V – L – U – What Shape Will The Recovery Be?

lightning-boltThere has been much talk about an economic recovery lately. Without analyzing WHETHER a recovery is even validated, the focus of attention has shifted to the actual shape of a recovery. Rather than getting caught up by wishful thinking, we actually bothered to take a look at the big picture. Sooner or later, the missing link in the above chain of reasoning will become painfully obvious…..

Those who fail to learn from history…

This bear market has often been compared to the 1972-1974, or 1980-1982 bear. The 80’s bear was fairly shallow with a 27% decline in the S&P 500 (NYSEArca: IVV). The 70’s bear did send the S&P 500 tumbling by 48%.  So far, the current bear market has melted the Dow Jones (top to bottom) 55%. This exceeds the 70’s and 80’s bear, and makes them unsuitable for comparison purposes.

The only comparison that still holds is the 1929-1932 bear market, also called the Great Depression. The first leg down reduced the Dow Jones by 48%. Even that was shallower than what we’ve experienced just recently. From 1929 to 1932, the Dow staged five powerful counter trend rallies, ranging from 23% to 48%.

After every counter trend rally, investors were wondering what shape the recovery would take. Yet, there was no recovery. Each counter trend rally was followed by new lows. The bear market was not over until the Dow Jones lost over 89% of its value.

No recovery in sight

The chart below shows a graphic illustration of the different recovery scenarios. Even though ignored by the media, analysts and economist alike, the “lightning bolt” scenario is the one supported by history and internal stock market indicators.

Some misconstrue investors’ elevated risk tolerance as the symbol for a new economic cycle. Perceived lower risk large cap funds, such as the Vanguard Large Cap ETF (NYSEArca: VV) or iShares Russell 1000 ETF (NYSEArca: IWB), have been trailing behind small or mid cap funds, such as the Vanguard Small Cap ETF (NYSEArca: VB) or MidCap SPDRs (NYSEArca: MDY).

Mid and small cap funds fell harder and faster than large cap funds during the decline, so it’s normal to see those compressed segments bounce back higher and faster. The same holds true for the financial and real estate sector, and their corresponding ETFs. Trusting in such make believe signals can easily turn out to be a Trojan horse. There are, however, reliable indicators that shed much needed light on the situation.

Full Story:  http://www.etfguide.com/research/179/8/V-–-L-–-U-–-What-Shape-Will-The-Recovery-Be?/

Leave a Reply

Your email address will not be published. Required fields are marked *