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What crash history tells us to expect for 2010

oil&gas

Well-known member
Apr 16, 2002
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Ghawar
You may need the charts from the original article to follow the author's technical
analysis.

http://www.clifdroke.com/articles/jan10/101810/011810.html

18th January 2010
by Clif Droke

Many have wondered why the 10-year cycle peak in late September/early
October didn’t produce a more meaningful correction in the broad
market. Instead, the 10-year cycle peak produced only a marginal six
percent pullback in the S&P 500 Index (SPX) instead of the much deeper
one usually associated with the 10-year peak.

A look at the past reveals why: the first full year following a crash
low has never produced a sizable correction in the stock market. That
historical truism certainly proved itself out in 2009. But what of the
second year after a crash? What can we expect in the coming year based
on market history? We’ll be taking up this question in the commentary
that follows.

The two most persistent traits that investors displayed in 2009 were
either the avoidance of the stock market altogether by remaining in the
safety of cash or else to look for opportunities to sell short each
time the market took so much as a breather. Both of these tendencies
were direct consequences of the historic credit crisis of 2008. It
has long been observed that retail investors typically shy away from
equities for at least the first two years following a major bear market
or stock market crash. The painful memories take time to heal and leave
deep and abiding scars.

Even for those stalwarts who stay the course and continue trading and
investing, a market crash creates a tendency toward conservatism. Traders
tighten up protective stops on all their trades, avoid over-trading,
refuse to buy large positions in any one stock and make a serious
effort at avoiding the mistakes that were made during the heady days
of the forgiving bull market. Indeed, the reversion to conservatism
and self-examination among market participants is one of the redeeming
qualities of a market crash. Bear markets are purgative in that they
cleanse the system of lavish excesses and restore a sense of propriety
to the market by and large.

For those investors who respond to the destruction wrought by a crash by
refusing to participate, the resulting effect is equally beneficial to
the overall soundness of the market. These non-participants, who comprise
the great majority of all potential retail investors, will spend the
next year building cash reserves and restoring their personal balance
sheets. While this won’t necessarily be of any benefit to the stock
market, nor to those who make their living in the brokerage or advisory
business, it will act as a reserve – or liquidity bank if you will –
for the future. For at some point the market will need this liquidity
and by the time those reserves are needed, the painful memories of the
previous bear market will have dissolved from the public’s collective
memory. As their confidence grows they will become more enticed by the
lure of the potential returns of stocks vis-à-vis the low-yielding
safety of the bond market.

Returning to our original observation concerning market behavior in
the 1-2 years following a crash, let’s examine some chart examples of
the past few bear markets. Perhaps the single best example and the one
that most closely correlates to our time is the crash of 1973-74. This
particular bear market was a function of the Kress 40-year cycle,
which bottomed in October 1974. It produced a painful and persistent
decline in the S&P 500 for the better part of two years, as well as
an economic recession. At the time this happened it was the worst bear
market stocks had suffered since the Great Depression. By the time it
ended the SPX had lost some 45% of its value. As you can well imagine
(and some of you may actually remember it), the feeling at the bottom
in October ‘74 was one of unmitigated doom and gloom – a feeling
that persisted in the public’s mind well beyond 1974.

The market was anything but forlorn in the two years following this bear
market. In the year 1975 the stock market rallied vigorously and with
relatively mild corrections along the way. The Dow Jones Industrial
Average (DJIA) rallied 100 percent in ’75, a record performance
following a bear market and one that stands to this day. The market
continued its recovery into 1976, and although its ’76 performance
wasn’t anywhere near as stellar as the one in ’75 it remains immune
to major corrections and kept the recovery going for two full years
following the bear market low in 1974.

Of course the market cycles which comprised the 1973-74 bear market
were considerably different than the cycles underlying the 2007-08 bear
market. Yet the market dynamics between the two eras are so remarkably
similar that the inference can still be drawn that ours is a situation
analogous to the 1975-76 recovery.

Notice in the above chart of the Dow that the 1976 follow-up to the
explosive 1975 rally was much more volatile and less dynamic, yet it was
still a positive year overall for the Dow. The possibility exists that
2010 could end up being a positive year overall in spite of the 4-year
cycle bottoming later this year. The inference that can definitely be
made is that the coming year will almost certainly show more bumpiness
than 2009 and less dynamic market action.

If 1976 holds any clues for how 2010 will play out then we can expect
more range-bound behavior from the major indices. This means stock
selection will become more important as the sectors showing only the
best relative strength, forward momentum and earnings growth should be
favored over weaker sectors. The coming year is likely to reward good
stock selection as opposed to the “buy with both hands” strategy
that played out so well in 2009. Market timing will also be more critical
in 2010 as opposed to last year since there are two major cycle bottoms
scheduled this year: one in the first quarter of the year and one around
late September/early October (namely the 4-year cycle).

The next example in our survey of bear markets is the bear market
of 1981-82. From the depths of this bear was spawned an apocalyptic
sentiment made infamous by several high-profile movies with Armageddon
type themes in the early ‘80s. While the ’81-’82 bear market
wasn’t as severe as the previous one of ’73-74, it was strong
enough to exert a profound influence on investor psychology and left
the retail investment crowd with a revulsion toward equities for the
next 2-3 years. It also launched the powerful ‘80s bull market,
which didn’t meet its apogee until the end of the decade.

Let’s turn our attention specifically to the 1-2 years following the
’81-’82 bear market. As you can see in the following chart example,
the first full year following the bear market low saw no major correction
in the SPX. Even 1984, which saw considerably more volatility than ’83
due to the bottoming 10-year and 30-year cycles, wasn’t as bad a year
as it probably should have been.

