Crashology 101

In the 2000 stock crash, which began to accelerate in fall of that year, the market bottomed in late 2002. That's about two full years, peak to trough. For the 1973 crash, the market began its slide in January and bottomed out in December of 1974. Again, about two years.

Here is a great Wall Street Journal page on stock crashes in general:

http://online.wsj.com/public/resources/documents/info-StockCrash_0710-14.html

Overall, stock crashes in the United States always seem to last about two years, peak to trough, even in the Great Depression. As Warren Buffett described that episode: “During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent.”

By this crude, two-year yardstick, the current market peaked in October of 2007, and we can expect it to recover sometime in late 2009.

Throughout this crash, I have realized why so many smart investors often end up with inferior results. The reason is two-fold: when the market is richly-valued, they accept small or nonexistent discounts in price relative to value. And then they become fearful or unable to purchase deep value securities when the market is in a state of chaos. It seems ridiculously obvious to say this, but we see distinguished investors falling into such traps nearly every day.

We’ve seen many examples of the first reason; there was no shortage of aggressive buyers in the markets for stocks, commercial real estate, and private equity in 2006 and 2007. And now, with investors fearful of macroeconomic disaster, they’re making decisions to do things like pile into gold at a thirty-year high.

As for the stock market, Buffett also wrote:

“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

“You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.”

While I do believe that sharp macroeconomic vicissitudes will continue over the coming years – and, for that matter, throughout our lives – many stocks probably have already bottomed. And, as Buffett says, we will probably see a sharp advance in the market before the economy improves.

When I look over all the potential global-macro trades – commodities, currencies, fixed income, whatever – the best opportunities that I see, in terms of risk and reward, are currently in the stock market.