Not Out of the Woods
That is right. If you thought the worst was over and you could return to business as usual with the stock market, think again. The spike in volatility alone should signal there has been a paradigm change. Regardless which popular metric you use; PE, Shiller’s CAPE Ratio, or Buffett’s Market to GDP comparison; this is still one of the most expensive markets of the past century. The other two were the 1929 and 2000 markets and we know how those turned out. And we still have a demographic scenario, see previous blogs, that warrants a major market drop.
The question is when. Some folks are under the mistaken impression that stock market crashes occur at market tops. That is far from the truth. A study of major bear markets, those declining 28-plus –percent, since 1923, the year the precursor to the S&P 500 was introduced, reveals there is always a preamble to every major bear market.
The stock market may well be fickle, but providence is kind. It always gives us advance notice of a coming crash with an attention-grabbing drop. This is shown in the analysis below for each of the following major bear markets (28% decline or more): 2007, 2000, 1987, 1973, 1968, 1962, 1946, 1937, and 1929. Intraday prices and daily closes are only available for the S&P 500 from 1950 on. Therefore, Dow Jones Industrial Average closes were used for the markets before that. Charts are provided below the analysis for each year using S&P 500 data. Links for charts are provided for all years using Dow Jones data.
The initial top for the 2007 market came July 17 when the S&P 500 had an intraday high of 1555.90. The index would drop the next week and eventually settle to an intraday low of 1370.60 a month later on August 16 - a drop of 11.9%. Henceforth, all highs and lows are intraday unless otherwise stated. The market would climb for seven weeks to reach a market top for the index of 1576,09 October 11, 2007 - 1.3% higher than its previous high. An initial 5.5% dip was followed by a quick recovery to 1552.76 October 31, before succumbing and dropping 10.8% to a low of 1406.10 November 26, 2007. The index would recover to a high of 1523.57 and continue on a series of lower lows and highs until its nadir of 666.79 March 9, 2009 for a 57.7% decline.
The 2000 market gave plenty of warning before the Dot.com plunge. The market faltered right after opening the New Year January 3rd. After reaching a high of 1478, the S&P 500 dropped to 1455.22 at the close. It dropped below 1400 the next three days and recovered to 1465.71 – the high January 20, 2000. From there it did a roller coaster ride down to the 1329.15 low of February 25 – a 10.1% drop from its high thus far. The market finally climaxed at 1552.87 March 24, 2000. It would drop precipitously April 14 to a low of 1339.40 – a 13.7% drop – but then slowly recovered to 1530.09 by September 1, 2000, only 1.5% below its all-time high. Thereafter it steadily went down with some sharp drops followed by rallies but only to the downtrend line. The market bottomed at 775.80 October 9, 2002 for a 50.1% decline.
The 1987 bear market was a swift one. After vacillating to a high of 337.89 August 25, 1987, the S&P 500 dropped to 308.58 by September 8 – an 8.7% hit. It quickly recovered to 328.94 by October 2, only 2.6% down from its high. It wobbled to a close below 300 October 15 before crashing the next Monday to close at 224.84 – a loss of 20.5% for that day. It would close lower December 4, 1987 at 223.92 but the low point for the move came the day after the plunge, October 20, when it dipped to 216.46 for a loss of 36.0% from the August high.
This, along with the 1968 bear market, were part of the mega bear market that spanned 1967 – 1982. The S&P oscillated within the 100 and 110 range for most of the year. It cleared the 110-barrier in late summer only to dip below it again before making its final surge as the year closed. It peaked at 119.79 December 12, 1972 and then dropped 4.3% to 114.63 December 21, 1972. The New Year propelled the index higher reaching a top of 121.74 January 11, 1973 - a 1.6% gain from the previous high. It quickly dropped to 111.85 by February 8 and then proceeded to careen downward over a series of bumps until hitting bottom at 60.96 October 4, 1974 – a 49.9% loss.
After an initial drop to start the year, the market climbed steadily from March through November finally topping December 2, 1968 when the S&P 500 maxed out at 109.37. The index dropped to 96.63 by January 13, 1969 (an 11.6% drop), fizzled in its rally coming within 0.43 points of the low March 17, and then rallied all the way up to 106.74 May 14, 1969. After coming within 2.4% of the top it succumbed finally hitting bottom May 26, 1970 at 68.61. That was a 37.3% haircut.
The stock market steadily climbed from October 1960 to December 1962 when the S&P 500 topped out at 72.64 December 12, 1962. Then it dipped to 67.55 January 24, 1963 for a 7.0% loss. The index quickly went back to 70 the next week and eked out a small gain the next month finally peaking at 71.44 May 15, 1.7% below the high. Thereafter, the index plunged to 51.35 June 25, 1962 for a 29.3% decline.
