This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

In my prior post called “The Worst It’s Ever Been?“, I compared the current market environment with three prior market crashes (1929, 1961, and 1987) in the Dow Jones Industrial Average. This was all sparked by a chart that Barry Ritholtz posted on The Big Picture. On the prior post, Bill Rempel left a comment asking “What’s your assessment of the four-year period BEFORE each date?”

Good question! I found a great site called Measuring Worth that has historical closing data for the DJIA going back to 1885(!) among other cool datasets. I was able to take the crash data I plotted yesterday, and append four years worth of data to the front of each set. (One note: I erroneously referred to the y-axis of each chart previously as “% Decline from Peak”, where what I was really showing was “% of Peak Value”. You knew what I meant, though :P )

Here’s the first extended chart, showing % of Peak Value vs. Trading Days. The legend gives the starting year of the dataset:

For a slight adjustment we ratio each time series into equal parts as I did previously:

From this chart, two things are evident to me. First, 1929 and 1987 both had quite a run-up going into the crash, while 1961 and 2007 have a much more moderate advance prior to the peak. These first two seem like bubble bursts in every sense, with a fast, dramatic crash ending a spectacular and ever-accelerating rise. The latter two seem to behave more like secular bear markets, with not a lot to show for 4.5 years of time one way or the other, with rallies and even declines taking quite a bit of time to form.

From this analysis, I would expect our current market environment to behave in future more like a 1961 and less like a ‘29 or ‘87. Any continued decline should be moderate, and I would stick to the 70% of peak number that I referred to earlier as a downside target for the Dow. Further, I would also expect the current market to decline more slowly and steadily rather than over only a couple of days. Now that we know the big weekend sell-off was caused by “Le Societe Genius-ale” and their fall guy (Rogue Trader my @$$), I would lean even harder in the direction of “slow and steady bear market” instead of a true market crash for the future. Caveat: Should more sub-prime, credit-default swap or other financial atom bombs drop, we could be in for more market fireworks. Heck, even The Beard arguably lost his head during the big sell-off as SG liquidated their position! People are jittery, and should they all decide to run for the exits, then all historical bets could be off. Should be fun times ahead in any case!

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

Barry Ritholtz from The Big Picture recently posted a chart of three prior stock market crashes in the S&P compared with our current market environment. There were some comments about the charts not being to any kind of scale to each other. I wanted to analyze a bit more. Of course this is all moot, thanks to the Beard Power unleashed last week, but indulge my study for the pure academia ;)

Unfortunately, being the cheapskate I am, I didn’t have access to free data for the S&P past 1950. So I took historical data for the Dow Jones Industrial Average from Yahoo Finance instead. I tried to isolate the data that was used in the Big Picture post. My charts of the Dow are above the charts Barry posted of the S&P:

Source: Bronson Capital Markets and http://bigpicture.typepad.com/

As you can see, I think I match the time periods in question pretty well. I then plotted them all on the same chart on a basis of percent correction from the peak vs. trading days after the peak:

To non-dimensionalize the time factor, I plotted the data against a ratio of start-to-finish time. For 2007, I assumed that if the current correction is indeed a crash it will follow the 1961 and 1987 time ratios fairly well:

The data from the 1929 crash really went on for a long time compared to the other crashes. When you isolate it to the first trading year after the peak, and ignore the protracted bear market through 1933, you get a more congruent picture:

Still, the data is not similar in that the 1929 data contains a large rally before the ultimate resumption of the killer bear market. I decided to truncate the 1929 data after the first higher low (at 79 trading days or 12/23/1929) as the 1961 and 1987 datasets seem to have been truncated. This would mark the end of the crash and the beginning of a new upward trend phase. The curves then collapse in a very satisfactory way:

Should this time prove to be a true crash, we can expect (according to historical average) to hit around a 70% decline from Dow 14,000 putting us near Dow 9,800. To stay on target for a similar timeframe, it would have to come sometime in the first two weeks of February. We’ll see if it all pans out and my assumptions are correct. It should be an interesting few weeks either way!

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com