It Could Be Worse

Today’s economic reports, stock market decline and related news stories were all pretty ugly. But they were 1970s ugly rather than 1930s ugly, which is some consolation.

The Dow Jones Industrial Average is down, as of today’s close, 44 percent from its all-time high set a little over a year ago. The decline from the January 1973 high to the December 1974 low was 45 percent. The decline from the September 1929 high to the July 1932 low was almost exactly twice as much, 89 percent. An 89 percent decline from the October 2007 high would put the Dow at about 1558, so today’s much-discussed close slightly below 8000 may not look quite so bad.

Mathematically, stock market movements resemble earthquakes; that is, they’re fractal and scale according to a power law. In oversimplified English, which is the only way I can understand this kind of thing, what that means is that exponentially larger movements occur exponentially less often than small movements. This is why seismologists are unable to tell Californians exactly when “the Big One” will occur but insist that the more time passes without a big one, the more likely it becomes. So same thing with the stock market.

The current bear market is the second since 2000; the decline from the January 2000 high to the October 2002 low amounted to about 38 percent. From the seismological point of view, that might mean that we’re less likely to get a “big one” of near 90 percent, and instead must suffer through a series of less catastrophic but still thoroughly unpleasant medium-sized shocks.

From the standpoint of technical market analysis, 8000 on the Dow isn’t very interesting anyway. The really interesting number is the October 2002 low at about 7286, which we could stretch a bit down to the 7000 level as an idealized 50 percent decline. If that range doesn’t hold, then we’re potentially looking at a decline to 1.) the 5300-5700 area, representing the trading range of a 1996 pause, for a possible 62 percent drop; the 3600-4000 range, which is the level of a somewhat significant sideways move in 1994 and would amount to a roughly 75 percent decline; or the aforementioned near-90 percent decline to the 1500 range. And of course there's always the possibility that the world could come to an end and the Dow would fall to zero, but personally I give that pretty low odds.

Those are, of course, the worst-case scenarios. The most optimistic case would be that the market is “base-building” right around where it is now and will launch a new, multi-year uptrend from here that will replenish all the 401(k) accounts and other investments that have been stripped in the past year. I’d feel a lot more confident about that scenario if it didn’t depend so much on believing that the same people who contributed so much to the current problems - and who are still apparently more interested in self-justification and self-aggrandizement than in doing anything for their society or their world - will somehow suddenly start making all the right decisions.