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Today's Expected Rout

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By mhirschey
January 22, 2008

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One year ago tomorrow, on January 22, 2007, the S&P 500 closed at 1,422.95. On Friday, the S&P 500 closed at 1325.19, or down 9.31% from the year ago level. Based upon the really ugly world-wide "Martin Luther King Day" rout on world markets, it is reasonable to expect the S&P 500 to begin trading tomorrow morning at roughly 1265.10, or down 4.52% from Friday's close and down 11.09% from the year-ago quote. We are in a severe correction that may or may not turn into a bear market.

Since 1950, there have been 14 unique instances when the overall market, as measured by the S&P 500, has suffered a sustained market correction of at least -10% in historical 12 month returns. On average, such corrections in the S&P 500 last 4.25 months and involve a decline of -14.1%. During the subsequent 12 month period, forward-looking investors consistently earn above-average market returns of 14.3% per year. Since 1950, there have only been 5 unique periods when the overall market, as measured by the S&P 500, has suffered a sustained bear market of at least -20% in 12 month returns. On average, these bear markets in the S&P 500 last 3.00 months and involve a decline of -24.7%. During the subsequent 12 month period, forward-looking investors consistently earn above-average market returns of 14.1% per year.

Based upon the historical data, there is perhaps another 5% to go on the downside after Tuesday's expected rout if this is merely a market correction. There is as much as another 10-15% of downside after Tuesday's expected rout, on average, if this is a bear market.
In either case, the data suggest it is still too early to buy the overall market after Tuesday's expected rout. Buyers typically have to wait another couple of months for the best prices, on average. It may not be too early to short vulnerable stocks, but it's getting late.

In my own case, I spent Saturday and Sunday looking hard at cost-efficient ways to short market indices, especially financial stocks. The fact that Tuesday prices will open sharply downward is throwing a wrench into the works, obviously.

Mark