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29/05/2009 - Is it time for a recovery?
The recent dramatic recovery of share prices throughout the world has not gone down too well with the pessimists. ”It’s a suckers rally” they say. But what does history say? When it comes to stock market performance, history is a better guide to what’s next, rather than current economic conditions. In the last 3 months the FTSE 100 Index is up over 20%, the Dow Jones Index over 25% and even better US financials are up 50%.
This recovery has not impressed pessimists. But look at this summary from the Peking Review on the woes of the US. Throughout the United Sates the picture is one of declining production, depressed markets, sharply rising unemployment, chaotic money markets and slumping stock exchanges. The country is in the grip of a deepening economic crisis, the worst since the Second World War. This has been a familiar story and could be repeated throughout the world and especially in the UK. This extract was printed on 7th February 1975.
However history does tell us that when sentiment is so low, equities are shunned and mountains of cash are hoarded. And also at the height of maximum despondency, elements are in place for contrarian buy signals. Levels of cash on the sidelines from experienced investors are significant. A survey in the US in early March showed that experienced investors held 46% in cash a record. The last two occasions when deposits were almost as high 38% in 1991 and 39% in 2002 were the two best occasions to have bought equities since November 1987.
Some of the arguments coming out are that 20 years is too short for accurate comparisons. Even pessimists must agree that there is a correlation over time between levels of extreme pessimism or optimism and future movements of stock markets. History does also show the more extreme the pessimism, the more bullish the buying signal and vice versa.
Looking at the last 40 years, the sole occasion when extreme pessimism was as high as it was in early March, was December 1974. That proved to be a significant buying opportunity despite the economic conditions in the UK. Over the following 12 months the UK stock market rose 149% including reinvested income.
But is this period of time enough as comparisons have been made with the great depression of the 1930s. So is 200 years enough? A study of the Standard & Poor’s (S&P) 500 Index in the US, comparing it with two valuable sentiment and rate of change indicators. This highlights four major financial crises coinciding with maximum extreme pessimism among experts and investors. The first three were in 1807, 1857 and 1932. The fourth? March 2009. Each crisis proved to be a buying opportunity for long term equity investors.
Another statistic covering the last 200 years a US analyst published a chart showing US stock market rolling 10 year average total returns from 1810 to the end of last year. Findings show four previous occasions when the rolling 10 year returns were close to, or below zero, as they are today. On each occasion, the following decade saw total returns from stock market investments close to 20% per annum.
This time it’s different isn’t it?
History does show it never is different. Again research in the US comparing similar periods of heavily falling stock markets in severe economic conditions predicted that the period from October to February represented a stock market bottoming, followed by a sharp increase. By nature, analysts are not optimists. They’re unemotional, so they do not get carried away on waves of euphoria or despondency. They just stick to the numbers. The numbers are reassuring. In every bear market, in the final bottoming phase, some sectors always outperform as others tank. After the markets bottoms, sector performance dramatically swaps places as we have seen with the banks and financial sector.
I know there is still economic uncertainty, job losses will continue for much of 2009.Stock market lead, not follow. Economic indicators suggest blue skies and warmer weather ahead so don’t stay in the cold.
Graham Laverick
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