What to Expect from Here

How quickly will stocks rebound when the current bear market ends (if it hasn’t already done so)? The New York Times’ Paul Lim offers some interesting data on that subject in his most recent column.

Citing data from James B. Stack, editor of the InvesTech Market Analyst newsletter, Lim says that after the nasty bear markets that followed the peak of 2000 and the peak of 1973, stocks took more than seven years to climb back to their previous highs, and after the crash of 1929, it took more than 25 years to do so.

Based on the average recoveries of the past, Lim says the Dow Jones Industrial Average might not make it back to previous highs until 2014 — “and some market observers say it could take significantly longer.”

One top investment mind Lim talked with is Robert D. Arnott, chairman of the investment management firm Research Affiliates. Arnott said investors shouldn’t expect that stocks will be putting up huge returns from here on out as they rebound from the recent plunge. “The folks who are thinking that we could go back to a sustained period of double-digit annual returns for stocks haven’t really studied their history,” he said. Arnott says that in the 90s, when stocks boomed, earnings growth was higher than average, and investors were willing to pay more for each dollar of earnings. But now P/E ratios are back below historic averages. “We have to move people away from the mind-set that anything less than double-digit returns is disappointing,” Arnott said.

Still, Arnott estimates that stocks will return about 8.5% per year, with dividends, over the long term — not too shabby.

Lim also notes that a bad year for stocks doesn’t mean long periods of huge excess returns are to follow. A new study from the London Business School (featured in a Credit Suisse report that offers some very interesting data) shows that, in the five-year periods following the worst years for stocks since 1910, stocks returned an average of 7.1 percentage points per year above the prevailing yield on a three-month Treasury bill; in the five-year periods following the best years since 1910, stocks returned 6.8 points per year above cash.

Nevertheless, there is no doubt that bounce-backs off down periods are often quite strong. Historically, Lim writes, bull markets have made 38% of their gains in the first 12 months after previous bear market lows. (And, I’d note that while it took several years to get back to the pre-bear highs of 1973 and 2000, other bulls reclaimed highs much more quickly. Following the rough bear that ended in 1982, stocks broke back through previous highs in less than three months. And following the bear that ended in 1970, stocks reached new highs in less than two years.)

“Here’s another way to think about it,” Lim writes. “Even if it takes 10 years for the Dow to claw back to its old highs, at an annual rate of nearly 7 percent, ‘you would have still done very well — certainly better than in T-bills,’ Mr. [Elroy] Dimson [one of the London Business School study authors] said. Single-digit stock returns may not seem all that thrilling, compared with the huge numbers posted during the bull market of the ’90s. But for many investors, a stretch of modest returns might be a great relief after the losses of the last few years.”

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