It's 2009. For many people this could not come soon enough. While we should take away some lessons from 2008 (Don't miss "
How to Evaluate Your Portfolio This Year
"), 2009 will bring its own set of twists, turns and challenges. Here are a few things that I will be looking at closely in 2009.
1. Negative Extrapolation: Avoid It!
There is a tendency in bad times to predict that conditions will worsen. On the flipside, when times are good there is a tendency to predict that conditions will get even better.
Last year saw some of the most outrageous calls of negative extrapolation by many analysts, commentators and professional investors (particularly the trend-trading technicians). This has instilled serious fear among investors. However, as bad as things may appear, 2009 may turn out to be a turning point for the economy and the stock market.
Quick review: The
Dow Jones Industrials Average
closed 2008 down 33.8% -- the worst year for the Dow since 1931.
According to Dow Jones Indexes, the worst performing year for the Dow was 1931, when the index dropped 52.7%. The second worst year was 1907, when it dropped 37.7%. And now, 2008 is the third worst year ever.
Now consider the following.
Excluding 2008, the Dow fell by more than 20% nine times: 1903, 1907, 1917, 1920, 1930, 1931, 1932, 1937 and 1974. Here's how the follow-up years performed: 1904 (+41.72%), 1908 (+46.63%), 1918 (+10.51%), 1921 (+12.72%), 1931 (-52.67%), 1932 (-23.07%), 1933 (+66.69%), 1938 (+28.06%) and 1975 (+38.32%).
At LakeView Asset Management (my firm), I keep
data going back to 1950. Before 2008, the worst year for the S&P 500 was 1974, when the index dropped 29.72%. In fact, other than 2008, the S&P 500 fell by 20% or more only twice since 1950: 1974 and 2002. How did the S&P 500 do after '74 and '02? In 1975 the S&P 500 rose 25.77% and in 2003 the index rose 26.38%.
With the exception of 1931 and 1932, the equity markets experience significant increases the year following a 20% or greater decline. So before you believe the negative extrapolation that is being spread, take a look at these historical data points for some quantitative support and ideas.