November 13, 2008

Every session in which the Dow Jones Industrial climbed since September 11th, all seventeen of them, showed an increase of more than 140 points. That includes today’s 552-point rally. Nevertheless, that index has dropped 21.6% over this period. Outsized daily rallies, particularly in thin volume like today, are a sign of market weakness, not strength. Ten of those up-sessions saw the Dow gain more than 246 points. With U.S. economic contraction gaining steam, it seems unlikely that a bottom is at hand. True, equity markets have in the past shown an uncanny ability to turn before the start of an economic recovery, but the lead time is about four-six months as was the case in 1982. If we emerge from recession by April, the downturn will not be in the same class as the recessions of 1973-5 or 1981-2, and that’s a bet I would not care to make.

Assuming the bottom of the Dow’s bear market lies below today’s intra-day low of 7965, here are some key milestones to watch. Below 7777 would constitute the largest percentage drop among all post-WW2 bear markets. 7197 is the last bear market’s low, which was reached on October 11, 2002. It’s never a good omen to fall below the trough of the previous cycle. 6437 was the level when former Fed Chairman Greenspan delivered is irrational exuberance speech on December 5, 1996. At 6000, the DJIA will have dropped 57.6% from its peak of 14165, and at 5000, the accrued decline would be 64.7%. At 2768, the drop would match the percentage plunge of Japan’s Nikkei-225 from 38916 at end-1989 to a low of 7604 in May 2003. And at 1532, the percentage decline would be the same as the bear market of 1929-32.

Even after today’s 6.7% rally, the Dow shows a net drop of 8.2% for the first seven sessions after the presidential election. In the first seven trading sessions following the previous nine presidential elections, the DJIA fell five times and rose four times. The net change was +0.2%, further suggesting no systematic bias in the immediate aftermath. The increases were 4.8% in 1980 even though the Fed did matched sales to tighten policy, 4.3% in 2004, 3.8% in 1996, and 1.9% in 1972. The declines were by 3.6% in 1976, 3.4% in 1988, 3.1% in 1984, 2.7% in 2000, and 0.4% in 1992.


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