Don’t worry about a stock market drop

March 14, 2013

A feeling of vertigo may seem natural as Wall Street approaches a record and stock markets around the world climb to their highest levels since 2007. With the Standard & Poor’s 500-stock index  now only 0.5 percent away from its 2007 high of 1565 and with the Dow Jones industrial average scaling new peaks almost daily, what will investors expect to see when they reach the mountaintop? The mountaineering analogy suggests, at best, a long descent and, at worst, a precipitous drop. But how literally should we take such metaphors?

Bearish analysts often claim that stock market peaks have always been followed by sharp falls, citing as evidence the record high of October 2007, which was quickly followed by a 57 percent collapse in 2008-09. They add that the previous peak, in March 2000, was followed by a 37 percent plunge and that last major high before that, in August 1987, preceded the biggest-ever market crash, in October 1987. These precedents, along with the even more vertiginous peaks of 1989 in Japan and 1929 on Wall Street, certainly sound scary, but they are meaningless.

It may be true that all major market peaks have been followed by big declines, but the reason is semantics, not finance or economics. A peak is, by definition, a high point followed by a decline. A new market high that is not followed by a fall in prices is simply not called a peak. A record of this kind, far from preceding a steep decline, tends to act as a staging post for higher prices. Looking back through history, it turns out that this benign type of record, paving the way for higher prices, is actually the norm.

There have been eight occasions in the past 100 years when stock prices on Wall Street, as gauged by the S&P 500 or its predecessor benchmarks, have broken through to significant new highs, defined for the purpose of this analysis as a breach of previous records by 3 percent or more: December 1924, September 1954, September 1963, August 1967, May 1972, July 1980, November 1982 and July 1989. All these record highs were followed by further price gains, and none experienced a significant decline for at least six months.

This history starts in 1924, when Wall Street broke out of a 10-year bear market that started before the World War One. After December 1924, when stock prices finally managed to break through their prewar peak, the stock market immediately advanced by a further 23 percent in the next 12 months. It then accelerated and soared much higher, gaining a total of 216 percent. It was only five years later, in September 1929, that stock prices hit a peak in the mountaineering sense, followed by the greatest bear market of all time.

It took the stock market 25 years to break the 1929 high, but when this finally happened that was emphatically a reason to celebrate rather than panic. After September 1954, when the 1929 high was finally breached, the S&P advanced by 36 percent in 12 months and by a total of 121 percent before the next major decline, which began seven years later in December 1961. With economic conditions in the early 1960s broadly favorable, this bear market was relatively brief and it took less than two years for stock prices to set a record in September 1963. Having set that new high, the S&P advanced by a further 16 percent in the next year and by 50 percent to a series of new peaks, in January 1966, August 1967 and December 1968.

It was only at that point, in the late 1960s, that stock market performance really deteriorated, as the global economy faced an inflation crisis, the disintegration of the postwar currency system and the 1973 oil shock. As a result, the trough in stock prices that followed the peak of December 1968 lasted more than three years. When stock markets rebounded to a new record in May 1972, this was followed by only a 9 percent advance, peaking in January 1973, when global equities plunged into their deepest and most protracted bear market since the 1930s. The S&P took seven years to clamber back to its January 1973 peak – and although the high set in July 1980 paved the way for a few months of further gains, these were quickly followed by another terrible bear market, starting in December 1980, in response to the second oil shock and an unprecedented double-dip U.S. recession.

It was only in late 1982 that the investment world finally emerged from this long series of economic disasters. When Wall Street confirmed this recovery on Nov. 3, 1982, by breaking out to a new high, this record was definitely not a reason for anxiety but, again, for celebration. Indeed, from that day onward stock markets around the world advanced almost without interruption until August 1987, by which time the S&P had gained 138 percent from its November 1982 high. And even bigger gains were to follow. Although the bull market was abruptly interrupted by the stock market crash of 1987, another record was set in July 1989, and this paved the way for the biggest winning streak of all time – a total gain of 360 percent from the July 1989 record to the final bull market peak of 1527 for the S&P on March 24, 2000.

Thirteen years later the S&P 500 has still not exceeded that 2000 high by a decisive margin. For such a breakout to occur, it would have to break not only the 2000 high but also the marginally higher record of 2007, by a few percentage points. That may not happen, and if Wall Street fails to overcome its 2007 record, a substantial setback is likely for all global stock markets. If, on the other hand, the S&P 500 does set a significant record, the message of history will be clear: New highs on Wall Street are much more likely to be springboards for further advances than peaks from which prices plunge.

