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Plenty of downside for Wall Street correction or crash

with one comment

The graph above compares the current stock market with the period from the Great Crash of 1929. That crash is often blamed on cheap credit and margin trading in the 1920s which offset the impact of the military demobilization after the First World War.

The parallel with the the banking excesses that followed the dot-com crash of 2000 are uncanny. Asset prices from houses to stocks got inflated in value by low interest rates.

Hence comparing 2009 with 1929 is not so unrealistic as the economic conditions that produced the crashes have a strong parallel. The argument runs that therefore the market rally that followed ought to be on the same pattern, and the subsequent meltdown in equity values.

After the rally?

Is this what we see in the graph above? The retracement from the bottom is similar but the length of time taken to reach it about double. What next? The precipitous collapse of the past couple of weeks does look like the start of a major correction, and one that the graph suggests is very overdue.

But look back at the 1929 chart and the remorseless plunge down and down. You have to believe another stimulus package would emerge today. But given the lack of a consensus on Capitol Hill these days it would not be as easy to pass as the first version, and remember where that uncertainty first took markets.

How far to fall?

After a long rally it is easy to project into an ever-rising future, but the sudden fall on the uptrend suggests this is now over, and there is an awfully long way to go down. How fast will the market fall and how low will it go?

It certainly is not hard to imagine a very sharp 10-20 per cent correction. Then a few of the optimists would buy on the dip. That indeed was the pattern of April 1930 to the bottom in 1932, except that the falls continued, more than wiping out the upside of the dips.

Markets do tend to always over-correct, that we know from history. But we also do not know what lies ahead for profits. If the optimistic forecasts are wrong – and a stock market correction would not help financial profits at all, for example – then valuations will be revised downwards, and a gradual, remorseless downtrend is a symptom of this.

With thanks to http://www.bearmarketcomparison.com for this chart. For the state-of-the-art current chart turn to http://www.clivemaund.com below:

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Written by Peter Cooper

January 25, 2010 at 9:44 am

One Response

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  1. Peter,

    Your insights are wonderful and I enjoy your blog. I think you underestimate the governments around the world and their ability to continue to a) manipulate the markets and b) convince the sheeple that everything is OK. This kind of thing can go on for years before the majority figures it out.

    Ed Note: thanks but they do get it wrong from time to time!

    Edna R. Rider

    January 25, 2010 at 6:20 pm


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