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Amateur Investors Weekend Market Analysis (1/2/10)

http://www.amateur-investor.net/Weekend_Market_Analysis_Jan_2_10.htm

For the year the Dow ended up 19%, Nasdaq (44%) and S&P 500 (23%). Looking at a historical performance chart of the Dow going back to 1897 shows that each year the Dow was down 20% or more it was followed by a positive return the next year except during the early 1930's. Thus in 9 out of the 11 cases (82%) the Dow finished with a positive return the following year.



There have already been several predictions for what will happen in 2010. The table below shows what occurred to the Dow in those years in which it had a positive return after previously falling 20% or more the year before. In 6 out of the 8 cases (75%) the Dow actually had a positive return in 1905, 1909, 1919, 1922, 1934 and in 1976 (highlighted in blue). Meanwhile in the other two cases the Dow was only down slightly the next year in 1916 and 1939 (highlighted in red). Thus just because there was a big upside reversal in the market in 2009 doesn't necessarily mean it has to drop significantly in 2010 based on past events. In fact there is a 75% chance the Dow could even end up with a positive return in 2010.

   
 1903 	1904 	1905 
 -23.6 	42.6 	37.8 
 1907 	1908 	1909 
 -37.7 	46.6 	15.0 
 1914 	1915 	1916 
 -30.7 	81.6 	-4.2 
 1917 	1918 	1919 
 -21.7 	10.5 	30.4 
 1920 	1921 	1922 
 -32.9 	12.3 	21.5 
 1932 	1933 	1934 
 -23.1 	66.8 	4.1 
 1937 	1938 	1939 
 -32.8 	28.0 	-3.0 
 1974 	1975 	1976 
 -27.6 	38.3 	17.9 
 2008 	2009 	2010 
 -33.8 	18.8 	?

Meanwhile as I mentioned last week the three time periods that look similar to what has occurred the past few years include the early 1900's, the late 1930's and the mid 1970's. Starting with the early 1900's first the Dow fell 49% from early 1906 through late 1907 which was then followed by an 61% rally in 9 months. This was then followed by a 14% pullback over a 2 month period before another 37% rally occurred through the latter half of 1909 as it got close to reaching its previous high made in early 1906. Overall the Dow gained 89% from the late 1907 low to the peak in late 1909.

Finally also notice that after the Dow peaked in late 1909 this was then followed by a 5 year correction in which the Dow eventually retested its prior 1907 low as it lost 46% of its value.



The next similar period was in the late 1930's as the Dow lost 50% from early 1937 through early 1938 which was then followed by a 63% rally over the next 8 months. After the 63% rally the Dow then went through a 5 month correction in which it lost 24% of its value. This was then followed by a 32% rally over the next 5 months however the Dow was unable to rally above its previous high made in late 1938. Meanwhile after stalling out in the Fall of 1939 the Dow then continued lower through early 1942 as it retested the previous low made in early 1938. Thus from late 1938 through early 1942 the Dow lost 42% of its value over the next 3 1/2 years.



Finally the last period was in the mid 1970's as the Dow lost 47% from early 1973 through late 1974 which was then followed by a 55% rally over a 7 month period. This was then followed by a 12% pullback over a month period before another 31% rally occurred through the middle part of 1976 as the Dow peaked. Thus from late 1974 through the middle part of 1976 the Dow gained 80% as it got close to rallying back to its previous high made in early 1973. Overall this pattern looks similar to the early 1900's.

Meanwhile after peaking in 1976 the Dow then traded in a choppy trading range for the next 7 years and was 25% lower by the middle part of 1982.



However as I pointed out last week when you factor in Inflation the chart above looks a lot worse in terms of real dollars as the Dow was substantially lower by the middle part of 1982 as it was down nearly 57% from the mid 1976 peak.



To sum things up in all three of these time periods the following things occurred with the Dow.

1. The Dow initially gained 55% to 61% over a period of 7 to 9 months after previously dropping from 47% to 50%.
2. After initially gaining 55% to 61% the Dow then went through a 2 to 5 month pullback in which it gave back from 12% to 24%.
3. After the 12% to 24% pullback occurred the Dow then rallied 30% or more during the next 6 to 10 months.
4. The Dow made a higher high in 1909 and 1976 with a positive yearly return while in 1939 it didn't as it had a small negative yearly return.
5. After the Dow peaked in 1909, 1938 and 1976 it ended up substantially lower 3 1/2 to 7 years later with values ranging from -25% to -46%.

Meanwhile if we take a look at the current chart of the Dow it lost 54% of its value from late 2007 through early 2009 which has been followed by a 63% rally over the past 10 months. If the Dow were to follow the previous time periods mentioned above then it's certainly due for at least a 10% to 15% pullback at some point in 2010. Calculating Retracement Levels from the March low to the most recent high a 23.6% Retrace would take the Dow back to around 9613 (9% drop) while a 38.2% Retrace would lead to a level near 9012 (15% drop). Meanwhile a 50% Retrace would come in near 8527 (19% Drop) while a 61.8% Retrace would be around 8040 (24% drop). If the Dow is going to act like 1909 or 1976 and end up with a positive return in 2010 then it probably shouldn't retrace more 23.2% to 38.2% in the coming months which would be a 10% to 15% correction.