dshort.com: Four Bad Bears, Adjusted for Inflation

Four Bad Bears, Adjusted for Inflation
February 3, 2009

Today's WSJ has an excellent article on the topic What Other Financial Crises Tell Us. The authors, Carmen M. Reinhart and Kenneth S. Rogoff, point out that "Equity prices tend to bottom out somewhat more quickly [than housing prices], taking only three and a half years from peak to trough -- dropping an average of 55% in real terms, a mark the S&P has already touched."

Their statistics prompted me to create a real (inflation-adjusted) version of our Four Bad Bears chart. When viewing the chart, you can use the blue links at the top to compare the nominal and real.

As a comparison shows, the higher the rate of inflation during a bear market, the greater the real decline.

The real decline of the Tech Crash was 51.2% versus the nominal 49.1%.
The real decline of the 1973-1974 Bear, during a period of high inflation, was 56.8% versus the nominal 48.2%.
The 1929-1932 real Dow decline appears slightly less severe than the nominal decline (86.2% versus 89.2%) because of price deflation. This is somewhat misleading, since deflation carries an additional set of economic liabilities.

As for today's bear, when I adjust the S&P 500 low of November 20th (a nominal decline of 51.9% using the latest Consumer Price Index), I get a real decline of 52.7%, a bit less than the -55% claimed by Reinhart and Rogoff. Perhaps they were citing an intraday low? The absolute intraday low of the current bear (so far) was 741.02 on November 21st. That adjusts to a real decline of 53.4%. Close, but not quite -55%.

Grim footnote: Reinhart and Rogoff mention a three-and-a-half-year average peak to trough decline in equities for past financial crises. As of today, the market peak of October 9, 2007 was about 16 months ago — which would put us well shy of the half-way mark for the average crisis.