This is significant for several reasons. Consider that 1984 by all
indications should have been a bearish year, yet it wasn’t that
bad for stocks in the overall scheme in spite of the fact that a
major long-term Kress cycle was bottoming. The reason for this was
because the public was still scared to the point of non-participation
and the lingering abhorrence to equities following the bear market
from two years prior was still a major factor. This can’t be is
emphasized enough. As ephemeral as crowd psychology can be, when the
retail investor is paralyzed with fear and revulsion toward stocks,
the market enjoys a strong support regardless of the cycles that may
be leaning against stocks as long as tight money conditions aren’t
prevalent. At extremes, negative crowd psychology is strong enough to
contend even with the cyclical forces of the stock market up to a point,
 

oil&gas

Well-known member
Apr 16, 2002
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Ghawar
The next bear market in our survey was one of the shortest in
history. I’m referring of course to the stock market crash of October
1987. Its after-effects in the public mind were profound to say the
least. The SPX launched a recovery rally early in 1988 and continued its
recovery into 1989 with nary a correction along the way. The ’88-’89
period is an example of a 2-year period following a bear market with
nothing bigger than an eight percent correction along the way.

Next we come to the bear market of 1990. The year 1990 was a painful
one for stock market investors as it heralded a bear market and a
serious crisis for savings and loan institutions. The year 1990 was the
single worst year of the S&L crisis and saw the failure of more than
100 small banks. The SPX declined sharply between July and October,
when the 24-year cycle bottomed. Following this important cycle bottom,
the stock market regrouped and began a new bull market that lasted until
the 30-year cycle peaked in late 1999. For our purposes we will only
observe that the two years following the October ’90 bottom saw the SPX
launch a recovery that saw only mild periodic corrections along the way.

Next we come to the summer 1998 market crash and mini bear
market. According to history we should have seen a 2-year recovery off
the September ’98 low. Instead, the turn of the century witnessed
the commencement of the 2000-2002 “Tech Wreck” which saw the NASDAQ
bubble burst. Internet stocks were particularly hard hit in the 2000-2002
period. The more conservative Dow 30 Industrial stocks fared considerably
better than the tech stocks in 2000, which was the second year of the
post-’98 crash period, however. The year 2000 proved to be more or less
a lateral trading range in the Dow, which prepared the way for the next
crash that was to follow in 2001-2002. The year 2000 was one of the rare
exceptions to the 2-year recovery rule that normally follows a crash. It
failed to extend the rally of 1999 because by ’99 the Internet bubble
had peaked, the Fed had begun tightening the money supply and conditions
were simply ripe for a bear market to come one year earlier than normal.

Going back 100 years, the only other exception to the 2-year recovery
rule we can find occurred in 1922-23 following the stock market crash of
1921. The market rallied the year following the ’21 crash but didn’t
follow through in the second year, as per the norm. In fact 1923 was
similar to the year 2000 in that it saw the Dow undergo a volatile
trading range, closing for the year at roughly break-even. Even when
the second year after a crash fails to show a clear upward bias, as in
1923 and 2000, the market still at least shows a relatively neutral
bias and has rarely if ever experienced a decisive downward trend in
the second post-crash year.

What can we expect of the gold price in 2010? Using examples of market
history as our guide we can see that gold didn’t always perform
as well as stocks in the second year of a post-crash recovery. The
years 1976, 1989 and 2000 are examples of this. What’s interesting
to note, though, is the impact the 4-year cycle tends to have on the
gold price. The 4-year cycle scheduled to bottom this year typically
increases demand for gold in the latter half of the year due to the
financial market volatility it creates and even more so during the
“hard down” phase of the 4-year cycle. This can be seen in 1974,
1978, 1982, 1986, 1990, 1998 and 2002.

This brings us to the present. With the most recent bear market almost
one year behind us, we’ve seen an extended market recovery since March
2009 with nothing worse than a six percent correction along the way. Our
historical survey tells us to expect more headwinds in 2010 due not
only to the above mentioned cyclical factors but also to the fact that
the market will be running into more overhead resistance. Volatility
is almost sure to become a bigger factor in 2010 than it was in 2009
and history shows that the second year following a market crash is
nearly always more variable and bumpy than the first year. The two
major cycles scheduled to bottom at various points in 2010 will be a
factor in producing this anticipated volatility.

While the second year normally shows a gain for the broad market
averages, the gain is usually considerably less than the first year. At
worse, the market trades in a more or less lateral trend and closes
largely unchanged on a year-over-year basis. Accordingly, technical
strategies that utilize trading range opportunities will be important
in the year ahead.
 

pokerdude

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Jan 20, 2004
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Between the legs of some hottie
I'll reread this when I'm sober. It's been a tough three days. China tightening, Obama bank regulations and US Dollar rallying. I'm short term bearish but still long (for now)
 

21pro

Crotch Sniffer
Oct 22, 2003
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Caledon East
be careful of technical analysis. it didn't predict a bottom in march 09 when fundamental investors saw it as necessary... hindsight is 20/20 but always a poor predictor.

however, I agree with what the author assumes will happen in 2010... only because of the fundamentals and political disarray. this global 1 government movement that we see put into action now following Coppenhagen is going to make it very tough for investors who follow OLD rules and statistics... it's about to get alot more expensive for all of us.

imo, more buying opportunities. and easy quick exits. but, not a time to be greedy...
 
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