Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Bear Market History
07/02/2009 12:33 pm EST
Given the historic market action in 2008 and 2009, I wanted to look back at some of the worst bear markets over the past 100 years to see if there was any interesting insights or conclusions that we could draw. I also thought that the charts of this period would be helpful to those of you who are students of the markets.
Perhaps it would make the most sense to start with our current market using the October 2007 highs and the lows at 6469 that were made the week ending on March 6, 2009. From the high to the low, the Dow declined 54.4% in 75 weeks. Possibly even more startling is that from the May highs (point a) to the March lows, the Dow was down 50.80%, and this occurred in just 41 weeks. The Dow formed two normal continuation patterns since the 2007 highs. One from the March lows to the May highs and the second from July into early September. As we look at some of the other bear markets, this might become more relevant.
Now we will go way back into history as I've selected five of the bear markets that had the greatest percentage declines since 1905, excluding the 2000-2002 market. The Dow closed above 100 for the first time in January of 1906 and then began what turned out to be a 48.5% decline lasting 96 weeks. The San Francisco earthquake and fire on April 6th (point 1) added additional selling pressure as the Dow finally made a short-term low in July (point 2). The bear market rally from July through early-January 1907 (point 3) was apparently not impacted by the anti-trust suits against Standard Oil of Indiana and American Tobacco, both of which began in August of that year. This rally retraced 61.8% of the prior decline. The drop from the January highs (point 3) was called the "Panic of 1907" as the Dow plunged 44.9% in 44 weeks, finally making its low in November of 1907. The continuation pattern that formed from the March lows until the July highs (point a) set the stage for the final decline. The 36.6% drop from the July highs to the August lows (point b) took just 18 weeks.
The selling accelerated in October after there was a run on the trust companies with Knickerbocker Trust having to close its doors. J.P. Morgan came to the rescue as then-President Teddy Roosevelt was hunting in Louisiana. This has been compared recently to the actions of Warren Buffett in the past few months. Another interesting fact is in regards to the interest rate on call money during this time as on October 24, 1907, call rates started the day at 6%, and by the afternoon were at 100%! The government and public decided that they could no longer trust the private financial companies, which led to the formation of the National Monetary Commission, and later, the Federal Reserve. On the positive side, the Dow did manage to rally back to the 100 level by 1909.
The third period I would like to look at is the bear market that lasted from the high in October 1919 to the lows in August 1921. This bear market also has some interesting parallels to today's market. The Dow made its high at 119.6 and over the next 96 weeks, declined 46.6%. At the 119 peak, the interest rates were the highest seen since 1907 and the markets were in what one called a "speculative boom." The first decline into the March lows was quite sharp as the Dow lost almost 25%. In March (point 1), control of the railroads was given back to the companies as they had been in government control for the previous 26 months. The drop from the April highs (point c) to the late December lows took the Dow almost 37% lower in 38 weeks (point d). Midway through this decline (point 2), the GM president bought a large amount of GM stock and lost $90 million. Does this sound familiar? Then in December (point d), JP Morgan assumed control of GM as the market had also reacted negatively to the election of Harding. From the December lows, the Dow rallied until early May before finally bottoming out in August of 1921.
The worst of them all, of course, was the bear market from 1929 until 1932 as the Dow declined 89% in 136 weeks. The year of 1929 started off with the Fed warning in January (point 1) of excessive speculation, but this buying was enough to push the Dow to significant new highs by the end of August. The historic plunge that terminated in October of 1929 took the Dow about 48% from its all-time highs in just ten weeks, even more severe than our recent decline. The rally into 1930 retraced just over 50% of the decline and the Dow peaked in April (point a). Then in May, Hoover proclaimed that the worst was over (point 2). From the April high at 294 to the low in July 1932, the Dow dropped 86% in 117 weeks. It is also interesting to note that the 261.8% projection using the rally from the October 1929 lows to the April 1930 highs was at 47.7, not too far above the actual low. The increase in volume in the summer of 1932 helped to identify the lows.
MORE: How Today's Market Compares to 1937-1938 |pagebreak|
In the fall of 2008, the market's decline was often compared to that of 1937-1938, and this period does match pretty well with what has happened in our recent bear market. The Dow peaked in March of 1937, and eventually bottomed in April 1938 after a 49% decline that lasted 56 weeks. From the March highs, the market declined into June and then staged a very sharp rebound that got very close to the prior highs, peaking in mid-August at 190. The decline that followed took both stocks and commodities lower as noted in the press at that time (point 1). The Dow plunged 40% in just 15 weeks and formed a near-term low the week of November 27, 1937. Then, after a 16-week rebound that traced out a nice flag formation, the decline resumed. The plunge in industrial production (point 2) may have added some selling pressure and the markets were nervous enough that in April 1938 (point 3), some short sale rules were changed. This might be compared to some of the regulatory changes that were made in the first quarter of 2009. By the time that Germany annexed Austria (point 4), increasing the already high war tensions in Europe, the Dow had bottomed. On the second leg of this bear market from the August 1937 highs to the 1938 lows, the Dow lost 48% in 34 weeks. The rebound from the April 1938 lows has been recently compared to the rally from the March 2009 lows. In 1938, the Dow gained 60% in 32 weeks as the rally peaked in November. During this rally, the corrections were rather shallow.
The bear market of 1973-1974 is still remembered by some, and many of us have looked at it often over the past 30 years. The Dow peaked in early July 1973 with a high of 1062 and it made a low in December 1974 at 570. This was a decline of 46.3% which lasted 101 weeks. Over the next few months, several significant events occurred, including the cease-fire in Vietnam, and later, the Watergate investigation picked up steam. As noted in a previous article, the Dow declined 20% over the next eight months, reaching a low of 845 on August 22. The rally from the August 22 lows was quite sharp, and even though it only lasted ten weeks, the Dow made a high of 998 on October 29 (point a). This was a rally of 18%, and while it slightly exceeded the 61.8% retracement resistance, it did not move above the 78.6% retracement level at 1020. In November 1973 (point 1), fuel prices reached record levels and the London market plunged, which added additional selling pressure.
From December 1973 through July 1974, the Dow consolidated in a just over a 100-point range and in March (point 2), the prime rate made a new high. Then in June, new car sales dropped 24% while the Dow was breaking to the downside (point 3). The next leg of the bear market took the Dow from 998 to 570, a drop of 44% in 61 weeks. President Nixon resigned in early August of 1974 (point 4) and the market declined further over the next few weeks. The Dow formed a nice bottom between late September and early December of 1974. The arrow marks the end of the first rally from the initial lows that ended November 8, 1974, just after the mid-term election. The Dow then turned lower once more and made marginal new lows over the next five weeks. The Dow Transports did not confirm these lows.
So can we draw any conclusions from this analysis? At this point, the 1929-1932 decline of 89% was clearly the worst, but nevertheless, our current bear market is next in line as it is well above the average decline of the other four that ranged from 46% to -49%. In terms of length, the current bear market is still one of the shortest at 75 weeks, even though it has lasted longer than the 1937-38 bear market. The average length of the other four bear markets was 107 weeks.
In terms of what we might call the second leg of the bear market, our decline of 50.8% in 41 weeks was worse in time and price than the others, with the exception being in 1929. In summary, the 1937-1938 period looks the most interesting, especially in terms of the rally off the 1938 lows, but if we were to follow this pattern, it would indicate a range-bound market for many years to come.
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