26 February 2009

But look at the upside ~ of depression

ANNANDALE, Va. (MarketWatch) -- It's become fashionable in recent months to look to the 1930s for an analogy to what we're suffering through today.
But how many of the commentators who so blithely throw the comparison around have actually analyzed what it would really mean to play out that decade's script?
I think you know the answer.
So, for this column, I decided to take that analogy seriously. And, not surprisingly, I found that it presents a very depressing portrait of what might lie ahead. If we think we've had it bad so far -- and we have -- we haven't seen anything yet.
Believe it or not, however, I also found some good news.
That, at least, is the conclusion to emerge from a recent interview with Jeremy Siegel, the Wharton finance professor and author of the classic investment book, "Stocks for the Long Run."
To locate the date during the 1930s that is most analogous to today, Siegel looked for the point at which the stock market after 1929 had -- as is the case today -- declined by half. He relied on a stock-market benchmark that he has calculated which takes dividends into account and also adjusts for inflation.
This point of 50% decline came very early in the Great Depression, according to Siegel -- at the end of 1930, in fact. As in the current bear market, that initial point of 50% decline came just 16 months after the August 1929 stock-market top.
But the bear market had only barely begun at that point. Over just the next five months, according to Siegel, on an inflation-adjusted total return basis, the stock market fell an additional 60%.
You read that right: That's a 60% drop on top of a 50% drop -- or should I say "on bottom of ..."?
If the stock market today were to suffer a further decline of similar magnitude, the Dow Jones Industrial Average ($INDU

) would be trading below the 3,000 level by the end of July.
To this extent, therefore, we had better hope that the analogy with the 1930s doesn't hold.
The news isn't all bad, however. That's because, according to Siegel, the stock market quickly recovered from its 60% plunge in early 1931 -- within two years, in fact. By June 1933, the market was actually ahead of where it had stood at the end of 1930.
Furthermore, over the five years beginning at the end of 1930, the stock market, on an inflation-adjusted total-return basis, produced a 7% annualized return -- notwithstanding the 60% drop in the first five months of that five-year period.
In other words, even if you had been so unlucky as to buy stocks right before a six-month decline of 60%, you would have been whole again within just two years and would have earned a 7% real return over the next five years.
Few investors would object to that outcome today, of course. A 7% real return over the next five years sounds awfully attractive, in fact. And, yet, assuming the analogy with the 1930s holds up, that is what will happen between now and February 2014.
Of course, there's no way of knowing whether we're really playing out a 1930s script. And even if we are so unlucky as to endure a 60% drop over the next five months, there are no guarantees that the market will recover as quickly as it did following the first half of 1931.
Nevertheless, insofar as we choose to compare the current bear market and the Great Depression, we owe it to ourselves to carefully analyze what that analogy holds. And, as awful as that analogy is, it also contains some welcome and surprising silver linings.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.

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