The market had been on a tear since the latter part of World War II and started 1946 the same way gaining 8% by February. Intraday highs and lows for the S&P 500 were not available for the analysis so, hereafter, Dow Jones Industrial Average closes will be used. The Dow Jones closed at 206.61 February 5, 1946. The index then plunged 10% to close at 186.02 February 26. It quickly recovered its previous high and surpassed it on a bucking horse ride up to 212.5 May 29, 1946 – a 2.9% gain from its previous high. The bumpy ride continued until August when the index reached 204.52 on August 13 and then fell in exhaustion finally closing at 163.13 October 9, 1946 for a 23.2% decline. Despite a number of rally attempts, the market would continue to struggle until February 1948 with a maximum loss of 28%. (Chart Link: http://ritholtz.com/wp-content/uploads/2005/12/19421950_circle.jpg)
After a precipitous drop from 1929 to 1932, the market seemed to be on recovery mode until it plateaued in early 1937. The Dow Jones closed at 194.4 March 10, 1937 to mark the end of the uptrend. The index then drifted lower for three months until bottoming June 14, 1937 at 165.51 for a 14.9% loss. It spent the next two months on a steady climb eventually topping at 189.34 August 16, 2.6% below the previous high. That was its last hurrah as the market plunged 49.1% to its 98.95 March 31, 1938 Dow Jones close. (Chart Link: http://blog.afraidtotrade.com/resolution-of-the-1937-dow-bear-market/)
Much like the 2000 market, the Big Crash of ’29 gave plenty of warning. After going sideways for the first half of the year, the market went through a 10.0% correction when it swanned from a 326.16 Dow Jones close May 6 to 293.42 May 27. Thereafter, it rose undaunted until reaching the market top close of 381.17 September 3, 1929. It drifted lower, slowly at first, but then gained momentum until reaching a low point Friday, October 4 with a 325.17 Dow Jones close – a 14.7% loss. It made a mad dash effort to recover the next week but was only able to manage a 352.86 close October 10. At 7.4% lower than the September high, this was the lowest percentage close to a previous high of any of the major bear markets. Then again, this was the granddaddy of all bears. Ten trading days later, on October 24, the index closed below 300. It dived Monday, October 28 and again the next day closing at 230.07. The market continued its plummet until eventually reaching bottom July 8, 1932 when the Dow Jones closed at 41.22 for a record 89.2% decline. (Chart Link: https://consciouslifenews.com/similarity-stock-market-charts-1929-2008-2016-may-show-epocalypse/11116392/#)
The table below summarizes data for all the major bear markets above. Note that Second Peak data refers to the percent difference between the second peak and the first.
Historical data shows that every major bear market since 1923 always provided investors with a warning. After initially peaking, there was a surprise drop followed by a recovery to a new peak. This peak was often below the initial peak but three out of the nine times it marked the market top, in 2007, 1973 and 1946. The market would then crash after the second peak. In two instances, 2000 and 1929, it gave two warnings; the first a correction months before peaking, and the second after peaking.
Declines after the initial peak ranged from 14.9% to 4.3% with an average of 10.8% and a median also of 11.6%. The initial decline's range was from a loss of 7.4% to a gain of 2.9% with an average of -1.4% and median of -1.7%. Taking out the 1929, 7.4% outlier, the average was -0.63% and the median -1.6%. The time between the two peaks ranged from 30 days to 5.4 months with an average of 96.7 days and a median of 93 days.
Assuming we are in the beginning stages of a major bear market, and having gone through a 10% correction we are in the same spot the 2007, 2000, 1968, 1946, 1937, and 1929 markets were in. Do not discount the magnitude of the decline. While officially it was barely a correction, a 10.2% drop, this only takes into account closing values. When measured from intraday high to intraday low, as the market study above, the decline was a more bearish -11.2% from the 2872.87 high of January 26 to the intraday low February 9. Although there was no consistent pattern for depth of the initial decline and the total decline, it is notable that the four largest initial drops led to declines of 49% or more - a level only achieved by the 1973 bear market after only a 4.3% decline. While there seemed to be no relationship between the severity of the bear market and the time lapse between the two peaks, five out of the six times the market went through a bonafide correction it took months, between 2.9 and 5.4 months, for the market to top and begin its downturn in earnest. The notable exception was the Crash of 1929, which only took 37 days between the first and seconds peaks. There is no discernible relationship between the initial decline and second peak level, nor the total decline and second peak level.
It could be that Morgan Stanley’s prediction of February 19, that a slowdown may loom starting in the second quarter, may be correct. We have already gone above the -7.4% level from 1929, so it would seem this market does not correlate all that well to that one and the wait to the next decisive peak will be measured in months. Using the range for the other correction markets as a guide, that would indicate the fall would come somewhere between April 20 and July 7. Moreover, odds are the second peak will not reach the heights of the first and come within -2.6% and -1.5% of the January 26 market top. Therefore, take cover once the S&P 500 reaches 2798 (-2.6%). That is your signal to exit the stock market. Thereafter, be greedy at your own peril.