by John Prestbo
Commentary: History suggests the Dow's move is halfway done
The bull market for U.S. stocks will continue until the autumn of 2011. That's the good news. The bad news is that in 18 months or so the Dow Jones Industrial Average will be at roughly 11,100, or slightly below the level it reached in April.
You might think I'm sticking my neck out to make a prediction like this. In fact, I am not predicting anything. Rather, I am simply projecting historical averages from the Dow's (DJI: ^DJI - News) 114-year track record onto current trends.
The purpose of this exercise may be considered whimsical by some people, but to me it is a way of establishing a kind of baseline expectation. The market may — and probably will — deviate to one degree or another. Meanwhile, we have a sense of what history suggests is reasonably possible.
Critics, who are always in good supply, might argue that profits and economic growth drive the stock market, not history. Indeed, that is so. But it also is true that markets and economies move in cycles. While history does not repeat itself exactly, it does revisit enough previous patterns to validate the value we place on someone being "experienced" — which essentially means having personally lived through some history.
Boom and bust
Now for the details: Since May 26, 1896, when it made its debut, the Dow through 2009 has risen in 73 calendar years and fallen in 40. (That adds up to 113, by the way, because we did not count 1896, which was not a full year.) This is an upward bias of 64% to 36%.
The Dow's upward moves lasted an average of 2.7 calendar years, or 32 months. It is this average that suggests the Dow's upward push might expire in November 2011, which of course remains to be seen.
The range of years also can be informative in an exercise like this. The rising Dow periods lasted as many as nine calendar years in a row (that was in the 1990s) and as few as one. Since the next longest span was five calendar years — in the 1920s and again in the 1980s — the nine-year streak is, arguably, an aberration. Taking it out reduces the average to 2.5 years, or 30 months. That would put the terminus of the bull run in September 2011.
The previous two sets of positive moves in the Dow each lasted two calendar years: 2003-2004 and 2006-2007, split by a slightly negative (down 0.61%) treading-water performance in 2005. Teasing out the actual high-low marks (based on the Dow's daily closing values) within these periods shows the first of these lasted 29 months and the second was 30 months.
The downward moves averaged 1.5 years, or 18 months. That is just one month longer than the October 2007-to-March 2009 bear market. Earlier downward moves had a narrower range, from four calendar years (1929-1932) down to one. The previous multi-year drop (2000-2002) was almost twice as long as average at 33 months.
The length of the bullish and bearish moves is only half of what history offers. Magnitude is the other.
The average increase in the Dow in the up years is 67.5%, which from the low point in 2009 produces a value of 10,969. The Dow already has closed higher than that (11,205 on April 26), which might imply that the market essentially will move sideways for a long while before it starts to drop.
But ranges come into play here. The nine-year streak in the 1990s delivered a 336.6% gain, while a one-year hiccup in 1915 lifted the Dow less than 1%. In between, there have been nine multi-year occurrences (41% of a total of 22) in which the Dow rose more than 67.5%.
Of those, two were achieved within the duration average of two calendar years (1904-05 and 1908-09). While they occurred more than 100 years ago, they did follow bear markets as deep as the one we recently endured. So, there is precedent for larger gains than the Dow has attained in the current run-up. But historically that has happened in just 10% of the relevant cases.
In downswings, the Dow loses an average of 20.4% — the spot-on definition of a bear market. The magnitude range is narrower, just as it was with duration, but not unimpressive: from a plunge of 80% in the four years ended in 1932 to a 0.18% slip in 1910.
While the 2008 trauma of a 33.8% decline was far from the worst, it was the largest to be confined to one calendar year. (It ranks third among ordinary calendar-year declines, behind a 52.7% plunge in 1931 and a 37.7% drop in 1907.) There have been 16 retreats that occurred completely in one calendar year (versus nine multi-year drops). Runners-up are a 32.9% fall in 1920 and a 32.8% pullback in 1937.
What good is all this information? It certainly does not provide a road map for your investment behavior in coming months. Markets will do what they do, and history — including historical averages — is just the vapor trail.
But knowing what has happened gives you a benchmark for your current outlook — is it too rosy, or not rosy enough? History makes a handy framework on which to hang your hopes and help evaluate their chances of coming true.
John Prestbo is editor and executive director of Dow Jones Indexes, a joint venture of CME Group, Inc., and Dow Jones & Co., Inc., publisher of MarketWatch. Fernando Fernandes and Ross Wiedman contributed research to this report.