The end of the year's first quarter provides us with a timely moment to reflect on the bear market of 2007-08.
Optimists hope we reached the bottom of the bear market on Tuesday morning January 22. Recall that investor panic, triggered by Societe Generale's banking scandal, drove the FTSE-100 down to 5339 shortly after the market opened. This intra-day low was almost 21 per cent below the high point reached last June.
A second sell-off ended on March 20 when the FTSE-100 bottomed out at 5495. Some view this decline as a retest of January's low. The fact that shares failed to penetrate January's low causes them to hope the bear market of 2007-8 is over.
If you accept the bullish case, we are now in a base-building period and are laying the foundation for a new bull market advance.
History provides a much different spin on recent events. Here are several fresh signals warning that this bear market has further to run.
JANUARY TO MARCH SIGNAL
There were 10 occasions in the last century when the UK stock market fell in the first three months of the year by at least 7.5 per cent.
A bear market was running each time.
Nine of those 10 bear markets continued for at least three additional months (to June). Most continued to run much longer than just three additional months.
Unfortunately, the FTSE-100 fell 12 per cent in this year's first quarter. History signals we are still in a bear market and it has longer to run.
FINANCIAL CRISIS
Some commentators claim that a major financial institution failure, like the recent Bear Stearns collapse, often coincides with bear market bottoms.
The facts are a bit different. Think back to the Long Term Capital Management hedge fund collapse in September 1998. Optimists forget there was a further Footsie decline of 10 per cent before the bear market finally ended in October.
The same pattern occurred in the bear market of 1972-4. Several financial institutions went bust during 1974 yet the stock market kept slipping ever-lower.
When viewed from this perspective, forecasting a bear market bottom because of the Bear Stearns collapse is a triumph of hope over fact.
EIGHT PER CENT RULE
It is not common knowledge but the UK stock market always gains at least eight per cent two months into a new bull market. Each of the last 14 new bull runs followed this rule.
The message from the past is painfully clear: At the end of the second month: no eight per cent gain, no bull market.
As far as 2008 is concerned, shares hit their intra-day low point for the year on the morning of January 22, 2008. The FTSE-100 fell to 5339.
As of March 22, exactly two months later, shares gained just three per cent.
Might this time around be an exception to the rule? Of course. But if history is any guide, you are betting on a long-shot.
HOW PAINFUL WILL THIS BEAR MARKET BE?
Last month's column made an important point that is worth repeating. History teaches that long-running bull markets like the one we enjoyed from 2003 to 2007 are typically followed by painful bear markets. It is a trend that has run for a century.
Every single bull market in the last century that ran for more than 600 trading days was followed by a painful bear market in which prices fell by more than 25 per cent.
Unfortunately, the bull market of 2003 to 2007 ran for 1,075 trading days when it peaked last June.
No one knows how painful the current downturn will eventually turn out to be. But history warns us to be alert for a drop of at least 25 per cent. This would be equal to a drop on the FTSE-100 to 5050 … if not lower.
Here's hoping history is wrong this time around.