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Monday, October 09, 2006

And Now the Hangover

By William Trent, CFA of Stock Market Beat

The celebratory mood triggered by the new closing record for the Dow Industrials quickly gave way to some sobering thoughts. The Wall Street Journal (as summarized by Seeking Alpha) said:

Remember the good old days of 1972? On November 10th, the Dow closed at 995.26, breaking the six-year-plus record of 995.15 from February 1966. Then after peaking at 1051.7 in January 1973, it fell, and took a decade to recover. According to Bollinger Capital Market’s John Bollinger, yesterday’s peak looks all too familiar: “Great bull markets are born from periods of excessively low valuations. All the current cycle has allowed us to do is bring us to just above average valuations.” Plagued by Watergate, inflation, oil woes and recession the 70s turned out to be no picnic. While these days may be better, as the article notes, “It hardly seems like a time for lots of bubbly.”

Well, when you’ve been keeping it on ice for six years you need to drink it sometime. However, Eddy Elfenbein notes that Dow’s cross-town rival the New York Times extended the gloominess back further in time.

The New York Times writes:
Market historians have noted that stocks can take a long time to recover from periods of great excess. The Dow and the S.&. P., for instance, did not return to their 1929 pre-crash peaks until 1954, long after the Depression and World War II ended.

That’s true, but it ignores the effect of dividends–which were quite generous back then–and inflation, which in this case was deflation.

The total return of the stock market in real terms made a new high by 1936, which is surprisingly similar to the period from the March 2000 peak to today. After 1936, the market collapsed again for another five years.So we have two comparisons of extended bear markets during which the markets moved generally sideways. One was inflationary, the other deflationary. One saw a President resign from office, while the other witnessed history’s longest Presidential term in office.

Which all goes to show why we think it is not so much the fundamentals in play, but the effects of long-term P/E cycles.

The author may hold a position in the securities discussed. A current list of the author's holdings is available here.

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