Wall St.’s Pain Worsens and Spreads

Can history tell us when the stock market’s pain will stop?

On Monday, as the blue-chip Standard & Poor’s 500 index officially sank into a bear market and the Nasdaq composite hit its worst-ever decline, investment pros scoured history books for an answer.

Some came away with grim lessons: A look at past bear markets shows that stocks sometimes fell longer and harder than investors thought possible at the time. And once the market finally turned around, in some cases it took years for investors to recoup their losses.

The most discomfiting fact may be that bear markets tend to be the mirror image of the bull markets that preceded them.

“What makes this one very scary is the preceding rise was so fantastic,” at least in the Nasdaq market, said Arnie Kaufman, editor of Standard & Poor’s Outlook newsletter in New York.

Jeremy Grantham, co-founder of Boston-based money management firm Grantham, Mayo and Van Otterloo, has studied a dozen of the deepest declines in the stock, commodity and currency markets. Especially in the equity market, he found that prices, rather than simply falling from an overpriced state to a level that arguably was fair value, often tumbled far lower than that as panicked investors sold out at any cost.

“Every bubble has burst historically,” Grantham said. And “when the bubble breaks, they unfortunately over-correct.”

Many Wall Streeters insist there is no reason to believe that a further drastic fall for most stocks is inevitable. They note that the average bear market since 1950 has seen the S&P; 500 lose 28% from its peak to its bottom. The S&P; already is down 22.7% from its record high a year ago.

Also, some sectors of the market, especially small and mid-size stocks outside the tech sector, have held up relatively well despite the plunge in tech shares.

What’s more, experts note that the economy, so far, remains in much better shape than was the case in the early 1930s or in 1973-74, when the two deepest bear markets occurred.

But each bear market has unique features, making it hard to draw any definitive conclusions from history, experts say.

Bear markets have been triggered by the onset of economic recession, but they also have occurred without recessions. Rising interest rates and national or global political shocks sometimes have caused bear markets.

Some downturns have been short-lived, whereas others have been drawn out.

The 1990 market slide sparked by Iraq’s invasion of Kuwait lasted a mere three months and took just five months to regain its former level, according to David L. Babson & Co. Other relatively short bear markets in the S&P; 500 occurred in 1957, 1961-62 and 1987.

But the 1973-74 bear market, amid a deep recession, was the worst of the modern era. It ground on for an excruciating 21 months and saw the S&P; slump 48%. After it ended, it took more than five years for the S&P; to climb back to its previous peak.

A key question is whether Nasdaq should be viewed as being in its own world or as a harbinger of deeper trouble for the broader market.

There are some parallels between Nasdaq’s collapse and the tumbling of the Dow Jones industrial average in 1929.

Both eras were marked by a “real technology fever,” Grantham said. In the 1920s, investors were smitten with widespread use of electricity and automobiles, the extension of telephone service to the middle class and the emergence of radio.

But, said John Steele Gordon, author of “The Great Game: The Emergence of Wall Street as a World Power, 1653-2000” (Touchstone Books, 2000), there was little thought as to how those innovations would be put to practical use and how companies would profit from them.

“The Internet is an incredibly powerful technology that will undoubtedly change the world,” Gordon said. “But exactly how to make money out of the Internet, nobody has figured out yet.”

Perhaps the biggest difference between the two periods, however, is government’s knowledge of how to handle a troubled market and economy. The Federal Reserve raised interest rates and slapped new tariffs on imported goods in the 1930s, glaring mistakes in hindsight. This time, the Fed is already cutting interest rates.

There are some similarities between today and 1973-74, experts say.

The most obvious is that the early 1970s was the “Nifty Fifty” era, when a handful of blue-chip, brand-name companies were considered to be so strong their stocks were viewed as invincible.

Yet they crumbled with soaring oil prices and rising interest rates in 1973-74--similar to the cascading prices now of tech giants Intel and Cisco Systems.

Still, many experts say the most important element in evaluating the market’s longer-term prospects is the economy. And most agree the U.S. economy is still in solid shape so far, despite this year’s slowdown.

“It’s a stock market event. It’s not an economic event,” Grantham said of Wall Street’s woes.

Investors should hope that there is one key difference between today’s bear market and those of the past: In earlier declines, the price-to-earnings ratio of the S&P; 500 often fell to the low-to-mid-teens before the selling ended.

Even with its drop so far, the S&P; has a P/E of about 21 today. Grantham figures that will fall to about 17 or so by the time the market bottoms. For many stocks, that could mean losses of about 40% from here, he warns.

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S&P; Bear Markets Since 1950

The blue-chip Standard & Poor’s 500 stock index has fallen 22.7% from its peak last March, a bear market’ by Wall Street’s usual definition. Not counting this decline, the index has fallen 20% or more in nine periods since 1950. Here’s a look at the magnitude of those declines, the duration of each decline (measured from the index’s peak to its final low), the number of months it took from the bottom to recoup 100% of the bear-market loss, and the index’s price-to-earnings ratio at each market low.

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No. of mos. No. of mos. from peak to recover P/E at Year(s) Pctg. decline to bottom 100% of loss bottom 1957 20% 3 12 11.5 1961-62 29 6 14 14.5 1966 22 9 6 13.0 1968-70 37 18 22 15.0 1973-74 48 21 64 7.0 1980 22 2 4 6.5 1981-82 22 13 3 8.0 1987 34 2 23 13.0 1990 20 3 5 14.0 Average 28 9 17 11.4

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Source: David L. Babson & Co.