The most significant correction for the financial markets since the new bull market began last March has taken place over the last few weeks. Investor sentiment studies have revealed a significant shift from optimism to pessimism during the short period of time, indicating the large declines of 2008 and early 2009 are still fresh in their minds.
Is the new bull market over just 11 months after it started? History would say this is unlikely, as periods of consolidation or corrections of 10 - 15 percent or so are very common after the initial strong up-trends which occur after the previous bear market decline is over.
The most recent example of this is the period from 2003 – 2004 market pattern. Just days after the beginning of the invasion of Iraq to oust Saddam Hussein in March of 2003, the stock market took off in a rally which resulted in a 47 percent rise for the S&P 500 Index in the next 12 months, peaking in March 2004. The stock market then traded essentially sideways for the next eight months before resuming the upward trend of the bull market which lasted until 2007. During this eight-month period, the market sustained a maximum correction of about 9 percent.
Another example I believe applicable because it was a financial crisis with similarities to our recent experience is the time period from 1990 – 1992. The S&P 500 Index rose about 40 percent from October of 1990 to the very end of 1991, then spent first eight months of 1992 moving sideways before further progress was made in 1993. A similar pattern existed at the end of the 1981 – 1982 recession with dramatic gains in 1982 – 1983, then a period of consolidation / correction in 1984, before moving to much higher levels in 1985 – 1987.
So let’s review how the current recovery has unfolded. From mid-March 2009 to mid-January 2010 the S&P 500 Index rose about 70 percent in 10 months. In the last few weeks it has sustained a correction of about 9 percent (so far), certainly something we would consider normal given the dramatic rise in prices in a short period of time.
Based on the patterns identified above which were significant stock market rallies coming out of periods of significant weakness, it appears the current trend is not unusual. Perhaps its magnitude is surprising, but the magnitude of the preceding decline was also surprising (and unpleasant!). I believe it is a reasonable expectation that stock prices may need to rest for a few months to consolidate recent gains and build a base of investor skepticism which may be the launching pad for the next leg up. Note that in the examples cited above the consolidation periods lasted around eight months.
History does not repeat itself in the exact same way each time, but I think some of the historical patterns can be used as “guides” to try to keep us in the middle of the road for decision making purposes. Yes, I know you're saying “But it’s different this time," but that’s exactly what was said in the early 1980s, 1990s and 2000s when those great bull markets continued after a siesta.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.