A Bear Market Lurks as Dow Nears 10000

By E.S. BROWNING Rarely has the stock market seen a six-month rally like the one it just turned in. The Dow Jones Industrial Average's 46% surge was one of just six of that magnitude in the last 100 years. And that is exactly what worries many analysts. All previous rallies of this magnitude took place in the 1930s and the 1970s, according to Ned Davis Research. Those were periods of turbulence for both the economy and the markets, and none of the gains was sustained. Many analysts believe that stocks are again in such a turbulent period, and that this rally could lead to another slump. Stocks did enjoy a rally of 40% in 1982, at the start of a long-running period of stock-market prosperity. That rally wasn't of the same magnitude of the others, however. It came as economic troubles, notably inflation, were finally being squeezed out of the economy. "We could end up having another big decline next year," said Tim Hayes, Ned Davis's chief investment strategist, who correctly forecast a rally early this year. "Right now, people are asking me, 'Is it too late to get in?' We are saying, sure, you can get in, but don't fall asleep at the wheel, you have to get out, too. If you are looking to put money in and then not look at it for a year, you are taking a big chance." View Full Image Everett Collection Stock traders on the floor of the New York Stock Exchange in 1936. For now, the year that once looked lost is starting to look like just the opposite, with the Dow up 12% since 2009 began. At 9820.20 Friday, it is closing in on 10000, a sight few anticipated when the Dow hit a 12-year low of 6547.05 on March 9. The current period is similar to the 1970s and the 1930s in the sense that the rally of the past six months came after an even bigger decline. That doesn't mean the future has to play out like the 1930s or the 1970s. As of today, stocks already have gone through a decade of trouble, and some analysts think the worst finally may be over. Even if stocks don't return to their March lows, however, they still could see some sharp ups and downs. Even the Federal Reserve has been warning that the economy remains far from normal, and that more difficulties lie in the future. Economic instability also was the problem in the 1930s and 1970s. The 48% rally of 1929-1930 turned out to be a tragic misfire, leading to an 86% plunge. The rallies in 1932 and 1933 together sent the Dow up to 110.74 in early 1934, from a low of 41.22 in 1932. Stocks then bounced up and down for years, with sharp gains and sharp declines. One problem with these rallies is that they tend to lack follow-through. More than half the gains tend to come in the first six months. The rallies of 1929 and 1932 each lasted less than six months. In 1932, the Dow rose 94% in two months after it hit the low point of the Depression years, but then fell 37%. The 1933 bull market lasted somewhat longer, but there again, if you bought after six months you missed most of the gains, and then saw stocks fall back below the level at which you bought. The stock market decline that preceded the current rally was much less severe than the 89% decline of 1929-32, and few expect stocks to endure as much turmoil as they did during this period. But analysts said the experience of the 1930s remains an indicator of what may be ahead. The bull market that began with a rally in 1974 lasted almost two years, much longer than those of the early 1930s, but it was much less powerful, rising only 76% in all. As in the 1930s, those who waited six months to buy missed most of the gains, and then saw stocks repeatedly run out of steam, not finally bottoming until 1982. Whether the current rally will be like the previous ones, massive early on but with poor follow-through, remains to be seen. But even some who see it continuing into next year worry that it could run out of steam before 2010 is over. View Full Image Getty Images Officials from the NYSE carry securities to banks and brokerage houses in 1937. The end of World War II saw stocks regain their footing. "We kind of envision a 1970s-style massive range-bound market," said Jordan Kotick, head of technical strategy at Barclays Capital in New York. Eventually, this rally will fizzle, as was the case in the 1970s, he said. Like many analysts, he expects a temporary pullback this autumn, but then expects the rally to resume into next year before finally ending. Mr. Kotick said his short-term optimism is based on the fact that world markets are rising in unison, and the U.S. gains are being led by technology, industrial and consumer stocks that feed on the economic recovery. Their strength suggests that the stock gains right now are based on economic fundamentals. Those who want to be optimistic might wish to examine the bull market that began in August 1982. The Dow rose just under 40% in the six-month rally that sparked that bull market, so the rally wasn't quite on a par with the others. But that was the one short-term rally of the last 100 years that did lead to a long-term bullish period for stocks. It marked the end of a 16-year period of market disappointments and the start of an 18-year period of prosperity. Stocks rose with only brief interruption until the crash of 1987. Then the market dusted itself off and resumed its rise, almost without incident, until it began its collapse in 2000. The long-term bull market that ran from 1982 through 2000 was one of the strongest in modern history, and many analysts credit then-Federal Reserve Chairman Paul Volcker's decision to squeeze inflation out of the economy by gradually raising the Fed's benchmark federal-funds rate to 20% in 1981. One reason for skepticism that the current stock market will be analogous to 1982 is that much of the economic adjustment, including the raising of rates by the Fed and the withdrawal of government stimulus, seems to be in the future, not in the past. Some analysts hope that the market's most serious troubles are behind it this time as well. "The March lows were a once-in-a-generation selling climax," from which stocks will gradually move higher, said Richard Ross, global technical strategist at Manhattan brokerage firm Auerbach Grayson. "There is certainly considerable upside left," he said. Write to E.S. Browning at jim.browning@wsj.com