Those who forget history are doomed to repeat it. That might not be such a bad thing if recent history on market recoveries is the guide.
On March 22, the
Dow Jones Industrial Average fell 96.5 points, or 1.02%, to 9389.48, its lowest close since March 3, 1999, amid a slowdown in the economy and a slump in corporate profits. The monthlong selloff brought the Dow within 0.09% of bear market territory, defined as a 20% drop from a record close. But as of Tuesday, it was up 17.6% from that day's nadir and 5.8% away from a new summit.
Nasdaq Composite has climbed even higher, surging 33% since its recent low of 1638.8 on April 4. But the Nasdaq has been weighed down in recent days as concerns about earnings visibility and, thus, a recovery among technology companies mount.
The Dow has pulled back a bit this week, too. But a glance in the rearview mirror shows the
blue-chip stock index is accustomed to stark turnarounds and lends credence to the notion that the Dow's rebound is justified.
"Blastoff phases tend to follow significant declines," says John Bollinger, market strategist at
, a Web site that gives investors a way to evaluate stocks on a technical basis. "The last two times we recorded these kinds of gains happened after we hit a low in 1990, and again in 1998."
Back on Oct. 11, 1990, the Dow declined to 2365.1, as the U.S. economy was in a recession, but two months down the road, it was up 9.4%. After six months, it was ahead 26.2%. Fast-forward eight years: Beset by political turbulence in Russia, North Korean weapons testing and the blowup of the
Long Term Capital Management
hedge fund, the index tumbled 512.6 points, or 6.4%, to 7539.1 on Aug. 31, 1998, its third-largest point drop. By February 1999, it had gained 24%. By August 1999, it had surged 44%.
Rewind even further to Black Monday: On Oct. 19, 1987, the DJIA plunged 508 points, or 22.6%, to 1738.74. The crash holds the record for the biggest point and percentage decline ever on the industrial average.
In the months leading up to the '87 crash, the economy was faced with rising inflation, and the
fed funds rate, in order to combat it, stood at 6.75%. The U.S. was bombing Iranian oil platforms, and there was hostility with U.S. trading partners. But just two months after the fact, the blue-chip index had risen 15.4% from its October low.
While historical circumstances vary, the latest moon shot isn't a new phenomenon. Further, the 30-stock index has been range-bound for almost two years now. In May '99, it was within 500 points of 11,000; today, it is a little more than 100 points from that level.
Analysts also point to several explanations for why the recent gains should stick. Chief among them is that we are in an interest-rate cutting environment. On May 15, the
Federal Reserve, citing uncertainty about the business outlook, slashed interest rates to the lowest level since May 1994. It was the central bank's fifth cut this year. According to
Ned Davis Research
, the DJIA rallies, on average, 3.1% in the 22 days after a rate cut. And it advances, on average, 19% in the 252 days following a reduction.
There is even proof the Dow is lagging behind, rather than leading, other market measures and may post greater gains as it catches up. The weekly advance-decline line on the
New York Stock Exchange, which measures the number of Big Board stocks that have advanced and declined over a five-day period, reached an all-time high on May 18. The trend, which shows more stocks rising than falling, is considered a bullish indicator.
S&P 500 Index -- if not weighted by companies'
market capitalization -- also hit its best level that day. And the
Value Line Arithmetic Index
, an equally weighted average of 1,700 companies, touched a record high on May 16.
What's more, the springtime rally has been across the board, not skewed to any sector in particular. Since March 22, of the 30 Dow stocks, 29 are trading up -- the exception being
. Several stocks have notched double-digit gains:
has risen 30.3%,
has climbed 27.1%, and
has advanced 17.6%.
So, why so many skeptics? Among some analysts, there is a consensus that the fundamentals do not support current price levels. "Given where we are in this economic cycle, it does not make sense that we're just off an all-time high," said Larry Rice, chief investment strategist at
, a privately held securities firm in New York. "It's hard to find value in this market."
On an absolute basis, stocks look expensive: The average
price-to-earnings ratio on the Dow is 24.1, above the 15-year median of 20. But when it comes to P/Es, what experts --
Alan Greenspan, for one -- examine is a relative valuation model, which compares the earnings yield on the S&P 500 with the current 10-year Treasury note yield.
Based on the Fed paradigm, if stock yields are greater than bond yields, it indicates that equities are overvalued, and vice versa. The 31-year average earnings-yield-to-Treasury-yield ratio is 1.1, according to Ned Davis Research. At 1.4, as of May 18, the equity market, as represented by the S&P 500, is above the average but far below the levels of late 1999, when it reached as high as 2.2.
Still, some strategists stand by the proposition that the Dow has gotten ahead of itself. "When stocks become popular, they exceed their long-run averages," said Chuck Carlson, contributing editor at
Dow Theory Forecasts
. "When 70% of Dow stocks are trading above their 200-day moving averages, we classify the index in high risk. Right now,
as of May 18 71% of them are above that level."
But money managers are finding reasons, and stocks, to buy. "The rate cuts have been more than sufficient to turn the economy around," said Dick Arvedlund, a manager at
Cypress Capital Management
. Among his group's likes: paper, chemical and steel. "The Dow
which represents about 20% of the approximately $8 trillion market value of all U.S. stocks, according to
is more reflective of the economy than any other index. It will go on to new highs."
The debate continues. "When preannouncement season begins, the Dow will give up gains," said Stanley Nabi, managing director of
Credit Suisse Asset Management
. Nabi expects the DJIA to lose half of the points it has accumulated since late March, due to weakness in earnings. He adds, "History may be enlightening, but it doesn't always repeat itself in an identical manner."