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Recovery time is a basic concept that we all understand in terms of being out of breath with a rapid pulse after a hard run (for the young), or a trip upstairs for some of us with a few more years of age. The greater the severity of the physical stress and the more prolonged the depletion of short-term reserves, the longer the required recovery time. The better conditioned we are going into hard work, the shorter our recovery time. Perhaps there are similar kinds of effects in the stock markets.

After a hard crash, it takes some time to recover. The more prolonged the initial crash, the more time it may take to recover. Recovery is a matter of both the economy and companies rebuilding strength, and of the investing community rebuilding faith and perhaps cash reserves. Recovery is also a matter of the financial condition of the economy and companies, and stock valuation levels, prior to a crash.

How hard was the stress on the down side? How prolonged was the stress? What kind of shape was the economy in and the market valuation in before the stress? What may that imply about required recovery time?

Those are important questions for you to ponder.

In any event, let’s consider some significant down markets and the approximate time it took for the market to retake the price of the prior peak.

  • 1968 peak: 3+ years to recovery
  • 1973 peak: 7+ years to recovery
  • 1980 peak: 2 years to recovery
  • 1987 peak: 2 years to recovery
  • 2000 peak: 7 years to recovery
  • 2007 peak: ??? (2+ years so far — 3 years in October).

We have often heard analysts comparing the decline after 2007 to the decline after 1973, which took seven years to recovery. The 2000 crash also took seven years to recovery, but the entire world was not in such hot water as it is today.

The 2007 crash was every bit as hard as the 1973 and 2000 crashes, so maybe it will require something closer to seven years than two. On the other hand, it was swift, as in 1987, which only needed two years to recover. And on the other other hand (if only we had three hands), none of the listed prior down markets were as global as the one we have experienced this time around.

The current path of market price recovery is at the 4-year rate. If the recovery will take more than 4 years, then the recovery rate will have to moderate (decline and then rise; or rise at a lower angle of incline).

At the moment, the recovery is essentially intermediate between the fast recoveries of 1980 and 1987; and the slow recoveries of 1973 and 2000.

click image to enlarge

The chart above plots trend lines that would lead to recovery to the 2007 peak price level over 2, 3, 4, 5, and 6 years. The red cross hairs with the black box at their intersection represents the common view among many sell-side analysts that the S&P 500 will close the year around 1300.

We ask whether it is reasonable to assume that the recent crash and current global conditions warrant a faster recovery than after 1973 and 2000. We don’t think it should, but markets are not constrained by “should,” although it is helpful to have the “should” in mind.

In the end, markets do what they do and not what analytic projection says they should do. What do you think the S&P 500 should do based on comparison to prior situations? What do you think it will do?

Holdings Disclosure:
As of March 3, 2010, we do not have current positions in any securities discussed in this document in any managed account.

Disclaimer:
Opinions expressed in this material and our disclosed positions are as of March 3, 2010. Our opinions and positions may change as subsequent conditions vary. We are a fee-only investment advisor, and are compensated only by our clients. We do not sell securities, and do not receive any form of revenue or incentive from any source other than directly from clients. We are not affiliated with any securities dealer, any fund, any fund sponsor or any company issuer of any security. All of our published material is for informational purposes only, and is not personal investment advice to any specific person for any particular purpose. We utilize information sources that we believe to be reliable, but do not warrant the accuracy of those sources or our analysis. Past performance is no guarantee of future performance, and there is no guarantee that any forecast will come to pass. Do not rely solely on this material when making an investment decision. Other factors may be important too. Investment involves risks of loss of capital. Consider seeking professional advice before implementing your portfolio ideas.

Source: Post-Crash Peak Price Recovery Time