« US margin excess confined to financials | Main | US labour market improvement on track (continued) »

Dow six-bear comparison: further update

Posted on Tuesday, June 8, 2010 at 12:51PM by Registered CommenterSimon Ward | CommentsPost a Comment

A prior post presented a comparison of the rebound in the Dow Industrials index from its trough in March 2009 with recoveries after the six largest twentieth-century bear markets, excluding the devastating 1929-32 decline. These bears involved index falls of 45-52%, similar to the 54% drop over October 2007-March 2009. (Prices slumped by 89% over September 1929-July 1932.)

At the time of the earlier post, the Dow had moved down to converge with the "six-bear average" of these earlier recoveries. With liquidity conditions for markets having deteriorated, a fall into the lower half of the historical range seemed likely in the short term, although a significant undershoot of the average might present a buying opportunity.

Updating the analysis, yesterday's Dow close was 8% below the six-bear mean and 1% above the bottom of the historical range – see chart.

Examining the six components, the recovery since March 2009 bears the strongest resemblance to the rebound after the January 1906-November 1907 decline. The Dow was mostly above the six-bear average during the early stages of this revival but a significant correction set in after about a year, echoing recent market weakness.

Like the recent bear, the January 1906-November 1907 decline was associated with a credit bust and financial panic that drained liquidity from markets. Both crises climaxed with the failure of a major bank – the Knickerbocker Trust Company in October 1907, Lehman Brothers in September 2008 – and a subsequent decisive "official" rescue effort (co-ordinated by J P Morgan in 1907, before the institution of the Federal Reserve). The economic consequences were similar, with a severe one-year recession in industrial output followed by a strong rebound.

Relative to the bear-market trough, the Dow is currently very close to its level at the same stage of the post-November-1907 recovery – see chart. On that occasion, prices were reaching a low and rallied by more than 20% over the following six months.

The "six-bear" evidence, therefore, suggests that market weakness will abate. Resumption of an uptrend, however, requires an improvement in liquidity indicators.

PrintView Printer Friendly Version

EmailEmail Article to Friend

Reader Comments

There are no comments for this journal entry. To create a new comment, use the form below.

PostPost a New Comment

Enter your information below to add a new comment.
Author Email (optional):
Author URL (optional):
Some HTML allowed: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <code> <em> <i> <strike> <strong>