When Will the Bear Retreat to Its Den?
By Stephen Smith
November 5th, 2008
With the global equity indexes down as much as they are in 2008, investors are caught in the headwinds of a severe and volatile bear market. The prospect for a meaningful recovery in stock prices is contingent upon improved credit markets and better clarity on the size and length of the global economic slowdown. Let’s examine the historical record for clues on how much longer this current bear market might persist. Of interest are the following questions: 1) how this bear market ranks in terms of price decline and duration; and 2) what the historical record tells us about the likely path of corporate profits during this period.
Looking at the Dow Jones Industrial Average (DJIA), investors have endured twenty-one bear markets since 1900 in domestic equities markets. This averages out to one bear market every 5.2 years. The current bear market began on October 10, 2007, 4.6 years following the conclusion of the previous bear market in March, 2003. The median price decline during that earlier period was 36.6%. The DJIA is down 40.3% from October 9, 2007 to October 10, 2008. The median length of bear markets is 17.3 months. We are currently in the twelfth month of this downturn.
Stock prices ultimately reflect investor’s expectations of future corporate earnings. What does history tell us about this current market relative to the corporate earnings cycle? Using the S&P 500 as a guide for stock prices shows that since 1945 stock prices usually peak in the calendar quarter immediately preceding the deterioration in corporate earnings, and that the average earnings decline is 21.5%. In this business cycle, analysts estimate calendar year 2008 earnings for the S&P 500 peaked in August 2007 at $106.50. Today the analysts’ consensus has dropped 24% to $81.31. Stock prices historically have begun recovering a full three calendar quarters before a corresponding rebound in corporate profits. The average corporate profit rebound over the ensuing business cycle is over 125%!
The current bear market has been extremely painful and has destroyed trillions of dollars in investment wealth. The immediate prospects for financial and economic recovery remain uncertain, but looking back historically at this market indicates that this episode is within the realm of previous bear markets in terms of length and price decline. In addition, the current market appears consistent with market performance during prior periods of economic contraction and falling corporate earnings. History also shows us that equity markets usually bottom well in advance of improving business conditions. In fact, stock prices often hit their cyclical lows when real time economic and financial readings are at their worst because the market is always looking at the future.
