Bear Market Rallies: Beware the Siren Call of Volatile Economic Markets.
It is understandable after the record fall of the Dow Jones Industrial Average from a peak of slightly over 14,000 in August of 2007 to a low reached last month of slightly over 8,000 that many are eager to search for a bottom. It is a tempting path to follow especially when the market is down 36% from those highs. There needs to be a cautious attitude about jumping into a market when future news is almost certain to be challenging for the economy. The October jobs report now puts us at an unemployment rate not seen in over a decade and for 2008, we have lost over 1 million jobs.
It is hard to shake off the notion that one should not jump into the market right now with both hands full of cash. Even solid companies have been hit hard and appear to be undervalued. Appear being the operative word here. Yet we need to remember that companies, even the solid in the group are projecting dismal future earnings which will only depress their prices.
In this article we will look at the incredible bear market rallies during the Great Depression and try to offer a cautionary approach for the near term investor. Let us first take a look at a chart from October 1, 1929 to October 1, 1932:
Click for a clearer picture
What you’ll notice that even after the great crash there were epic rallies during this time. Let us recap the above rallies below:
November 1929 - April 1930: +48%
June 1930 - September 1930: +12%
December 1930 - February 1931: +21%
May 1931 - June 1931: +27%
October 1932 - November 1931: +35%
July 1932 - September 1932: +72%
Take a look at the those significant rallies within the Great Depression Dow market. Keep in mind the longer-term trend from the high in September of 1929 (380) to low in July of 1932 (41) represented a 90 percent decline in value. That is why heavy market volatility is a symptom of a market in utter distress and not a healthy signal to purchase. We need only look at the Dow for the last 3 months and we’ll see some disturbing similarities starting to emerge:
In the last few months, we have seen a rally of 11%, 8%, and a whopping 17% in a matter of a few days. These are normally gains that are reserved for one good year on the Dow. Think that isn’t true? Let us look at the Dow performance for this decade:
2000: -6.2%
2001: -7.1%
2002: -16.7%
2003: +25.3%
2004: +3.1%
2005: -0.6%
2006: +16.3%
2007: +6.4%
2008: -32.57% (year to date performance)
That 17% run up we just had in a matter of days is larger than some of the yearly returns. These up and down motions simply reflect a market that is utterly in disarray and trying to find some semblance of a bottom. Those jumping into the market today may have a run like the previous bear market rallies we have just witnessed but make no mistake the longer trend is going lower. Why? A few reasons:
(1) Employment is weak and will continue to be weak. As I discussed in a previous article peak unemployment normally hits 2 years after a recession start date which puts us at peak unemployment in 2010.
(2) Earnings will continue to suffer. The current dividend yield for the Dow remains extremely low at 3.7%. This clearly has the market overvalued for the extent of volatility inherent in it. The average yield of previous bear market bottoms is 6.7% to compensate for the added market risk. The yield hit 16% in 1933 during the bottom of the Great Depression which should give you an idea of where we stand. If this is as bad as then it is quite possible to see yields this high.
However, even if yields were to be at a moderate 6.7% the Dow would need to fall to approximately 5,000 and that is the yield we saw in the early 1980 and early 1990 recessions.
(3) Consumer psychology of diversification. In major bear markets like the one we are currently in, being diversified is actually a poor strategy. The only way to stay safe is to be in cash. Let us take a look at a few investments and see how they have done for the year:
2008: Year to date
Dow: -32.57%
NASDAQ: -37.89%
S & P 500: -36.6%
Gold (ounce): -12.2%
Oil: -37%
Nikkei: -40%
FTSE: -31%
Hang Seng: -48%
We can go on and on but this is simply a reflection of the global nature of this market crisis. The only bright spot incredibly was the United States Dollar:
The U.S. Dollar Index is up 11% for the year. This is primarily because of the massive de-leveraging going on around the world and also the fact that all economies are entering into major recession. There was for a time an idea that many countries would be fine even if the U.S. had internal problems. That is clearly not the case.
Conclusion
As tempting as it may be to jump back in the market, history tells us that there will be more continued market volatility and the likelihood of the market trending lower is very high. Even experts get things horribly wrong. Let us take a look at the now infamous book that was published in 1999 to serve as a sturdy reminder:
If we look at year to date performance of various sectors, it would seem that going with cash is not exactly a bad strategy. It is definitely not recommended to go all in to stocks regardless of what many experts are saying. We had a consumer confidence report that was at 41 year lows. Be careful with that siren call because this is going to be one of the toughest recessions we’ve had in a very long time.
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The October 2008 Job Report: Digging Deeper into the Data. True Unemployment Rate at 11.8%.
