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THE DOW JONES INDUSTRIAL AVERAGE'S NEW RALLY HIGH last week is giving at least some investors renewed hope that they may soon be able to recover the losses they incurred during the 2007-2009 bear market.
In fact, if the Dow Jones Industrial Average were to gain as much over the next eight months as it did over the last eight, it would be above the 16,000 level by next June.
Unfortunately, the chances of that happening are quite low, even if you think the bull market still has further to run. That's because a bull market typically produces its greatest gains at its beginning. Its rate of advance thereafter tends to be markedly more subdued.
That at least is the conclusion to emerge from a detailed statistical analysis of 18 previous bull markets back to 1907. The analysis was conducted by Ned Davis Research, the quantitative research firm that caters to institutional investors. The 18 bull markets were chosen because, in the firm's judgment, they took place in financial environments similar to what prevails today.
The firm's findings: These past bull markets lasted an average of just under 17 months, or about one and one-half years. If the bull market that began last March lives up to that norm, therefore, we are at the half-way point of the advance.
That's the good news.
The not-so-good news is that, in the first half of those past bull markets, the Dow produced an average gain of 40.1%. In the second half, in contrast, the Dow's average gain was less than half as much: 17.1%.
During the current bull market, of course, the Dow has modestly beaten this average -- rising about 56% over the last eight months. If the Dow's rate of advance in the next months were lower by the same proportion as the historical average, then we can expect another 24% gain before the bull market is over.
That's nothing to sneeze at, to be sure. But the Dow at the end of such a gain would still be well below its all-time high.
Note, furthermore, that these projections are based on an average. In nine of the 18 bull markets that the firm analyzed, total gains were smaller than what we've already realized over the last eight months. So there's no guarantee that the stock market will be higher at all in eight months' time, much less be 24% higher.
To be sure, the other nine of the 18 bull markets analyzed by Ned Davis Research did better than average. But in only two of them did the Dow do better in the second half than in the first. And in both of those cases, the Dow's first-half return was mediocre.
For all these reasons, it is quite difficult to find support in past bull markets for an expectation that the stock market's pace over the next eight months will be anything like what we've experienced over the last eight.
Ned Davis Research found support for their conclusion from several alternate perspectives as well. One is that the stock market tends to perform better during the four months prior to the end of a recession than in the period thereafter. Since it now appears as though the recession officially ended in June, this historical pattern would suggest that the market's return between the March low and the end of June would be faster than the market's rise thereafter.
This moderation of the advance has already started, by the way: The Dow gained 29% from March 9 through June 30, which is equivalent to an annualized rate of 128%. Since then the Dow has tacked on another 21%, equivalent to 70% annualized.
Finally, it's worth noting that different groups of stocks tend to thrive in the early and later stages of a bull market. In the early stages, for example, the best performers tend to be the riskiest stocks -- those of companies that are most vulnerable to an economic downturn and which therefore gain the most at the first sign that the recession might be coming to an end. And, sure enough, this is precisely what has been the case since March.
As the bull market matures, however, leadership gradually shifts to higher quality blue-chip stocks. So even if you disagree with the notion that the stock market will rise more slowly in coming months than it has since March, you still might want to shift your equity exposure away from more speculative secondary stocks towards higher-quality blue chips.
Mark Hulbert is founder of The Hulbert Financial Digest. He is a senior columnist for MarketWatch.
Comments? E-mail us at online.editors@barrons.com
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