Wednesday, January 21, 2009

Secular Bull and Bear Markets Since 1900

I always find it instructive to look at the extremes. So, in this post I will look at the best and worst periods in the last 100 years or so of stock market history -- the secular bull and bear markets. By "stock market" I mean the major U.S. indices such as the DJIA (Dow Jones Industrial Average) and the S&P 500 Index.

Secular bull markets ultimately lead to a market top. I think of the periods that have followed as periods of disinterest. These are long periods where the market fails to reach a sustainable new all-time high. These long flat periods are where we typically see the major bear markets and stock market crashes -- though, interestingly, the crashes do not always immediately follow the peaks; some bubbles burst, others seem to just fizzle out.

Three Secular Bull and Bear Market Cycles

In my view there have only been three major, secular bull and bear market cycles in the last 100 years: (For this discussion, you may want to reference the graph of closing prices in 100 Years of Stock Market History.)

1. The 1920's bubble that burst in 1929 (see graph in this post). The Great Depression followed; during that stock market crash, the market went down every year until it bottomed in 1932. It took about 25 years for the stock market to close the year above the 1928 close.

2. The post WWII bull market that peaked in 1965. It took 17 years (1982) until the market permanently eclipsed the 1965 close. However, if you look at the graph in the 100 years post, you won't see anything nearly as dramatic as the post-1928 crash. The market looks pretty flat, with the largest decline not occurring until '73-'74 (that, trust me, felt like a lot worse bear market than it appears to be on the graph).

3. The bull market that began around 1982; it was the longest in history. The dot-com/internet bubble topped out in 1999. The bubble burst in a manner similar to the 1929 market crash, and reached a temporary bottom in 2002. However, it's not yet clear how this cycle will play out. We don't yet know when we will permanently close above Dow 11,500; nor is it clear where the cycle will bottom out.

What Can We Learn From Analyzing the Bubbles and Crashes Since 1900?

Stock market secular bull & bear markets since 1900
Major Bubbles & Crashes Since 1900

Note: To get a feel for the difference in 10-year returns in dollars, see the graph in this post.

The above table (click to enlarge) summarizes some information about the best and worst periods in stock market history that I found useful. You could argue that since I've only included known peaks and troughs it doesn't tell us much that we didn't already know. Obviously, the 5 and 10 year forward returns from a peak are not likely to be very good; similarly, the returns from permanent bottoms cannot be negative. However, it was useful to me to quantify the difference between the tops and bottoms.

Peaks, Troughs and P/E Ratios

Most striking is the difference in NPE, or normalized price/earnings ratios. (Note: For more on NPE, see About Normalized P/E Ratios.) If you divide the 76 years for which I have calculated NPEs into 10 groups (dectiles) according to increasing NPE, the really major stock market peaks are associated with the top two (9th and 10th) NPE dectiles. The two major bottoms are both in the first dectile. The highest NPE ratio (33) is close to five times as large as the smallest (7). I think it's fair to say that the best and worst years provide at least anecdotal evidence that valuation is critical. History, at least since 1900, shows that holding periods beginning in times of very high NPEs show poor returns; holding periods beginning in times of very low NPEs tend to show superior returns.

Because this is year-end data, the 2002 trough is somewhat understated. The actual low in October was around 7300. Even so, the NPE of 16 would only be a 7th dectile reading. Perhaps that's why the 2002 bottom did not prove to be an enduring one.

Note: The above table is in the Benchmark Dates tab of the Stock Market Analysis Model. If you have trouble downloading the spreadsheet, see this post.

Related Posts:

For an index of all stock market posts, by subject area, click here. In addition to the links above, posts that may be of special interest include:
The 1929-1932 Stock Market Crash Revisited: Perhaps the ultimate bear market.
The Extraordinary Impact of Price to Earnings Ratios.
Dow Price/Earnings Ratio Impact on Future Returns - A Summary

Last updated 9/6/2011

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