(Part III – Lessons from history).

In Part I this series, we looked at the fundamental factors that were behind the fall of the stock market over the last six months. In Part II we looked at the emotional and human side of the fall and its impact on our participation in the markets. In both the parts, we discussed the time it would take for the fundamental and emotional factors to settle down. In this third and final part, we look at history and past market crashes to see if they have any lessons for us.

Traditionally, a bear phase is one where the market has fallen by 20% or more from its previous high. With this in mind, I have looked at the various times since 1980 when the Sensex (India’s most popular stock market index) has fallen by over 20%. The details are in the table below.

The first column provides the highest value of the Sensex before the bear phase began. The second column gives the date when this high value was achieved. The third column gives the lowest value of the Sensex for that bear phase and the next column the date when this lowest value was achieved. The fifth column gives the date when the previous highest value (before the bear phase) was regained by the Sensex.

The next three columns give the number of months each part of the bear phase took and the last column the percentage fall of the market from that bear phase’s highest to lowest point.

As we can see from the data, the fastest bear phase had a 1-month decent and a 4-month recovery phase with a total of 5 months for it to go from its high point to regaining the high point. This bear phase occurred in 2006 and, in retrospect, was a deep correction of the bull market with no change in underlying fundamentals.

The longest bear phase was associated with the dotcom bust of 2000-01 which has a 19-month decent, then took 36 months (3 years!) to recover its previous highs and a total of 55 months for the Hi to Hi time frame. This bear phase was certainly accompanied by wildly overvalued fundamentals.

The bear phase we are currently in is certainly more than a deep correction and at the same time, one whose fundamentals are NOT close to being as damaged as the dotcom bust.

For the Indian markets, the averages for the decent, recovery and Hi–Hi  phases are 13, 14 and 27 months. If we go by this, then we are looking at the first half of 2010 when the Sensex will go back to its highs. More importantly from the shorter term perspective, we may still have another 6 months, i.e. around Jan – Feb 09 before the current decent phase is over.

In a nutshell, we probably have some more pain left in the system before the worst is over and have 1 ½ to 2 years from now before we see the previous highs. Till this time, we are likely to see some rallies which will give false hope but will inevitably be followed by falls. Astute & experienced traders will be able to profit from these.

For the rest of us, those of us who have the faith, courage and patience to see wealth grow slowly, we will have many good opportunities between now and end of this year to invest long term (> 2 years) funds and god willing, gain a health profit for us by 2010.