Recent market gyrations are quite confusing. Bullish pundits tell us it is a temporary bout of weakness while the bears warn us to put on our seat belts and look out below.
Investors were heartened by a powerful late-June rally. The FTSE-100 added 113 points on Thursday June 29 and another 42 points on Friday. Bulls and bears both agree that an interest rate announcement by America's Federal Reserve (Thursday) and end-of-quarter institutional activity (Friday) played a role in this rally.
But the long-term implication of this healthy bounce remains unclear. Pessimistic bears continue to mutter we are merely enjoying a short-term dead-cat bounce. Optimistic bulls point to healthy economic conditions, vigilant central bankers and robust far-eastern economies.
During periods of uncertainty like now, history can provide investors with a useful perspective. Unfortunately, the message from the past is negative as far as 2006 is concerned.
Some of my recent columns for the London Stock Exchange analysed how the UK stock market typically behaves near the start of a US presidential election cycle and the implications of late-Spring price weakness. Here is fresh historical signal that, once again, has a negative message for today's investor.
In the 30 trading days following May's opening bell, the UK stock market declined by 8-9 per cent depending upon which broad index is used. It was one of the biggest drops at this point in the year since accurate daily price records were first collected more than seven decades ago.
For those who analyse long-term trends, this decline is worrying. The issue is not just the size of the fall, but its longevity. Shares often bounce up and down from week to week. But a stock market that falls down for at least 30 days at this point on the calendar is, in historic terms, a worrying sign.
There were 10 occasions since 1935 when the average British portfolio fell by at least seven per cent in the 30 trading days from the first of May. It is not common knowledge but full-fledged bear market was running in each of those years. We all know there are no guarantees in the world of investing. Even so, if the past is any guide, the key question is no longer whether a bear market is on the horizon. Today's question is how big will it be?
Projecting future declines from 30-day price swings is obviously a dicey undertaking. Surprise announcements about inflation, interest rates and a host of other market-moving issues can easily throw a trend off course. Even so, history provides a provocative clue about the ultimate size of the current down turn.
Nine of the ten bear markets flagged by big declines in May through mid-June eventually reduced the price of the average share by at least 27 per cent. Each decline ran for at least one year. Most ran longer.
The only downturn that didn't fit the pattern was from May to November 1979 when prices fell by "just" 23 per cent. It is worth noting that Margaret Thatcher's May victory in that year had been widely anticipated by investors. Their hopes for the future probably contributed to the sizeable run-up in advance of election day. Viewed from this perspective, some of 1979's mid-year drop was due to profit-taking, not a sudden reversal in the nation's economic prospects.
The bottom line: this year's big decline in May and early-June should be treated like an important yellow-flag warning signal. There are no certainties in the world of investing. But if history is any guide, the bear market of 2006 is already underway and has yet to reach its half-way point. Further declines lie ahead.
To sign up for an email alert when a new Expert Commentator article appears click here.