The chart updates a comparison of the rise in the Dow Industrials index from its low in March 2009 with six prior increases following bear markets involving a fall of about 50%. (The six bears bottomed in November 1903, November 1907, December 1914, August 1921, April 1942 and December 1974. The Dow fell by 45-52% into these lows versus a 54% decline between October 2007 and March 2009.)

From its 2009 low until April 2010, the Dow mostly traded above a "six-bear average" of the prior recovery paths. This probably reflected unusually loose monetary conditions due the Federal Reserve's QE1 securities purchases, totalling $1.725 trillion.

Following the end of QE1 in March 2010, the Dow traded back to and then below the six-bear average. By early July, the index was 10% beneath the average and within 1% of the bottom of the range spanned by the prior recoveries. This suggested a buying opportunity.

The Dow built a base over the summer and took off in September as the Fed signalled QE2, following through with the announcement of a $600 billion securities purchase plan in early November. This liquidity injection, supplemented recently by a rundown of the Treasury's supplementary financing program (SFP), has pushed the index 11% above the six-bear average – a larger deviation than at the July low.

The Dow is now higher than at the equivalent stage of five of the six prior recoveries. All five of these predecessors suggest a significant fall by year-end, ranging from 10% to 31% from Friday's close of 12391 (i.e. to between 8500 and 11200).

There is, however, one exception – the rise from the low in November 1903. At the comparable stage of that increase (i.e. in November 2005), the Dow embarked on a 23% surge over 11 weeks to a level equivalent to 16000 currently.

History, therefore, suggests a five-sixths probability of a decline in the Dow but a one-sixth chance of a "moonshot" scenario, involving a final blow-off and subsequent sharp correction.

The Dow's surge over November 1905-January 1906 occurred after it had breached its previous all-time high, reached in June 1901. The move into new ground may have stimulated buying. Currently, the Dow is still 13% below its October 2007 peak but smaller stocks are close to breaking out – the Russell 2000 index is within 3% of its high. US investors are showing more interest in domestic equities, channelling $12 billion into US-focused stock mutual funds so far this year, according to the Investment Company Institute, following an outflow of $88 billion in 2010.

The "moonshot" scenario could, perhaps, be triggered by the further $450 billion rise in bank reserves implied by the Fed completing QE2 and the SFP falling to $5 billion as planned – see Friday's post.

Equity investors face a dilemma: the odds favour market weakness but there is an outside chance of a blow-off that would cause a defensively-positioned portfolio to underperform significantly. Any such surge, however, would probably end badly: the January 1906 peak marked the start of another major decline, of 49%, to a low in November 1907.