What a 22% Rally Means for Your Portfolio

There's talk -- a lot of talk -- about the "R" word. That talk revolves around whether we're already in a recession, about to hit one, nearly halfway through one already, and how deep, wide, mild, severe, mentholated, or decaffeinated this particular one is and/or will be.

The prospect of a recession has a lot of people fearful about a lot of things, including whether now is a good time to sell all their stocks and burrow down with cash under the mattress. If history is any indication, however, right about now could be a good time to invest.

I was recently perusing the latest edition of Jeremy Siegel's classic, Stocks for the Long Run. In it are thorough charts depicting how investments have done over the past 60 years. One chart I found particularly interesting. Over the past six decades, stock prices have bottomed out roughly five months before the bottom point of a recession and risen a little bit more than 22% on average by the time the economy itself reached its nadir.

That's not going to come as a great surprise to many experienced investors. The market has an uncanny knack of anticipating the worst (and best) well before it occurs. The relevant questions now are:

• Have we hit the market bottom?
• Is there any reason to believe that market history would be a useful guideline to what will happen this time?
• Is there any good and logical reason to believe that the economy should take a turn for the better four to six months from the stock market bottom?

1. Have we hit the market bottom? Maybe, since the market is already up 11% since its recent low on March 17. However, declaring that we've hit a market bottom, and that stocks will move up from there (as they must from the bottom), is simply putting the rabbit in the hat. We can't prove that the market has hit bottom, but what we can say is that the current rise, while the economy is quite possibly still declining, is not out of line with history.

2. Is the past a useful guideline? Will stock prices anticipate a turn in the economy again? Another way of asking this question is, "Are things different this time?" Answering "yes" to that question is a good way to get yourself laughed at in stock market discussions. Things are probably not different this time.

3. Is there a good reason to expect an economic recovery starting four to six months after March 17, the most recent low point for the market? Well, sure. You've got all those government incentive checks arriving, and that payout will be completed by mid-July -- exactly four months from the mid-March bottom. Also, for a while, "experts" have been predicting that the second half of the year will be better than the first half. Yes, I did put "experts" in quotes there.

I don't think those checks will radically turn the economy around, but combine all that money arriving into people's accounts with the multitudes who are expecting better things in the second half of the year, and you could reasonably expect July to be the bottom of this economic downturn.

Let's not worry too much about timing, OK?
So a little past history combined with a dollop of current economics could persuade us that the worst may be behind us, market-wise.

But is that reason enough to invest in this market? Let's take a look at what happened with some specific stocks from the last turnaround, the 2001 recession, as measured by Siegel.

Stock prices bottomed on Sept. 21, 2001, shortly after the market had reopened following 9/11. The economy itself, according to the National Bureau of Economic Research, bottomed only two months after the market found its low, in November 2001. Here's how the biggest stocks in the S&P 500 did over that time. (Prices are adjusted for dividends.)

What do you notice? Apple, obviously, skews the total, primarily because at the time it had nowhere near the market cap it does today.

But other than Apple's fantastic returns, the other notable thing is that the bottom of the market decline in 2001 was a decent, but not great, time to be investing in large-cap stocks for the long term. After all, unless you were invested in Apple, you've not even doubled your money over the last 6 1/2 years from the very bottom, the very peak of panic.

And, more important, even those returns apply only to people who held all the way through the real bear market of 2002 -- a difficult task for those who had all their money in stocks. Few people who were overallocated to stocks in 2001 were able to hold on to what they had without selling out at what became much lower prices. And many followed up that mistake by waiting too long past the 2003 bottom to get back into the market.

The Foolish bottom line
What distinguishes today's opportunity from 2001's is that stocks are, as a group, dramatically more attractive on a price/earnings (or any other ratio you'd like to choose) basis than they were back then. But just as was true in 2001, you must diversify your portfolio beyond stocks if you're anywhere near retirement -- or planning one someday. Doing otherwise risks having to sell your stocks at just the wrong time.

That's why at Rule Your Retirement, we look at when you should be adding bonds, REITs, foreign investments, and other investment instruments into a diverse retirement portfolio. Although now does look like a good time to be adding new money to the market -- for both the long and short term -- if you don't have the proper asset allocation, you're not doing yourself any favors.

Feel free to join us at Rule Your Retirement to see how we look at asset allocation and a host of other investing and retirement issues. If you aren't ready to commit, try it free for 30 days.

Bill Barker does not own shares of any company mentioned in this article. Microsoft is an Inside Value recommendation. Johnson & Johnson is an Income Investor pick. Apple is a Stock Advisor choice. The Motley Fool has a disclosure policy.