Wednesday, 6 August 2008

Goodbye, Bear Market?

"Believe it or not, history offers surprisingly good news about what the stock market will likely do from here. No, history doesn't always repeat itself, but, as the saying goes, it rhymes. So please don't cash in your stocks for CDs until you read the rest of this article. To ignore history would be folly."

"Do things seem worse than they were during other bear markets? If so, it's partly because of our tendency to forget the distant past and focus instead on the recent past. I submit that the events surrounding many past bear markets were at least as frightening as those of this one. I certainly remember the anxiety surrounding the 1987 crash, when the Dow Jones industrial average plunged 22.6% in one day—eclipsing the 1929 crash. I thought we might well enter a depression. Instead, stocks hit bottom less than two months later."

"Yet, soon after the onset of a bear market, the market generally has risen. One month after breaking the 20% threshold, the S&P had gained 3%, on average, during those nine bear markets. Two months later, it had risen 6%. on average. Three months later, it was up 5%, and six months later, the S&P had returned 7%. Twelve months after the initial decline, the market had surged 17%, on average."

How can the market advance so much so quickly when stocks tumble another 11% after hitting the 20% bear market threshold?

James Stack, president of InvesTech Research, says it's because bear markets tend to be "V"-shaped in their final stages. That is, share prices tend to decline dramatically and quickly as investors capitulate, then rebound just as quickly. "Once a bear market ends, the rally out of that bottom is very sharp and very, very profitable," Stack says.

Yes, we all know that averages and statistics can be misleading. After all, the returns above are for the average bear market. What's to say that this will turn out to be an average bear market, with all the bad news still out there?

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