Monday Morning: Market may mimic Pearl Harbor rebound

Last week’s surge suggests the stock market may be in the process of recovering from the shock of the World Trade Center attacks.

That is undoubtedly a reaction to the efforts of the Federal Reserve Board and the Bush administration to use monetary and fiscal policies to get the economy moving and restore confidence in the capital markets.

Last week, the Fed reduced the fed funds rate to 2.5%, and Congress debated a massive program of tax cuts and spending increases designed to jump-start the economy.

If the market is indeed on its way to recovery, it will be a remarkably quick turnaround. A study by Libertyville, Ill., researcher Crandall Pierce & Co. (crandallpierce.com) shows that the impact of a crisis on the stock market, and presumably the underlying economy, depends on the condition of the stock market at the time of the crisis.

In a bull market, and by inference a strong economy, a crisis has a relatively benign impact on the stock market. In a bear market, a crisis has a far greater and longer-lasting impact.

Crandall Pierce found that when a crisis occurs during a bull market, the initial market reaction of the Dow Jones Industrial Average is to decline for an average of nine calendar days and lose only 4.3% of its value. The market returns to its pre-crisis level in an average of 38 days, and from the date of the crisis, the bull market continues for 27.4 months and gains an average of 44.9%.

Some of the bull market events that Crandall Pierce examined were the Hunt brothers’ silver crisis in 1980, the Asian currency crisis, President Eisenhower’s heart attack, the launch of Sputnik I, the Grenada invasion, the Cuban missile crisis and the assassination of President Kennedy.

Interestingly, the collapse of the metals markets after the Hunts failed in their attempt to corner the silver market had a greater impact on the stock market than any other bull market crisis examined.

The market impact from both the Cuban missile crisis and the Kennedy assassination lasted only one day. In the former case, the bull market continued for 39.6 months and gained a total of 75% from the time of the crisis. In the latter case, the bull market continued for 26.6 more months, and the market gain was 35.8%.

The impact of a crisis during a bear market is much more severe. On average, the market falls for 15 calendar days and loses 9.9% of its value before stabilizing. In addition, in a majority of cases, the market does not return to its pre-crisis level until the following bull market is well established. The bear market continues for another 12.1 months, and the market loses an average of 23.6% after the event.

That is not a pretty picture. The most severe reaction in a bear market environment occurred when Germany occupied France in World War II. That time, the market lost 23.1% in just 15 days. The bear market continued for another 23.6 months, and the market lost 37.3%.

During the 1973 Arab oil embargo, the market declined for 40 days and dropped 20.1% before beginning to recover. However, it did not get back to the pre-crisis level for 13.3 months, by which time the next bull market had begun.

After the Sept. 11 World Trade Center and Pentagon attacks, the market declined for 11 calendar days and dropped 14.3%. While the number of down days was less than the average for a bear market, the amount of the drop was much greater.

That undoubtedly reflects the government’s strong efforts to rebuild confidence and stimulate the economy. Given the magnitude of those efforts, it is possible that the bear market could be short-circuited and end in less than the average of 12.1 months observed by Crandall Pierce and with less than the average 23.3% decline from the crisis event.

The question is, which of the past events does this crisis most resemble? Is it the German occupation of France, which plunged the world into World War II and had a long negative effect on the market despite a huge increase in defense spending?

Or, is it the attack on Pearl Harbor, the effect of which lasted only 4.7 months and produced a 20.3% decline as the country rallied behind the war effort? Only time will tell for sure, but so far it’s looking like Pearl Harbor.

Mike Clowes is the editorial director of InvestmentNews.