PHOTO: Traders work on the floor at the New York Stock Exchange, March 14, 2013. REUTERS/Brendan McDermid

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“if Wall Street fails to overcome its 2007 record, a substantial setback is likely for all global stock markets.” I guess the author had to cover his idea for this article so as not to look entirely stupid should stocks falter.

Posted by keebo | Report as abusive

The US stock market, today, is the most over-bought and overly bullish since late 2007. It’s forward P/E is based on record high E (earnings) as a percent of sales and GDP. Its rebound since March 2009 has been engineered by the Fed’s ultra-easy monetary policy, which by all accounts cannot continue in perpetuity.

So to ‘argue’ that one need not worry about a stockmarket drop is beyond being misguided. It’s being idiotic.

Posted by PeterMarlow | Report as abusive

If the plan is to buy low and sell high then in general now is not the time to buy. However, if your in for the long haul, and not just interested in the short term, then a drop shouldn’t bother you and you wouldn’t sell either. If your older and close to retirement then you should sell now and buy securities. Of course all this is basic standard approach that will not be the advice of brokers or television investment experts. For these standard approaches you need no expert.

This current bubble will burst when the fed finally drives inflation high enough to force themselves out of asset buying mode. When that happens, the market will have a hick-up that will be interpreted by some as the beginning of the end and may trigger a larger panic sell.

An alternative investment strategy is to educate yourself on various technology topics and then invest in companies that have technologies you believe in. Typically you want medium sized corporation where the technologies potential could add a significant amount to their bottom line. Dedicated companies, with just the one technology usually get destroy by the vulture capitalists and large corporations are to diluted by multiple products such that any gain in a specific technology area is insignificant in comparison to their overall portfolio. This strategy requires continued education and requires no expert advice, but you will have to put some work into it, which by definition is not what investers want to do. They typically want someone else to do the work and for them to get the benefit.

Posted by brotherkenny4 | Report as abusive

‘There is no real estate price bubble.’ – David Lereah (NAR),
February 2006

‘We’re going to drop significantly, but it’s not a balloon bursting. This is a soft landing for the housing markets.’ – David Lereah (NAR) in Business Week, May 2006

Posted by Laster | Report as abusive

“Don’t worry about a stock market drop”

“That may not happen, and if Wall Street fails to overcome its 2007 record, a substantial setback is likely for all global stock markets.”

Mr. Kaletsky likes to be sure any mistake has some cover.

Posted by keebo | Report as abusive

do you have change for a trillion dollar bill…?

Posted by rikfre | Report as abusive

Thanks for your “what me worry” scenario.

Here’s one that fits the real truth a whole lot better.

“List of recessions in the US”

“There have been as many as 47 recessions in the United States since 1790″.

That means the US economy is highly unstable, with a recession or depression occurring at an average rate of a financial disaster happening every 5 years.

We are long overdue.

The odds are NOT in your favor. essions_in_the_United_States

Posted by PseudoTurtle | Report as abusive

I’d like a reasonable explanation from Reuters as to why they are blocking and/or monitoring comments to this article.

Given that your stated policy, is “We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate”, I would like to understand why Reuters chooses to act arbitrarily and capriciously in terms of comments submitted by readers.

For once, why don’t you people take responsibility for your actions and explain what you are doing?

The unmitigated power to suppress public opinion, especially when it is taken by a news organization supposedly dedicated to presenting relevant truths and not just propaganda, is a tremendous responsibility.

Unfortunately, Reuters has rarely lived up to its responsibities to its readers, thus denying them the right to free speech.

Suppression of free speech is a slippery slope indeed, especially when it is made by unseen forces that act with impunity.

Posted by PseudoTurtle | Report as abusive

Reading this article made me feel dizzy, not just because of the height at the current peak, but mostly because of the dizzying effect of circular logic.

Posted by reality-again | Report as abusive

“When stock markets rebounded to a new record in May 1972, this was followed by only a 9 percent advance, peaking in January 1973, when global equities plunged into their deepest and most protracted bear market since the 1930s.”

This sentence is the one that screamed out to me!!! Maybe i’m just a pessimist but I think this might be 1973 all over again…

Posted by heyrevolver | Report as abusive

Just look at a long term chart. This is a triple top for sure. Nothing goes straight up and there is no reason for people to pay twice again as much for stocks. Are the sales and earnings a lot more than in the past. No.

I know a financial planner that trades but it’s all about the charts. He doesn’t care a bit about fundamentals. This is just momentum trading.

Posted by Joenole | Report as abusive