Market Backdrop: 1990 vs. Today

History often repeats itself in the stock market. Over time, the stock market has demonstrated the tendency to respond to recurring economic and market conditions in a strikingly similar way. For example, the factors affecting market today bear a meaningful resemblance to the conditions facing stocks back in 1990. And the market’s response in both instances has been uncannily similar. But while history can provide a surprisingly useful road map in anticipating future market movements, the correlations are never perfect from one episode to the next, as unexpected surprises often surface along the way.

The market backdrop in 1990 and today are similar in many ways. Back in 1990, the banking system was in crisis and the economy was trending toward recession. The primary driver of the economic slowdown at the time was a deterioration in consumer spending and a sharp rise in oil prices following the Iraqi invasion of Kuwait. Unemployment was rising and corporate earnings growth was decelerating. All of these elements could easily be used to describe the current environment for the stock market today. And the response of the stock market in both episodes up until recently has been equally similar (see chart). From the 90 trading days prior to the market bottom in October 1990 and March 2008 to the 60 trading days following these lows, the stock market as measured by the S&P 500 has taken a near identical path. However, it appears that in recent days the market may have decided to split off on a new route.

click to enlarge image

Past performance does not always predict future results. During the 1990 episode, the stock market as measured by the S&P 500 initiated a decisive move higher in early January 1991. Applying the 1990 road map to today, it could have been anticipated that a similar upward turn in the market might have been initiated in mid June 2008. But instead of starting a move higher, the stock market instead began a sharp move lower around this time, having since declined by -7% through last Friday.

Key differences separate the 1990 episode from today. While the story is very similar between the 1990 episode and today, it seems that the differences reside in the details. For example, the spike in oil prices that began in August 1990 had already come back down on the most part by January 1991. However, oil prices in today’s market are continuing to reach new highs seemingly with each passing day. Also, the U.S. Federal Reserve was still in the early stages of an interest rate cutting cycle in January 1991. Today, some are projecting that the Fed may raise rates in the coming months in order to fight off inflation.

The market is waiting on oil and the Fed. Stocks do not necessarily need proof of accelerating economic growth before moving higher, as the market historically anticipates a economic recovery and begins to rally well in advance. Instead, the two primary impediments to a sustained move higher in the stock market appear to be high oil prices and expectations about the future direction of interest rates. If the price of oil manages to shed some of its froth and recent inflation concerns begin to fade, investors may finally feel encouraged to commit new money to work in the market.

Conclusion: Market sentiment remains fragile, but a sustained market rally may potentially be closer than it appears. Using 1990 as a guide, the market has shown the ability to emerge from similar challenges facing the market today. A decline in oil prices and an easing of inflation concerns would likely help push the market toward similar upward path enjoyed in early 1991.

Comments

[williemo:]

the main diff is this credit crunch is way more severe......and we didn't go bomb the hell out of the the Iraqi's this month.......ie, 'The Gulf War', which brought us out of the dull-drums. Now is diff......banks can't get capital like they could then. We're going down further, just get ready.

2008 Jul 08 03:30 PM

[vaduz:]

given the actions by the fed - selling their good quality treasuries against cramp form the investment banks on a large scale (if i see this right) - there is a big difference on the situation. thus the markets will rather go lower (dow 10000)

2008 Jul 09 05:09 AM