Where is the stock market heading in 2009?

By David Schwartz 11:43 8- Jan -2009

Investors may worry about banks, real estate and other aspects of the economy. But history sings a positive tune. If the past is any guide, prices should advance.

Despite recent stock market strength, many investors are fearful about the year ahead. Words like "dead-cat bounce" and "temporary strength" often appear.

I am quite optimistic about 2009. I believe the bear market of 2007-8 is over and shares will enjoy a whopping rally in 2009. The FTSE 100 will end the year near 5300.

Many forecasts are based upon subjective judgements. My own preference is to stick to solid facts. Here are four facts worth thinking about that will play a roll in 2009.

Fact 1: History teaches that new bull markets typically begin well before economic recoveries become apparent. This trend has run for more than a century.

A thoughtful reader of my columns recently presented me with a complete set of monthly newsletters dating back to the 1920s, sponsored by old-time broker McAnally, Inglis & Littlejohn. These circulars were highly regarded in their time.

The June 1932 issue caught my eye. It was distributed just as a powerful four-year bull market began. The lead paragraph warned of a continued "drift toward economic collapse"

Five months later, with the UK stock market up 23 per cent, the November1932 issue warned of "a return of the gloom which we hoped had been left behind".

Downbeat opinions were also expressed by commentators at the bottom of most other bear markets. The plain vanilla truth is that most investors, including the experts, typically miss the start of new bull markets.

Fact 2: The low point for the 2007-8 bear market was reached on November 24. The FTSE-100 ended the day down 44 per cent from its peak. An intra-day low was touched one month earlier with the index briefly falling 46 per cent below its 2007 high.

Let's put these figures into perspective. There were 18 other bear markets in the last 100 years. Thirteen declined by less than 46 per cent which makes this bear market well above-average in intensity.

There were five more painful declines. Two were in the 50 per cent area, slightly larger than this year's drop. Three others were much more painful. All three were associated with catastrophic events like depression or worries in 1940 that we were losing the war.

I believe the current crisis is not of Great Depression or national survival magnitude. If I am right, recent lows were probably the bottom of the bear market or just a few percentage points shy of a bottom.

Fact 3: Some investors worry that my optimism is misplaced and a re-run of the Great Depression is now underway. Supporters of this view note that shares fell sharply in late-1929 and regained half of that loss in the first few months of 1930. Savage follow-up losses then kicked in for the next two years in lock-step with a deteriorating economy.

I do not think this comparison is valid. Pessimists forget that Herbert Hoover held office until March 1933. His continued support for balanced budgets as well as other economic blunders helped to make a bad economic situation worse.

Fortunately, today's economic guardians learned from errors made in the Great Depression. Governments throughout the world are now taking decisive action. Some have been slow to act but their tardiness can be measured in weeks, not years.

I have little doubt that some of the recent stimulus steps will prove to be ineffective. Even so, a combination of vast sums of money and fast response time will prevent any re-run of the Great Depression.

It goes without saying that today's stimulation is likely to trigger disappointing trading conditions down the road in 2010-12 due to higher inflation and higher taxes. But that is tomorrow's problem. As far as 2009 is concerned, objective historical statistics signal a high likelihood that the bear market has ended, or is very close to its eventual low.

Fact 4: I just completed a special analysis of UK stock market advance once a major decline ends. The results were heartening. History shows that new bull market rallies are typically quite powerful.

There were seven powerful bear market downturns in modern times. Once these downturns ended, prices rose by at least 40 per cent in the next 13 months six times.

The sole exception to the rule was in the aftermath of the 1987 Crash. Shares rose just 15 per cent in the next 13 months. Recall that Tory Chancellor Nigel Lawson raised base rates eight times in the second half of 1988. Rates rose from 7.5 per cent to 13 per cent. Clearly, it takes a great deal of steady effort to hold back a powerful rebound rally after a big bear market ends.

Pulling it all together, I believe the FTSE 100 will end 2009 near 5300, about 40 per cent above its November 2008 low. Some will regard this forecast as quite daring. But history suggests that I am being conservative.

My forecast assumes the current economic slowdown will continue to worsen in the months ahead and real estate prices will also keep declining. But there is one other issue that could throw my projections completely off course. If a major negative surprise occurs, such as a major financial institution failure, all bets are off.