Friday, August 5, 2011

Bull and Bear Market Analysis


So let's look a bit closer at the history of the Dow Jones. It is obvious from the previous posting and the chart below that we have experienced numerous crashes, small and large since the Great Depression. Scientists may tell you that stock prices move in a random fashion, but if I look at the long term stock price trend below to me it doesn't look random at all. Overtime, our economy grows and so do the companies that make up the Dow Jones Industrial and the companies that make up all those other broad based stock market indexes.



I used the Dow Jones Industrial history starting in 1932 to measure the length of bull and bear market cycles. I counted starting in 1933 until yesterday, 23 market cycles. They are tabulated below.


For each bear market (Low) there was a bull market (Peak), some bear markets were not much more than a minor correction (e.g. between January 1994 and November 1994) others showed drops of 49% from the peak. The same for the bull market phases where some moved barely 20% from the low while others such as between November 1994 and April 1998 moved nearly 142% off the low. On average the entire cycle from Low to Peak to Low lasts 3.5 years but may be as long as 7 years. The biblical 7 fat and 7 meagre years are apparently a bit drawn out compared with today's cycles.

Also, the current August 2011 drop is around 11% while it is just 2.5 years from the previous low with the Dow Jones not even fully recovered to its October 2007 high. This makes me suspect that the current drop is not yet a bear market; more likely we're dealing with a correction. But really, just like the numerous previous cycles this one will recover and exceed previous highs as well eventually.

Many experts tell you that you need to have a long investment horizon to fully recover and that the older you get the more you should invest in conservative fixed income instruments such as bonds. When you're 50 years old, an investment rule of thumb suggests that you should have 50% bonds (1% for each year). Well, excuse me but the average person has a life expectancy of close to 82 years and the average bull-bear market cycle lasts 3.5 years so I think that in today's age most people can easily wait out a market cycle.

With interest rates likely to rise in the coming years investing in government bonds (except maybe short term bonds to park temporary investment funds) is not as save as those experts would like you to believe. If interest rates of 5 year bonds move up from 3.5 to 4 or 5% you can  lose up to half the bond's value.
Well there you have it. Once again, the world will not come to an end after all!

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