Hope and Waterfalls

John Dorfman offers hope for a stock market recovery in his new Bloomberg column. A few bits:

Market action during and after “waterfall declines” -- sudden drops of 20 percent or more in a few days or weeks -- tend to follow a pattern, featuring three phases. First there is the dramatic decline itself, often recession-related. Next there is a basing period of one to three months when the stock market moves sideways. Then there is generally a rally lasting six to 12 months, carrying stocks up 24 percent on average.

If that happened this year, the Dow Jones Industrial Average would recover to 9,133 and the S&P 500 would bounce back to 955.

Dorfman uses Ned Davis Research to find that we've seen 11 "waterfall" declines since 1929. He believes we're now in the next phase -- finding a base. And he believes this provides a guide for 2009:

Traders say that the stock market likes to go up with as few people onboard as possible. Today, many people have retreated to cash, or to a mixture of cash and bonds. Many of these investors will miss the next rally.

Using data from Ned Davis and Bloomberg, I examined what happened in the market three months, six months and 12 months after the market low in the 10 descents cited earlier.

In seven cases out of 10, it took several days or weeks for the market to hit a final low after the waterfall decline. That bottoming process took 2 1/2 months after the crash of 1987, for example. The same interval applied with the post-Internet bubble bear market of 2000 to 2002. So far, the current basing period -- assuming that I’m right, and we’re in one -- has lasted three months.

More:

Three months after the post-waterfall low, the market was higher in all 10 cases. The average gain was 15 percent.

Six months after the low, the market was higher in nine of the 10 cases (flat in 1937). The average gain was 17 percent.

Twelve months after the low, the market was higher in nine cases out of 10 (flat in 1929-1930). The average gain in 12 months was 24 percent.

You'll want to read the entire piece. While I don't know if Dorfman's hunch will prove true, I do believe this is not to time to dump stocks and move to cash or bonds. It is a good time to make strategic lateral moves, such as my recent move into Microsoft and, before that, Cheung Kong Holdings. (Whether those two specific plays work out only time will tell.)

I'm trying to position the portfolio for the eventual recovery. Whether it comes later this year or the one after that. Or the one after that. Or the one...well, you get the idea.

Comments

[DonR]

This time it's different !!!!

[CONTROLLED GREED.com]

DonR: It might be, but I don't believe anyone knows for certain.