Trying to explain the unemployment rate is a challenge since there are many nuances to look out for. For example, today the unemployment rate came out at 6.5%, the highest since March of 1994. That would be troubling in itself. What was also released in the report is a horrible number of 240,000 jobs being lost in October. Probably more surprising is the September employment number was revised to show a 284,000 job loss. What does this amount to? 1.179 million jobs have been lost since the start of 2008. It has been a very challenging year on the jobs front.
In this article we’ll try to breakdown some of the details in the job report since it may be confusing to many. I will also argue that the true unemployment rate is more likely to be near 11.8%.
First let, us take a look at the exponential jump in the unemployment rate:
From this chart it is pretty clear how quickly the employment situation has deteriorated. Much of this has to do with housing and the credit crisis and areas like California housing that are simply having the worst housing decline in recent memory. The above chart doesn’t show the entire picture however. Let us expand the chart out to 1990:
The above chart does a better job showing the current employment situation in perspective. We have the early 90s recession and also the early recession this decade. The troubling thing about unemployment is that the rate doesn’t peak for a few years after a recession has started. Let us take a look at this with data from the Federal Reserve showing recessions:
Recession
Early 1980s recession: July 1981 - November 1982
Recession of the early 1990s: 1990-91
Early 2000s recession: 2001-2003
Peak Unemployment
Early 1980s recession: Peak hit on February 1983 at 10.4%
Recession of the early 1990s: Peak hit on June 1993 at 7.8%
Early 2000s recession: Peak hit on June 2003 at 6.3%
Using the above as a guideline, we get a pretty reliable range of approximately 2 years from when the recession begins, to where peak unemployment is hit. The third quarter GDP was our first official contraction although it was slight. So we can mark the start of the “official” recession on July of 2008. Meaning, we can expect peak unemployment to hit sometime in the summer of 2010 if the last three recessional patterns hold up.
Again, this recession by all estimates will be more painful and more prolonged so it is hard to say if the above will hold true. If we go back to the Great Depression, that contraction lasted a painful 10 years from 1929 to 1939. If you think that was long you should consider the Long Depression of 1873 - 1896. A 23 year contraction.
Let us now look at a chart in the employment report which I believe reflects a better view of the real unemployment rate. A-12 shows various ways of measuring employment. I believe that U-6 in the table is a much better reflection of the country’s employment scene:
Now why is this a better measure. It includes “marginally attached workers” who are people that are looking (or not looking) for work but want to work. You can consider this batch the discouraged worker subset. In addition, the number of part time workers has been growing. So looking at the difference between U-3 which is reported by the median and U-6 we get a large difference. One is 6.5% and the other pushes the number up to 11.8%. That is why it feels much worse than a 6.5% environment. I think most people would agree that someone who wants work but has given up searching should be considered unemployed. Then in this subset, you have those looking for work but not stating why but this may be someone working a few hours at a job but in reality is looking for full-time employment. They too should be considered. The 11.8% number is stunning and incredibly high. Remember at the height of the Great Depression the unemployment rate hit 25%:
The above pattern also holds out for the Great Depression. The actual business contraction cycle peaked in August of 1929 and didn’t hit trough until March of 1933. The market hit a peak in September of 1929 but we are referring more to the business cycle. As you can see from the chart, the peak was hit in 1933 but in reality peak unemployment was essentially reached in 1932 which already was over 20%. So using the above model of 2 to 3 years from the start of the cycle, it also held true back then as well. Depending on the severity, the longevity of the contraction can be drawn out. As you can see from the other charts above, the 2001-03 recession quickly recovered.
As of October of 2008, 10,080,000 people are unemployed from a total 155,038,000 workforce. I wanted to dig deeper into the Great Depression data but of course it is hard to find data during this time. I did however find a 1930 Census report and here are the raw numbers:
Very quickly we can say that the data in this chart was most likely produced in 1929 which would have had the favorable unemployment rate of roughly 5%. But let us take that actual workforce and we can then get a figure of the actual number of unemployed during that time:
1930 Workforce: 48,832,859
1930 unemployed: 2,429,062
5% rate
If we use the 25% peak reached in 1933, we can say that 12,208,214 people were out of work during the Great Depression. That should put that 10,080,000 number in perspective. Keep in mind our employment base is now 3 times as big but just thinking that we have nearly as many people unemployed since the Great Depression is a sobering fact.
So when you dig into the employment report, you will find some fascinating data that goes beyond the actual mainstream number reported. Given the history of past recessions, we can expect the employment situation to deteriorate at least until the summer of 2010.
