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There are a few frameworks we can use to build a model of the stock market. We’ve looked at the Weinstein stage analysis of the market and compared the previous bear market to this one. A recent Morgan Stanley report authored by Teun Draaisma, Ronan Carr, Graham Secker, Edmund Ng, Matthew Garman provides a more nuanced model.
They looked at 19 historical secular bear markets. Most of them were in equity markets around the world but they also considered one bear market in gold. Then they looked at what happens in the aftermath of each secular bear market. The report identifies 4 separate stages:
- a decline which on average slices market valuation by half in a little more than 2 years
- a rebound or counter-trend rally - taking prices 70% higher in 17 months
- a shallow correction which lasts almost as long as the rebound rally
- finally a trading range which lasts almost 6 years
Applying this script, the current bear market showed a 56% decline from its peak in October 2007. That’s perfectly within the historical parameters.
In the next stage, the S&P 500 climbed +53% from the March 2009 lows. According to the historical pattern of secular bear markets, we would have expect the S&P 500 to climb 70% from its low to 1150. But if it had followed this pattern, then it would arrive there by July 2010. However, the S&P 500 has managed to climb two thirds of its allotted 70% counter rally in only 5 months. So this rally is anomalous because its slope is much, much steeper than the average historical one.
The third stage is understandable as such a large move usually gives back a portion due to profit taking. But the next and last stage is the most interesting.
This is where the market has to finally digest the consequences of what initiated the bear market in the first place. A trading range or base building - according to Weinstein’s model - is necessary because it sets the stage for the next bull market.
Broad multi-year trading ranges followed the initial rebound in 10 of 19 bear markets. In most cases, structural problems in the real economy acted as a headwind to a new bull market…
During this moribund time in the market, structural pains such as inflation, deflation, inordinate debt levels, unemployment, etc. work themselves through the economy.
But for now, the consequence of this research is that the counter trend rally which we seem to be in right now can go on for much longer than most anticipate. Even if we do manage to climb the remaining 20% to 1150 on the S&P 500, the market can take its time until the summer of next year. The report concludes:
If the aftermath of these 19 secular bear markets is anything to go by, the current rally could go on a bit longer; is likely to stall a few months before the first Fed rate hike, which we expect in Q3 of 2010 … and is likely to be followed by some sort of trading range for years to come because of the structural problems of financial sector and household deleveraging as well as the poor state of government finances.
But as the study itself proves, while the past may rhyme - it hardly ever repeats.
Examples of the Four Stages of Secular Bear Markets
The following charts are 4 examples of individual markets which demonstrate the stages mentioned above. Notice that while the trading range may sound boring, on average they have a +50% width, making them extremely tradeable and lucrative. For example, the first instance, the 1930’s experience had a trading range of +/- 147%:
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