domingo, 25 de julho de 2010

Sixteen Dow Recoveries: The "Real" View

Sixteen Dow Recoveries: The "Real" View

July 24, 2010  New Update Here is another look at the Sixteen Dow Recoveries which I surveyed earlier today, this time adjusted for inflation/deflation as explained in the previous post. In the first chart, I've removed the 1932 data series. The rally following the Crash of 1929 was indeed an outlier — one that consisted of a series of cyclical bull and bear rallies. By removing it, the vertical axis shrinks from 180% to 100%, improving our ability to see the differentiation among the other recoveries. For comparison, here's a link to the nominal 16-rally version.

Why is inflation adjustment useful for this overlay? Throughout history inflation has undergone some dramatic changes, as this chart illustrates. High inflation, such as during the 1974 recovery, gives an exaggerated sense of price growth. Deflation, which accompanied several of the earlier market cycles, makes recoveries appear weaker. By adjusting for the inflationary/deflationary cycles, we get a clearer sense of the real value of the index price across time.
Now let's extend the time frame. Here is a set of charts with increasing numbers of market days: 500, 1000, 2000, 3000, 4000, and 5000. Depending on the historical period, the number of market days in a year varies slightly. But it rounds out to about 250 market days per year. So the time frames in this series are approximately 2, 4, 8, 12, 16, and 20 years. The series includes the 500-day chart with the 1932 recovery (Great Depression) omitted, but I added it back to the longer charts. At 1000 market days, the 1932 recovery continues to lead the pack. But at 2000 day (about eight years), the recovery after the 1921 low has risen dramatically. Of course, with the benefit of hindsight, we know that this remarkable advance was the last stage of the Roaring Twenties stock bubble, as the 3000-day (12-year) overlay makes clear. At 4000 days (about 16 years), the recovery from the low in 1982 is approaching the final surge of the Tech Bubble. The 5000-day chart shows how the Tech Bubble played out for the Dow, topping out in January 2000 after a brief scare in 1998 triggered by the Long-Term Capital Management Crisis (that dip after the 4000-day mark). The chart below shows the 5000-day (approximately 20-year) overlay:

Here is a table summarizing the comparative performance of these 16 Dow recoveries at seven points in time.

The overlay charts give visual evidence of the wide range of recovery patterns. The table helps quantify the magnitude of the difference. Two of the earlier recoveries, 1903 and 1914, and two of the later recoveries, 1962 and 1970, subsequently failed. Likewise the 1938 and 1974 rallies failed before being rescued by later recoveries.
This last observation touches on an important aspect of the overlay charts. As the timeframe increases, the same recovery appears in multiple data series. I've point this out for the 2009 recovery in both the 4000- and 5000-day charts. But several of the data series show later recoveries in the longer time frames. Another example I've annotated is the Crash of 1987 on the 5000-day chart. That event gave rise to another of the 16 recoveries — the black line, which itself merges into the 2002 recovery.
Cyclical and Secular Markets
How will our current recovery fare during the coming months and years? I'm reluctant to make any inferences based on the overlay charts other than the obvious. History shows us that some recoveries are the beginnings of secular bull markets. Others turn out to be cyclical bear market rallies.
The recovery since March 2009 is the second in the first decade of the 21st century, and it started from a lower low. As we can see in the inflation-adjusted chart below, history has witnessed several other examples of multiple recoveries in relatively close succession with lower starting points. Will the current recovery be another such example? Only time will tell.

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