BOSTON — The stock market is often uncannily prescient when it comes to anticipating better days ahead. Long before the finest minds are able to script out a path to economic recovery, military victory, or whatever it is that plagues the world — stock markets rally. With very few exceptions over the past 100 years, markets have rallied some six to nine months before the end of an economic downturn. Typically the more severe the decline in share values, the more vigorous the subsequent rallies that follow.
Stocks tend to hit rock bottom when hope has been extinguished, when the world looks down a long, dark tunnel only to see pitch black. As the first thin rays of light appear far in the distance, they are invisible to the naked eye of even the most cunning seers. Yet they are mysteriously identified by the night-vision goggles of the market.
The reasons for this are the subject of much debate. Of course the stock market is notorious for its drunken follies during the late stages of bull markets, such as we witnessed during the dot com euphoria of the late 1990s. But let’s look at some of the major bottoms in the U.S. stock market. The market’s predictive prowess comes to play most often towards the end of deep and scarring bear markets. It is then, in its sober wisdom, that the stock market so often detects those signals of hope that are inaudible amid the static of noisy pessimism.
Take July 1932, when the Dow Jones Industrial Average sank to its Depression-era low of 41 points before rallying to more than 100 by the end of 1933, a gain of more than 140 percent. The newspapers of July 1932 reflected a nation paralyzed by fear, poverty and hopelessness. The market’s rise off the low was due, in retrospect, to the early and fragile hope that Franklin Delano Roosevelt, widely expected to win the November election, might actually deliver on what began as just a campaign slogan: “I pledge you, I pledge myself, to a new deal for the American people.”
The economic statistics that coincided with the powerful 1932-1933 rally are grim. Unemployment continued to rise in 1933 to a level of nearly 25 percent while the economy continued to contract. Yet the market correctly identified that at least some of the many economic and social initiatives of the early 1930s would eventually gain traction and arrest the decline in economic activity.
The low made during WWII is equally illustrative. It occurred in the spring of 1942, a time when Japan’s string of successes throughout the Pacific was stunning and the German move eastward into Russia looked unstoppable. The Dow hit 93 before rallying to around 145 by late summer 1943, a 56 percent move.
In his book, "Wealth, War, and Wisdom," former chief investment strategist for Morgan Stanley Barton Biggs writes:
"The New York stock market recognized that the victories at the battles of the Coral Sea and Midway in May and June of 1942 were the turn of the tide in the Pacific, and from the lows of that spring never looked back, but I can find no such thoughts in the newspapers or from military experts of the time. A barrage of defeats and surrenders had engendered intense criticism of the management of the war and the commanders in the field. The wise men of the media were so busy wringing their hands that they didn’t grasp the significance of the battles of the Coral Sea and Midway as the high-water mark of Japan’s grand design for empire and of its attack on the United States."
A final important market low worthy of examination took place in December 1974. It occurred against the backdrop of a country numb from Nixon’s resignation in August of that year and the impending collapse of the South Vietnamese regime (the fall of Saigon would take place in April 1975). The Dow advanced from 577 in December 1974 to 879 in June 1975, just six months later, for a return of 52 percent.
It was during this period that stagflation — the toxic combination of slow growth and high inflation — became the buzz word of the day. Consensus opinion held that Watergate would disgrace the office of the presidency for decades to come and render the United States impotent on the global stage. Yet the stock market somehow discerned that inflation would eventually return to pre oil-shock levels, that Gerald Ford would usher in a period of political calm, and that business would once again prosper in the face of the costly and protracted Cold War.
The question that looms today is: can policy makers prevail in warding off a long and deep recession? In the face of the current crisis, the actions of the U.S. Federal Reserve, Treasury and Congress have been swift. With all the partisan bickering in Washington, this may not seem the case. Yet the Lehman bankruptcy, the key cause of the dislocation to credit markets, which in turn led to the collapse of the global economy, occurred only last September. In other words, in less than six months, the proportional size and breadth of the policy response to our economic woes dwarfs by a large margin what it took the Japanese authorities to do some five years into Japan’s economic downturn in the 1990s.
Certainly many of the initiatives to stimulate the economy will fail, as did many under Roosevelt. Yet the actions taken collectively are bold, imaginative and vast in scale. We are not only talking about traditional spending and highly aggressive and innovative monetary stimulus, but a huge mortgage relief program and the largest financial stability initiative in history. In the aggregate, the economic recovery program which is just now gathering steam is so massive in scope that one is forced to look to the Great Depression to find even a remote precedent.
Yet our economic downturn cannot by any good measure be seriously compared to the Depression. Unemployment in the United States, according to the most dire predictions, is likely to reach 10 to 12 percent in 2010 versus a peak of 25 percent during the Depression; GDP, again under the most pessimistic assumptions, is forecast to contract by a cumulative 8 to 11 percent before this recession ends, whereas during the Depression, GDP was cut in half.
Might we be approaching one of those junctures in history where we see pitch black while the stock market begins to make out the silhouette of a late 2009 recovery? Certainly if the whispers of a recovery some six to nine months away exist at all, they are being drowned out by the cacophony of the media and the high-pitched rancor on Capital Hill. If the history of previous bear markets provides any insight, it is that stocks will rise long before the most seasoned economists and financiers can spot an economic recovery on the horizon.
Andrew Parlin is a founding principal of Parlin Investments LLC in Boston. Contact: firstname.lastname@example.org.
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