Dorfman: Market Performance after Waterfall Declines – up 24% Over Next 12 Months

Value investment manager and Bloomberg columnist, John Dorfman, provides some historical stock performance statistics after periods of dramatic market declines (or what he calls, “waterfall declines”).

According to Dorfman, “market action during and after ‘waterfall declines’ — sudden drops of 20 percent or more in a few days or weeks — tend to follow a pattern, featuring three phases. First there is the dramatic decline itself, often recession-related. Next there is a basing period of one to three months when the stock market moves sideways. Then there is generally a rally lasting six to 12 months, carrying stocks up 24 percent on average.”

Dorfman thinks we are now seeing the second phase of the downturn known as the basing period. Since the market tends to be a discounting mechanism and bottoms 3-9 months before the end of the recession, Dorfman postulates that the “country’s economic contraction is more likely to bottom out in late 2009”, which puts us in the bottom phase for the market.

Using data from Ned Davis and Bloomberg, Dorfman shows how stocks have performed after 10 waterfall like declines (1929, 1937, 1940, 1946, 1957, 1962, 1970, 1974, 1987 and 2002).

His findings show the following:

  • “Three months after the post-waterfall low, the market was higher in all 10 cases. The average gain was 15 percent.
  • Six months after the low, the market was higher in nine of the 10 cases (flat in 1937). The average gain was 17 percent.
  • Twelve months after the low, the market was higher in nine cases out of 10 (flat in 1929-1930). The average gain in 12 months was 24 percent.”

Dorfman makes it clear that he is not trying to minimize the current state of the world’s economic problems, but echoes a similar view as Warren Buffett in his 2008 annual letter — that is, we’ve seen many crises in the past and the US economy — and stocks — have always gone on to recover, and that, while history may not repeat exactly this time, it will most likely rhyme.

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