Thursday, October 09, 2008

After Another Dismal Day for Stocks

A glance at a logarithmic graph of the Dow Jones Industrial Average since its inception in 1928 can provide some perspective on recent losses.

The logarithmic scale of the graph linked above is helpful in showing the change in the index as a percentage of its value rather than as units of the index. With that in mind, the present selloff, though certainly sobering, does not look unprecedented.

Actually, much worse for the country was the period from the mid 1960s until the early 1980s when stocks hardly moved at all. Thoughtful folk like SWNID will attribute that prolonged economic stasis to the misguided economic policies of the time, especially to high marginal tax rates that discouraged productive investment and sent money into tax shelters.

With the present selloff, one also observes that since 1999, the market is similarly in prolonged stasis. We attribute that to the prolonged rise in stock values from 1982 to 1999. The market then was overbought and has corrected. Now, we suspect, it is oversold.

In the longer term, the graph shows that the present is hardly like the worst of the past. In fact, its rather like a lot of the past, all of which was followed by better times. Investment bargain hunters will do well in times like these, as will those who use dollar-cost averaging to make steady progress over time.

2 comments:

Aaron Burgess said...

The question for me is whether the past has anything to do with the future. What if we are in uncharted territory and all comparisons to the past have little explanatory power, providing no direction for investors?

Many are saying that our satistical models which are dependent on past events are unable to deal with the multilayered nature of current economics realities.

Nassim Taleb talks about the statistical regress fallacy which is believing that the probability of future events is predictable by examining occurrences of past events.

Jon A. Alfred E. Michael J. Wile E. SWNID said...

The past is largely what we have to go on for the future. And here the focus is not on specific market behaviors but on economic situations over time: that panics, crashes and recessions are followed by periods of growth.

It would be futile to use the past to pick a bottom or predict a specific rally, or lack thereof, to time the market. But it's perfectly reasonable to say that unless human nature changes, production, innovation and exchange will be restored and will move forward.

For the conclusion that this will hold true we rely not just on the past of the markets but on our estimate of the nature of human behavior as often irrational and herd-like but nevertheless adaptable and resourceful over time.

And we'll conjecture that right now the buyers are the people who will end up winning, even if they don't exactly pick the bottom of the market.