October’s Brutal Surprise

11/12/2008 12:30 pm EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor of NoLoad Fund*X, says October was one of the worst months ever for stocks, but she’s looking for a rebound when we least expect it.

By any measure October was one of the worst months ever for markets worldwide. Selling was indiscriminate and not only for stocks, but commodities, currency, and bonds as well. Panic that the world was heading into recession carved trillions in value from global markets, the most ever recorded.

But the final week was the best week for the US market in 34 years, reminiscent of the sharp recoveries from previous bear market lows.

Unlike previous bear markets, the current rout that started a year ago left all but 2% of the Standard & Poor’s 500 lower. In contrast, during the last bear market that started in 2000, the S&P 500 lost 49%, but a surprising 54% of the 500 stocks managed to move higher.

The average diversified US stock fund lost 19% in October and there were few places to hide. Value and growth funds tumbled side by side, ending with value funds as a group modestly ahead. Large-cap funds held up slightly better than small caps. Among sector funds, health care, biotechnology, and utilities held up best.

Domestic markets were among the calmer markets. Japan’s Nikkei hit a 26-year low. Emerging markets were hard hit—roughly $900 billion was lost from the 25 major emerging markets. Argentina and Brazil saw their biggest one-month losses since 1998, down 40% and 26%, respectively. Russia won the volatility prize, closing October down 29% even after a 43% gain in the final week.

The current bear market is worse than both the average and median of the past 12 bear markets since 1926, but it’s not unprecedented. Sell-offs of similar or worse magnitude occurred on four separate occasions, including the Great Depression. Excluding the depression, the magnitude and duration of the other three occurrences suggest that we may indeed have reached a bottom. Each of these markets generated solid investment returns over the following one, three, five, and ten years, once the bottom was reached.

Market recoveries often occur in bursts, particularly during the months following a bottom.  For instance, the average market return for the six months following a market bottom has been 31%. The average cumulative returns produced after the prior bear markets have bottomed amounted to 296%.

The mathematics of loss are such that if one loses 30%, it takes 3.7 years of cumulative 10% gains to recover. At a 5% annual compounded growth rate, it takes over seven years to recover a 30% loss.

The actual average and median amount of time it took to recover losses after prior bear markets since 1929 has been 2.91 and 1.63 years. These short time periods are entirely due to the sizable gains during past market recoveries, particularly during the six months to a year following a bottom.

The current rally may be a new bull market, or it may simply be a sharp correction following a brutal decline. Over the long term, however, the market tends to recover well before the economy or most investors’ predictions.

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