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History Shows We’ve Hit Bottom

01/05/2009 11:30 am EST


Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, Standard & Poor’s chief investment strategist, says the S&P 500 may well have bottomed in November, by several historical measures.

From October 9, 2007 through November 20, 2008, the Standard & Poor’s 500 index declined 52%, making it the third worst bear market since the 1929 to 1932 crash. One of the more amazing characteristics of this decline was its speed. The average “mega-meltdown,” or bear market decline of more than 40%, traditionally took 21 months to play out. This one took 13 months.

Where do we go from here?

Probably not lower, in our opinion. There are several reasons that a bear-market bottom may already be in place: The 52% decline is near the 54% drop recorded in the 1937 to 1938 bear market—the second worst since 1929. The current bear market retraced 103% of the advance during the 2002 to 2007 bull market. Traditionally, bear markets retrace an average 73% of prior bull-market gains.

At the 752 level, the S&P 500 was trading at a P/E ratio on trailing operating earnings-per-share (EPS) of 11.5x, equal to the lowest operating P/E ratio in the 20 years that S&P has been tracking operating results.

Finally, on December 8th, the S&P 500 closed 21% above the November 20th closing low.

Technically, that’s a new bull market. History indicates that only once since World War II (September 2001—January 2002) did the S&P 500 experience a bear-market gain in excess of 20% that was subsequently followed by an even lower low. Again, you have to go back to the 1930s to find exceptions to this rule.

S&P’s Investment Policy Committee has a year-end 2009 target of 1025, [which] anticipates about a 20% gain. By historical standards, that’s fairly conservative. When this bear market finally ends, history (which is no guarantee of future results) indicates speedy partial recovery. In the first 40 days after establishing a bear-market bottom, the S&P 500 has traditionally recovered an average 33% of the loss seen in the just-ended bear market. That would suggest an initial rally in the 500 from the 752 level to around 1020 before the market provides us a second opportunity to get back in.

Should November 20th end up being the low for this bear market, we believe 2009 may end up being a fairly good year for stock returns, if history is any guide. During the first year of a new bull market since 1932, the S&P 500 rose an average 46%.

We think next year’s potential recovery may be a bit more muted than in the past because of the price damage suffered by stocks in 2008. As a result, S&P believes that while a bear-market low may already be in place, the S&P 500 may meander in a trading range of 800 and 1100 over the intermediate term, as investors evaluate the recession and its impact on corporate earnings and equity valuations.

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