Having called for a ferocious rally from extreme oversold conditions in equities back in March, my current caution on the speed of the recent advance is inspired by a keen sense of history and market psychology. The 2007-9 bear market in equities has been unusually severe but it has also been unusually short by the standards of previous big bears, as detailed in the table and chart below. This suggests that a period of base-building will be necessary before markets can embark on a sustained recovery. The table compares the fall in the Dow Industrials between October 2007 and March 2009 with the seven biggest bear markets of the last century. The peak-to-trough decline of 54% exceeds every prior downturn except the depression bear of 1929-32, when prices slumped by 89%. It is remarkable that the NASDAQ decline 9 years after the tech bubble peaked is actually larger than the fall in either the Nikkei or Dow at an equivalent stage of their generational bear markets.

The falls in the six other bear markets ranged from 45% to 52%. Prices seem to find a floor after a decline of about a half. This was true even in the 1929-32 bear: after a 48% drop between September and November 1929, equities rallied by 48% before embarking on a further prolonged slide. A recovery from the levels plumbed in March this year was clearly predictable on historical patterns. If the bear market ended in March, however, it will have been only 17 months in duration, five months less than the shortest of the twentieth century bears.  This implies that there may be more work to do on the downside, at a minimum in terms of time if not price, before a sustained advance can credibly begin. It must be borne in mind, however, that the huge boom in leverage that drove economic and earnings growth in recent years (over $5 of debt for each increment of US GDP) cannot be repeated, and on the contrary sustained deleveraging by the US consumer and banking system will be a major headwind constraining a recovery.


Some of the prior bear markets show little resemblance to the recent decline. The 1909-14 and 1937-42 downturns were influenced by world wars. A repeat of 1929-32 is unlikely; policy mistakes made in the early 1930s have so far been avoided. Some respected financial and economic analysts argue that equities experience severe bear markets at the end of 30-year economic cycles, and thus place the recent decline with the 1919-21 and 1973-74 bears, which also occurred around 30-year cycle troughs. (Equity market behaviour around the 30-year low in the 1940s was distorted by the war.)

There is also a case for comparing the recent decline with the 1906-07 bear, which was associated with a major financial panic and extreme banking system distress. The failure of the Knickerbocker Trust Company in October 1907 and the subsequent policy response, orchestrated by J P Morgan, contain many parallels with events surrounding Lehman's bankruptcy last autumn. These three bear markets (i.e. 1906-07, 1919-21 and 1973-74) bear a close resemblance, with equities declining by 45-49% over 22-23 months. The chart provides a comparison with the recent decline. Equities undershot the historical range in early 2009, probably reflecting fears of banking system nationalisation, but have since returned to a level consistent with the prior bears. If these three earlier cycles are a guide, equities are unlikely to embark on a sustained advance at this stage.  Prices need to consolidate their recent gains, although the 50% peak-to-trough barrier should provide important support.