Bull and Bear Market Crashes

09/20/01 03:32:23 PM

by David Penn

Do the market implosion of 1987 and the subsequent rally hold any lessons for investors in the current equity downturn?

Security: $INDU
Position: N/A

In what is understandably an often-desperate effort to understand the latest leg in the bear market, some have looked to the Crash of 1987 for guidance on how to resume buying stocks once again. Looking at historic market conditions--such as those at the beginnings of wars, political crises and other major events--can be helpful in reminding traders and investors what markets CAN do under duress. However, it is essential to remember that different crises will affect different markets in ways that likely have NOT happened before. Each market must be taken on its own terms if it is to be invested in or traded successfully.

The most important difference between the current downturn and the Crash of 1987 is that the 1987 event occurred in the middle of a raging secular bull market from 1982 to 2000. Stock prices had been climbing especially quickly since 1984, when Dow investors finally were able to say goodbye to Dow 1000 and its discontents. By the spring of 1986, the Dow Jones entered what would turn out to be a three-month diamond continuation pattern, from which it broke out at the beginning of 1987. A peak was reached in August and the crash came soon afterward. After holding steady in September, the Dow Jones finished the month of October down from its high by 42%.

With its savage, short-term decline and the slow but steady two-year recovery, the Crash of 1987 may not be the best guide to the autumn declines of 2001.

Graphic provided by: Prophet Finance.

From a long-term perspective, the climb from this trough in October 1987 was difficult, but steady. In fact, a series of alternating up and down months dominated the Dow Jones Industrials almost without variation as stocks began to recover. A down November was followed by an up December. A down January was followed by an up February, and so on until the Dow Jones reached 2280 in the spring of 1989, having retraced about 40% of its previous decline. However, it is hard to believe that investors and traders at the time were heartened by the seesawing Dow, which took an additional two years to finally recoup the losses from the 1987 crash.

Unfortunately, the current market downturn comes as a more broad-based and severe version of the market downturn that may have come this fall anyway. As many have noted, the stock market was in bad shape going into autumn in the first place, with little more than ego and optimism keeping many bad stocks from going "the way of all things." If the stock market has entered, as I suspect it has, a secular bear market, then a resolute rally (such as the one that followed the 1987 crash) seems much less likely.

While the example of the downturn that followed the Japanese attack on Pearl Harbor in December 1941 may be a better comparison to our present circumstance (or even the launching of the German blitzkreig against France), one obvious flaw in this approach is that these incidents came at the end of a secular bear market (1929 to 1942) not at the beginning of one. Stocks in 1942 had already gone through a period during which they (and those who traded them) were widely loathed by the average citizen. The New Deal was in full swing during this period, which helped shift sentiment in favor of government and, to a degree, against businesses. The crises in the airlines industry and in technology notwithstanding, our secular bear market is far too young to have yet engendered the kind of reflexive anti-business (or, at least, anti-stock) attitudes that seem to develop when prolonged bear markets arrive.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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BULL/BEAR MARKET

Bull and Bear Market Crashes

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