Previous posts have compared the rally in the Dow Jones Industrials index from its March 2009 low with recoveries following six previous bear markets involving a peak-to-trough fall of about 50%. (The Dow declined by 54% between October 2007 and March 2009.) As explained below, the current recovery looks extended relative to history, suggesting, at the least, a pause for breath.
The six bear market troughs considered in this analysis occurred in November 1903, November 1907, December 1914, August 1921, April 1942 and December 1974. The Dow Industrials fell by between 45% and 52% into these lows. (The 1929-32 bear market was excluded because it involved a much larger decline, of 89%.) In each of the six cases, the trough of the bear market was rebased and shifted forwards in time to match the March 2009 low. The subsequent recovery paths were then traced out and an average calculated – see first chart.
This “six-recovery average” proved to be a good guide to the underlying trend in US stocks over the two-and-a-half years following the 2009 trough. Since late 2011, however, the Dow has diverged positively from the average and is currently near the top of the range spanned by the historical recoveries.
Relative to the prior bear market trough, the Dow was higher at the corresponding stage of the recovery in two of the six cases – the rallies from the August 1921 and April 1942 lows. These recoveries are highlighted in pink in the second and third charts respectively.
In the former case, the equivalent month to February 2013 was September 1925. If the Dow were to replicate its performance then, it would rise rapidly into mid-year before correcting back to the current level. Strength would then resume, with the index exceeding the mid-year peak by the end of 2013 – second chart.
In the second case, the equivalent month to February 2013 was May 1946. This comparison is more bearish, suggesting an imminent peak and sharp fall into the summer – third chart.
To summarise, the current level of the Dow is above its implied year-end level in five of the six historical recoveries. In the single exception, a further near-term advance was completely retraced before the bull market resumed.
A common response when this comparison is presented is that a stronger recovery path is warranted currently because of unprecedented monetary policy stimulus. This stimulus, however, may already be reflected in market valuation, which is higher than at the corresponding points historically.
