Anil Sharma's  Instablog

Every recession is different in the way it unfolds, the underlying problems which make it happen and time it takes for stock market to respond to it. The Peak to Trough decline and then rise from Trough to Peak again is also quite different every time. However, 2009 recession was stranger than rest of the recessions because we saw a clear double dip in stock market when it was unfolding. Housing started the downturn well in the beginning of 2008 and S&P 500 was almost 22% down already when big bank problems started unfolding around Sept. 2008. But then Lehman crash aggravated the situation and we saw another sharp decline of ~45% from pre-Lehman levels. All this resulted into the deepest decline in almost 60 years. The $100 invested at peak of the market in 2007 came down to only $44 at the bottom of decline in March 2008. The following table shows for recessions after 1950 what is the value of $100 invested in S&P500 at the peak of stock market just before the recession started and what is the value of the same $100 at the peak with in 6 months of end of recession.

As we can also see from charts below, which show almost 3 years stock market data from past recessions, there is usually a single spurt of decline either sharp or slow averaging about 25% drop and then recovery starts showing mostly the same pattern of rise as the decline was i.e. sharp or slow. In 2008-09, slow drop of almost 22% itself was in the category of stock market response to the housing downturn but then came another sharp drop of ~45%. From that drop point of ~670 on S&P500 we have come up almost 58% retracing sharp post-Lehman drop in similar fashion very quickly to highs of ~1070 for S&P500. However, people are very concerned at this point since this rise was very quick and they are looking for either sharp pullback or chance of a “W” shape recovery. Although history is not the perfect indicator for what would happen in future but people’s psychological response that we can see in historical data can give us good sense of what could be expected. Looking at the 2009 chart we can see that market is not yet at pre Lehman levels of around 1200 and then even at that level we were down ~22% from pick levels of 2007. In the past recessions except the 2001, when there was only single drop in recessions and then rise within six months we saw the $100 invested at the peak before was at least $85 or even more at peak after recession. This time we are actually at only $68 at 1070 level on S&P 500 post recession. It would be $77 at 1200 on S&P500 and $85 at 1250 level on S&P500. Approx. 1250 is essentially pre-Lehman level as well. Empirically from looking at historical response then shouldn’t we actually rise to ~1250 sharply and then see a slow rise from there. Although nobody can tell what the future holds but I am not sure why people are so desperately looking for a sharp decline at this level of S&P500 at around 1050 or so during recovery while we are seeing all the good indicators like drop in job loss, good ISM and housing index data, full government support for extended period of time, profitability and possible revenue growth for companies and stabilization of banking system. We could actually see another 10-15% rise just to get to pre-Lehman levels from here.