with solar energy. We
> must turn the US into a massive solar collector. The Cost of doing
> this will be 100% of GDP for 25 years. The cost of not doing it is
> the end of civilization. Don't get it? Stock markets are not just
> headed down they are headed for zero...........

Mar 09 09:33 AM

[frosty:]

Steinhilber says, 'surely this period will be remembered as an example of how not to manage a systemic banking crisis' as if HE knows how to manage the crisis. One of the problems, it seems to me, is that too many people know how to manage the crisis, all radically different, without much concensus forming.

If the Treasury and Fed and worldwide financial and regulatory authorities stumble on their way up the hill, it's because it's a rocky climb and their is no straight line path to the top that can be mapped out ahead of time. The truth is, there are many different methods that will ultimately stabilize financial markets including the extremes of doing absolutely nothing and full nationalization. They have different outcomes however, many of which are unacceptable. Hopefully, governments will find a solution that has the best chance to rebuild what has been lost while at the same time causing the least pain for the masses and businesses.

Mar 09 10:52 AM

[John Lounsbury:]

J.D. - - -

Interesting article. Thanks.

I have a few questions:

1. Why do you start your 1937-38 comparison chart in August 2008, but start the 1973-74 comparison chart at the market top in October, 2007?

2. Why not compare the current market to 1929-32? That is the last time we had as extensive financial system distress as now. Why not address the question of whether Obama "stimulus" starting in the second year of the collapse will be more or less effective compared to Roosevelt "stimulus" starting in year four? Will the economic outcome be different this time? Will things still go pretty much in the same direction for the next several years? Can government action make things worse than the 1930's? Or, will we get a fairly rapid rebound and would a comparison to 1981-82 (as suggested by Moon Kil Woong) be more appropriate?

I think you have just scratched the surface of possible historical comparisons.

Mar 09 11:38 AM

[PROXIMO:]

JET--Why not open your own shop and offer your well reasoned analysis professionally? I'm sure you'd do phenomenal.


On Mar 09 09:21 AM Jet wrote:

> The '09 Depression has no historical precedent. Oil prices spiked
> to $150 in July 2008 which instantly crashed everything. The resulting
> chain reaction is what we are now watching. If they do manage to
> stop the fall and we see any world economic recovery and growth,
> oil prices will just spike again and cause the next Oil Crash. This
> is not a banking or paper problem. The world ran out of oil plain
> and simple. The only fix is to replace oil with solar energy. We
> must turn the US into a massive solar collector. The Cost of doing
> this will be 100% of GDP for 25 years. The cost of not doing it
> is the end of civilization. Don't get it? Stock markets are not
> just headed down they are headed for zero...........

Mar 09 01:24 PM

[Aryk:]

See www.gold-speculator.co.../


On Mar 09 11:38 AM John Lounsbury wrote:

>
> 2. Why not compare the current market to 1929-32?

Mar 09 06:02 PM

[John Lounsbury:]

Aryk - - -

Thanks for the link. I enjoyed the articles comparing the current market to 1929-32.

Mar 10 02:03 AM

[mr freddo:]

We cannot move forward until the financial system is repaired. The government is incapable of nationalizing the banks because the losses that may develop in the derivatives market are in the 10's of trillions of dollars. The existing system must be allowed to crash and burn. What our government should be doing now is setting up a structure of new national banks with fresh capital and clean balance sheets. If you allocate $300 billion in capital to the new banks and lever that capital at 8:1, that would be a stimulus of $2.4 trillion dollars in new loans to business.

Looking at the past will not give you a clue about this crisis.

Mar 10 02:15 AM

[User 371080:]

Sure thing User 294807, very helpful well thought through comment .........


On Mar 09 09:33 AM User 294807 wrote:

> Sure thing Jet, very helpful well thought through comment .........
>

Mar 10 06:56 AM

[Stop printi...:]

I couldnt agree with you more. This is exactly what the problem is in our country. We are printing money, printing money, and printing money but when it circulates in our economy it eventually leaves our country since we do NOT produce our everyday goods: walmart junk, gas, food, and clothing all come from overseas. Mostly China, which also owns more then 50% of US Debt. History repeats itself and WWII helped the US get out of the depression. My only fear is if we do not invest in clean forms of energy, start producing our own goods, and invest in new technologies to secure our planets eco-stablization... history will repeat itself again and Russia, China, and a handful of other nations will be blockading US oil supplies weakening our country internally.


On Mar 09 08:14 AM MJJP wrote:

> What got us out of the great depression was the great stimulus package
> called World War 2. Whats different now than then is that WE produced
> the goods to make the difference. Giving the average guy on the street
> more money in his pocket to buy goods from Walmart made in China
> only helps China. Studies have shown that every job in durable goods
> supported another 300+ jobs in the economy. Our now overweight service
> sector only supports about 150 and at wages far less than manufacturing.
> The government needs to create a stimulus but one which forces people
> to actually work. Put money in new rail, energy projects, tax breaks
> for homeowners to redo homes for insulation, tax breaks for new efficient
> heating systems, tax breaks for getting rid of 10 year old gas guzzlers
> etc. We need to take back some labor intensive industries and protect
> that market (shoes clothing electronics etc) If others countries
> cry foul tell them to build their infrastructure if they need jobs
> for their population. They are only successful while standing on
> our backs.

Mar 16 12:14 AM