Bear Markets: How Bad Can They Get?

October 6, 2008

Market historians classify a bear run as any decline that exceeds 20%.  The Dow Jones Industrial Average fell below 10,000 today for the first time since October 2004 and is 29.9% below its high of 14,165 a year ago. Nearly nine years have passed since the end of the 1987-2000 bull run, which took the DJIA from 1,738 to 11,723.  Equities are a favored long-term investment, but this is not the first multiyear period in which share prices failed to sustain a discernible rise.  In the 20+ years from December 1961 (734.9) to August 1982 (776.9) the DJIA recorded an average annualized 0.27% rate of appreciation, and the DOW did not recover to its 1929 peak until 1954. 

The bear market of 1987 experienced a peak-to-trough decline of 36.1% and was known for its two-month brevity.  An even worse bear market, with a 38.6% drop from 11,723 in January 2000 to a low of 7,197 in October 2002, occurred 6-8 years ago.  The largest and third-largest bear runs in the DOW since the Second World War occurred mostly on Nixon’s watch: 35.9% to 631 between December 1968 and May 1970 and 45.1% to 578 from January 1973 to December 1974.  The still-spiraling global credit crunch has already acquired the reputation of being the worst economic accident since the Great Depression.  If this label proves deserved and not hype, it stands to reason that the bear run in stocks should be the largest since the 1930’s.  A drop of 45% from 14,165 would depress the DOW to 7,780, and a decline beyond the 7,197 low in October 2006 would constitute a peak-to-trough fall of 49.2%.

The Japanese Nikkei experienced two bear markets of more than 50% in the last 18-1/2 years.  The first was a 63.2% plunge from 38,915 at end-1989 to 14,309 in August 1992, and the second drop from 20,833 in April 2000 to 7,415 in March 2003 amounted to 64.4%.  Each of these slumps was surpassed by the DOW’s 89.5% liquidation in the Great Depression from 386 in September 1929 to 40.6 in July 1932.  A comparable plunge in the present bear market would see the DOW bottom out at 1,488.

Downward swings of 20% or more are more common in commodities than equities.  From a peak of $147.27 per barrel in July, oil at today’s low of $88.89 showed a drop of 39.6%.  That is slightly greater than the 39.6% decline from a peak of $78.40 in July 2006 to a low of $49.90 the following January and much bigger than the decrease of 27.7%  between a high of $55.67 in October 2004 and a low of $40.25 two months later.  Between the July peak and September trough, gold retreated 27.7%.  Against the recessionary global economic backdrop, the latest down-cycle in oil prices appears more sustaining than the two earlier sharp drops, which were reversed subsequently.  The latest cool-down in oil costs has been welcomed but may not be innocuous if in fact such heralds the onset of deflationary global forces.  In a blog entry from October 1st, I noted sharply falling consumer and wholesale prices were a distinguishing feature that still separates the 1930’s depression from the present global slowdown.  To avoid an economic event that is worse than a bad recession, it will be incumbent upon monetary officials at the Federal Reserve and other major central banks to ensure that neither final goods and services prices nor the stock of money shift into declining trends.


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