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Recently we looked at the 1970’s bear market as a template for today using the simple technical indicator of distance from the long term trend.
To expand on that comparison exercise let’s put aside the 1970’s for now and go back a bit further. Here’s a chart from a recent research report form CitiFX showing the similarity between the recent Nasdaq 100 index and the Dow Jones Industrial during the 1930’s and beyond:
…the price action in stocks following the only two occasions where U.S. equities fell by more than 80%. Those two occasions were the Dow Jones Industrial Average from 1929 to 1932 (fell 89%) and the NASDAQ from 2000 to 2002 (fell 83%)
The similarities continue out of the price chart. The 1938 rally was ignited by the suspension of mark to market accounting and the establishment of the uptick rule which limited short selling (sound familiar?). If the comparison between these two time periods holds, then the market will grind lower, hitting a new low in the next 4 years.
The next chart shows the Dow Jones Industrial during the 1970’s (blue) superimposed with the recent bear market (red):
Back then the Dow fell 45% over 11 months while recently the decline has been 54% over 17 months. The comparison to this time period suggests a continuation of the rally for the majority of 2010 up to the previous high. But for the next 7 years the market meandered sideways, unable to make further gains.
You can download and read the full 39 page report from the FREE Trading Resource section (Reports & Articles). The report is very indepth and looks at not only equities during various market crisis and bear markets but also does a similar study of other major asset classes.
Both the 1930’s and the 1970’s share the distinction of being “lost decades”. According to a Mark Hulbert, the trailing ten-year real return was -2.7% for December 1974 and -3.3% for August 1939. In contrast, the recent “lost decade” provided -4% annualized returns (adjusted for inflation). No wonder then that we see constant comparisons to those previous dark times.
Aggressive Bear Market Rally
Citi concludes that “… we are in an aggressive bear market rally (cyclical bull market) within the structural bear market that will see us lower in the coming years.” It strains the usefulness of any comparison between two different time periods when we expand it to include not only equities but gold, bonds, and the US dollar. But Citi believes that “…if we are forced to define where in history this combination most closely resembles the answer is 1975-1976″.
Mutual Fund Flows… or Ebbs
Another notable similarity not discussed in the CitiFX report is the change in the behaviour of retail investors. We’ve already discussed at length the risk averse US investor who has pulled their money out of equity funds and sought the safe haven of fixed income. This, even as the stock market has persistently gone higher. While some of this change in fund flows may be explained by the aging US population, most of it is due to the traumatic losses and volatility that have been sustained by US investors.
It is very unusual for investors to ignore a rising market. But it is an understandable reaction after having been burned so many times within a decade. The last time we saw such “scarring” in the psyche of investors was in the aftermath of the 1970’s bear market. Then, as now, US retail investors left equity mutual funds in droves. In fact, from 1974 to 1982 US equity mutual funds saw net redemptions every single year. This is exactly why I made the distinction between the short term and long term consequences of the fund flows we are seeing.
While in the short term we can interpret them as a counter indicator to the extremely bullish sentiment registered in the various surveys and polls, in the long term the stock market needs the patronage of US retail investors to be able to embark on and sustain a new secular bull market.
History never repeats, the saying goes; it rhymes. If that is true, then we can look forward to some further short term gains but a very challenging market in the medium to long term.
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