Saturday, October 11, 2008

Heading towards depression?

A 40 % drop in the Dow Jones Industrial Avg in a year (Oct 09, 2007 to Oct 09, 2008) is not something that happens every 5 years, it doesn't even happen once in 10 years. This has only happened twice before in the last 100 years! The last time the Dow lost more than 40% in a 12 months period was in 1973-1974. Of course, before that the Dow lost almost half its value in the 1932 depression.
So are we heading towards a depression? Here are some reasons I think that the stock markets are a poor indicator of the current state of the economy and that we are in a state of panic and fear rather than depression.
- The world economy is very interlinked now - more than it was in 1974 and definitely more than 1932. Even a slight chance/indication of an economy the size of the US will result in the financial gurus/experts/government officials to do anything and everything in their power to get this behemoth back on track.
- The government now is far more proactive and keen to avert a crisis like that. Far too much is at stake now. They will beg, borrow or steel (from China. UAE, Saudi Arabia and even India) to have some mobility in the financial wheels of this country. The US has knows what it feels to be a super power and to let that power slip from it's hands is unthinkable, unimaginable and frankly, impossible. You might as well say goodbye to the world as you know it if a 1932 like situation is to happen again.

So talks of depression - please.. in fact, there were signs that the stock market was looking to touch the bottom on Friday, Oct 10th. If that were to happen, here is an interesting piece of information/fact/history for you.
Below are the worst and best years of Dow in terms of percentage.

1 1931 -52.67
2 1907 -37.73
3 1930 -33.77
4 1920 -32.90
5 1937 -32.82
6 1914 -30.72
7 1974 -27.57
8 1903 -23.61
9 1932 -23.07
10 1917 -21.71

1 1915 81.66
2 1933 66.69
3 1928 48.22
4 1908 46.64
5 1954 43.96
6 1904 41.74
7 1935 38.53
8 1975 38.32
9 1905 38.20
10 1958 33.96

Do you see a pattern?
After dropping 31%in 1914, it gained 82% in 1915. After dropping 23% in 1932, it gained 67% in 1933, went up 38% in 1975 after dropping 27.60% in 1974 etc. As a matter of fact, we haven't seen a big gain like that since 1975. So the big question is - are we due one this/next year? I am willing to bet this will be the top most thought of traders in the coming weeks/months.
So what can you do? It is a common belief that it is very hard to catch a falling knife - and you can never predict when the knife is going to hit the floor (because you don't know where the floor is) so put is a fixed sum of amount in equities regularly, preferably once every week or 2 weeks. This is also known as dollar cost averaging

1 comment:

Brad said...

There is a good reason the stock markets bounced back on Monday the 13th of October. I could tell you, but I might let you work it out...